Abstract
The recent global crisis which originated in the USA in 2007, and then rapidly spilled over to the rest of the world has had profound implications for economic theory and policy. This chapter delves into the causes of the extent and severity of the crisis. In particular, we try to understand the factors responsible for triggering and perpetuating the crisis in the USA. The latter portion of the chapter is devoted to an evaluation of the policies undertaken by the US Fed and Treasury to control the crisis especially QE (quantitative easing) and fiscal stimuli.
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Notes
- 1.
As a matter of fact, the first recorded banking crisis seems to have occurred in Rome during the reign of the emperor Tiberius in AD 33 (see Frank 1935).
- 2.
- 3.
In India, for example, a long-term fiscal policy outline was announced in December 1985, automatic monetization of the budget deficit via the system of ad hoc Treasury Bills was abandoned in March 1997, monetary targeting was replaced by interest rate targeting around 1997, and the exchange rate regime was progressively liberalized from a pegged system to a managed float over 1992–97.
- 4.
There are several measures used to measure the leverage of a firm. The two measures most in common use are the debt ratio (ratio of total debts to total assets) and the debt-equity ratio (ratio of total debts to total equity).
- 5.
The value-at-risk for a firm’s portfolio is defined as the maximum loss that the firm can expect on that portfolio over a given period with a given probability. Thus, if the value at risk on a portfolio is Rs. 200 million over the next month with a probability of 1%, this would mean that there is a 1% chance that the firm can lose Rs. 200 million on the portfolio over the next month. Usually, the value at risk is stated in terms of confidence levels. Thus, our firm can assert with a 99% confidence level that the maximum loss on its portfolio (over the next month) could be Rs. 200 million.
- 6.
Oil prices since then have been on a steady decline and in July 2016 at $41 per barrel were nearly back to their 1997 levels.
- 7.
On 10 March 2000, NASDAQ reached its peak at 5048, but went into a continuous side thereafter falling to 68% of its peak value on 17 September 2001.
- 8.
Because the GFC originated in the USA, we have focused on the developments there. Developments elsewhere in the world, especially the OECD and EMEs (including India) were broadly similar—any differences being of degree rather than kind.
- 9.
FICO refers to Fair, Isaac & Co.
- 10.
Acronym for “originate-to-distribute” model, as the original mortgages are now removed from the bank’s books and the risk of default is correspondingly shifted from banks to investors in the MBS. Banks favoured the new arrangement as it released valuable capital for them to expand their loan base.
- 11.
Under SIVA (stated income, verified assets) loans proof of income was replaced with a “statement” on faith. NIVA(no income, verified assets) loans replaced proof of employment requirements with a proof of money in borrowers’ bank accounts, whereas “No Income, No Assets” (NINA) or Ninja loans were based only on credit scores, with no proof of any owned assets.
- 12.
Within the ARM there were further options. The interest-only ARM, allowed the homeowner to pay only the interest (not principal) of the mortgage during an initial “teaser” period. Even looser was the payment option ARM loan, in which the homeowner has the option to make monthly payment that does not even cover the interest for the first two or three years of the loan.
- 13.
On a personal note, while pursuing my post-graduate courses more than 40 years ago I used to marvel at the high abstraction levels of mathematical concepts like rings, ideals and conformal mappings. Little did I know that one day these very same concepts would be put to such profitable private, and devastating public, uses!
- 14.
There are several (closely related) definitions of systemic risk and we mention here the two most commonly used. The G-10 (2001) define systemic risk as “the risk that an event will trigger a loss of economic value or confidence in, and attendant increases in uncertainty about, a substantial portion of the financial system that is serious enough to quite probably have adverse effects on the real economy”, whereas the IMF (2009) definition runs somewhat parallel as “a risk of disruption to financial services that is (i) caused by an impairment of all or parts of the financial system and (ii) has the potential to have serious negative consequences for the real economy”.
- 15.
A VaR gives the maximum loss that a bank may have to incur on its portfolio with a specific probability. Thus, a VaR of Rs. 10 million at 1% significance means that the there is a chance of 1%, that the bank may sustain a loss exceeding Rs. 10 million on its portfolio or 99% of the time its loss is guaranteed to remain below that amount.
