Transcript Financial Globalization

Latest Generation of Systemic Crises:
“I don’t think we are in Kansas anymore”
Augusto de la Torre
The World Bank
Finance Forum
June 20-22, 2002
Key facts on recent financial crises
Increasing frequency of severe twin crises
Twice as disruptive as currency crisis, adding 15% to
cumulative output loss (Bordo et al. 2001)
Sudden stops
Current account deficits are not new
 Large & sustained deficits/surpluses during gold standard era
What is new: speed of major current account reversals
Linked somehow to financial globalization
Sudden stops have exogenous components and
international capital markets are imperfect
 Russian contagion, “globalization hazard” (Calvo 2002), weak
framework of international institutions
Key facts on recent financial crises (2)
…but not explained by globalizatin per se
Gold standard era—greater financial globalization…
…with less frequent currency and twin crises
With isolationism per se not preventing crises
Frequent currency crises in Bretton Woods, despite
domestic financial repression and capital controls
Emergence of new, disturbing varieties
Triple (currency, banking, and public debt) crises
Widespread breakdown of contracts/property rights
Crises have become more frequent…
14.00
Banking Crises
Frequency (annual % probability)
12.00
Currency Crises
Twin Crises
10.00
All Crises
8.00
6.00
4.00
2.00
0.00
1880-1913
Source: Bordo et al. 2001
1919-1939
1945-1971
1973-1997 (21
countries)
1973-1997 (56
countries)
…but not more severe, on average…
All countries
1880-1913
Currency Crisis
Banking Crises
Twin Crises
All Crises
2.6
2.3
2.2
2.4
Currency Crisis
Banking Crises
Twin Crises
All Crises
8.3
8.4
14.5
9.8
1973-1997
21-nations
1919-1939
1945-1971
Average duration of crises in years
1.9
1.8
1.9
a
2.4
3.1
2.7
1.0
3.7
2.4
1.8
2.6
Average crisis depth (cumulative GDP loss in %)
14.2
5.2
3.8
a
10.5
7.0
15.8
1.7
15.7
13.4
5.2
7.8
Notes: a indicates no crises
Source: Bordo et al. 2001
1973-1997
56-nations
2.1
2.6
3.8
2.5
5.9
6.2
18.6
8.3
Contagion Risk
(Runs)
Anguish zones under financial globalization
Multiple equilibria
Current account / fiscal deficits 
Overvalued currency
II
Highly indebted
government
IV
Wretched Trinity:
Weak currency
Fear of floating
Weak institutions
Currency mismatches
Low currency & maturity
mismatches
I
Blessed Trinity:
International currency
Flexible exchange rate
Sound institutions
III
Weak institutions
Incentive Distortions
Contagion Risk
(Runs)
Anguish zones under financial globalization
Multiple equilibria
Highly indebted
government
Run on the currency
Depositor run on system
Current account / fiscal deficits 
II
IV
Run by foreign
portfolio investors
Low currency & maturity
mismatches
I
Currency mismatches
III
Depositor
flight to quality
Incentive Distortions
Type IV crises:
Management and resolution issues
Containment
Loss allocation
Restructuring
Regeneration
International financial architecture
Type IV crises – containment issues
Contract-abiding containment proves insufficient
Defenses of currency (int’l reserves, interest rate hikes)
and of banks (LOLR)—inconsistent and break down
Full deposit guarantee (to retain depositors at home
while facilitating bank closures) lacks credibility
Huge coordination/discernment problems
Forcible containment—through contract violation
Deposit freeze (“corralito”) and deposit securitization
Stock pesification cum float
Generalized internal and external defaults
Alternative to consider
Stock dollarization cum pesification at the margin
Type IV crises – loss allocation issues
Allocation through administrative measures or
negotiation (not via hyperinflation)
Pressures on government to “compensate” agents
for the effects of extreme policies
Not independent of nature of forcible containment
Huge coordination/discernment problems
Dominance of political economy dynamics
Process depends significantly on quality of governance
and power of traditional oligarchies
Burden sharing takes on new meaning
Type IV crises –restructuring issues
Fear of bank closures in midst of runs
Post-freeze securitization could help restructuring
By shrinking banks’ balance sheets
But asset management/disposal still a major issue
Special problems for bond-based recapitalization
How to value debt issued by government in default?
Bank nationalizations
Can recapitalization debt be made senior without
violating negative pledge and other clauses?
Innovative corporate restructuring frameworks
Type IV crises – regeneration issues
Growth regeneration depends on…
Confidence and capital reflows
Degree of openness in trade structure
Speed/effectiveness of loss allocation and restructuring
…but its sustainability requires regeneration of
financial intermediation…
Establishment of currency as “store of value”
Questions on new industrial organization of sector
(narrow banks, offshores, etc.)
Segmentation of access
…and institutional regeneration
Contractual and regulatory environment
Democratic governance
Type IV crises – int’l architecture issues
Imperfections of int’l financial markets
Contagion (Calvo’s EMF)
Defaults (int’l bankruptcy, exit consents, UDROPs,
floor to debt to facilitate agreement on haircuts)
Potential role of IFIs in peso debt markets development
Externalities of fluctuations in international currencies
Fixing them would benefit EMs the most…
…but incentives for industrial countries are weak
Multilateral & regional institutions have a major
responsibility