10 papers on the ongoing crisis you must read



A year ago the world fell of a cliff. Lehman Brothers filing for bankruptcy was only the last straw in the long-drawn credit crisis that began a few years earlier. In this post, I present some papers that have analysed this crisis and ushered in a new world order. What is this new world order?

“It is about marrying an entity called risk, through a ceremony called globalisation, in which man and nature tango on the still waters of stability, predictability, security. Anyone — least of all economists but equally politicians, businessmen and scientists — who believes that an unstable financial world will vanish once governments across the world find fiscally-debilitating parachutes after the world fell of the financial cliff following Lehman’s bankruptcy, is living in a past that’s never going to return.”

Meanwhile, here are 10 papers I found useful while tracking this crisis.

The political economy of the subprime crisis: Why subprime was so attractive to its creators by Peter L. Swan. The author in this paper shows that the crisis is not an accident. “All the major parties responsible for the crisis appear to have gained something from what transpired, at least in the short-run. Moreover, it seems to have been as much, if not more, a failure of government and its agencies inclusive of regulators as much as any failure of capitalism. Finally, the apparently arbitrary, if not self-interested, bank bailouts seem to indicate that governments are likely to directing bank policy for some time.” He leaves us with a question: “Are politicians in what has become, effectively, a socialised banking system, the best people to be setting bank lending policies and making investment decisions on citizens’ behalf?”

Regulation and the Role of Law in Economic Crisis by Ioannis Glinavos. In this short and crisp paper, Glinavos highlights the persistence of market centred theories that defined the state market relationship before the crisis. I particularly liked the short introduction to regulation. It then goes on to explore how capitalism has been shaken by the credit crisis. The paper then suggests that “while the current financial crisis has shown the limitations of modern capitalism, and while it is possible that a fundamental rethink of the role of the state in the market may take place as a consequence, this rethink has not yet materialised in policy proclamations and government aspirations on a global scale.”

Return of the State? The G20, the financial crisis and power in the world economy by Donald Nordberg. This paper looks at the G20 and the emerging new world order it is attempting to bring. He brings out the cultural differences within G20 like French President Nicolas Sarkozy bemoaning the “influences of ‘Anglo-Saxon capitalism’ and from neo-Marxists, who view the economic crisis as a harbinger of the resurgence of states over markets. A little over a decade ago, however, the late doyenne of international political economists, Susan Strange, wrote eloquently about the reasons why the state was in retreat, its structural power draining away in favour of markets. Have the intervening dozen years, with their recurrent crises in markets and corporate governance, demonstrated the need for a return of the state? This analysis of the G20 London communiqué, the G20 signifies its persistent weakness and concludes that the G20 leaders, at least, sense a more complex network of power relationships, and that structural power rests in the network.”

The Political Economy of Global Finance Capital by Richard Deeg Mary A. O’Sullivan. This is essentially a review of six books — Capital Rules: The Construction of Global Finance by Rawi Abdelal; Political Power and Corporate Control: The New Global Politics of Corporate Governance by Peter Gourevitch and James Shinn; Playing the Market: A Political Strategy for Uniting Europe, 1985-2005 by Nicolas Jabko; Monetary Orders: Ambiguous Economics, Ubiquitous Politics, edited by Jonathan Kirshner; The New Masters of Capital: American Bond Rating Agencies and the Politics of Creditworthiness by Timothy Sinclair; Moving Money: Banking and Finance in the Industrialized World by Daniel Verdier.

This Time is Different: A Panoramic View of Eight Centuries of Financial Crises by Carmen M. Reinhart and Kenneth S. Rogoff. In this paper, the authors take a very long-term view of the history of financial crises from 14th-century British default to the current United States sub-prime financial crisis. “Our study,” the authors say, “is based on a new dataset that spans all regions. It incorporates a number of important credit episodes seldom covered in the literature, including for example, defaults and restructurings in India and China. As the first paper employing this data, our aim is to illustrate some of the broad insights that can be gleaned from such a sweeping historical database. We find that serial default is a nearly universal phenomenon as countries struggle to transform themselves from emerging markets to advanced economies. Major default episodes are typically spaced some years (or decades) apart, creating an illusion that ‘this time is different’ among policymakers and investors. A recent example of the ‘this time is different’ syndrome is the false belief that domestic debt is a novel feature of the modern financial landscape. We also confirm that crises frequently emanate from the financial centres with transmission through interest rate shocks and commodity price collapses. Thus, the recent US sub-prime financial crisis is hardly unique. Our data also documents other crises that often accompany default: including inflation, exchange rate crashes, banking crises, and currency debasements.”

The Aftermath of Financial Crises by Carmen M. Reinhart and Kenneth S. Rogoff. The authors examine how long a crisis lasts. “We find that asset market collapses are deep and prolonged. On a peak-to-trough basis, real housing price declines average 35 per cent stretched out over six years, while equity price collapses average 55 per cent over a downturn of about three and a half years. Not surprisingly, banking crises are associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls an average of over 9 per cent, although the duration of the downturn is considerably shorter than for unemployment. The collapse in tax revenues in the wake of deep and prolonged economic contractions is a critical factor in explaining the large budget deficits and increases in debt that follow the crisis. Our estimates of the rise in government debt are likely to be conservative, as these do not include increases in government guarantees, which also expand briskly during these episodes.”

The Subprime Panic by Gary B. Gorton is a slightly technical paper that gets behind the panic in the crisis. “Understanding the ongoing credit crisis or panic requires understanding the designs of a number of interlinked securities, special purpose vehicles, and derivatives, all related to subprime mortgages. I describe the relevant securities, derivatives, and vehicles to show: (1) how the chain of interlinked securities was sensitive to house prices; (2) how asymmetric information was created via complexity; (3) how the risk was spread in an opaque way; and (4) how trade in the ABX indices (linked to subprime bonds) allowed information to be aggregated and revealed. These details are at the heart of the origin of the Panic of 2007. The events of the panic are described.”

What’s Wrong with Executive Compensation? By Jared Harris. The author explores the question by examining several common criticisms of CEO pay through both philosophical and empirical lenses. “While some criticisms appear to be unfounded,” he writes, “the analysis shows not only that current compensation practices are problematic both from the standpoint of distributive justice and fairness, but also that incentive pay ultimately exacerbates the very agency problem it is purported to solve.” I found strands of Amartya Sen’s The Idea of Justice here.

Why Did Some Banks Perform Better During the Credit Crisis? A Cross-Country Study of the Impact of Governance and Regulation by Andrea Beltratti and René M. Stulz. In this July 2009 paper, the authors show how after accounting for country fixed effects, “banks with more loans and more liquid assets performed better during the month following the Lehman bankruptcy, and so did banks from countries with stronger capital supervision and more restrictions on bank activities.”

Ulrich Beck, Globalization and the Rise of the Risk Society: A Critical Exegetic Analysis by D.S.L. Jarvis. In this paper, Jarvis examines the work of Beck who said that mankind is no longer concerned exclusively with making nature useful, or with releasing mankind from traditional constraints. Genuine material needs, he notes, has “been objectively reduced and socially isolated through the development of human and technological productivity, as well as through legal and welfare-state protections and regulations.”

This is a list of 10 out of more than 400 papers that have, in their own ways, attempted to explore this crisis. This list is neither comprehensive nor the best. Just papers I found insightful while trying to decode this highly-complex phenomenon that we will all have to learn to live with.

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