Financial Levees: Intermediation, External Imbalances, and Banking Crises Mark S. Copelovitch Department of Political Science & La Follette School of Public Affairs University of Wisconsin – Madison [email protected]David Andrew Singer Department of Political Science MIT [email protected]
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Financial Levees: Intermediation, External Imbalances, and Banking Crises
Financial Levees: Intermediation, External Imbalances, and Banking Crises. Mark S. Copelovitch Department of Political Science & La Follette School of Public Affairs University of Wisconsin – Madison [email protected]. David Andrew Singer Department of Political Science MIT [email protected]. - PowerPoint PPT Presentation
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Financial Levees:Intermediation, External Imbalances, and Banking Crises
Mark S. CopelovitchDepartment of Political Science &La Follette School of Public AffairsUniversity of Wisconsin – Madison
• Widely seen as proximate or underlying causes (Reinhart and Reinhart 2008, Bernanke 2009, Reinhart and Rogoff 2009, Caballero 2011, Chinn and Frieden 2011)
• Building on earlier work on crises in Latin America and East Asia (Diaz-Alejandro 1985, Calvo 1998, Kaminsky and Reinhart 1999)
The new conventional wisdom?
• Obstfeld and Rogoff (2009): crises and imbalances “intimately related”
• Bini Smaghi (2008): “two sides of the same coin”
• Portes (2009): “global macroeconomic imbalances are the underlying cause of the crisis”
The Global Imbalance Chorus
Portes (2009)• “Global imbalances…brought low interest rates, the search for yield, and
an excessive volume of financial intermediation, which the system could not handle responsibly”
King (2010)• “The massive flows of capital from the new entrants into western financial
markets pushed down interest rates and encouraged risk-taking on an extraordinary scale”
Reinhart and Reinhart (2008)• “Capital inflow bonanza periods are associated with a higher incidence of
banking, currency, and inflation crises in all but the high income countries.”• “Episodes end, more often than not, with an abrupt reversal or “sudden
stop” a la Calvo (1998)”
Problems With the Imbalances View
Empirical anomalies
• Some countries with large current account deficits escaped the crisis (Australia, New Zealand) while others were hit hardest (US, UK, Greece)
• No “sudden stop” in the US, despite collapse of interbank lending
• 2/3 US capital inflows came from Europe, not large surplus countries
• “Financial crises, driven by excessive loan growth, occurred by and large independent of current account imbalances” (Jorda, Schularick, and Taylor 2011)
– 1981-2007: weak correlation between credit booms and both current account deficits (0.01) and bonanzas (0.11)
– Large credit booms in key surplus countries (China 1997-2000; India 2001-4; Brazil 2003-7; Japan in 1980s; US in 1920s)
SOURCE: Borio and Disyatat 2011; Bureau of Economic Analysis
Global imbalances are destabilizing only under certain circumstances• Unpacking the “current account”
– Savings minus investment: an intertemporal phenomenon– Deficits are especially problematic when returns on investment are uncertain
• Financial sectors with low levels of securitization are resistant to the destabilizing influences of capital inflows
– Securitization exacerbates the mispricing of risk– Disintermediation distorts the assessment of returns on investment
Traditional banking activity acts as a “financial levee”• Caveat: traditional banking does not prevent all crises!
– Bank credit growth is still a key determinant of financial instability
Empirical Analysis – Variables and Model Specifications
• Dependent variable = 1 if country i experiences a banking crisis in year t– All crisis (Reinhart and Rogoff 2008/9): 375 crises (20.1%), 1981-2007– Systemic crises (Laeven and Valencia 2008): 114 crises (2.4%), 1981-2007
• Key independent variable: Level of securitization of the financial sector– Measured two ways:– 1) Regulatory measure of depth/liberalization (Abiad et. al. 2008)
• Has a country taken measures to develop securities markets (0/3)?• Is a country’s equity market open to foreign investors (0/2)?
– 2) Market/bank ratio: stock market volume / bank lending