5/8˝ text bulk Praise for continued from front flap “Insightful, far-ranging, and complete, yet still manages to be a lot of fun to read.” — Robert J Shiller, Yale University “Students keep asking me: where can I read about the financial crisis and what we are—or are not—doing about it? Without putting together a reading list of twenty to thirty items, there aren’t many good answers Padma Desai’s new book, which is at once comprehensive and brief, remedies that.” —Alan S Blinder, Princeton University, former Vice Chairman of the Board of Governors of the U.S Federal Reserve Padma Desai is the “There are an abundance of books by journalists providing an insider’s chronology of events Yet there are few books that step back and provide an analytical perspective on the financial meltdown and the Great Recession That is the great service Padma Desai provides in this book.” Christopher Butt Gladys and Roland Harriman Professor of Comparative Economic Systems and director of the Center for Transition Economies at Columbia University She has served as president of the Association for Comparative Economic Studies and as advisor to the Russian Finance Ministry for the U.S Treasury She is the author of Conversations on Russia and Financial Crisis, Contagion, and Containment: From Asia to Argentina —George A Akerlof, University of California, Berkeley, and Nobel Laureate in Economics —Douglas A Irwin, Dartmouth College, author of Peddling Protectionism: Smoot-Hawley and the Great Depression “Padma Desai provides a very wise and thoughtful account of the origins of the financial crisis, the prospect and policies for recovery, and the future of national and international economic management She also draws very effectively on her great experience and distinction as a scholar of economic transformation, economic history, and international economics.” Columbia Desai From Financial Crisis to Global Recovery From Financial Crisis to Global Recovery and South America, and the extent and value of U.S and E.U regulatory proposals Refocusing on American financial practices, Desai evaluates hedge funds and derivatives, credit default swaps, and rating agencies, pondering whether the dollar can remain a reserve currency She concludes with a historical comparison of the Great Depression and the Great Recession, weighing the effect of the economic collapse on the future of American capitalism “Padma Desai explains the World Financial Crisis in human terms In every chapter she associates the abstract principles of economics with stories about real people in real situations These stories focus on who was making what decisions and when and why they were made It is what we need to understand the crisis.” —Nicholas Stern, London School of Economics and former Chief Economist of the World Bank University Jacket illustration: Reinhard Blumenschein info@blumenschein.com Jacket design: Lisa Hamm Press l ISBN: 978-0-231-15786-5 52750 New York cup.columbia.edu From Financial Crisis to Global Recovery Padma Desai $27.50 “Padma Desai provides a wide-ranging analysis of the economic problems of the past decade and the prospects for the future of the global economy She brings the unique perspective of someone who has taught in the United States for decades but also is deeply rooted in her native India and the developments in the Soviet Union and Russia, the focus of her academic research.” —Martin Feldstein, Harvard University, President Emeritus of the National Bureau of Economic Research and former chief economic advisor to President Reagan I n this book, Padma Desai makes the complexities of economic policy and financial reform accessible to a wide audience Merging a compelling narra tive with scholarly research, she begins with a systematic breakdown of the factors leading to America’s recent recession, describing the monetary policy, tax practices, subprime mortgage scandals, and lax regulation that contributed to the crisis She also discusses the Treasury-Fed rescue deals that saved several financial institutions and the involvement of Congress in passing restorative policies Desai follows with an analysis of stress tests and other economic measures, and she frankly assesses whether the U.S economy is truly on the mend Expanding her view, she considers the prospects for recovery in North America as a whole, as well as in Europe, Asia, continued on back flap 780231 157865 printed in the u.s.a Columbia Jacket: Desai, From Financial Crisis to Global Recovery Contact: Lisa Hamm Columbia University Press 212 459-0600 x 7105 trim: x 4-color process only gloss lam All art is live and in position FROM FINANCIAL CRISIS TO GLOBAL RECOVERY FROM FINANCIA L CRISIS TO GLOBAL REC OV E RY Padma Desai C O LUM B IA U N I V E R SI T Y P R E S S N EW YO R K Columbia University Press Publishers Since 1893 New York Chichester, West Sussex Copyright © 2011 Columbia University Press All rights reserved Library of Congress Cataloging-in-Publication Data Desai, Padma From financial crisis to global recovery / Padma Desai p cm Includes bibliographical