The Financial Crisis:
A global perspective
(cont’d.)
Net capital flows increased from less than
$200 billion in 1996 to over $1.2 trillion in 2006,
with virtually all of it flowing to high-income
countries with booming mortgage markets
The $1 trillion shift in Current Account Balances from 1996-2006
(shares of global total)
Shares of CAB increases
Shares of CAB decreases
China
21%
OPEC
20%
US
67%
High-income, nonhousing boom countries
37%
Other high-income
housing boom countries
29%
1997-2001 debt-crisis
LDCs
22%
LDCs, excluding OPEC
and debt-crisis countries
4%
Total
100%
Total
100%
At first, inflows to the US helped fuel the dot-com boom, driving the
stock market to an all-time high by the end of 1999.
Inflation-adjusted total return index for the S&P 500, 1871-1999:
Percentage deviation from its upward trend of 6.6% per year since 1871
120.0%
Percentage deviation from trend
104.2%
94.7%
100.0%
89.3%
80.0%
65.7%
60.0%
40.0%
29.4%
20.0%
-4.2%
0.0%
-20.0%
-40.0%
-40.8%
-51.1%
-60.0%
-58.3%
-46.3%
-51.2%
-61.6%
1996
1991
1986
1981
1976
1971
1966
1961
1956
1951
1946
1941
1936
1931
1926
1921
1916
1911
1906
1901
1896
1891
1886
1881
1876
1871
-80.0%
But the dot-com boom ended in 2000. The stock market fell by 50%
over the next 3 years. Investors went looking for other options as the
economy faced the threat of a recession.
Inflation-adjusted total return index for the S&P 500, 1960-2003:
Percentage deviation from its upward trend of 6.6% per year since 1871
120.0%
100.0%
80.0%
60.0%
40.0%
20.0%
0.0%
-20.0%
-40.0%
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
-60.0%
Savers then shifted to safer bonds, driving bond prices up and interest
rates down. The Fed also lowered interest rates to promote a “soft landing”
for the economy. Real mortgage interest rates fell 50%.
Real interest rate on conventional mortgages
6.0
5.0
4.0
3.0
2.0
1.0
0.0
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
With low interest rates and depressed stock
prices, savers were motivated to look
elsewhere in an attempt to earn higher but
still safe returns.
•
•
•
Mortgages, backed by real property as collateral, had
historically been safe assets, with returns that exceeded
government bonds, so savers turned to the housing
market.
And borrowers, attracted by the low interest rates,
borrowed not just for new housing purchases, but also
to refinance existing mortgages and cash in some of
their new housing wealth to pay for increased
consumption.
The rest is our recent history.
The basic economic model of capital migration
was completely reversed during the decade
leading up to the global financial crisis.
Funds that ordinarily would have been used to
finance productive investments in low-income,
capital scarce countries were instead used to
fund residential housing investments and higher
consumption spending in high-income countries.
The same 1999 article that described the
government’s pending homeownership drive
expressed concerns about its long-run effects:
New York Times, Sept. 30, 1999:
In moving, even tentatively, into this new area of lending,
Fannie Mae is taking on significantly more risk, which may
not pose any difficulties during flush economic times. But the
government-subsidized corporation may run into trouble
in an economic downturn, prompting a government
rescue similar to that of the savings and loan industry in
the 1980's.
In his 2005 address, Bernanke mixed of
cautious optimism and concern:
“[A] return to approximate balance may take
some time. Fundamentally, I see no reason why
the whole process should not proceed smoothly.
However, the risk of a disorderly adjustment
in financial markets always exists.”
We all know now that the hard landing is what we ended
up with.
So, where does the giant pool of money
appear to be headed now?
Net capital flows have returned to close to their precrisis level, with a shift back in the direction predicted by
capital migration theory: industrial countries have
accounted for 84% of CA increases and only 18% of CA
decreases.
