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Causes and Consequences
of the 2008 Crisis
Andrew K. Rose
April 24, 2010
Leading Through Innovation
The “Great Recession” Crisis of 2008:
the Defining Event of the Decade
● Downturn unusual in Many Respects
 Affected Most Countries
 Essentially Simultaneous
 Unusually Deep Recession
 Unusually Long Recession
Financial Crisis has lead to Policy Challenges
● Most Dramatic: Policy Reform, including:
 New Capital Requirements (“macro-prudential”)
 Dissolution of Institutions “too big to fail”
 New Regulatory Reforms
 Organization of Derivatives
 Limits on Executive Compensation/Bonuses
 Development of Early Warning Systems
But What do We Know about
Actual Causes of the Crisis?
● The Crisis hit all rich countries, many developing
 But not all countries affected equally
 East Asia and (especially) Central Europe affected
particularly severely
● Can we learn about causes of crisis from varying
intensity across countries?
● Relevant because policy prescriptions depend on
crisis diagnosis
Can Investigate by Economic Modeling
● Many manifestations of crisis are easily measurable
across countries and time
● Similarly, many potential causes of the crisis can be
quantified
● Can compare cross-country incidence of crisis to its
cross-country manifestations
Interpreting this International “Cross-Section”
For 2008 crisis we know lots of information
inadmissible to actual policy makers:
1.
2.
3.
4.
There was a crisis (many false signals in reality)
The timing of the crisis (ditto)
The countries involved
Crisis involved banks, security markets, (at least
some) housing markets, and (at least some)
exchange rates
 IMF: each of these is different
• Mix probably not comparable/predictable from
history!
Use Data for a Large Number of Countries
● Sample is cross-section of 107 countries
 All countries >$10,000 per capita GDP
 All countries >$4,000 per capita GDP, plus
population > 1 million
● Separate dates
 Data on Crisis Manifestations from 2008
 Data on Crisis Causes from 2006 or earlier
Critical Crisis Manifestations: Straightforward
● Numerous Indicators of 2008 Crisis
● Real: Economic Growth (2008 GDP growth)
● Financial Markets:
 Stocks: use 2008 equity market collapse
 FX: use 2008 exchange rate devaluation
 Bonds: use 2008 change in Institutional Investor
creditworthiness
• Also use Euromoney as robustness check
Crisis Manifestations
Bottom quartile
Upper quartile
% Changes,
2008:
Iceland
Ukraine
Estonia
Argentina
Latvia
Ireland
Korea
New Zealand
UK
Hungary
Luxembourg
Denmark
Singapore
Swaziland
Finland
Japan
France
Netherlands
Thailand
Poland
Real GDP
II Rating
-4.7
2.1
-2.8
6
-4.6
-2.8
2.6
-.9
.7
.4
.6
-.9
1.2
2.7
1.4
-.5
.7
2
3
4.8
-32.5
-12.1
-9.4
-13.6
-8.3
-7.8
-7.3
-5.4
-5.5
-7.6
-2.6
-2.6
-3.8
-2.6
-2.6
-5.7
-2.6
-2.5
-3.5
-1.5
Stock
Market
-90.0
-74.3
-63.0
-49.8
-55.1
-66.1
-40.7
-37.4
-31.5
-53.2
-59.5
-48.6
-48.9
3.9
-53.4
-42.1
-42.7
-52.3
-47.6
-51.1
Price of
SDR
90.0
48.6
1.7
6.9
-.3
3.1
30.9
30.4
33.9
6.1
3.1
1.5
-2.7
33.2
3.1
-22.4
3.1
3.1
1.3
18.6
Potential Crisis Causes: Problematic
● Considerable disagreement concerning underlying
causes of 2008 Crisis
Potential Causes 1: Financial Policies
• Crisis widely perceived as demonstrating regulatory
flaws, e.g. Bernanke (2009)
– Improper incentives within institutions
• Basel capital requirements
– Contributed to lending pro-cyclicality
– Codified role for rating agencies
– Encouraged opaqueness through securitization
and moving assets off balance sheets
Many Measures of Financial Policies
• Economic Freedom of the World data base
– Private Bank Ownership
– Foreign Bank Competition
– Interest Rate Controls
– Quality of Credit Market Regulation
• World Bank Central Bank data set
– Overall Capital Stringency
– Ability to Take Prompt Corrective Action
– Capital Regulatory Index
– Official Supervisory Power
– Restructuring Power
– Power to Declare Insolvency
Potential Causes 2: Financial Conditions
● Degree of maturity mismatch, due to short-term debt
obligations, e.g. Cecchetti (2008)
● Risky lending practices
 Feldstein (2009): Appraised value of US mortgage
contracts grew from 70-80 % to 90-100 %
 Community Reinvestment Act encouraged lending
to broader set of borrowers
● Exploding leverage of firms and households
Measures
●
●
●
●
●
●
●
Private Sector Domestic Credit as share of GDP
Domestic Bank Credit as share of GDP
Share of domestic credit consumed by Private Sector
Bank Liquid Reserves as a share of assets
Share of Non-Performing Loans
Bank Capital as a share of assets
Bank Claims as a share of deposits
Potential Causes 3: Asset Price Appreciation
• Widely cited as a source of fragility, in US and
elsewhere, e.g. Feldstein (2009)
• Buiter (2009): Investment diverted to real estate from
“productive uses”
• US mortgage delinquencies highest in areas that
experienced highest amount of appreciation
• U.S. areas with high latent housing demand had
highest decreases in denials
– Sub-prime lending fed appreciation
• Real estate appreciation mirrored in other financial
markets, particularly equity markets
Measures
● Real estate
 Percentage Change in Real Estate Prices
• Based on data from the BIS and augmented by
an Asia-specific study by Glindro, et al (2008).