references and index ISBN 978-0-231-15786-5 (cloth : alk paper)—ISBN 978-0-231-52774-3 (ebook) Global Financial Crisis, 2008–2009 Financial crises—United States Recessions—United States United States—Economic conditions—2009– United States—Economic policy—2009– I Title HB37172008.D472011 330.973—dc22 2011002617 Columbia University Press books are printed on permanent and durable acid-free paper This book is printed on paper with recycled content Printed in the United States of America c 10 References to Internet Web sites (URLs) were accurate at the time of writing Neither the author nor Columbia University Press is responsible for URLs that may have expired or changed since the manuscript was prepared For Martin Wolf The economics journalist of the day Contents Preface i x Financial Crisis Origin Banking Sector Stress Tests: United States Versus the European Union 21 Is the U.S Economy on the Mend? 45 Global Recovery Prospects: North America and Europe, Asia, and South America 80 Hedge Funds and Derivatives, Credit Default Swaps, and Rating Agencies 110 U.S and EU Regulatory Proposals: How Strict? How Cooperative? 127 The Dollar’s Future as a Reserve Currency 173 viii CONTENTS The Great Depression and the Current Financial Crisis 192 The Future of American Capitalism 214 Notes 35 Index 43 Pre f ac e The financial crisis has prompted a vigorous outpouring of books from economists, journalists, and financial commentators who have analyzed it from a variety of perspectives From beginning to end, they tell a complete story of why the American economy spiraled into a devastating financial mess, how the financial crisis evolved into a global phenomenon, and how policymakers sought to put out one fire before turning to the next one The economists stay away from a personalized narrative, stick with the economic features, explain them engagingly, and occasionally suggest an alternative policy framework that provides a more promising outcome The journalists create entertaining narratives around the decision making and the personalities involved in the process without providing an analytical model of the origin of the crisis and the policy handling The financial commentators s et out a r igorous analytical u nderpinning of t he t urmoil’s origin a nd its e volution, but w ithout explaining brain twisters such as over-the-counter derivatives and credit default swaps, which are beyond t he grasp of most economics students Even the difference bet ween quantitative monetary softening by t he Federal Reserve and discretionary easing via a change in the federal funds rate needs to be spelled out for beginners This book is different I have written it for my undergraduate students who plan to major in economics or financial economics I have also used 240 N OT E S Ibid., F436 Ibid Geoff Dyer and Jamil Anderlini, “Hopes Fade of Rapid Removal of Peg to U.S Dollar,” Financial Times, March 8, 2010, Paul Krugman, “Chinese New Year,” New York Times, January 1, 2010, A29 Ibid Alan Beattie and Jamil Anderlini, “Battle Lines Are Blurred in Dispute Over Renminbi,” Financial Times, April 6, 2010, Alan Beattie, “Geithner Turns Up Heat Over Renminbi,” Financial Times, September 17, 2010, 10 Steve LeVine and Dexter Roberts, “China Thinks Beyond the Dollar,” BusinessWeek, May 28, 2009, www businessweek com/ magazine/ content/ 09 _23/ b4134024721528 htm (accessed December 29, 2010) 11.Robert Triffi n, Gold a nd th e D ollar C risis (New Haven, CT: Yale University Press, 1961) 12 Ibid., 8–9 13 Ibid., 63 14 Ibid., 64 15 Ibid., The Great Depression and the Current Financial Crisis Richard M Ebeling, “Monetary Central Planning and the State, Part 3: The Federal Reserve and Price Level Stabilization in the 1920s,” Freedom Daily 87 (March 1997): 2 Milton Friedman and Anna J Schwartz, A M onetary H istory of th e U nited States, 1867–1960 (Princeton, NJ: National Bureau of Economic Research and Princeton University Press, 1963), 297 John Maynard Keynes, Treatise on Money (London: Macmillan, 1953), 258 Harold Bierman Jr., “The 1929 Stock Market Crash,” Economic History Ser vices, February 5, 2010, http:// eh n et/ encyclopedia/ article/ Bierman c rash (accessed December 29, 2010) Edward Teach, “The Bright Side of Bubbles,” CFO Magazine, May 1, 2007, www cfo com/ article cfm/ 9059304 (accessed December 29, 2010) John Kenneth Galbraith, The Great Crash 1929 (New York: Houghton Mifflin Harcourt, 2009), 11 R ichard L ambert, “ Crashes, B angs, a nd W allops,” Financial T imes, Ju ly 19, 2008, 22 Special to The New York Times, “President Hoover Issues a Statement of Reassurance on Continued Prosperity of Fundamental Business,” New York Times, October 26, 1929, Anonymous, “U.S Industrial Stocks Pass 1929 Peak,” New York Times, November 24, 1954, 12 N OT E S 241 10 Friedman and Schwartz, A Monetary History of the United States, 608 11 Ibid 12 Ben Bernanke, Essays on the Great Depression (Princeton, NJ: Princeton University Press, 2000), 41 13 Friedman and Schwartz, A Monetary History of the United States, 434 14 Christine Romer, The