Larry Allen - The Global Economic Crises A Chronology

Larry Allen’s The Global Economic Crises A Chronology is book that resolves around how the growing strength of speculative forces deepend the global financial crisis that began unfolding toward the end of 2007 as written on overview. He firstly discourse Japanese Miracle, Financial Revolution and Housing Market because we need know the reasons behind the ecomomic crises before talking about the global banking and financial crises. Outstandig issues can be summarized in these chapters; In Japan, there was some restrictions until early 1970’s; Plaza Accord Agreement about depreciation of the dollar for all that Japan took steps to protect its growing economy from a weaker dollar; since house is non-tradable good, the price of houses is free to move up according to George’s theory of business cycles; higher correlation between money supply growth and house price; the full width and depth of the movement toward financial deregulation and innovation so these factors led to national economies less able to intelligently and resiliently assimilate external shock. When we bring all these pieces together, we can better understand the causes of the economic crisis.

I think the most crucial chapter of this book is Global Banking and Financial Crises as we can understand from the name and purpose of the book. We easily see how savers and investors embraced higher risk levels to preserve rates of return in the face of falling interest rates. Then investors found some financial intermediaries such as “Hedge Funds” which are more riskier than other investments and sufficiently private in ownership and partnership to enjoy exemption from most goverment regulations. Structured investment vehicle were often called “conduits” and become what was collectively called the “shadow banking system”. As Bill Gross, founder of Pimco, said “this banking system has lain hidden for years, untouched by regulation, yet free to magically and mystically crate and the package subprime loans into a host of three latter conduits that only Wall Street wizardly could explain.” The main problem of economic crises in 2008 was rising price in house market. As I said above, from 2001 to 2004 very short term interest rates were too low and because of that situation investors was turning to invest in houses with mortgage backed securities. The advantage of investment in house market had leaded supply of loan to subprime layers increased. The problem began with default in these loans. Banks siezed the houses which were shown as collateral by subprime layers. The increasing number of houses seized is bring about that the supply of houses increased. In the same environment, nobody wanted to give credit to subprime layers so the demand of houses decreased. Both decreasing in demand and increasing in supply engendered the falling price of houses correspondingly the assets of banks sharply decrased. As a result banks entered into a liquidity squeeze, confidence in financial markets diminished and the crisis erupted.

I think by applying expansionary monetary policy to keep interest rates low between the years 2001-2004 and by increasing interest rates after 2004 when the credit expansion is intense, there was some wrong policies followed by FED. In addition to these wrong policies -to my way of thinking- , since the second half of 2007 primarily Fed and other central banks such as Europe, Canada, Japan have injected massive amounts of liquidity into the market to overcome the liquidity shortage. This move was necessary but it was not a remedy to solve the crises because money injection could not bring a solution to the problems in housing market which lies at the root of the crises and could not replace the capital of financial institutions which was melting in the process. Surely the another important precaution could be get to grips with problem of default risk. Restructuring of loans and forestalling to usurp houses could be targeted. In this way downward pressure force of house’s price could be diminished. But it was pell mell structure. So perhaps I’d mentioned above could not be done.