● Equity market appreciation
 Market Capitalization as a share of GDP
 Value of Stocks Traded relative to GDP
 Stock Market Growth.
Potential Causes 4: International Imbalances
• Many countries built up deficit international financial
positions over boom
• Arguments over source of “global imbalances”
– Asian and other country efforts to build up foreign
exchange reserves
– Lax policies in West?
• Countries with high CA deficits had larger exchange
rate depreciations
– High exposure to U.S. also led to depreciation
Measures
• Measures of the external balance position
– Net External Position as % of GDP
– Current Account as % of GDP
– External Debt as % of GNI
– Gross Financing in Capital Markets as % of GDP
– Real Effective Exchange Rate
• Measures of adequacy of foreign reserve holdings
– Total Reserves as % of external debt
– Short-Term Debt as % of Reserves
– Total Reserves over value of a Month of Imports
– M2 as % of Total Reserves minus Gold
– M2 as % of Central Bank Foreign Assets
Potential Causes 5: Macroeconomic Policies
● Easy monetary policy
 Taylor-rule indicated Fed Funds rate below levels
consistent with 2% inf. target 2003-2006
 “Greenspan put” exacerbated asset appreciation
● Lax fiscal policy
 Countries pursued unsustainable deficits
 Poor fiscal positions hindered counter-cyclical
policies during crisis
Fiscal and Macro Measures
• Fiscal policy
– Government Budget Surplus/Deficit as % of GDP
– Central Government Debt as % of GDP
– Total Debt as % of GDP
– Debt Service Burden as % of GDP.
• Macro conditions
– CPI inflation
– GDP growth
Monetary Measures
• Monetary policy
– Currency Union dummy
– Aggregate GDP of Monetary Zone
– EU, but not EMU dummy
– Inflation Targeter
– M2 as % of GDP
– M3 as % of GDP
Potential Causes 6: Contagion
● Exposure to “Center” Country (US?) can hurt
● “Trade Channel”
 Downturn in US hurts foreign exports
● “Financial Channel”
 Deterioration of US assets (mortgages?) hurts
foreigners that hold American assets
Measures
● Exports to USA (as proportion of all exports)
 Also consider other epi-centers
 Also consider 2-way trade (not just exports)
● Share of US assets (proportion of wealth)
 Also consider other potential epi-centers
 Also consider debt, long-term debt
 Also consider BIS Consolidated banking data
 Even more (only for American exposure): US TIC
assets (as proportion of national GDP)
• Also consider American equity/long
debt/debt/treasuries/long treasuries
 Also consider $PPG debt denominated in yen/$
Results
● Strong Result: Richer Countries more dramatically
affected by crisis
 No effect of country size (population)
Richer Countries Hit Worse:
Combined Crisis Manifestations and real GDP p/c
2
2
Papua Ne
Kyrgyz R
0
Qatar
Slovakia
Peru
Barbados
Libya
El Colombia
Salva
Oman
Panama
Trinidad
Costa
Venezuel
Bahamas
Morocco
Egypt
IranRi
Lebanon
China
Tunisia
Bahrain
Saudi
Ar
Kuwait
Sri Lank
Mauritiu
Israel
Brazil
Slovenia
Indonesi
Macedoni
Switzerl
Malaysia
Cyprus
Ecuador
Botswana
Malta
Taiwan
Chile
Czech
Re
Jamaica
Hong
Kon
Germany,
United
A
Poland
Netherla
France
Japan
Swazilan
Finland
Singapor
Denmark
Namibia Thailand
CroatiaPortugalSpain
Belgium
United
S Luxembou
Mexico
Greece
Canada
Romania
Austria
Norway
Italy
Sweden
Bulgaria
South
Turkey
AfRussia
Australi
Lithuani
Kazakhst
Hungary
UK
New
Zeal
Korea
Ireland
Latvia
Argentin
Estonia
0
Ukraine
-2
-2
-4
Iceland
-6
-4
7
9
11
7
Default
9
11
Euromoney, not II
2
0
0
-5
-2
-4
-10
7
9
Drop Exchange Rate
11
7
9
Maximum Likelihood, not PF
Factors (y) against log real GDP per capita (x)
11
Unfortunately, no Strong Consistent Crisis Causes
• Few potential causes are robustly significant across
countries
• In particular, real estate appreciation cause
insignificant
– Widely cited as a principal “cause of crisis” in US