Economist, June 20, 2009, 82 15 Thomas F Cooley and Lee E Ohanian, “FDR and the Lessons of the Depression,” New York Times, August 27, 2010, A17 16 Ibid 17 Editorial, “FDR’s New Deal Prolonged the Great Depression,” Examiner, October 30, 2008, 18 Burton Folsom Jr and Anita Folsom, “Did FDR End the Great Depression?” Wall Street Journal, April 12, 2010, A17 19 Jean Edward Smith, FDR (New York: Random House, 2007), 250 The Future of American Capitalism Adam Smith, The Wealth of Nations (New York: Random House, 1937), 14 Ibid., 13 Ibid., 291 Ibid., 288 Ibid., 289–291 Ibid., 289 Ibid., 291 Ad am S mith, The Theory o f M oral Sen timents (E dinburgh: M illar, K incaid, and Bell, 1767), 282 George Akerlof and Robert D Shiller, Animal Spirits (Princeton, NJ: Princeton University Press, 2010), 10 J ohn M aynard Ke ynes, The G eneral Theory of E mployment, I nterest, a nd Money (New York: Harcourt, Brace, Jovanovich, 1964), 150 11 Ibid., 151–152 12 Ibid., 159 13 Ibid., 150 14 Robert Skidelsky, Keynes: The Return of the Master (New York: PublicAffairs, 2009), 86 15 Ibid., 88 16 J ohn M aynard Ke ynes, Essays i n P ersuasion (New York: W W Norton & Company, 1991), 321 17 Eric Dash and Nelson D Schwartz, “As Reform Takes Shape, Some Relief on Wall Street,” New York Times, May 24, 2010, B1 18 Ibid 19 Ibid 242 N OT E S 20 D avid E nrich, “ Studies Q uestion B ank C apital Fe ars,” Wall S treet J ournal, August 4, 2010, C1 21 Ibid 22 Ibid 23 Eric Dash and Nelson D Schwartz, “U.S Banks Aim to Turn Rules to Thei r Advantage,” New York Times, July 18, 2010, Index Abbott, Tony, 104 Abu Dhabi Investment Fund, Accurate Accounting of Fannie Mae and Freddie Mac Act (proposed), 13 Agricultural Adjustment Act of 1933, 204 AIG: bailout of, 16–18, 130; compensation restrictions for, 139; and credit default swaps, 117 American Express, 29, 30 American Insurance Group See AIG American Recovery and Reinvestment Act of 2009, 52 See also Stimulus package AmTrust Bank, 32 Angelides, Phil, Anti-dumping duties, 179 Argentina, recovery prospects in, 82–83 Asian economies: as economic leaders, 105; recovery prospects in, 100–105 See also specific countries Asset restructuring by banking sector, 27 Assets Supervision and Administration Commission of the State Council (SASAC, China), 102 Australia, recovery prospects in, 104 Auto financing, 42–43, 158 Bachus, Spencer, 13 Bafin (German regulator), 119–20 Bailouts: of AIG, 16–18, 130; banking sector implications of, 26–27; of Fannie Mae and Freddie Mac, 12; of Greece, 37, 39; and International Monetary Fund, 58; and moral hazard, 134–36 Bair, Sheila, 32, 229 Balance of payments, 191 Baltic states, recovery prospects in, 97–100 See also specific countries Bank for International Settlements (BIS), 34 244 Bank holding companies, 129–31 Banking Act of 1933, 131, 202–3, 230 Banking Act of 1935, 205 Banking sector: asset restructuring by, 27; bailout implications for, 26–27; capital adequacy in, 27, 155–56; in China, 103; in East Asia, 104; Financial Crisis Responsibility Fee levied against, 64–66; in market system of Adam Smith, 217–18; and recovery prospects, 108–9; response to new regulatory environment, 231–34; resurgence of major banks, 29–31, 75; in Russia, 98–99; stress tests for, 21–44; structure of, 129–32 See also Big banks; Credit markets; Small banks Bank of America: as bank holding company, 130; checking account services at, 233; compensation restrictions for, 139; credit card changes at, 232; and Financial Crisis Responsibility Fee, 64; Merrill Lynch takeover by, 18–19; stress test results for, 23–25; TARP repayment from, 29 Bank of Canada, 96 Bank of England, 96 Barclays, 29, 164 Barofsky, Neil, 16, 25 Basel Committee on Banking Supervision: capital requirements, 129, 132–34, 230; and EU regulatory proposals, 164, 165–67 BATS Trading, 121 Bear Stearns takeover by JPMorgan Chase, Beijing National Bureau of Statistics, 102 Bernanke, Ben: and Bear Stearns takeover, 9; on capital requirements, 133; and cash shortage, 8; on Federal Reserve’s regulatory role, 149–50; on Friedman, 206; and housing bubble, INDEX 7; and Merrill Lynch takeover, 18–19; and monetary policy signals, 59; on stress tests, 25; and TARP, 20; and tax cuts expiration debate, 75; on “too-big-to-fail” problem, 134, 161 Biden, Joe, 52 Big banks: bailouts and moral hazard for, 134–36; profit resurgence at, 29–31, 75; “too-big-to-fail” problem for, 131, 134, 161 Bilateral trade, 186 BIS (Bank for International Settlements), 34 Blankfein, Lloyd, 135 Blue Sky Laws, 203 Brazil: bilateral trade with China, 186; and dollar as reserve currency, 174, 182; recovery prospects in, 82–83, 106 Britain See Great Britain Brokertec, 121 Brown, Gordon, 94 Budget deficits: in EU, 81, 86–87, 89; in Great Britain, 94; during Great Depression, 205; and health care costs, 66–67; in Keynesian economics, 224–25; and tax cuts expiration debate, 71–74; in U.S., 60–67, 71–74, 205 Bush, George W., See also Tax cuts Business Cycle Dating Committee, 77 Byrd, Robert, 63 Cajas (regional savings banks), 35, 39 Canada, recovery prospects in, 96–97 