The Global Financial Crisis

Conference in Bretton Woods, NH
June 3-4, 2011
Charles Engel of the University of Wisconsin, Kristin Forbes of MIT, and Jeffrey Frankel of Harvard's Kennedy School, Organizers

Conference participants in the Gold Room at the Mt. Washington Hotel 
(where the 1944 treaty was signed)

Seated at table: Helene Rey, Kristin Forbes (project chair), Beatrice Weder, Galina Hale, Carmen Reinhart, Carol Bertaut, Sebnem Kalemli-Ozcan, Kathryn Dominguez, Linda Tesar, Richard Portes. Standing: Jim Poterba, Paul Joskow, Shang-jin Wei, Claudio Raddatz, Daniel Goroff, Sergio Schmukler, Larry Summers, Vince Reinhart, Andres Velasco, Jeremy Stein, Pierre-Olivier Gourinchas, Jose de Gregorio, Linda Goldberg, David Scharfstein, Gian-Maria Milesi-Ferretti, Eswar Prasad, Jeffrey Frankel (project co-chair), Jonathan Ostry, Stijn Claessens, Ralph Tryon, Frank Warnock, Barry Eichengreen, Andrew Rose, Marcos Chamon, Atish Ghosh, Enrique Mendoza, Hyun Song Shin, Takatoshi Ito, Hui Tong and Steven Kamin. Attendees not pictured: Joshua Aizenman, Marcel Fratzscher, Yuko Hashimoto, Raghu Rajan, Bent Sorenson, and Kai Truempler.

Problems that initially emerged in the U.S. subprime market quickly spread around the world to generate the most severe and synchronized global financial crisis and recession since the Great Depression. The global ramifications of this crisis were largely unforeseen and have forced a rethinking of international financial linkages. Previous academic research did not adequately address the causes, consequences or appropriate policy responses. Research in international macroeconomics also did not sufficiently incorporate the complexities of financial markets. The new research papers presented at this conference attempted to address these shortcomings by advancing our understanding of global aspects of the recent financial crisis and better integrating research on international macroeconomics with that in corporate finance. These papers also attempted to provide intellectual underpinnings for policies to better manage and reduce the likelihood of future financial crises.

Some of the key questions discussed at Bretton Woods were: What was the role of increased financial integration in the crisis? How did global imbalances contribute to and evolve during and after the crisis? What drives extreme swings in international capital flows? How was the crisis transmitted internationally? What was the role of international banks and investors in driving contagion? How important was leverage and liquidity shortages—and can these be addressed through policy? How effective are different policies such as reserve accumulation and capital controls in protecting economies from global crises? Are there changes to the global financial architecture that would reduce vulnerability to crises in the future?

The papers presented at this conference were part of a larger project on the Global Financial Crisis run by the NBER with generous financial support from the Sloan Foundation. Click here for more information on the project. The main findings from the research presented at Bretton Woods will be debated at a symposium at the National Press Club in Washington, DC on Sept. 22, 2011with policymakers, investors, the press, and thought leaders from around the world through an interactive set of panels and discussions. Click here for more information on the symposium.

Below are summaries of the research papers presented at Bretton Woods, along with links to the executive summaries, corresponding data sets and other supporting technical material. Click here for the formal conference agenda.

Bergljot Barkbu and Ashoka Mody, IMF, and Barry Eichengreen, University of California at Berkeley and NBER

International Financial Crises and the IMF: What the Historical Record Shows (NBER Working Paper No. 17361)

Barkbu, Mody, and Eichengreen survey the modern history of financial crises, providing a context for the other papers discussed at the conference. Along with indicators of economic performance in the subject countries, they present a comprehensive description of multilateral rescue efforts spanning the last 30 years. They show that while emergency lending has grown, debt restructuring has become progressively less frequent. This leads them to ask what can be done to rebalance the management of debt problems toward a better mix of emergency lending and private sector burden sharing. Building on the literature on collective action clauses, they explore the idea of "sovereign cocos," contingent debt securities that automatically reduce payment obligations in the event of debt-sustainability problems.

