Modern Financial Crises: Argentina, United States and Europe

261 Pages·2016·3.86 MB·English

by  Beniamino Moro

Financial and Monetary Policy Studies 42
Beniamino Moro
Victor A. Beker
Modern
Financial
Crises
Argentina, United States and Europe
Financial and Monetary Policy Studies
Volume 42
SeriesEditor
AnsgarBelke,Essen,Germany
More information about this series at
http://www.springer.com/series/5982
Beniamino Moro (cid:129) Victor A. Beker
Modern Financial Crises
Argentina, United States and Europe
BeniaminoMoro VictorA.Beker
DepartmentofEconomics DepartmentofEconomics
andBusiness UniversityofBelgranoandUniversity
UniversityofCagliari ofBuenosAires
Cagliari,Italy BuenosAires,Argentina
ISSN0921-8580 ISSN2197-1889 (electronic)
FinancialandMonetaryPolicyStudies
ISBN978-3-319-20990-6 ISBN978-3-319-20991-3 (eBook)
DOI10.1007/978-3-319-20991-3
LibraryofCongressControlNumber:2015946316
SpringerChamHeidelbergNewYorkDordrechtLondon
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Preface
This book is devoted to the analysis of the three main financial crises which
happened in the present century. The first one was the 2001 Argentina’s default
onitsexternaldebt;thesecondwastheAmericansubprimecrisis;andthethirdwas
the European public debt and banking crisis. In fact, the recent Great Crisis has
extendedovertwoperiods:thefirstonecoveredthe2007–2009subprimecrisisin
theUSA,whilethesecondtooktheformofatwinsovereigndebtandbankingcrisis
inEuropeafter2010andinsomerespectspersistsin2015.
Theseeventshaveledtoincreasinginterestonthesubjectoffinancialcrises,to
which economists had paid almost no attention during the optimistic years of the
so-called Great Moderation, which cover the last two decades of the twentieth
century following the two oil crises that happened in the 1970s. However, as
ReinhartandRogoffexhaustivelyshow,financialcrisesandsovereigndebtdefaults
are far fromstrange eventsineconomichistory, inboth lessdevelopedaswell as
developedcountries.
While in 2003, Padma Desai, from Columbia University, could still assert that
therewasabigdifferenceinthedebtmanagementbetweendevelopedandemerg-
ingcountries,eventsafter2007showthatthisisnolongervalid.Inspiteofbeing
endowed with a sophisticated network of financial institutions and supervisory
regulatory agencies, the US economy was hit by a financial crisis that has much
incommonwithpreviousepisodesinemergingcountries.Thesamehashappened
intheEuropeanUnioninthelastyears.Moreover,thepoliciesbeingundertakenby
crisis-hitcountriesaresimilartothoseArgentinatriedin2001initsdesperateeffort
tosavethepeso-dollarpeg.
Undoubtedly, the financial crisis damaged the reputation of economics. The
institutional changes that made the 2007–2008 crisis possible were inspired by
the mainstream belief based on the self-reliance of utter competition, rationality,
and efficiency; the same origins had the analytical models used to build the
subprimemortgagesecuritizationpyramidthatnearlyblewupthefinancialsystem
intheUSA.
v
vi Preface
Thepurposeofthisbookisthreefold.First,togiveapictureofthreeepisodesof
modern financial crises. Second, to analyze what went wrong with mainstream
economic theory, which noteven took into consideration the possibility ofsuch a
kindofeconomicturmoil.Third,toreviewmacroeconomictheory,byreevaluating
Keynes’s original contribution, on one side, and by taking account of the most
insightful analysis of Neoclassical theory, on the other. We point out the need to
rebuilt macroeconomics with a view on studying economic illness of modern
economies,ratherthantryingtoprovetheirlongruntendencytoequilibrium.
Studyingeconomicpathologiesandhowtocurethemshouldbeencouragedin
bothKeynesianandNeoclassicalschoolsofthought,whilefewerresourcesshould
be devoted to merely showing why an economy is in good health. It is time to
recover the contributions on economic crises by authors like John Kenneth Gal-
braith, Charles Kindleberger, John Maynard Keynes, and Milton Friedman. They
cannotbeignoredbyanyeconomistnowadays.