Capital adequacy: in banking sector, 27; Basel Committee requirements, 129, 132–34, 230; Dodd-Frank Act requirements, 155–56; and EU regulatory proposals, 164; Federal Reserve guidelines, 132–33; for hedge funds, 112; postponement of higher reserves requirement, 229–30 See also Stress tests INDEX Capitalism, 214–34; Keynesian economics, 220–25; market system of Adam Smith, 216–19; and regulatory environment, 225–34 Capital Purchase Program, 21 Carried-interest tax, 111 Cash-for-clunkers program, 46, 54 CCP (Central Counter Party), 167 Center for Public Integrity, 3, Central Bank of Russia, 98 Central Bank of Spain, 36 Central clearing for derivatives, 115, 231–32 Central Counter Party (CCP), 167 CFTC See Commodity Futures Trading Commission Checking accounts, 233 Chile, recovery prospects in, 82–83, 106 China: bilateral trade with Brazil, 186; and dollar as reserve currency, 174, 184; recovery prospects in, 77, 79, 82, 102–3; renminbi revaluation in, 175–82; savings flow from, 2–3, 173; stimulus package in, 54, 102, 178 Chi-X Europe, 121 Chrysler, 139 Circuit breaker system, 125 CIT Group, 32–33 Citigroup Inc.: as bank holding company, 130; and cash shortage, 8; compensation restrictions for, 139; credit card changes at, 232–33; and Financial Crisis Responsibility Fee, 64; as futures commission merchant, 156; stress test results for, 23–25; TARP repayment from, 30 Civil Works Administration, 205 Clawback provisions, 169 CMBS (commercial mortgage-backed securities), 43 CoCo (contingent convertible) bonds, 133 Colombia, recovery prospects in, 82–83 24 Commercial banks: in banking system structure, 129–31; and Federal Reserve’s regulatory role, 148; and Glass-Steagall Act, 203; and Great Depression, 200; interest on reserves held by, 59; and “too-big-to-fail” problem, 134 Commercial mortgage-backed securities (CMBS), 43 Committee of European Banking Supervisors, 38 Commodity Futures Trading Commission (CFTC): and derivatives regulation, 142, 148, 149, 152, 156–57; and “flash crash,” 125–26; regulatory role of, 225; and shareholder participation rules, 227 Commodity trading, 29, 75, 111 Community banks, 145, 147, 159 See also Small banks Compensation See Executive compensation Comptroller of the Currency, 147, 153 Congress: and AIG bailout, 18; House Financial Services Committee, 135, 141–43, 146–47; and TARP, 19–20; and tax cuts expiration debate, 63 See also specific legislation Congressional Budget Office, 54, 72 Conrad, Kent, 72 Construction industry: in Britain, 95; in China, 104; and housing market, 35, 50 Consumer confidence, 48, 50, 59 Consumer Financial Protection Agency, 146–47, 153 Consumer Financial Protection Bureau, 158–59, 161, 211, 230–31 Consumer price index (CPI), 47, 79, 180 Consumer protection: banking sector response to new regulatory environment, 232–34; credit card regulations, 144–45, 146, 226, 232–33; 246 Consumer protection (continued) and Federal Reserve, 144, 145; mortgage regulations, 144, 146, 158, 226, 233–34; regulatory proposals for, 144–47; and small banks, 158–59 Consumption spending: in China, 102; and consumer debt, 75; as GDP component, 47–48; in Germany, 89 Contingent convertible (CoCo) bonds, 133 Cooper, Jim, 71 Core capital, 132–34 Corporate social responsibility, 227 Corruption, 91 Counterparty risks, 133, 167 Cox, Chris, 20 CPI See Consumer price index Credit Card Act of 2009, 144 Credit cards: consumer protection regulations for, 144–45, 146, 226, 232–33; debt eligible for TALF, 43 Credit default swaps, 116–17, 120 Credit markets: auto financing, 42–43, 158; business lending, 21, 46, 50, 77; and federal funds rate, 56; interbank lending, 34–35, 46, 56, 59; and recovery prospects, 45–46 Credit standards, 9–10 Credit Suisse, 29, 39, 156 Cuomo, Andrew, 19 Currency markets See Foreign exchange trading Currency swaps, 58, 92 Dark pools, 123–25 Darling, Alistair, 168 Defense spending, 72 Deflation: during financial crisis, 50–51; during Great Depression, 194, 198, 202, 210 De Gaulle, Charles, 86 Denmark, recovery prospects in, 81, 95, 96–97 INDEX Derivatives, 112–16; and banking sector response to new regulatory environment, 231–32; Chinese investments in, 102; Dodd-Frank Act provisions for, 156–57; EU regulatory proposals for, 167–68; and Lehman Brothers collapse, 15–16; regulatory proposals for, 141–44, 152 Deutsche Bank, 29, 119, 137, 164 Dimon, Jamie, 231 Direct Edge, 121 Discount rate, 46, 56, 59 Dodd, Christopher, 118, 127–28, 148, 228 Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010: assessment of, 160–63; on derivatives, 116; on hedge funds, 112; passage of, 45, 128; provisions of, 154–60; on rating agencies, 118 Dollar: and gold standard, 185, 196; as reserve currency, 184–87, 190–91; volatility of, 187–89 Donaldson, William, 137 Double-dip recession, 76–79 Durable goods orders, 47, 79 East Asian economies: recovery prospects in, 103–5 See also specific countries Eastern Europe: recovery prospects in, 97–100 See also specific countries ECB See European Central Bank Economic and Monetary Union (EMU): background to, 85; creation of, 