Executive Summary

Sebnem Kalemli-Ozcan, University of Houston and NBER; Bent Sorensen, University of Houston; and Sevcan Yesiltas, Johns Hopkins University

Leverage across Firms, Banks, and Countries (NBER Working Paper No. 17354)

Kalemli-Ozcan, Sorensen, and Yesiltas present new stylized facts on bank and firm leverage for the years 2000 to 2009 using internationally comparable micro-level data from several countries. They document the following patterns: 1) there was an increase in leverage ratios of investment banks and financial firms during the early 2000s; 2) there was no visible increase for non-investment banks and non-financial firms; 3) off balance-sheet items constitute a big fraction of assets, especially for large banks in the United States; 4) the leverage ratio is pro-cyclical for investment banks and for large non-investment banks in the United States; and 5) banks in emerging markets with tighter bank regulation and stronger investor protection experience significantly less deleveraging during the crisis. These results show that excessive risk taking before the crisis was not easily detectable outside of investment banks, because the risk involved the quality rather than the amount of assets.

Executive Summary
Data (zip file)

Kristin Forbes, and Francis E. Warnock, University of Virginia and NBER

Capital Flow Waves: Surges, Stops, Flight, and Retrenchment (NBER Working Paper No. 17351)

Forbes and Warnock analyze the drivers of international waves in capital flows, building on the literature on "sudden stops" and "bonanzas" to develop a new methodology for identifying episodes of extreme capital flow movements. Using quarterly data on gross inflows and gross outflows and differentiating activity by foreigners and domestics, they identify episodes of "surges, stops, flight, and retrenchment" and show how their approach yields fundamentally different results from the previous literature which instead used measures of net flows. Global factors, especially global risk, are important determinants of these episodes. Contagion, especially through the bilateral exposure of banking systems, is also important in determining stop and retrenchment episodes. Domestic macroeconomic characteristics are generally less important, although changes in domestic economic growth influence episodes caused by foreigners. The researchers find little role for global interest rates and global liquidity in explaining surges in foreign capital flows (independent of global risk and global growth). Nor do they find much of a role for capital controls in reducing capital flow waves.

Executive Summary

Carol Bertaut, Laurie Pounder DeMarco, Steve Kamin, and Ralph Tryon, Federal Reserve Board

ABS Inflows to the United States and the Global Financial Crisis (NBER Working Paper No. 17350)

The "global saving glut" (GSG) hypothesis argues that the surge in capital inflows from emerging market economies to the United States led to significant declines in long-term interest rates in the United States and other industrial economies. In turn, these lower interest rates combined with innovations and deficiencies of the U.S. credit market, and are believed to have contributed to the U.S. housing bubble and to the buildup in financial vulnerabilities that led to the financial crisis. Because the GSG countries for the most part restricted their U.S. purchases to Treasuries and Agency debt, their provision of savings to ultimately risky sub-prime mortgage borrowers was necessarily indirect, pushing down yields on safe assets and increasing the appetite for alternative investments on the part of other investors. Bertaut, DeMarco, Kamin, and Tryon present a more complete picture of how capital flows contributed to the crisis, drawing attention to the sizable inflows from European investors into U.S. private-label asset-backed securities (ABS), including mortgage-backed securities and other structured investment products. By adding to domestic demand for private-label ABS, substantial foreign acquisitions of these securities contributed to the decline in their spreads over Treasury yields. Through a combination of empirical estimation and model simulation, the authors verify that both GSG inflows into Treasuries and Agencies and European acquisitions of ABS played a role in contributing to downward pressures on U.S. interest rates.

Executive Summary
Data Figures
Data -holdings

Galina Hale, Federal Reserve Bank of San Francisco

Bank Relationships, Business Cycles, and Financial Crisis (NBER Working Paper No. 17356)

Hale uses network analysis to formally describe bank relationships in the global banking network between 1980 and 2009 and to analyze the effects of recessions and banking crises on these relationships. She constructs a novel dataset that builds a bank-level global network from loan-level data on syndicated loans to financial institutions. The network consists of 7,938 banking institutions from 141 countries. She shows that the network became more interconnected and more asymmetric, and therefore potentially more fragile, prior to 2008; its expansion slowed in recent years, dramatically so during the 2008-9 crisis. Hale then uses a stylized model to describe the potential effects of banking crises and recessions on bank relationships. She finds that the structure of a global banking network is not invariant to banking crises nor to recessions, especially those in the United States. While recessions appear to encourage banks to make new connections, especially on the periphery of the network, the global financial crisis of 2008-9 made banks very cautious in their lending, meaning that almost no new connections were made during the crisis, particularly in 2009. Also, during country-specific recessions or banking crises, past relationships become more important because few new relationships are formed.

