Financial Crisis summary

A nice summary banking crisis in history via New N Economics:

Out of 42 systematic banking crises across 37 countries, despite the implementation of a wide range of policies, all resulted in the re-allocation of wealth away from taxpayers and towards debtors (banks). None avoided recessions and all recessions were severe.
There are always three phases in financial crisis:
(1) Initial Condition - macroeconomic conditions are usually weak before a banking crisis.
· fiscal balances are usually negative (-2.1% of GDP on average);
· current accounts are usually negative (-3.9% on average);
· inflation is high (137% on average);
· GDP growth is average (2.4% on average);
· non-performing loans tend to be high (25% of total loans on average).

In this case of U.S. financial crisis:
· In 2007, annual fiscal balances as a % of GDP were negative in the U.K. (-0.29%) and the U.S. (-1.36%)
· current account as a % of GDP was negative in the U.K. (-4.32%) and in the U.S. (-5.30%)
· GDP growth was 3.06% in the U.K. and 2.03% in the U.S.
· Exceptions: high inflation and non-performing loans (4.8% in the U.S.)

(2) Crisis Containment – emergency liquidity support and blanket guarantees are commonly used. In the 42 banking crises, 71% were complimented by new liquidity measures, while 29% included blanket guarantees on deposits.

In this case of U.S. financial crisis:
The U.S. Federal Reserve Bank (Fed) has extended its liquidity facilities since December 2007 when the first Treasury Auction Facility (TAF) was announced. In addition, the Fed has opened additional funding measures, the Term Securities Lending Facilities (TSLF) and the Primary Dealer Credit Facility (PDCF); both facilities accept a wide range of collateral from Depository Institutions (regulated by the Fed) and Primary Dealers in exchange for Treasury bills or direct funding.
The Bank of England (BoE) extended its lending facilities in April 2008. Like the Fed, and under the Special Liquidity Scheme, the BoE now accepts a wide range of collateral, including mortgage-backed securities in exchange for government bills and bonds for a one year term. Further, the government offered a guarantee on deposits at Northern Rock (mortgage lender in the U.K.) during its collapse.

(3) Crisis resolution – reduced regulation is often a theme in the resolution phase, but strict regulatory standards follow the resolution. This does not usually solve the problem, and often, a restructuring of the banking system occurs.

In 86% of the 42 crises, despite regulatory forbearance, governments were forced to intervene directly by closing banks, facilitating mergers, or nationalizations.

In this case of U.S. financial crisis:
Fed had a blind eye to the bad assets these banks hold. They tried to maintain phony asset prices to keep those institutions alive. An alternative way showed somehow success in Sweden is to let asset prices fall, strip out bad assets and sell them, combine and recapitalize the good pieces, and sell those to the public too. But U.S. government chose to come down the path which most of cases in history also proved failed.(all data is from IMF)

Overall, the current financial crisis in U.S. and U.K is not unusual in the world of banking crisis. The difference is this crisis is rooted and spread in developed market other than in developing market as most crisis stemmed from. In developed economy, a significant amount of capital is at stake. The current financial crisis puts $66.1 trillion, 40% of the world’s stock of capital at stake.

Now the U.S. financial crisis has hit the second phase and moved toward resolution phase. I think the financial sector cannot recover until U.S. housing market bounces. As we still forecast the housing market would reach bottom this year and will not become health until 2010, most of banks’ assets, especially mortgage-backed securities cannot restore their value for a long time. So the future for U.S. market is not good, and the total cost of this crisis will be high.