86–87; and Greek budget crisis, 90–91; recovery prospects in, 81, 84–89 EFSF (European Financial Stability Facility), 91–92 Elliot, Douglas J., 229 Employment, lagging recovery in, 67–71 See also Unemployment EMU See Economic and Monetary Union INDEX Energy sector, 99 England See Great Britain Equity participation notes, 16 ESpeed, 121 Estonia, recovery prospects in, 81, 97 European Central Bank (ECB): balance sheet assessment by, 40–42; and Greek sovereign debt crisis, 37–38, 39; and inflation, 96; and monetary policy, 33–34, 87–88; and recovery prospects, 81 European Commission, 163 European Financial Stability Facility (EFSF), 91–92 European Systemic Risk Board, 171 European Union (EU): background to, 85; banking sector cleanup debate, 35–36; banking sector problems, 33–35; enlargement of, 86–87; and European Financial Stability Facility, 92; problem assets exposure of, 34–35; recovery prospects in, 84–89; regulatory proposals in, 129, 163–72; stress tests in, 22, 36–40 Eurozone: bank fi nancing of private sector in, 163; monetary policy in, 87–88; problem asset exposure in, 34; recovery prospects in, 81; stress tests in, 22 Executive compensation, 138–41; Dodd-Frank Act provisions for, 160, 161; EU regulations on, 164–65, 168–69; regulatory proposals for, 151; and TARP, 27–28 Exports: from China, 2, 181; from Japan, 101; and recovery prospects, 47, 77, 97, 101, 109; and renminbi valuation, 181 Fannie Mae: Federal Reserve acquisition of mortgages from, 57–58; loan modification programs of, 11–13; reform of, 13–15; Treasury takeover of, 9–15 247 FCMs (futures commission merchants), 156 Federal Deposit Insurance Corporation (FDIC): and bank holding companies, 131; creation of, 202, 210; regulatory role of, 147; role of, 130; and small bank failures, 21–22, 31–33; and stress tests, 27 Federal funds rate, 3, 42, 46, 56 Federal Housing Finance Agency, 12 Federal Open Market Committee (FOMC), 51, 205 Federal Reserve: and AIG bailout, 16–18; bailout implications for, 26–27; capital requirement guidelines, 132–33; and cash shortage, 8; and consumer protection rules, 144, 145; currency swap facilities, 92; and dollar volatility, 188; emergency lending facilities, 130; and Great Depression, 196–98, 205–6, 210; and inflation, 96; and monetary easing, 56–60; monetary policy signals by, 42, 46, 58–60; monetization of government debt, 57–58; mortgagebacked securities acquired by, 57–58; problem asset disposal by, 41; regulatory role of, 147, 148–50, 153–54, 161, 225; and stress tests, 21; and TALF, 22, 42–43 See also Monetary policy Feinberg, Kenneth, 139, 140 Fiduciary standard, 158 Fifth Third Bank of Ohio, 233 Financial Crisis Inquiry Commission, 6–7 Financial Crisis Responsibility Fee, 64–66 Financial Services Authority (U.K.), 167, 169 Financial Stability Oversight Council, 151, 154 Fisher, Irving, 199 248 Fitch Ratings, 117, 118 “Flash crash” (May 6, 2010), 125–26 Flash orders, 122–23 FOMC (Federal Open Market Committee), 51, 205 Ford, Henry, 204 Foreclosures, 1, 9, 10, 13–15 Foreign exchange trading: and big bank profit resurgence, 29; by Central Bank of Russia, 98; and derivatives, 113; and hedge funds, 111; in India, 103; and liquidity crunch, 84 See also Dollar; Renminbi valuation France: budget austerity in, 93; and EU membership criteria, 85; and EU stimulus package, 88–89, 92–93; problem asset exposure in, 34; recovery prospects in, 96–97 Frank, Barney, 13, 20, 72, 128, 228 See also Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 Franklin, Benjamin, 93 Freddie Mac: Federal Reserve acquisition of mortgages from, 57–58; loan modification programs of, 11–13; reform of, 13–15; Treasury takeover of, 9–15 Friedman, Milton, 197, 202, 206 Futures commission merchants (FCMs), 156 G-20, 155–56, 187, 188 Garrett, Scott, 13 Gates, Robert, 72 GDP See Gross domestic product Geithner, Tim: and AIG bailout, 17; on derivatives regulation, 141; and Fannie Mae/Freddie Mac reforms, 13; and Financial Crisis Responsibility Fee, 64; and government spending, 93; and renminbi valuation, 179, 182; and TARP, 31; on tax cuts expiration, 72 INDEX General Motors, 139 General Theory of Employment, Interest, and Money (Keynes), 220 Gensler, Gary, 115 Germany: budget austerity in, 93; and EU membership criteria, 85; problem asset exposure in, 34; recovery prospects in, 77, 96–97; regulatory proposals in, 129; short selling ban in, 119–20; stimulus package in, 54, 88–89, 92–93; and stress tests, 35, 36, 37–38, 39 Glass-Steagall Act of 1933, 131, 202–3, 230 Goldman Sachs: as bank holding company, 130; compensation changes at, 169; and compensation restrictions, 139; and Financial Crisis Responsibility Fee, 64; as futures commission merchant, 156; profit resurgence at, 29; proprietary trading by, 137, 157; stress test results for, 23–24; TARP repayment from, 29, 30 Gold standard, 185, 196 Government expenditures: and budget deficit, 61; as GDP component, 47–48; and job creation, 53; and stimulus package, 52 Gramm-Leach-Bliley Act of 1999, 130, 203 Grassley, Charles E., 64–65 Great Britain: bank compensation regulation in, 