Executive Summary
Data #1
Data #2

Nicola Cetorelli, Federal Reserve Bank of New York, and Linda S. Goldberg, Federal Reserve Bank of New York and NBER

Liquidity Management of U.S. Global Banks: Internal Capital Markets in the Great Recession (NBER Working Paper No. 17355)

The recent crisis highlighted the importance of globally active banks in linking markets. One channel for this linkage is management of liquidity across an entire banking organization, with funds flowing across international affiliates and within geographically diverse banks. Cetorelli and Goldberg analyze such liquidity management by U.S. banking organization during the Great Recession. Faced with a shock to the parent, global banks activated internal capital markets, shuffling funds in and out of specific locations based on the relative importance of such locations as local funding pools and on their overall foreign investment strategies, and differentiating across "core" and "periphery" business locations.

Executive Summary

Andrew K. Rose, University of California at Berkeley and NBER, and Mark M. Spiegel, Federal Reserve Bank of San Francisco

Dollar Illiquidity and Central Bank Facilities during the U.S. Sub-Prime Crisis (NBER Working Paper No. 17359)

While the global financial crisis was centered in the United States, it led to a surprising appreciation in the dollar, suggesting global dollar illiquidity. In response, the Federal Reserve partnered with other central banks to inject dollars into the international financial system. Empirical studies of the success of these efforts have yielded mixed results, in part because their timing is likely to be endogenous. In their paper, Rose and Spiegel examine the cross-sectional impact of these interventions. Theory consistent with dollar appreciation in the crisis suggests that the impact should be greater for countries that have greater exposure to the United States through trade and financial channels, less transparent holdings of dollar assets, and greater illiquidity difficulties. The authors examine these predictions for observed cross-sectional changes in CDS spreads, using a new proxy for innnovations in perceived changes in sovereign risk based on Google-search data. They find robust evidence that auctions of dollar assets by foreign central banks disproportionately benefited countries that were more exposed to the United States through either trade linkages or asset exposure. They obtain weaker results for differences in asset transparency or illiquidity. However, several of the important announcements concerning the international swap programs disproportionately benefited countries exhibiting greater asset opaqueness.

Executive Summary
Data-zip file
Technical Appendix

Marcos Chamon, Atish R. Ghosh, Jonathan D. Ostry, and Mahvash S. Qureshi, IMF

Managing Capital Inflows: The Role of Controls and Prudential Policies (NBER Working Paper No. 17363)

Chamon, Ghosh, Ostry, and Qureshi analyze the effects of prudential policies and capital controls in reducing financial fragility related to capital inflows. They construct new indexes for prudential policies and for financial-sector-specific capital controls for 50 emerging market economies over the period 1995-2008. Their results indicate that both prudential regulations related to the currency of denomination and capital controls tend to reduce the proportion of foreign currency-denominated loans by the domestic banking sector, and to shift the country's external liability structure away from portfolio debt. Other prudential policies, however, appear to be more effective in restraining overall banking system credit booms. Experience from the global financial crisis suggests that countries that had such prudential policies and capital controls in place prior to the crisis fared better in terms of the output decline during the crisis.

Executive Summary
Panel Dataset
Cross-Section Dataset

Marcel Fratzscher, European Central Bank

Capital Flows, Global Shocks and the 2007-08 Financial Crisis (NBER Working Paper No. 17357)

The causes of the 2008 collapse and subsequent surge in global capital flows remain an open and highly controversial issue. Using a factor model coupled with a dataset of high-frequency portfolio capital flows to 50 economies, Fratzscher finds that common shocks - key crisis events as well as changes to global liquidity and risk - have exerted a large effect on capital flows, both in the crisis and in the recovery. However, these effects have been highly heterogeneous across countries, with a large part of this heterogeneity being explained by differences in the quality of domestic institutions, country risk, and the strength of macroeconomic fundamentals. Comparing and quantifying these effects shows that while common factors ("push" factors) were overall the main drivers of capital flows during the crisis, in particular for emerging markets, country-specific determinants ("pull" factors) have been dominant in accounting for the dynamics of global capital flows in 2009 and 2010.