Shifts in Current Account Balances from 2006-2010
(shares of global total)
Shares of CAB increases
Shares of CAB decreases
High-income housing
boom countries, excl. US
18%
China
16%
OPEC
35%
US
72%
LDCs, excluding OPEC
and debt-crisis countries
24%
High-income, nonhousing boom countries
12%
Debt-crisis LDCs
24%
Total
100%
Total
100%
Inflation-adjusted housing prices have continued to fall, but
they remain above the stable level of the 1990s.
US real house price index (1991 = 100)
150.5
160.0
150.0
140.0
117.9
130.0
108.3
120.0
110.0
100.0
90.0
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
80.0
Stock prices have rebounded since the depths of the
crisis but are still nearly 15% below their past trend.
Inflation-adjusted total return index for the S&P 500, 1960-2003:
Percentage deviation from its upward trend of 6.6% per year since 1871
120.0%
100.0%
80.0%
60.0%
40.0%
20.0%
0.0%
-14.9%
-20.0%
-40.0%
-45.6%
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
-60.0%
Recommendations based on the global
approach to the financial crisis:
US:
1. Reduce the budget deficit (but note that current
account deficits persisted during the budget surpluses of the
1990s).
2. Increase domestics savings (but the huge capital
inflows themselves have depressed savings by pushing
down interest rates and pushing up asset prices).
Emerging markets:
1. Improve governance
2. (Re)open capital markets
Bernanke focused on the LDC part of the
remedy in his 2005 remarks:
[H]elp and encourage developing countries to re-enter
international capital markets in their more natural role as
borrowers, rather than as lenders. For example, developing
countries could improve their investment climates by
continuing to increase macroeconomic stability, strengthen
property rights, reduce corruption, and remove barriers to
the free flow of financial capital. Providing assistance to
developing countries in strengthening their financial
institutions--for example, by improving bank regulation and
supervision and by increasing financial transparency--could
lessen the risk of financial crises and thus increase both the
willingness of those countries to accept capital inflows and
the willingness of foreigners to invest there. Financial
liberalization is a particularly attractive option, as it would
help both to permit capital inflows to find the highest-return
uses and, by easing borrowing constraints, to spur domestic
consumption.
Once poorer countries bring their savings home
and richer countries send theirs abroad,
the US standard of living may fall,
but US manufacturing jobs will come back.
4. The Eurozone crisis
The PIIGS (Portugal, Ireland, Italy,
Greece, and Spain)
= the US of the Eurozone
The giant pool of savings flowed in from 1996-2006.
Current Account Balances, 1996 vs. 2006: The PIIGS and other high-income countries
The PIIGS
Other Eurozone-12
UK and US
1996
6.7
2006
3.2
2.7
1996-2006
-6.0
-4.4
-1.6
-2.4
-6.8
-10.8
-9.4
-9.0
-9.2
-8.0
-6.2
-5.7
-6.0
-12.0
-0.8
-3.9
-3.5
-3.2
-2.6
-3.0
-3.3
-0.6
-0.2
0.0
-11.3
CAB, Percent of GDP
0.7
3.0
4.0
6.0
4.6
6.2
9.0
-15.0
Greece
Ireland
Italy
Portugal
Spain
Germany
Others (avg.)
United
Kingdom
United States
And the giant pool of savings is now flowing out.
Current Account Balances, 2006 vs. 2011: The PIIGS and other high-income countries
The PIIGS
Other Eurozone-12
UK and US
9.0
6.2
4.6
2006-2011
-3.1
-1.9
-3.2
-2.1
-4.0
-3.1
-3.5
-3.0
-2.6
-0.6
-0.4
0.0
-8.3
-6.6
-6.0
-6.0
-12.0
-10.8
-9.4
-9.0
-11.3
CAB, Percent of GDP
0.1
1.3
2.5
2.8
3.6
3.0
3.0
2011
4.1
6.0
5.7
5.5
2006
-15.0
Greece
Ireland
Italy
Portugal
Spain
Germany
Others (avg.)
United
Kingdom
United States
But the US floats, while the PIIGS are trapped in the euro.