168–69; bank nationalization in, 26; budget austerity in, 95; recovery prospects in, 77, 81, 94–95, 96–97 Great Depression, 192–213; current financial crisis contrasted with, 206–13; and institutional buildup under New Deal, 202–5, 210–11; and monetary policy, 196–98; origins of, 194; and short selling, 119; and stock market crash, 199–201 INDEX Greece: bailout of, 37, 39; budget crisis in, 90–93; sovereign bonds of, 22, 33–34, 37–39, 81 Greenspan, Alan, 6–7, 72–73, 133, 149 Gross domestic product (GDP): components of, 47–48; in Eastern Europe, 100; and employment growth, 67; in EU countries, 81; in recession, 47–48; and recovery prospects, 46; in Russia and Ukraine, 100 Group of 20, 155–56, 187, 188 Halterman, Marvene, Hawley-Smoot Tariff Act of 1930, 193 Health care reform, 66–67 Hedge funds, 111–12; Dodd-Frank Act provisions for, 156–57; EU regulatory proposals for, 170–71; regulatory proposals for, 141–44, 152; and TALF, 43 Highbridge Capital Management, 157 High-frequency trading (HFT), 120–22 Home Owners’ Loan Corporation, 209 Hoover, Herbert, 193, 201 House Financial Regulatory Reform Bill (2009): on compensation restrictions, 139, 140; on consumer protection, 144–47; on derivatives, 141–43; on hedge funds, 143–44; passage of, 135; and regulatory turf battles, 149; Senate bill compared to, 150–54 House Financial Services Committee: and Consumer Financial Protection Agency, 146–47; and derivatives regulation, 141–43; and OTC derivatives regulation, 141–43; regulatory proposals by, 135 Housing and Urban Development Department, Housing market: in China, 103, 180; and consumer protection regulations, 233–34; and consumption spending, 24 50; and foreclosures, 1, 9, 10, 13–15; during Great Depression, 201; in Spain, 35; in U.S., 1–2, 15, 50–51, 233–34 HSBC, 164 Hu Jintao, 179 Hungary, recovery prospects in, 81, 97–98 Iceland, banking crisis in, 83–84 Icesave Bank, 84 Import-substitution, 175, 176 India: and dollar as reserve currency, 174, 182; monetary policy in, 83; recovery prospects in, 82, 102–3; stimulus package in, 103 Indonesia, recovery prospects in, 82, 103–5 Inflation: in Asian economies, 82; EU membership criteria for, 86, 88; in Great Depression, 194, 202, 208; in Iceland, 83–84; and recovery prospects, 46, 51, 59; and renminbi valuation, 180–81; in Russia, 99 Insurance regulation, 130, 170–71 Integrity Funding LLC, International Association of Insurance Supervisors, 130 International Monetary Fund (IMF): and Baltic states, 97; and EU bailout program, 58; and European Financial Stability Facility, 92; on Financial Crisis Responsibility Fee, 65; and Greek sovereign debt crisis, 39; and Iceland, 84; and Special Drawing Rights, 186–87; and Ukraine, 99 Investment Bankers Association, 203 Investment banks, 129–31, 148, 203 Investment Company Act of 1940, 111 Investment outlays by businesses: and credit markets, 50; as GDP component, 47–48 Investment trust companies, 200, 201 250 INDEX Invisible hand of market, 219 Ireland, sovereign bonds of, 22, 33, 34 Italy: budget austerity in, 93; and EU membership criteria, 85; recovery prospects in, 96–97 Loan modification programs, 11–13 Lobbying: on consumer protection regulations, 146; by hedge funds, 111; by mortgage lending industry, Long Term Capital Management, 112 Japan, recovery prospects in, 82, 101–2 Joint Committee of the Congress on Taxation, 63 Jones, Alfred Winslow, 111 JPMorgan Chase: as bank holding company, 130; Bear Stearns takeover by, 9; and consumer protection regulations, 146; and credit default swaps, 116; derivatives trading at, 232; and Financial Crisis Responsibility Fee, 64; as futures commission merchant, 156; profit resurgence at, 29; proprietary trading at, 157, 231; stress test results for, 23–25; TARP repayment from, 29 Maastricht Treaty (1992), 86 Madoff, Bernard, 148 Malaysia, recovery prospects in, 82, 103–5 Manufacturing sector: and consumption spending, 50, 75; in Great Britain, 95; and inflation, 51; and recovery prospects, 47, 51–52, 76, 79; in Russia, 99; World War II impact on, 212 Margin requirements, 142 Market system, 216–19 McConnell, Mitch, 69 Medvedev, Dmitri, 99, 182 Merkel, Angela, 16, 38, 80, 88–90, 92, 119 Merrill Lynch, 8, 18–19 MetLife Inc., 130 Mexico, recovery prospects in, 82–83, 106 Minimum wage, 204 Mitterrand, Franỗois, 86 Monetary policy: cautionary signals, 5860; easing of, 56–60; in eurozone, 87–88; and Great Depression, 196–98, 209–10; and monetization of government debt, 57–58 See also European Central Bank; Federal Reserve Money supply, 46, 51, 197–98 Moody’s Investor Service, 117, 118 Moral hazard, 134–36 Morgan Stanley: as bank holding company, 130; and Financial Crisis Responsibility Fee, 64; profit resurgence at, 29; TARP repayment from, 29 Mortgage-backed securities: and British banks, 94; Federal Reserve Kan, Naoto, 101 Keynesian multiplier, 53 Keynes, John Maynard, 198, 220–25 Kindleberger, Charles, 199 King, Mervyn, 127 Korea See South Korea Kovacevich, Richard, 23 Krugman, Paul, 61 Labor Department, 69, 76 Lagarde, Christine, 35, 89 Landesbanken (regional banks), 35, 