1. FINANCIAL CRISES Lessons and Prospects
Guillermo Calvo
Columbia University
November 12, 2007

2. Outline
I. RUSSIA VS. SUBPRIME
II. LOOKING FORWARD

3. I. RUSSIA VS. SUBPRIME

4. Key Differences between Russia and Subprime
Russian 1998 brought about a sizable spike in spreads, while in subprime episode the spreads and yields are below their pre-Asia 1997 levels, and those in recent turmoils.
Subprime benefited from G7 central bank credit from its inception, while in the Russian Crisis G7 central bank action (e.g., coordination of LTCM creditors) and credit came after EM bond market meltdown.
EMs and LAC, in particular, exhibit CA surplus, while in 1998 they were in deficit.
In LAC key countries like Argentina, Mexico and Brazil have de-dollarized their financial systems.

5. Current Account (millions of USD) EMBI spread (basis points)
External Financial Conditions for EMs
(EMBI sovereign spread & Current Account Balance in EMs, millions of USD, last four quarters)
Tequila Crisis
Asian Crisis
Russian Crisis
-50000
50000
100000
150000
Jan-91
2500
2000
1500
Current Account (millions of USD)
EMBI spread (basis points)
1000
500
Jul-91
Jan-92
Jul-92
Jan-93
Jul-93
Jan-94
Jul-94
Jan-95
Jul-95
Jan-96
Jul-96
Jan-97
Jul-97
Jan-98
Jul-98
Jan-99
Jul-99
Jan-00
Jul-00
Jan-01
Jul-01
Jan-02
Jul-02
Jan-03
Jul-03
Jan-04
Note: Includes Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Slovak Republic, South Africa, Thailand, Turkey and Venezuela.

6. Annualized growth: 10.6% 2002.IV-2004.III
LAC 7: INVESTMENT
(LAC-7, s.a. Investment, 1998.II=100)
Annualized growth: 10.6% IV-2004.III
Russian Crisis
110
100
Annualized growth: 7.4%
1990.I-1998-II 90 80
Annualized growth: - 4.1%
1998.II-2002-IV 70 60 50
1990.I
1991.I
1992.I
1993.I
1994.I
1995.I
1996.I
1997.I
1998.I
1999.I
2000.I
2001.I
2002.I
2003.I
2004.I

7. LAC 7: GROWTH (LAC-7, s.a. GDP, 1998.II=100) Russian Crisis 115 110
Annualized growth: 5.5% IV-2004.III
Russian Crisis
115
110
105
100 95
Annualized growth: 4.4% 1990.I-1998.II
Annualized growth: 0.2% II-2002.IV 90 85 80 75 70 65
1990.I
1991.I
1992.I
1993.I
1994.I
1995.I
1996.I
1997.I
1998.I
1999.I
2000.I
2001.I
2002.I
2003.I
2004.I

8. External Financial Conditions for EMs
(EMBI+, bps) 50
250
450
650
850
1050
1250
1450
Jan-02
Mar-02
May-02
Jul-02
Sep-02
Nov-02
Jan-03
Mar-03
May-03
Jul-03
Sep-03
Nov-03
Jan-04
Mar-04
May-04
Jul-04
Sep-04
Nov-04
Jan-05
Mar-05
May-05
Jul-05
Sep-05
Nov-05
Jan-06
Mar-06
May-06
Jul-06
Sep-06
Nov-06
Jan-07
Mar-07
May-07
Jul-07
Sep-07
ENRON Effect
Fears of FED tightening
Greenspan’s “conundrum” testimony
Yields
Pre-Asian Crisis EM Yields
=-32.1%
Spreads
Pre-Asian Crisis EM Spreads
=-48.1%
Beginning of improvement in international financial conditions 8 8

9. AFRICA: EMBI+ Spread (Sovereign Spread, in bp) Russian Crisis 9
EMBI+ Africa includes debt instruments issued by Algeria, Morocco, Nigeria and South Africa.
Source: Datastream. 9

10. Volatilty of the EMBI Spread
(Monthly standard deviation, bp over US Treasury bonds) 50
100
150
200
250
300
Jan-91
Jun-91
Nov-91
Apr-92
Sep-92
Feb-93
Jul-93
Dec-93
May-94
Oct-94
Mar-95
Aug-95
Jan-96
Jun-96
Nov-96
Apr-97
Sep-97
Feb-98
Jul-98
Dec-98
May-99
Oct-99
Mar-00
Aug-00
Jan-01
Jun-01
Nov-01
Apr-02
Sep-02
Feb-03
Jul-03
Dec-03
May-04
Oct-04
Mar-05
Aug-05
Jan-06
Jun-06
Nov-06
Apr-07
Sep-07 10 10

11. What’s behind actual small spillover effects on Emerging Markets?
A conjecture is that EMs have shielded themselves with larger stock of international reserves, current account surpluses, and de-dollarization.
Another conjecture is that small spillover effects are a result of the speedy and timely bailouts engineered by G7 central banks.
I lean towards the second conjecture because it appears that even G7 stock markets suffered less now than in Besides, EM CA surpluses may not be robust.

12. II. LOOKING FORWARD

13. Sovereign Wealth Funds, SWFs
SWFs could amount to around US$2.5 trillion,
are funded by international reserves,
and intended to acquire real assets.
SWFs are small as a share of G7 stock market capitalization. Thus, they should have a small effect on stock market prices.
However, if the demand for liquid assets is inelastic, dumping that amount of liquidity in exchange for real goods may have a noticeable impact on global inflation, especially if G7 central banks keep interest rates low.

14. Are Imbalances behind any of this?
In principle, the subprime crisis is unrelated to global imbalances. It could have occurred even if US CA was zero.
But it may have been triggered by SWFs’ unwinding of international reserves.
International reserves are the counterpart of US CA and, especially, fiscal deficits.
Thus, their unwinding may have put an upward spin on interest rates, revealing subprime weakness.
In any case, under this optic the crisis would be triggered not by a credit SS, but by a liquidity SS.

15. What if Inflation is in the Horizon?
The Fed will find itself between a rock and a hard place.
The “rock” of inflation
and the “hard place” of financial fragility, e.g., more mortgages may become non-performing.
This may result in higher policy uncertainty, and raise the probability of liquidity crises.
As a result, nominal and possibly real interest rates may increase.

16. FINANCIAL CRISES Lessons and Prospects
Guillermo Calvo
Columbia University
November 12, 2007