May, 2013 Archives


The 2008 Global Financial Crisis – A Political Economy Analysis Using Minsky’s Financial Instability Hypothesis

by Riaan Nel in News

Here is my updated Chapter 1 of my thesis.  Feel free to comment.

“…the credit crunch of 2007, the financial crash of 2008 and the recession of 2009 are all aspects of a much wider crisis…This crisis can be viewed from a number of perspectives: as a crisis of the banking system, as a crisis of regulation, as a crisis of the continued hegemony of the United States over the global economy and the political crisis of the legitimacy of the global order.  Taken together these add up to … the idea of a crisis of capitalism” (Gamble, 2009:42)

On Thursday, August 9, 2007, traders in the international money markets in New York, London and other prominent financial centers experienced a sudden and dramatic surge in interest rates for overnight and term interbank loans.  On Friday, August 10th the Federal Reserve Bank of New York infused the market with liquidity resulting in a decline of the overnight rate, but interbank term rates increased even more.  It was as if term lending for Libor one- and three-month rates became disconnected from the overnight rate.[1]  Banks all of a sudden demanded more liquidity or did not want to lend to one another.  The immediate spark igniting the surge in interbank rates was the announcement on August 9th by French bank BNP Paribas that it froze $2.2 billion in three of its investment funds.  The reason was due to an inability to determine the value of the underlying securities after suffering severe losses the preceding two weeks. This unsettling event followed on the heels of the announcement the previous month by US investment bank Bear Stearns that two of its subprime mortgage hedge funds lost almost all of their value.[2]  The cause of these losses and uncertainty was the increasing delinquencies and defaults on subprime mortgage loans in the United States – mortgage loans that have been securitized and were owned by investment funds and banks all over the world.   This surge in interbank term rates was the beginning of a global financial crisis that resulted in what many now refer to as The Great Recession.

 It is the aim of this study to explain the causes of the 2008 global financial crisis from a political economy perspective.[3]  This chapter will review the background, historical context and importance of the crisis. I will formulate a specific research question that will guide the study, offer an explanatory hypothesis regarding the crisis, and outline the theoretical framework within which the crisis will be analyzed. Issues of ontology will be addressed, as well as a discussion of the delimitations and limitations of the study.  Lastly the structure of the study will be outlined.

1.1        Background and Importance

The period of time between 1987-2007 is known as the Great Moderation.  This refers to a trend of reduced volatility in business cycle fluctuations in the advanced economies.  It was an extended period of impressive economic growth that was attributed to free-market economic policies and globalization.  As Casey (2011) notes, post-war economic history began with the Long Boom – 30 years of full employment and unparalleled economic growth.  This period was characterized by Keynesian macro-economic policies and the creation of the social welfare state in the developed world.  When an economy was in recession Keynesian theory recommended spending; however, many advanced economies, specifically the US, found it hard to stop spending in good times.  Increased government spending, especially US spending to finance the Vietnam war, led to higher prices, and lower productivity and profits.  The Long Boom’s end coincided with the oil crisis in the early 70’s as well as the end of the Bretton Woods global monetary arrangement in 1971 when Nixon ended gold convertibility.  The Western world entered an era of stagflation.[4]  Governments tried to intervene with more spending which just fueled the inflationary spiral.  The Keynesian approach came into disrepute, opening the door for the rise of neoliberalism.  Reagan and Thatcher were at the vanguard of a switch from a state led global political economic system to a market led system.  Gamble refers to this newly emerging system as the financial growth model.

“This new financial growth model used tax cuts to stimulate the economy, and it promoted privatization of public assets and deregulation of the private sector, particularly the financial sector. It sought to expand credit, not restrict it, and to enlist the financial sector as the most important driver of growth and competition in the economy. It led to the rise of the investment banks and the rating agencies to their commanding position in the global economy at the beginning of the twenty-first century, and the proliferation of new financial vehicles and instruments, a readiness to ‘leverage’ every asset whether in the public or private  sector, and to make all citizens and organizations ‘financial subjects’ “ (Gamble,   2009:15).

