The Global Financial Crisis
and Developing Countries
Oxford Department of
UNDP HDR Course, St
Catherine’s College, Oxford
22 September 2008
1. What is happening on global
2. What does it mean for
3. What can be done from a human
What is happening on
global financial markets?
Origins of current financial crisis
• Since 1990s deregulation of financial markets: risk
pricing replaces prudential supervision. Rise of
derivative “assets” with opaque markets and few
players. Bank loans replaced by bonds etc.
• Huge US fiscal deficit, monetary expansion
(“Greenspan put”), low savings led to a US
mortgage boom/bust (non traded sector) and a
huge current account deficit (traded sector).
• Mortgage bubbles (e.g. 1992 in UK) are familiar with
obvious political costs; join recurrent bubbles in
past decade (dotcoms, LTCM, Tequila etc);
• But this is by far the most serious systemically
because it threatens the global banking system
itself as creditor, and whole US electorate as debtor.www.StudsPlanet.com
• Sub-prime lending had spread from inner-city
areas right across the US by 2005. By then,
one in five mortgages were sub-prime, and
they were particularly popular among recent
immigrants trying to buy a home for the first
time, and the poor.
• House prices were high, and it was difficult to
become an owner-occupier. But these
mortgages had a much higher rate of
repossession than conventional mortgages
(and thus much riskier) because they were
adjustable rate mortgages (ARMs). Payments
were fixed for two years, and then became
higher and linked to Fed interest rates, which
also rose substantially.
• A wave of repossessions is sweeping
America as many of these mortgages
reset to higher rates. By late 2007, one
in ten homes in Cleveland had been
repossessed and Deutsche Bank Trust,
acting for of bondholders, was the
largest property owner in the city.
• As many as two million families will be
evicted from their homes as their cases
make their way through the courts. The
Bush administration is pushing the
industry to renegotiate, but mortgage
companies are being overwhelmed by
a tidal wave of cases.
Scale and Spread
• Collapse of the government backed
mortgage system in the USA (Fannie and
Freddie) followed by meltdown of major
investment banks (Lehman, Bear, Merrill)
exposed to mortgage market
• Mark-to-market asset pricing effects on
balance sheets and cumulative liquidity
retraction due to rising risk aversion;
• Now affecting Insurance (AIG) ; and
pensions funds next?www.StudsPlanet.com
Global mortgage boom and bust
The end of the stock market boom
Financial Times, 20 Sept 2008
• “…bank boards and bank executives have
failed to understand complex mortgage-
backed banking products, as have central
bankers, regulators and credit rating
• “…a reward system that has granted huge
bonuses to those who peddled toxic
• “Almost as absurd has been the degree of
leverage racked up by investment banks.”
• “There are no atheists in foxholes and no
ideologues in financial crises,” Mr. Bernanke told
• Freddie Mae and Freddie Mac (re)nationalised;
Merrill sold to BankAmerica; Lehman to Barclays;
Goldman and Morgan become banks again; US
govt $700bn purchase of bad debt; G3 central
banks support world banking.
• Expansionary monetary policy (to avoid recession
like 1930s) and scale of US Govt (and G3) bailouts
will have large repercussions, yet to be evaluated
[lessons of Mexico etc?]www.StudsPlanet.com
Scale of the potential bailout
(already up to $850bn)
What does it mean for
Growth and trade
• World GDP growth already projected by IMF to
slow down by 2 % points (from 5 to 3 for 2008
and 09); probably more. So with 2% world
growth; global GDP per capita falls
• Asia probably most resilient (though exports to
US will fall); LA will slow down, Africa recession?
• Commodity prices declining already; volumes
too. Natural resource exporters will be hit; food
and oil importers to benefit.
World growth will slow, reducing
trade expansion etc.
An end to the commodity boom?
Investment and aid
• International investment (bonds, FDI) will
slow down; as will emerging market
stocks; as global confidence declines
• Sovereign spreads will rise due to rising
risk premium (default probability x risk
aversion): already up to 4%.
• Aid flows already under pressure; will be
hurt by fiscal overload in G3.
S&P 500 vs Emerging Markets Index
Unsurprisingly, G3 market
expectations are bad
Recent ODA rise will be difficult to
Poverty and human development
• MDG goals even less likely to be met
(growth and aid are main drivers)
• Limitations of family support (Asia), few
universal benefits (LA) and narrow safety
nets (Africa): effect on poor
• Previous crises increased inequality,
which remains even when growth recovers
• Commodity price reverse will change
lottery of winners and losers
What can be done from a
Proactive macroeconomic policy
• Countercyclical monetary policy and real
exchange rate management (inc. capital
– MICs with forex reserves already do this;
– but LICs constrained by IMF.
• Support domestic banks (esp for agriculture and
SMEs), underwrite longterm investment lending;
keep real interest rates low.
• Raise tax pressure (not rates) to maintain fiscal
balance and reduce public borrowing.
HD strategy for difficult times
• Evidence (UNICEF) that for children
employment stability more important than
wages; implications for e.g. inflation policy
• Essential to ringfence budgets (in real terms)
for education and health; extend schemes for
(simple) universal benefits.
• Focus on inequality (especially horizontal)
rather than just poverty; to reduce conflict
and increase social cohesion.
International action and the “duty to
• Essential to moderate G8 policy shifts (e.g.
bank regulation, interest rates, exchange
rates) from viewpoint of impact on world poor.
• Need for UN to speak in a clear, timely and
credible fashion on these issues (TDR08
good, UN/DESA etc silent)
• Regional arrangements for mutual currency
support etc are vital (Asia progressing; LA
talking; Africa nothing). Role for sovereign