GLOBAL FINANCIAL CRISIS:
Causes and Consequences
Hyeongwoo Kim
Auburn University
October 30, 2010
Prepared for the 4th KSEA-AL Symposium on Automotive Technology
US Financial CrisisUS Financial Crisis
� The collapse of the
US sub-prime
mortgage market in
2007 triggered a global 2007 triggered a global
financial crisis.
� The failure of Lehman Brothers resulted in a serious
disruption in international financial markets.� Stock prices (level, sd)
� Exchange rates (level, sd)
Global RecessionsGlobal Recessions
� This US financial crisis triggered recessions not only in
the US but also in the rest of the world.Real GDP growth rates ↓ (Fig)� Real GDP growth rates ↓ (Fig)
� Unemployment rates ↑ (Fig)� Still very high in the US (Unemployment durations ↑)
� Inflation rates ↓ (recessions) after initial increases
(expansionary M policies) (Fig)
� Policy makers tried to stop it, but less
successful� Expansionary monetary policies
� Interest rate cuts (short, long)
� Quantitative easing (US)
Policy ResponsesPolicy Responses
� Quantitative easing (US)
� Expansionary fiscal policies� Stimulus checks
� Cash for clunkers
� Government spending vs. tax cuts
� Private sectors did not respond as expected� Consumption (Fig) and Investment (Fig) barely
responded.
� International trade shrank (Fig).
Causes and ConsequencesCauses and Consequences
� The profession seems to agree on that the
crisis was triggered by the collapse of the US
sub-prime mortgage market. Then, natural
questions are,
� Why did it collapse?
� The value of the US sub-prime mortgage market
is tiny (6.7% of total mortgage debt in 2009).
Why did it spread to,
� Other financial industries?
� Other non-financial industries?
� Other countries?
Causes of the CrisisCauses of the Crisis
� Why did it collapse?
� Housing price bubble
� Unsustainable (Fig)
� Bubble is supposed to burst.
� Some blame Greenspan – unclear (Fig)� Some blame Greenspan – unclear (Fig)
� Overall asset bubbles around 2000
(Fig)
� Securitization (financial
innovations, loophole mining)
� Excessive leverage (off-balance
sheet activities)
� Moral hazard (too big to fail)
Other Financial SectorsOther Financial Sectors
� Financial activities are highly intertwined.
� The Glass-Steagall Act (Banking Act of 1933) were repealed,
� Depository Institutions Deregulation and Monetary Control Act of
1980 (Regulation Q)
� The Gramm–Leach–Bliley Act (November 12, 1999; Bank-holding � The Gramm–Leach–Bliley Act (November 12, 1999; Bank-holding
company)
� Virtually no separation of banking from securities industry now
� Update: President Obama signed the Dodd-Frank financial regulation
reform bill (July 21, 2010).
� The collapse of the sub-prime mortgage market quickly
spread to other financial industries.
NonNon--Financial Real SectorsFinancial Real Sectors
� Spill-over effects to non-financial
industries
� Caused by liquidity crunchCaused by liquidity crunch
� Excess reserves ↑ (Fig)
� Money multiplier ↓ (Fig)
� Higher borrowing costs due to high
degree uncertainty
� Risk premium ↑ (Fig)
� Credit default swap ↑
Contagion to Other CountriesContagion to Other Countries
� Financial markets are highly integrated across countries
(Financial channel)
� De-regulation (can be costly, Korea vs. China in 1997)
� Shares of foreign investors
� Mrs. Watanabe (Fig)
� Substantial increases in volumes of international trade
(Real activities channel) (Fig)
� Supposed to be good (comparative advantage)
� May become vulnerable to foreign shocks
� Exchange rate shocks (highly volatile and persistent)
Contagion to Other CountriesContagion to Other Countries
� Highly integrated international economies may imply,
� Higher degree co-movement in 2000s
� Coupling phenomenon
� Static synchronization (Fig)
� Temporary dynamic correlations (Fig)� Temporary dynamic correlations (Fig)
� Severer and more persistent adverse effects of a foreign
shock in 2000s.
� Dynamic synchronization (Fig)
� 1% ↓ in the US stock price � 0.5% and 2% ↓ in German stock
prices in the 1970s and in the 2000s, respectively, in the long-run.
� More Significant adverse effects in the 2000s both quantitatively and
qualitatively
Policy ImplicationsPolicy Implications
� Kim and Kim (2010a,
2010b) studied the recent
US financial crisis and
identified the channels of
contagion in international contagion in international
financial markets.
� Contagion occurred
abruptly and lasted for a
short period of time.
Policy ImplicationsPolicy Implications
� Kim and Kim (2010a,
2010b) studied the recent
US financial crisis and
identified the channels of
contagion in international contagion in international
financial markets.
� Substantial level effect
� Stock prices (level)
� Exchange rates (level)
Policy ImplicationsPolicy Implications
� Kim and Kim (2010a,
2010b) studied the recent
US financial crisis and
identified the channels of
contagion in international contagion in international
financial markets.
� EWS, Currency Swap
Agreements
� Strengthen the roles of
domestic agents in
financial markets
Thank you.Thank you.Thank you.Thank you.
Stock Prices
Stock Returns Volatility
Foreign Exchange Rates
FX Depreciation Rates Volatility
Real GDP Growth Rates
Unemployment Rates
CPI-based Inflation Rates
Overnight Inter-bank Rates
10-Year Government Bond Yields
Real Consumption Growth
Real Investment Growth
Exports-Imports Growth
US Money Growth
Housing Price and Fundamentals
500
600
700
800
900
1000
150
200
250
Po
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Home Prices
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500
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1880 1900 1920 1940 1960 1980 2000 2020
Po
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Year
Home Prices
Building CostsPopulation
Interest Rates
Source: Irrational Exuberance (2nd Edition), Robert J. Shiller
Interest Rates
Commodity Prices
Risk Premium
US Trade Openness
Mrs. Watanabe
Excess Reserves
Money Multiplier
Stock Market Synchronization
BEKK Conditional Correlations
Impulse-Response Analysis