1. REMARKS ON GLOBAL CRISIS İKT 438 JANUARY 2011 1

3. WHY THIS GLOBAL CRISIS ANYWAY ? Fedreserve rates up to 2004 too low ? Excess dollar liquidity ?X A central bank aims at … The cost of higher policy rates to deal with asset prices: Lower output Bernanke: Policy rates are not to blame Asset prices ? ~ Irrational exuberance (1992) Inflation baskets vs asset prices: Unresolved, so far … Blanchard et al. : Policy rates cannot deal with excess leverage, excessive risk-taking Imprudent banking: Subprimes Not much to do with 21st century or globalization Information asymmetry Lack of transparency, lack of uniformity in accounting systems Blame it on the complex derivatives ? Off-balance sheet items Is marked to market valuation a problem ? 3

4. Authorities/shareholders tolerance towards excessive risk taking, over-leveraging  Reinhart, Rogoff What do textbooks say about it ? Acemoğlu : Free markets # unregulated markets Acemoğlu : Greed is neither good or bad Checked  competition, innovation  growth Unchecked  too much risk  failures ↓ Regulation / supervision necessary Evolution of economic policies  1929 : Liberal 1929  : Protectionism; rise of the fiscal policy 1970  : Interventionist policies fail 1980  : Globalisation, liberalism again 2008  : Interventionism again 4

7. Areas, institutions outside supervision maps Competition with offshores push onshores towards risky investments Hedge funds, investment banks Ineffective cooperation between central banks and regulatory/supervisory authorities Not much noticed, but … The thin line, again: The Turkish experience Credit rating agencies  Iceland AAA ? Turkey Single B 1996-2006 ? Always late; analysis capacity debated Who should pay for it ? Lenders or investors ? Global imbalances: US in trouble … China too  Currency wars  Trade wars ? Exchange rate : Easy to blame others Long-run equilibrium value of the exchange rate 6 C/A 2007

8. 7

14. Strong economies : Banks lend to weaker ones in higher i

15. Weak economies : Banks & corporates borrow in common, credible currency ; at lower i ; avoid the problem of “original sin”

16. Then… the global crisis : crises always reveal inherent weaknesses

17. No mechanisms to deal with member states’ national problems

18. Discussion : rescue them (moral hazard), or leave them alone ? (French, German banks ?)

19. Discussion : ecb should deal wıth problems alone ?

20. Discussion : IMF or EMF ? Before the crisis, after the crisis..

22. Bail-out simply aimed at putting a new iron curtain between the north and south, or the core and the periphery

24. Increase in EFSF resources, in spite German resistance

25. Lower i in rescue packages, e-bonds to replace domestic bonds

27. Strong economies’ leadership in a new fiscal pactIf not, and only the current rescue efforts are continued, sooner or later the weaker economies are out of the euro-zone : Remember, 90 % of Germans want DM!

29. DAMAGE OF THE GLOBAL CRISIS Though not as bad as 1929 … 15

30. 16 *Indonesia, Malaysia, Phillippines, Thailand, Vietnam Source: IMF (World Economic Outlook)

31. 17 Source : Economist Intelligence Unit

32. 18

33. 19 Growth in 2009

35. 22 Source : Economist Intelligence Unit

36. OUTLOOK 1st and 2nd derivatives, market indicators OK, but not enough Watch: Gold, long term interest rates Gold : Hedge against inflation ; lazck of confidence in national currencies EM’s recover faster : Global crisis turns into regional crises. Only when contraction in housing markets in US is over Easy to detect Only when contraction in financial systems is over Liquidity  Loans or Public Debt ? Why tax the banks ? Are losses still on balance sheets ? Recovery in capital markets may take a long time Problems, delays in the reform process  Expectations’ improvement far from being satisfactory Politicians, recession and the reform process. Watch out! Are there strong governments ? Solutions, at last 23

38. If liquidity problems distort prices, liquidity risk should be taken into a/c Credit spreads reflect not only credit but also liquidity risk Fair value , also alternative valuation methods to see actual and estimated values. Carry only some items on accrual basis: Long term loans, simple debt Standard setters independence should not be compromised 25

39. Solutions for the regulation/supervision of the financial systems Re-assessment of liquidity, reserve requirements Minimum liquidity requirements ↑; Net stable funding: Promote long term liabilities Basel II a problem ? Flaws: Banks’ own internal risk models, role of credit rating agenciesBut, it took so long to enforce it … Solution: More authority to BIS; Financial Stability Board 26

41. Support for “too-little”

42. Limits on leveraging (debt/capital)

43. Contingency capital

49. Corporate governanceReshaping of the boards experts versus independent members; large vs small boards Further separation of trading, risk teams Enhancement of risk management 30

50. Dangers of the new regulatory framework Too many rules may overlap with each other  regulatory arbitrage Recall: Regulatory arbitrage behind complex instruments, hedge funds Capital is like water, will flow around obstacles Financial institutions’ profitability ↓  move to capital markets An efficient financial system is a must for economic growth Criterion: Benefits of regulation > losses as market efficiency ↓ (Ersel) 31

51. Ineffective cooperation between CBs and regulatory/supervisory authorities Solution: Macro prudential regulation of systemic risks Cure to the asset bubble problem.. Systemic risk premiums, capital requirements, insurance CB’s: Do price stability and financial stability objectives clash in the long run ? CBT’s Financial Stability Report, recent measures The previous trend to separate authorities in charge of price stability and financial stability may be reversed (Blanchard et al.) 32

53. Global imbalances: US in trouble … China too Solution: No easy solution: Correction lower growth ? Tobin tax: Circumvention Effect on exchange rate not proved Increases costs of capital Negative effect on growth Yuan revaluation, dollar devaluation ? Failure of international coordination G20; IMF; EU institutions Better international coordination needed Faster pace in the assessment of financial systems in developed economies needed Faster pace in structural reforms crucial Fiscal policies to become more countercyclical in the future New automatic stabilizers: Cyclical invesment tax Temporary transfers to low income economic agents Blanchard at al. again 34

57. Are governments ready to give up authority ?

58. Government to government bilateral fundingAs recovery of capital flows may take a long time 35

60. Avoid overreaction to the past: 1933, 1999, 2011 ?

61. The more we see recovery, the less will be the chance for reformsPolicymakers will only be successful if and when they are ahead of markets with positive surprises (EU) 36

64. Tactics  Cut budget deficits or raise policy rates ?

68. “This time is different: Eight Centuries of Financial Folly” Carmen M. Reinhart, Kenneth S. Rogoff

69. “How Should We Respond to Asset Price Bubbles? “ Frederic S. Mishkin 39