This paper summarizes and explains the main events of the liquidity and credit crunch in 2007-08. Starting with the trends leading up to the crisis, I explain how these events unfolded and how four different amplification mechanisms magnified losses in the mortgage market into large dislocations and turmoil in financial markets.

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Deciphering the Liquidity and Credit Crunch 2007-08

Using various methods, the size of the shadow economy in 76 developing, transition, and OECD countries is estimated. Average size varies from 12 percent of GDP for OECD countries, to 23 percent for transition countries and 39 percent for developing countries. Increasing taxation and social security contributions combined with rising state regulations are driving forces for the increase of the shadow economy, especially in OECD countries. According to some findings, corruption has a positive impact on the size of the shadow economy, and a growing shadow economy has a negative effect on official GDP growth.

/pdf/shadow-economies-size-causes-and-consequences-1rnohp2zuz.pdf

Shadow Economies: Size, Causes, and Consequences

The crisis of 2008-09 has focused attention on money and credit fluctuations, financial crises, and policy responses. In this paper we study the behavior of money, credit, and macroeconomic indicators over the long run based on a newly constructed historical dataset for 12 developed countries over the years 1870-2008, utilizing the data to study rare events associated with financial crisis episodes. We present new evidence that leverage in the financial sector has increased strongly in the second half of the twentieth century as shown by a decoupling of money and credit aggregates, and we also find a decline in safe assets on banks' balance sheets. We also show for the first time how monetary policy responses to financial crises have been more aggressive post-1945, but how despite these policies the output costs of crises have remained large. Importantly, we can also show that credit growth is a powerful predictor of financial crises, suggesting that such crises are

Credit Booms Gone Bust: Monetary Policy, Leverage Cycles and Financial Crises, 1870-2008

Over the last thirty years, a new paradigm in banking theory has overturned economists' traditional vision of the banking sector. The asymmetric information model, extremely powerful in many areas of economic theory, has proven useful in banking theory both for explaining the role of banks in the economy and for pointing out structural weaknesses in the banking sector that may justify government intervention. In the past, banking courses in most doctoral programs in economics, business, or finance focused either on management or monetary issues and their macroeconomic consequences; a microeconomic theory of banking did not exist because the Arrow-Debreu general equilibrium model of complete contingent markets (the standard reference at the time) was unable to explain the role of banks in the economy. This text provides students with a guide to the microeconomic theory of banking that has emerged since then, examining the main issues and offering the necessary tools for understanding how they have been modeled. This second edition covers the recent dramatic developments in academic research on the microeconomics of banking, with a focus on four important topics: the theory of two-sided markets and its implications for the payment card industry; "non-price competition" and its effect on the competition-stability tradeoff and the entry of new banks; the transmission of monetary policy and the effect on the functioning of the credit market of capital requirements for banks; and the theoretical foundations of banking regulation, which have been clarified, although recent developments in risk modeling have not yet led to a significant parallel development of economic modeling. Praise for the first edition:"The book is a major contribution to the literature on the theory of bankingand intermediation. It brings together and synthesizes a broad range ofmaterial in an accessible way. I recommend it to all serious scholars andstudents of the subject. The authors are to be congratulated on a superbachievement." -- Franklin Allen, Nippon Life Professor of Finance and Economics, WhartonSchool, University of Pennsylvania "This book provides the first comprehensive treatment of the microeconomicsof banking. It gives an impressive synthesis of an enormous body ofresearch developed over the last twenty years. It is clearly written and apleasure to read. What I found particularly useful is the great effort thatXavier Freixas and Jean-Charles Rochet have taken to systematicallyintegrate the theory of financial intermediation into classicalmicroeconomics and finance theory. This book is likely to become essentialreading for all graduate students in economics, business, and finance." -- Patrick Bolton, Barbara and David Zalaznick Professor of Business, Columbia University Graduate School of Business "The authors have provided an extremely thorough and up-to-date survey ofmicroeconomic theories of financial intermediation. This work manages to beboth rigorous and pleasant to read. Such a book was long overdue and shouldbe required reading for anybody interested in the economics of banking andfinance." -- Mathias Dewatripont, Professor of Economics, ECARES, Universit

Microeconomics of banking

http://deepblue.lib.umich.edu/bitstream/handle/2027.42/39681/wp297.pdf?sequence=3