• Same is true for almost all other causal variables
Absence of Correlations: Robust
2008 Crisis Manifestations against Capital Regulatory Index
Depreciation against SDR
-50
-100
0
-50
50
0
100
Stock Market Change
2
4
6
8
2
6
8
GDP Growth Rate
-5
-30
5
-10
15
10
Country Credit Rating Change
4
2
4
6
8
2
4
6
Barth, Caprio and Levine 2003 Capital Regulatory Index
8
Stock Market Run-up Does Best
2008 Crisis Manifestations against Stock Market Runup
Depreciation against SDR
-50
-100
0
-50
50
0
100
Stock Market Change
0
200
400
600
0
400
600
GDP Growth Rate
-5
-30
5
-10
15
10
Country Credit Rating Change
200
0
200
400
600
0
200
2003-06 Change in Market Capital (%GDP), WDI
400
600
Domestic Credit Growth Insignificant
2008 Crisis Manifestations against Domestic Credit Growth
Depreciation against SDR
-50
-100
0
-50
50
0
100
Stock Market Change
-100
0
100
200
300
-100
100
200
300
GDP Growth Rate
-5
-30
5
-10
15
10
Country Credit Rating Change
0
-100
0
100
200
300
-100
0
100
2006 Domestic Bank Credit (%GDP), WDI
200
300
Bank Claim/Deposits
2008 Crisis Manifestations against Bank Claim/Deposit Ratio
Depreciation against SDR
-50
-100
0
-50
50
0
100
Stock Market Change
0
1
2
3
4
0
2
3
4
GDP Growth Rate
-5
-30
5
-10
15
10
Country Credit Rating Change
1
0
1
2
3
4
0
1
2006 Bank Claims (%Deposits), IFS
2
3
4
Real Estate Appreciation Insignificant
2008 Crisis Manifestations against Real Estate Price Runup
Depreciation against SDR
-50
-100
0
-50
50
0
100
Stock Market Change
0
50
100
150
0
100
150
GDP Growth Rate
-5
-30
5
-10
15
10
Country Credit Rating Change
50
0
50
100
150
0
50
2003-06 Change in Real Real Estate Prices
100
150
Bank Leverage Insignificant
2008 Crisis Manifestations against Bank Capital Adequacy
Depreciation against SDR
-50
-100
0
-50
50
0
100
Stock Market Change
5
10
15
20
25
5
15
20
25
GDP Growth Rate
-5
-30
5
-10
15
10
Country Credit Rating Change
10
5
10
15
20
25
5
10
2006 Bank Capital (%Assets), WDI
15
20
25
Current Account
2008 Crisis Manifestations against Current Account
Depreciation against SDR
-50
-100
0
-50
50
0
100
Stock Market Change
-40
-20
0
20
40
60
-40
0
20
40
60
GDP Growth Rate
-5
-30
5
-10
15
10
Country Credit Rating Change
-20
-40
-20
0
20
40
60
-40
-20
0
2006 Current Account (%GDP), WDI
20
40
60
Budget Deficits
2008 Crisis Manifestations against Government Budget
Depreciation against SDR
-50
-100
0
-50
50
0
100
Stock Market Change
-10
0
10
20
-10
10
20
GDP Growth Rate
-5
-30
5
-10
15
10
Country Credit Rating Change
0
-10
0
10
20
-10
0
2006 Budget Surplus/Deficit (%GDP), WDI
10
20
Results suggest that Measurable Pre-existing
Conditions had Little Common Impact
• Few potential causes have robust effects on crisis
intensity
• That is, can’t easily align causes and consequences
of 2008 crisis across countries
Results Disappointing for Policy Reform/Modelers
● Can model incidence of crisis well, but not link it to
observable causes
● Not an artifact of econometric methodology
 Scatter plots yield similar results
● Disappointing, given voluminous analysis of causes
of observed crisis
● Ex ante for future crises: much harder!
 Even then, we’re ignoring the problem of timing
Why are Results so Weak?
• Data limitations
– Will it improve as crisis recedes?
• Focus mostly on national characteristics
– Inappropriate if crisis international due to
contagion or common shock – but few sensible
signs of contagion when included (American
exposure helps!)
– Vulnerability to common shocks typically viewed
as dependent on national fundamentals
• Causes may differ across countries
– Japan: little financial exposure, but trade downturn
So Caution is Warranted
● Economists should be Humble
● Difficult to engage in Policy Reform if Crisis Causes
are uncertain
● Much motivation for ongoing research