Thebookisorganizedasfollows.PartI,whichcontainsonlyChap.1,introduces
onthemaincharacteristicsoffinancialcrises.Itisthecombinationofasymmetric
information and illiquidity that gives rise to the possibility of a banking crisis, a
situationwherebyalldepositorswanttheircashback.Asecurities-basedfinancial
systemhasthesameattributesastheclassicbankingbusinessmodel.Inbothcases,
a financial crisis is associated with an increase in demand for liquidity or more
liquidsecurities.Thisputsstrainonthebalancesheetsofthoseintermediarieswho
provideliquidityinfinancialmarkets:theirassetsfallinvalue,includingsovereign
bondsoftroubledcountries,andtheirliabilitiesincreaseinvalue.Torestoretheir
ownfinancialequilibrium,thoseintermediariesselltheirassetsinasituationwhere
buyers are relatively fewer. Securities prices fall further, and this causes “panic,”
the “flight to quality,” the “run,” or whatever one chooses to call it. Short-term
creditdriesup,includingthenormallystraightforwardrepurchaseagreement(“the
run on repo”), interbank lending, and commercial paper markets. This panic is
usuallyfollowedbyaverysharprecession.
PartII,whichcontainsChap.2,isdevotedtotheanalysisofthe2001Argentine
default. A detailed presentation is made of the events which led to Argentina’s
external debt repudiation. In particular, the role of the IMF is pointed out and the
lessonswhichemergefromthisexperienceareemphasized.Infact,itisverydifficult
tounderstandhowArgentina’sexternaldebtlargelyincreasedinthe1990sdespite
justcomingoutfromdefaultwithouttakingintoaccountthatinthe1990sArgentina
wasconsideredthebestpupiloftheIMF,theWorldBank,andtheUSgovernment.
TheIMFplayedakeyroleinrestoringconfidenceinArgentinabycapitalmarkets.
So,itseemstobeclearthataprimaryresponsibilityinthe2001publicsectordebt
crisis was played by the IMF endorsement of an economic scheme which was
doomedtofail.
PartIIIis devoted totheAmerican2007–2009subprime crisis.Itcontainstwo
chapters.Chapter3discussestheAmericansubprimemeltdown.Theroleofbanks
and rating agencies that created and certified as almost risk-free securities assets
that were actually highly risky—as the events after 2007 overwhelmingly
showed—is pointed out. Credit rating agencies played in the American crisis the
Preface vii
same role as the IMF played in the Argentine case: to induce lenders to put their
moneyintobuyingsecuritiesofdoubtfulcollectability.Inparticular,theroleofthe
so-called shadow banking system which emerged during the last 30 years is
highlightedaswellasitsresponsibilityincreatingtheconditionsforapanic.
Chapter4explainsthatthistimethepanicfirstlytookplaceintherepomarket,
which suffered a run when “depositors” required increasing haircuts. Fears of
insolvency reduced interbank lending, and this so-called “run on repo” caused
temporary disruptions in the pricing system of short-term debt markets. The
subsequent crisis reduced the pool of assets considered acceptable as collateral,
resulting in a liquidity shortage. With declining asset values and increasing hair-
cuts, the US banking system was effectively insolvent for the first time since the
GreatDepression.
Part IV is devoted to the European debt crisis. It contains three chapters.
Chapter 5 analyzes how, via the banking system, the financial contagion was
extended from the USA to Europe. In fact, we observe the extension of the Great
CrisisfromtheinternationalbankingsystemtotheEuropeansovereigndebts.The
problemisthattheexpansionaryfiscalpoliciesofdeficitspendingimplementedby
most States to tackle the crisis have created very large public deficits. To save
banks,privatedebtbecamepublicdebt.Atthesametime,withdeterioratingpublic
finances,sovereignriskhasincreasedandworsenedbank’sbalancesheets.Infact,
it is really a sequence of interactions between sovereign problems and banking
problems.Thefullexplanationoftheseinteractionsalsofocusesontheimbalances
of European Monetary Union (EMU) countries balance-of-payments. The
European crisis has shown that it can spread quickly among closely integrated
economies,eitherthroughthetradechannelorthefinancialchannel,orboth.
Chapter6 explainswhy, inthe European crisis, TARGET2 payment system of
EMUcountriesbecamecrucial,reflectingfundingstressinthebankingsystemsof
most crisis-hit countries. In this context, the ECB has assumed a crucial role to
overcome the financial crisis. Anyway, a deep depression followed the financial
turmoil. To promote a full economic recovery in Europe, a strict interconnection
betweensinglecountriesfiscalpoliciesandtheECB’sautonomousmonetarypolicy
is necessary. In this regard, in the medium term, a successful crisis resolution
requiresmorepoliticalintegrationofEMUcountries,whichshouldincludeafiscal
unionandabankingunion.However,intheshortrun,apromptrecoveryisessential
to get out of trouble, and this requires that surplus countries (specially Germany)
expandaggregatedemandandletdomesticwagesandtheensuinginternalinflation
rateincrease.