Corporate Governance in the Asian Financial Crisis

Contagion is a term used to describe the spillover of the effects of shocks from one or more firms to others, l It is widely considered to be both more likely to occur in banking than in other industries and to be more serious when it does occur. Bank (depository institution) contagion is of particular concern if adverse shocks, such as the failure or near-failure of one or more banks, are transmitted in domino fashion not only to other banks and the banking system as a whole, but beyond to the entire financial system and the macroeconomy. The risk of widespread failure contagion is often referred to as systemic risk. The potentially damaging aspects of bank failure contagion were among the major factors that led Gerald Corrigan, Former President of the Federal Reserve Bank of New York, among others, to conclude that banks and banking are unique and require government regulation (Corrigan, 1982, p. 9; Corrigan, 1987, p. 5; Corrigan, 1991-92, pp. 1-5). He argued that:

Bank contagion: A review of the theory and evidence

One of the most feared events in banking is the cry of systemic risk. It matches the fear of a cry of fire in a crowded theater or other gatherings. But unlike "fire," the term "systemic risk" is less clearly defined. Moreover, unlike fire fighters, who are rarely accused of sparking or spreading rather than extinguishing fires, bank regulators have at times been accused of, albeit unintentionally, contributing to rather than retarding systemic risk. This paper discusses the alternative definitions and sources of systemic risk, reviews briefly the historical evidence of systemic risk in banking, describes how financial markets have traditionally protected themselves from systemic risk, evaluates the regulations adopted by bank regulators to reduce both the probability of systemic risk and the damage caused by it if and when it may occur, and makes recommendations for efficiently curtailing systemic risk in banking. I Systemic Risk Systemic risk refers to the risk or probability of breakdowns in an entire system, as opposed to breakdowns in individual parts or components, and is evidenced by comovements (correlation) among most or all the parts. Thus, systemic risk in banking is evidenced by high correlation and clustering of bank failures in a country, a number of countries, or globally. Systemic risk may also

What Is Systemic Risk, and Do Bank Regulators Retard or Contribute to It?

In a developed economy, financial crises are rapidly conveyed to the payment system, which tends to rely on private credit extensions in most countries. While many authors recommend that the central bank do no more than provide adequate aggregate liquidity during a crisis, this policy requires well-functioning private credit markets to channel liquidity to solvent, but illiquid, firms. This paper presents a model of private lending which defines a crisis as a time when lenders become uncertain about how to assess financial risks and, therefore, rationally withdraw from making new loans. In such an environment, a government lender of last resort can improve social welfare. Copyright 1996 by Ohio State University Press.

Financial Crises, Payment System Problems, and Discount Window Lending

In both the industrialized and developing worlds, a distinctive feature of the last two decades has been prolonged buildups and sharp collapses in asset markets such as stock, housing, and exchange markets. The volatility has sparked intense debate in academic and policy circles over the appropriate monetary and regulatory response to dramatic market shifts.This book examines asset price bubbles to further our understanding of the causes and implications of financial instability, focusing on the potential of central banks and regulatory agencies to prevent it. The book grew out of a conference jointly sponsored by the Federal Reserve Bank of Chicago and the World Bank Group in April 2002.

Asset price bubbles : the implications for monetary, regulatory, and international policies

The appropriate role of bank regulation, or whether banks should be regulated at all, has long been a matter of controversy. Banks are the oldest and largest financial institution. Their liabilities serve as money, which distinguishes them from non-financial firms, for which government regulation is generally less pervasive and more limited. We believe that most of the arguments that are frequently used to support special regulation for banks are not supported by either theory or empirical evidence. We also argue that banks should be regulated prudentially only to reduce the negative externalities resulting from government-imposed deposit insurance. Banks are believed to be inherently unstable because they are structurally fragile. The perceived fragility stems from their maintaining low ratios of cash reserves to assets (fractional reserves) and capital to assets (high leverage) relative to their high short-term debt. But such fragility does not imply instability if depositors and bankers are aware of it and act appropriately. This appears to have been the case in most countries. In the United States, the bank failure rate was lower than that for non-banks from I 865 until the establishment in I9I3 of the Federal Reserve System. This occurred despite restrictions that prevented banks from diversifying geographically through branching. Ironically, the failure rate increased only after the establishment of a central bank that was intended to reduce the severity of bank crises. Before the United States had a central bank, banks themselves established private clearing houses, resembling the private central banks in other countries, to provide both prudential supervision and prevent abrupt local declines in the assets that served as bank reserves and money. Nevertheless, we take as given not only a government central bank, but also government-operated deposit insurance. Thus, we do not disagree greatly with Dowd's defence of free or laissez faire banking, but focus instead on how banks should be regulated in an existing non-laissez faire structure to achieve the best of both worlds.

George G. Kaufman

Papers

Bank contagion: A review of the theory and evidence

What Is Systemic Risk, and Do Bank Regulators Retard or Contribute to It?

Financial Crises, Payment System Problems, and Discount Window Lending

Asset price bubbles : the implications for monetary, regulatory, and international policies

The Appropriate Role of Bank Regulation