The Great Moderation coincided with the end of the cold war, reforms in China, increased globalization, and the dominance of monetarist free-market economic theories, fueling an unprecedented economic boom largely driven by new technologies and increased productivity in the US.  With communism discredited, capitalism became the dominant global system.  From Southeast Asia, India, Eastern Europe, China and Latin America, nations competed to attract investment capital.  Even though there were peripheral financial crises, the financial growth model became widely adopted.[5]  One of the most salient characteristics of the Great Moderation was globalization – the increasingly close integration of national markets.  Cohen (2008:79-80) refers to  globalization as a fundamental transformation of economic geography.  In place of territorially distinct economies we now have a more unified global marketplace.  Production processes and financial markets are transcending space, with economic networks spreading without regard for distance or borders.  Transaction times are being compressed, and relations are growing more and more intense, deepening linkages. The global integration of finance through electronic interconnectivity, facilitated unrestricted capital flows and speculative investments.  The financial sector grew disproportionately large compared to other industries.  More and more complex and innovative financial vehicles were being created, blessed by the regulators in the US as instruments that will decrease risk by spreading it throughout the system.  As prosperity continued to spread to hitherto underdeveloped areas, large financial institutions started using leverage and securitization to create astonishing wealth for their organizations.    As mentioned there were economic and financial crises during the Great Moderation, but they were easily contained without any major setbacks for global growth.  This all came to an abrupt and dramatic end one fateful weekend in September 2008 (Casey, 2011).

The crisis manifested in the global money markets which represent the first stage of the monetary transmission channel where monetary policy connects with the financial system and the global political economy.  Term money market rates, like the 3-month Libor, influence a host of rates throughout the economy, and poorly functioning money markets impinges on the availability and cost of credit to businesses and households in the global economy (Taylor & Williams, 2008:1). The three-month Libor Overnight Index Swap (OIS) for August 2007 dramatically illustrates the extent of the developing crisis.[6] The three-month Libor-OIS spread is a measure of what the markets expect the US federal funds rate to be over a three-month period compared to the three-month Libor.[7] The Libor-OIS spread is used to indicate those factors, other than interest rate expectations, that influence interbank rates, such as risk and liquidity (Taylor, 2009:15). Historically, the spread on average was 11 basis points, but on August 9, 2007, the spread surged to 34 basis points, fluctuating wildly between 30 basis points and a maximum of 106 basis points over the following months (Taylor & Williams, 2008:10-11) (see Figure 1).

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When Will QE End?

by Riaan Nel in News

Tim Duy’s Bottom Line on all the recent Fed announcements, I can’t agree with him more:  Assuming current data holds, the beginning of the end of QE is coming.  But not immediately.  Maybe three meetings out in September assuming that the impact of fiscal drag remains largely contained to the GDP data.  The Fed does not want us to jump to conclusions about future policy moves based on that initial shift.  But I am hard-pressed to see a forecast that would allow for up-and-down moves once the Fed pulls the trigger.  Up-and-down moves cannot be their expected policy path.

To read Tim’s post:


The Market Can’t See The Froth For All The Bubbles

by Riaan Nel in Global Investments

Great article by John Hussman about the relationship between the height of the equity markets and actions by the Federal Reserve:

…As in 2000, and as in 2007, it is not necessarily the case that stocks will decline immediately. Still, the percentage of bearish investment advisors reported by Investors Intelligence has declined to just 18.6%, from 18.8% the week earlier. The last times that bearish sentiment was below 20%, at a 4-year market high and a Shiller P/E above 18 … were for two weeks in May 2007 with the S&P 500 about 1525, two weeks in August 1987, and 3 weeks of a 5-week span in December 1972 and January 1973, which was immediately followed by a 50% market plunge. Still, a handful of observations in March-May 1972 preceded the late-1972 peak and were followed by a modest further advance, and that lag is enough to discourage any near-term conclusions in the present instance. To complete the record, the instance before that was in February 1966, which was promptly followed by a bear market decline over the following year.