Executive Summary

Claudio Raddatz and Sergio Schmukler, The World Bank

On the International Transmission of Shocks: Micro-Evidence from Mutual Fund Portfolios (NBER Working Paper No. 17358)

Raddatz and Schmukler use micro-level data on mutual funds from different financial centers investing in equity and bonds to study how investors and managers behave and transmit shocks across countries. They find that the volatility of mutual fund investments is driven quantitatively by both the underlying investors and fund managers through injections/redemptions into each fund and managerial changes in country weights and cash. Both investors and managers respond to country returns and crises and adjust their investments substantially, for example, generating large reallocations during the global crisis. Their behavior tends to be pro-cyclical, pulling out of countries during bad times and increasing their exposures when conditions improve. Managers actively change country weights over time, although there is significant short-run pass-through from returns to these weights. Consequently, capital flows from mutual funds do not seem to have a stabilizing role and expose countries in their portfolios to foreign shocks.

Executive Summary

Pierre-Olivier Gourinchas, University of California at Berkeley and NBER; Helene Rey, London Business School and NBER; and Kai Truempler, London Business School

The Financial Crisis and The Geography of Wealth Transfers (NBER Working Paper No. 17353)

Gourinchas, Rey, and Truempler study the geography of wealth transfers during the latest financial crisis. They construct valuation changes on bilateral external positions in equity, direct investment, and portfolio debt at the height of the crisis to map who benefited and who lost from the massive movements in relative asset prices. They find a very diverse set of fortunes governed by the structure of countries' external portfolios. In particular, they are able to relate the gains and losses on the debt portfolio to the widespread exposure to ABCP conduits and to the degree of dollar shortage. They also uncover a wider set of countries who played the role of "global insurers" in this last crisis.

Executive Summary

Philip Lane, Trinity College Dublin, and Gian Maria Milesi-Ferretti, IMF

External Adjustment and the Global Crisis (NBER Working Paper No. 17352)

The period preceding the global financial crisis was characterized by a substantial widening of current account imbalances across the world. Since the onset of the crisis, these imbalances have contracted to a significant extent. Lane and Milesi-Ferretti characterize the ongoing process of external adjustment in advanced economies and emerging markets by first documenting how countries whose current account balances were in excess of what could be explained by standard economic fundamentals prior to the crisis also experienced the largest contractions in their external balance. They then examine the extent to which the process of external adjustment reflected primarily changes in domestic demand, external demand, or international relative prices, and whether the adjustment process differed between countries with fixed versus flexible exchange rate regimes. They find that in deficit countries, external adjustment was achieved primarily through demand compression, rather than expenditure-switching.

Executive Summary
Data #1
Data #2
Stata code-base case
Stata code-sensitivity tests
Stata code-CA regressions

Stijn Claessens and Hui Tong, IMF, and Shang-Jin Wei, Columbia University and NBER

The Channels for the Real Collateral Damage of the 2008-2009 Global Crisis: Evidence from Firms in 42 Countries (NBER Working Paper No. 17360)

Claessens, Tong, and Wei use accounting data for 7,722 non-financial firms from 42 countries to examine how the 2007-9 crisis affected firm performance and how various linkages propagated shocks across borders. They separate the effects of changes in external financing conditions, domestic demand, and international trade on firms' profits, sales, and investment using both sectoral benchmarks and firm-specific sensitivities estimated prior to the crisis. They find that the crisis had a bigger negative impact on firms with greater demand and trade sensitivity, and particularly so in countries more open to trade. Financial openness though appears to have had limited impact.

Executive Summary

Kathryn M.E. Dominguez, University of Michigan and NBER; Yuko Hashimoto, IMF; and Takatoshi Ito, University of Tokyo and NBER

International Reserves and the Global Financial Crisis (NBER Working Paper No. 17362)

Many emerging market countries accumulated impressive international reserve portfolios prior to the global financial crisis. Dominguez, Hashimoto, and Ito analyze how these pre-crisis international reserve accumulations, as well as exchange rate and reserve decumulation policy decisions made during the crisis, can explain cross-country differences in post-crisis economic performance. If the main rationale for accumulating reserves was to provide precautionary self-insurance, then the global financial crisis should have provided the ultimate vindication for that strategy. This analysis distinguishes between passive valuation changes and active management of the assets in international reserve portfolios. The authors find evidence that reserves served as an important counter-cyclical policy tool for a number of emerging market countries during the crisis. Among countries that depleted their reserves, those that were able to replenish their reserve accumulations by the end of 2009 were also the countries that experienced the largest output recoveries in 2010.

Executive Summary

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