Chapter7makesadistinctionbetweenafirstgroupofEuropeancountrieswhose
debt problems have roots before 2007, but did not worsen significantly after that
year, and a second one of new highly indebted countries. Among them, Spain
appears as a special case. The development of the indebtedness process in these
three different types ofcountriesallowsisolatingthe factors which weredetermi-
nant in each case. The conclusion is that the European indebtedness process does
not accept a unique explanation and that its solution will necessarily require
resourcetransfersfromtherichertothepoorercountriesoftheEurozone.
viii Preface
PartVisdevotedtotheimpactoftheGreatCrisisoneconomicthought.Italso
contains three chapters. Chapter 8 deals with the theoretical debate on the Great
Crisis,whichcontrastKeynesiantoNeoclassicaleconomists.AccordingtoKeynes-
ians,thecentralcauseoftheprofession’sfailuretoforecasttherecentGreatCrisis
is the abandoning of Keynesian theory, and the prevailing of monetarism and
neoclassical vision that whatever happens in a market economy must be right.
AccordingtoNeoclassicals,instead,economicmodelsdonotjustfailtopredictthe
timingoffinancialcrises,theysaythatwecannot.Keynesianssuggestthatdeficit
spending is the right policy to put the economic system in a full employment
equilibrium path, while Neoclassicals think that fiscal stimulus is only a bad way
to transfer money from taxpayers to inefficient bureaucrats, policymakers, and
zombie firms. Anyway, Keynesians and Neoclassicals share the opinion that we
needamoretighteningregulationoffinancialmarkets.Commercialbanks,whoare
allowed tomanagesystemiccontracts likebankdeposits,andforthatreason they
have access to the lender of last resort, should be kept strictly separated from
investment banks, hedge funds, and other financial speculative institutions, none
ofwhichshouldbeconsideredtoobigtofail.
ThepurposeofChap.9isthreefold.First,itseekstoclarifywhateconomicsis
guiltyof;second,tospelloutwhatsortofscienceeconomicsis,whatislegitimate
toexpectfromitandwhatisnot;and,third,todiscusstheflawsofeconomicsand
howtocorrect them.Itisarguedthatwhathappened withthecrisiswasacaseof
malpracticebyhundredsofprofessionalsinbanksandratingagenciesthatcreated
andcertifiedasvirtuallyrisk-freesecuritiesassetsthatwereactuallyhighlyrisky,as
the events after 2007 overwhelmingly demonstrated. Such a massive case of
malpracticeexposeddeepfailuresintheregulatorysystem.
Chapter10discussestheimpact oftheUSfinancialcrisisoneconomictheory.
Ananalysisismadeoftheresponsibilityofeconomicsandeconomistsinthecrisis
andhowtoredirecteconomicsresearchagendatoaddressrealeconomicproblems
instead of building elegant models with little, if any, relationship with policy and
practical issues. In particular, the predictability capability of standard economic
modelsisdiscussed.Suggestionsineconomictheorizingaremadesoastoprevent
thecrisisfromhappeningagain.Whatthisimpliesformacroeconomicsisempha-
sized. Readers are reminded of the origin of macroeconomics as a branch of
economics; a claim is made to reevaluate Keynes’ original contribution to eco-
nomic analysis and to return to Keynes’ thoughts, which have been ignored or
misstatedduringthepast40years.
Finally,PartVIcontainstwochapters.Chapter11dealswithcurrentissuesand
policies regarding the last updated developments of the three crises dealt with in
thisbook:inArgentina,UnitedStates,andEurope.Argentinarestructureditsdebt
in2005withasignificantreduction,whichwasacceptedby76%ofthecreditors
andresumedpaymenttothem.In2010,aseconddebtswapwasofferedwhichwas
acceptedbyanother17%ofthecreditors.So,only7%ofthebondholdersrejected
thetermsofthedebtexchanges,whichanywayposessomeopenquestions.Inthe
USA,theconsequencesoftheDodd–FrankActareanalyzed,whileintheEMUit
still remains unsolved a near-defaulting situation for Greece. For all the other
Preface ix
EMU’s countries, the recent quantitative easing monetary policy implemented by
the ECB succeeded to calm financial markets and created the right environment
necessarytopromoteanewEuropeaneconomicrecovery.
Chapter 12 concludes with policy recommendations to avoid crises from hap-
pening again as well as on the economic theory research agenda. The role in the
crises of institutions like the IMF, the banking system, and ratings agencies is
underlined as well as the need for reform of the financial system regulatory and
supervisory architecture. Studying economic pathologies and how to cure them
should be the core of the economics research agenda in the coming years, while
fewerresourcesshouldbedevotedtomerelyshowingwhyaneconomyisingood
health.
BuenosAires,Argentina VictorA.Beker
Cagliari,Italy BeniaminoMoro
June2015