36, 39 Landsbanki, 84 Latvia, recovery prospects in, 81, 97–98 Lehman Brothers, 15–16, 221 Levin, Sander, 181 Lewis, Kenneth, 18–19 Lincoln, Blanche, 152, 157, 230 Liquidity crisis, 8, 34–35 Lithuania, recovery prospects in, 97 Liu Mingkang, 188 INDEX acquisitions of, 56, 57–58; regulatory environment for, 3–6 Mortgages: consumer protection regulations for, 144, 146, 158, 226, 233–34; credit standards for, 9–10; and federal funds rate, 3; and housing bubble, See also Subprime mortgages Munnell, Alicia H., National Association of Manufacturers, 204 National Bureau of Economic Research, 51, 77 National Credit Union Administration, 145 National debt, 61 National Development and Reform Commission (China), 176 National Industrial Recovery Act of 1933, 204 National Recovery Administration, 204 Natural resources, 99, 109 Netherlands: and EU membership criteria, 85; recovery prospects in, 96–97 New Deal, 202–5, 209, 210–11 New York Community Bank, 32 Nixon, Richard, 185 Northern Rock, 26 Norway, recovery prospects in, 81, 95 NYSE Euronext, 121 Obama, Barack: and budget deficit, 63, 74; and consumer protection regulations, 145, 230; and dollar as reserve currency, 188; and export growth, 77; and Fannie Mae/Freddie Mac reforms, 15; and political environment, 213; on proposed job recovery plan, 69; and renminbi valuation, 181; and stimulus package, 25 52, 55–56; and tax cuts, 72; and Volcker rule, 136 Office of Thrift Supervision, 145 Origins of crisis, 1–20; easy monetary policy, 2–3, 6–7; Great Depression comparison to, 206–8; regulatory failures, 3–7; securitization of subprime mortgages, 8–9; Treasury-Fed rescue deals (2008), 9–19 Over-the-counter (OTC) derivatives, 112, 141–43 See also Derivatives Paulson, Hank, 9, 11, 16, 18–19, 20 Pelosi, Nancy, 73 People’s Bank of China: foreign exchange reserves of, 177; and renminbi valuation, 176, 179, 180; and savings flow to U.S., 2–3, 173, 174 Poland, recovery prospects in, 98, 100 Portugal: budget crisis in, 93; sovereign bonds of, 22, 33, 34 PPI See Producer price index PPIP (Public-Private Investment Program), 22, 44 Price, Joseph, 19 Private sector: bank financing of, 163; job growth in, 47, 79 Producer price index (PPI), 47, 51, 59, 76, 79 Property ownership, 219 Proprietary trading: banking sector response to new regulatory environment, 231–32; in Dodd-Frank Act, 157; high-frequency trading by, 121; regulatory proposals for, 136, 137–38 Protectionism, 179 Proxy access rule, 159–60 Public-Private Investment Program (PPIP), 22, 44 Public spending See Government expenditures 252 Public works projects, 52, 205, 209 Putin, Vladimir, 99 Rating agencies, 117–18, 226 Recession: defined, 47; double-dip, 76–79 Reconstruction Finance Corporation, 208 Recovery prospects: in EU and EMU, 84–89; international comparisons, 80–109; in U.S., 45–79 Reed, John S., 137 Regions Financial of Alabama, 233 Regling, Klaus, 92 Regulatory capture, Regulatory environment, 127–72; and Basel Committee capital requirements, 132–34; and capitalism in U.S., 225–34; concessions on, 229–31; for consumer protection, 144–47; for derivatives, 141–44; in EU, 163–72; and executive compensation, 138–41; and Federal Reserve role, 148–50; for hedge funds, 141–44; House vs Senate versions, 150–54; impact of, 225–29; and moral hazard, 134–36; and Volcker rule, 135–38, 152, 157, 162, 228, 230 See also specific legislation Remittances, 83, 106 Renminbi valuation, 175–82, 186 Reserve Bank of India, 103 Reserve currency, 173–91; demand for additional, 182–84; dollar as, 184–87, 190–91; and renminbi valuation, 175–82, 186 Reserves See Capital adequacy Resolution Authority, 137, 154, 163, 211, 225 Retail sales, 50, 79 Reverse repurchase trials, 58 Roosevelt, Franklin D., 192, 202–5, 208–10, 212–13 Royal Bank of Scotland, 26, 94 INDEX Rural Electrification Authority, 205 Russia: and dollar as reserve currency, 174, 182, 184; monetary policy in, 83; recovery prospects in, 81, 98–100; stimulus package in, 99 Samuelson, Paul, 179 Sarkozy, Nicolas, 80, 93, 169 SASAC (Assets Supervision and Administration Commission of the State Council, China), 102 Savings: flow from outside U.S., 2–3, 109, 173; household rate in China, 175–76; household rate in U.S., 190 Schapiro, Mary, 148 Schumer, Charles, 173, 179, 182 Schwartz, Anna, 197, 202 SDRs (Special Drawing Rights), 186–87 Securities Act of 1933, 203 Securities and Exchange Commission (SEC): creation of, 202, 210; and dark pools, 124; and derivatives regulation, 142, 147–48, 149, 152, 156–57; and “flash crash,” 125–26; and flash orders, 124; and hedge funds, 111; and high-frequency trading, 122; investment bank monitoring by, 130; and ratings agencies, 117–18; regulatory role of, 225; and shareholder participation rules, 227; short-selling ban instituted by, 119 Services sector, 50, 79, 95 Shareholder role in corporate management, 159–60, 221, 226 Shelby, Richard, 231 Short selling, 118–20; EU regulatory proposals for, 167–68; and Great Depression, 119 Small banks: and consumer protection regulations, 158–59; failures of, 21–22; and housing market collapse, 