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How did a domestic housing slump turn into a global financial crisis?

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  • Kamin, Steven B.
  • DeMarco, Laurie Pounder
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    Abstract

    The global financial crisis clearly started with problems in the U.S. sub-prime sector and spread across the world from there. But was the direct exposure of foreigners to the U.S. financial system a key driver of the crisis, or did other factors account for its rapid contagion across the world? To answer this question, we assessed whether countries that held large amounts of U.S. mortgage-backed securities (MBS) and were highly dependent on dollar funding experienced a greater degree of financial distress during the crisis. We found little evidence of such direct spillovers from the United States to abroad. Although CDS spreads generally rose higher and bank stocks generally fell lower in countries with more exposure to U.S. MBS and greater dollar funding needs, these correlations were not robust, and they fail to explain the lion’s share of the deterioration in asset prices that took place during the crisis. Accordingly, less tangible channels of contagion may have played a more important role in the global spread of the crisis: a generalized run on global financial institutions, given the opacity of their balance sheets; excessive dependence on short-term funding; vicious cycles of mark-to-market losses driving fire sales of MBS; the realization that financial firms around the world were pursuing similar (flawed) business models; and global swings in risk aversion. The U.S. sub-prime crisis, rather than being a fundamental driver of the global crisis, may have been merely a trigger for a global bank run and for disillusionment with a risky business model that already had spread around the world.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of International Money and Finance.

    Volume (Year): 31 (2012)
    Issue (Month): 1 ()
    Pages: 10-41

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    Handle: RePEc:eee:jimfin:v:31:y:2012:i:1:p:10-41

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    Web page: http://www.elsevier.com/locate/inca/30443

    Related research

    Keywords: Financial crisis; Transmission; Mortgage-backed securities;

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    References

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    1. G. Andrew Karolyi, 2004. "Does International Financial Contagion Really Exist?," Journal of Applied Corporate Finance, Morgan Stanley, vol. 16(2-3), pages 136-146.
    2. Gary B. Gorton, 2008. "The Panic of 2007," NBER Working Papers 14358, National Bureau of Economic Research, Inc.
    3. Fratzscher, Marcel, 2009. "What explains global exchange rate movements during the financial crisis?," Journal of International Money and Finance, Elsevier, vol. 28(8), pages 1390-1407, December.
    4. Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediary leverage and value at risk," Staff Reports 338, Federal Reserve Bank of New York.
    5. Morris Goldstein, 1998. "The Asian Financial Crisis," Policy Briefs PB98-1, Peterson Institute for International Economics.
    6. Barry Eichengreen & Ashoka Mody & Milan Nedeljkovic & Lucio Sarno, 2009. "How the Subprime Crisis Went Global: Evidence from Bank Credit Default Swap Spreads," NBER Working Papers 14904, National Bureau of Economic Research, Inc.
    7. Patrick McGuire & Ilhyock Nikola Tarashev, 2008. "Global monitoring with the BIS international banking statistics," BIS Working Papers 244, Bank for International Settlements.
    8. Moser, Thomas, 2003. "What Is International Financial Contagion?," International Finance, Wiley Blackwell, vol. 6(2), pages 157-78, Summer.
    9. Ricardo J. Caballero & Alp Simsek, 2009. "Fire Sales in a Model of Complexity," NBER Working Papers 15479, National Bureau of Economic Research, Inc.
    10. Carol C. Bertaut & William L. Griever & Ralph W. Tryon, 2006. "Understanding U.S. cross-border securities data," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue May, pages A59-A75.
    11. Viral V Acharya & Philipp Schnabl, 2010. "Do Global Banks Spread Global Imbalances? Asset-Backed Commercial Paper during the Financial Crisis of 2007–09," IMF Economic Review, Palgrave Macmillan, vol. 58(1), pages 37-73, August.
    12. Daniel O. Beltran & Laurie Pounder & Charles Thomas, 2008. "Foreign exposure to asset-backed securities of U.S. origin," International Finance Discussion Papers 939, Board of Governors of the Federal Reserve System (U.S.).
    13. Patrick McGuire & Goetz von Peter, 2009. "The US dollar shortage in global banking," BIS Quarterly Review, Bank for International Settlements, March.
    14. Viral V. Acharya & Philipp Schnabl, 2010. "Do Global Banks Spread Global Imbalances? The Case of Asset-Backed Commercial Paper During the Financial Crisis of 2007-09," NBER Working Papers 16079, National Bureau of Economic Research, Inc.
    15. Carol C. Bertaut & Laurie Pounder, 2009. "The financial crisis and U.S. cross-border financial flows," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Nov.
    16. Steven B. Kamin & Laurie Pounder DeMarco, 2010. "How did a domestic housing slump turn into a global financial crisis?," International Finance Discussion Papers 994, Board of Governors of the Federal Reserve System (U.S.).
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    Cited by:
    1. Philippe Bacchetta & Eric van Wincoop, 2013. "The Great Recession: A Self-Fulfilling Global Panic," Working Papers 092013, Hong Kong Institute for Monetary Research.
    2. Bacchetta, Philippe & van Wincoop, Eric, 2012. "Sudden Spikes in Global Risk," CEPR Discussion Papers 8853, C.E.P.R. Discussion Papers.
    3. Dwyer, Gerald P. & Lothian, James R., 2012. "International and historical dimensions of the financial crisis of 2007 and 2008," Journal of International Money and Finance, Elsevier, vol. 31(1), pages 1-9.
    4. Vithessonthi, Chaiporn, 2014. "Monetary policy and the first- and second-moment exchange rate change during the global financial crisis: Evidence from Thailand," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 29(C), pages 170-194.

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