- 16.
The US stock market peaked in October 2007, when the Dow Jones Industrial Average index exceeded 14,000 points. It then entered a pronounced decline, which accelerated markedly in October 2008.
- 17.
This refusal came after both the Bank of America and Barclays Bank refused to buy out Lehman Bros’ nearly $50 billion of soured real estate mortgages (including an estimated $17 billion of MBS).
- 18.
The Federal Reserve Banks offer three discount window programs to depository institutions: primary credit, secondary credit and seasonal credit, each with its own interest rate. Primary credit refers to very short-term (usually overnight) loans extended to banks and other depository institutions in sound financial condition. This rate is slightly higher than the federal funds rate. Less sound financial institutions are allotted secondary credit from the discount window at rates higher than the primary credit rate. Seasonal credit is extended to relatively small depositories with recurring seasonal fluctuations in funding needs, mainly agricultural credit banks. The discount rate for seasonal credit is an average of selected market rates.
- 19.
All depository institutions that were eligible to borrow under the primary credit program were eligible to participate in TAF auctions. Each TAF auction was for a fixed amount, with the rate determined by the auction process (subject to a minimum bid rate). The TAF was discontinued on March 8, 2010.
- 20.
The TSLF was addressed to provision of liquidity to primary dealers, during periods of heightened collateral market pressure. Under this program, the FRB loaned relatively liquid Treasury Securities for a fee to primary dealers for one month, in exchange for eligible collateral consisting of other, less liquid securities. The TSLF programme was initiated in March 2008 and was discontinued in February 2010.
- 21.
The AMLF provided funding to US depository institutions to finance their purchases of high-quality asset-backed commercial paper (ABCP) from money market mutual funds under certain conditions. The program was intended to foster liquidity in the ABCP market and money markets more generally. The AMLF ran from September 2008 to February 2010.
- 22.
The fiscal multiplier is simply the ratio of the change in output \( \Delta Y\left( t \right) \) in response to a fiscal stimulus \( \Delta B\left( t \right). \) One can distinguish between the impact multiplier \( \left( {\Delta Y\left( t \right)/ \Delta B\left( t \right)} \right) \), the multiplier at horizon k \( \left( {\Delta Y\left( {t + k} \right)/\Delta B\left( t \right)} \right) \), the peak multiplier \( \underbrace {Max}_{0 \le k \le N}\left( {\Delta Y\left( {t + k} \right)/\Delta B\left( t \right)} \right) \) over any horizon N, and the cumulative (total) multiplier at horizon N, \( \left\{ {\frac{{\left[ {\mathop \sum \nolimits_{k = 0}^{N} \Delta Y\left( {t + k} \right)} \right]}}{{\left[ {\mathop \sum \nolimits_{k = 0}^{N} \Delta B\left( {t + k} \right)} \right]}}} \right\} \) (see Spilimbergo et al. 2009).
- 23.
Countries which acquired OECD membership after 2010 (such as Chile, Latvia.) are also excluded.
- 24.
The calculation of these multipliers is based on the 2002 version of the OECD-INTERLINK Model (see Box 3.1 OECD 2009).
- 25.
A substantial part of the US fiscal stimulus (about 13.7% as per the ILO estimates and about 8.9% as per the OECD estimates—see Table 6) was also spent on direct transfers to those households adversely affected by the crisis, and the economically vulnerable. About $48 billion was allotted to the Supplemental Nutrition Assistance Programme (SNAP) which provided assistance to low-income families in the form of food vouchers. On the health front, the stimulus provided for premium reductions for health benefits under the Consolidated Omnibus Budget Reconciliation Act of 1985 ( COBRA), which gave workers, who had lost their health benefits the right to purchase group health coverage.
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Nachane, D.M. (2018). Inception of the Global Crisis in the USA. In: Critique of the New Consensus Macroeconomics and Implications for India. India Studies in Business and Economics. Springer, New Delhi. https://doi.org/10.1007/978-81-322-3920-8_5
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