50; stress tests for, 31–33 Smith, Adam, 216–19 INDEX Social Security Act of 1935, 203–4, 210 South Africa, recovery prospects in, 104 South America, recovery prospects in, 106–7 See also specific countries South Korea: recovery prospects in, 82, 103–5; stimulus package in, 54 Sovereign debt: on ECB balance sheet, 40–42; of EU countries, 22, 33–34, 37–39, 81; stress test criterion for default of, 37 Spain: budget crisis in, 93; recovery prospects in, 96–97; sovereign bonds of, 22, 33, 34; stress tests in, 35, 36, 39 Special Drawing Rights (SDRs), 186–87 Standard & Poor’s, 117–18 State budgets, 55, 71 State-owned enterprises: in China, 102, 175; German regional banks, 35, 36, 39; Vneshekonombank (Russia), 98 Steinbruck, Peter, 35 Stiglitz, Joseph, 214 Stimulus package: assessment of, 55–56; in China, 54, 102, 178; in EU, 54, 88–89, 92–93; impact of, 52–54, 56, 61; in India, 103; international comparisons, 54–55; in Japan, 101; in Russia, 99; in U.S., 52–56, 61 Stock markets: and big bank profit resurgence, 75; and cash shortage, 9; crash of 1929, 199–201; Fannie Mae and Freddie Mac share values on, 13; “flash crash” (May 6, 2010), 125–26; and Keynesian economics, 220, 222–23; and Treasury bond yields, 19 Stress tests, 21–44; in EU, 33–42; independent assessment of, 25–26; results of, 23–25, 39–40; and TARP funding, 26–27; in U.S., 23–34 Strong, Benjamin, 197 Student loans, 42–43 Subprime mortgages: and British banks, 94, 95; and recovery prospects, 108–9; securitization of, 1, 3, 8–9 253 Summers, Lawrence E., 26, 55–56, 66, 149, 228 Supplementary capital, 132–34 Sweden: loans to Latvian banks, 98; recovery prospects in, 81, 95, 96–97 TALF (Term Asset-Backed Loan Facility), 22, 42–43 TARP See Troubled Assets Relief Program Tax credit for home buyers, 46, 54 Tax cuts: expiration debate over, 63, 71–74; role in crisis, 2–3 Taylor, John B., 149 Temporary Liquidity Guarantee Program (TLGP), 32–33 Tennessee Valley Authority Act of 1933, 204, 205 Term Asset-Backed Loan Facility (TALF), 22, 42–43 Thain, John, 33 Thane, John, 30 Tier and Tier capital, 132–34 Timoshenko, Julia, 99 TLGP (Temporary Liquidity Guarantee Program), 32–33 “Too-big-to-fail” banks, 131, 134, 161 Trade deficit, 174, 177, 181, 189 Treasury bonds: Chinese investment in, 3, 173; Federal Reserve purchases of, 46, 57–58; and high-frequency trading, 121; and inflation, 60; stock market decline’s impact on, 19 Treasury Department: and AIG bailout, 18; bailout implications for, 26–27; and derivatives regulation, 115; and dollar volatility, 188; and Fannie Mae/Freddie Mac bailout, 12; and PPIP, 22, 44; regulatory proposals by, 135; troubled asset purchases by, 44 Trichet, Jean Claude, 39, 86 Triffin, Robert, 184–85, 188–89, 190–91 254 Troubled Assets Relief Program (TARP): and AIG bailout, 18; and capital adequacy requirements, 133; constraints of, 27–28; passage of, 1, 19–20; repayment and exit from, 29–30; and stress tests, 21, 23–28; termination debate, 30–31 Turquoise (trading platform), 121 UBS: and cash shortage, 8; as futures commission merchant, 156 Ukraine, recovery prospects in, 82, 98–100 Unemployment: in EU, 89; extension of benefits for, 71; during Great Depression, 193, 202, 205, 208; and housing market, 46; in Japan, 101; lagging recovery in, 67–71; and monetary policy, 51; and recovery prospects, 47, 73, 79; in Russia, 99; stimulus package impact on, 53–54, 61; in U.S., 50–51; in Venezuela, 107; World War II impact on, 211–12 United Kingdom See Great Britain United States: banking system structure in, 129–32; budget deficit in, 60–67; economic problems in, 47–52; monetary policy in, 56–60; recovery prospects in, 96–97; and SDRs, 187; stimulus package in, 52–56, 61 Utility sector, 201 INDEX Venezuela, recovery prospects in, 82–83, 106–7 Volcker, Paul, 123–24, 134–35 Volcker rule, 135–38, 152, 157, 162, 228, 230 Waddell & Reed Financial, 126 Wage regulations, 204 Wall Street Journal/NBC poll: on budget deficit, 74; on economic recovery prospects, 79; on extension of unemployment benefits, 71 Wealth of Nations (Smith), 219 Welch, Jack, 227 Wells Fargo: as bank holding company, 130; campaign contributions from, 5; checking account changes at, 233; and consumer protection regulations, 146; and Financial Crisis Responsibility Fee, 64; stress test results for, 23–25; TARP repayment from, 30 Wen Jiabao, 177, 178, 181 White House Council of Economic Advisors, 53 World Trade Organization (WTO), 175 World War II, 211–12 Yanukevich, Viktor, 99 Yushchenko, Viktor, 99 Zhou Xiaochuan, 178, 182 ... however, belongs to another project From Financial Crisis to Global Recovery follows my earlier book Financial Crisis, Contagion, and Containment: From Asia to Argentina published by Princeton University... Padma Desai FROM FINANCIAL CRISIS TO GLOBAL RECOVERY Financial Crisis Origin A v ariety o f fac tors co ntributed to t he U S e conomy’s r ecession, w hich exhibited c atastrophic s ymptoms of.. .FROM FINANCIAL CRISIS TO GLOBAL RECOVERY FROM FINANCIA L CRISIS TO GLOBAL REC OV E RY Padma Desai C O LUM B IA U N I V E R SI T Y P R E S S N