Download What kind of a crisis is this?

What kind of a crisis is this?
XXVI Meeting of the Latin American Network of
Central Bankers and Finance Ministers, October 16,17 2007
Michael Dooley Cabezon Capital and UCSC.
Mid July Subprime Hits the Market
• Bill Pool says those who lose on subprime
deserve it.
• Economists are calm but the market sells.
• EM debt spreads jump 50 bp.
• But main problem is in mortgage related
assets.
EMBI spread
Spread between conforming and nonconforming mortgages
Credit Crunch in August
Three month dollar LIBOR
Why Worry?
• Moving risk from banks to ultimate holders
a necessary part of the plumbing of the
system.
• The plumbing has worked on very narrow
spreads.
• When the garbage disposal backs up
dinner is in trouble.
Does size matter?
• Initial estimates of $150 Billion loss
seemed trivial.
• But who has the loss?
• If fraud this obvious gets by the rating
agencies what else is out there?
• Better to mistrust everyone till everyone
marks to market.
What’s new?
• The most directly affected intermediaries
do not have access to the discount
window.
• Banks could act as conduits but they had
their own troubles.
• TED spread still high and a potential
problem.
Direct reduction of the policy rate
needed?
• Market did not know what the Fed,ECB,
BOE would do.
• Moral hazard vs. common sense.
• Common sense won initially in 2 of 3 then
in 3 of 3.
Impact on Emerging Markets
• Was this a serious threat to emerging markets?
• Two aspects: EM was not strongly affected by
the liquidity crisis in August.
• But if liquidity crisis had spread to real activity
EM is still vulnerable.
• Our view is we were very close to a very large
sell off of EM debt and equity.
• Fed 50 – 50 move was all that prevented this.
Stronger Balance Sheets
• Debt GDP ratios and projections look
much better
• Currency mismatches much less of a
problem.
Growth still tied to US
• Export markets for Asia.
• Commodity prices.
Real interest rates still low
• BW II still dominates system.
• Asian savings placed in international
markets depresses real rates.
• Difficult to have a crisis with this support
for asset prices.
• Conclusion August another in a long line of
disasters that didn’t happen.