Among the macroeconomic pathologies that contributed to the crisis were, first, excessive global liquidity creation by key central banks and, second, an ex-ante global saving glut, as a result of the entry of several high-saving countries (notably China) in to the global economy and by the global redistribution of wealth and income towards commodity exporters that also had, at least in the short run, high propensities to save lots of.
Neither the Fed, nor the ECB, nor the lender of England exactly covered themselves with glory in addressing the global shut-down of the financial wholesale markets and the continuing crunch and illiquidity in the interbank markets. The ECB probably did best, accompanied by the Fed, with the lender of England to arrive a well-beaten third.
All three central banks are actually injecting fair levels of liquidity not only in the overnight interbank markets, but also at longer maturities, especially at 1 and three months. THE LENDER of England was most reluctant to tackle the large spreads between, say, 3-month Libor and the market’s expectation of the state policy rate over a three month horizon (as measured by the fixed leg of the overnight indexed rate swap or OIS). It believed (against the data and the chances) that reflected largely market perceptions of counterparty default risk, instead of liquidity risk. THE LENDER also only recently widened its set of eligible collateral in 3-month repos (sale and repurchase operations) to assets beyond compared to the high-grade sovereign debt instruments it had insisted on before. For the December 2007 and January 2008 auctions it announced, additionally it is, for the very first time, ready to do repos from this wider selection of collateral at market-determined rates, instead of insisting on a penalty floor for the rate, since it did in September.
The ECB immediately threw large levels of liquidity at the longer-maturity interbank markets and the Fed pumped in moderate amounts. Interestingly, except in the short-run, the result on the interbank spread over the OIS rate didn’t respond very differently for sterling, the euro and the united states dollar. Before one concludes out of this that open market operations at these longer maturities haven’t any influence on the spreads, you have to recognise that the necessity for liquidity might not have already been the same in the three interbank markets. To begin with, many UK banks with subsidiaries in the Eurozone (plus some with subsidiaries in america) obtained liquidity through these subsidiaries. Other indicators of liquidity of the interbank market, including the level of private transactions, claim that, despite having comparable spreads, UK banks continue steadily to face especially tight liquidity conditions.
In the united kingdom, failures of the Tripartite financial stability arrangement between your Treasury, the lender of England and the FSA, weaknesses in the lender of England’s liquidity management, regulatory failure of the FSA, an inadequate deposit insurance arrangement and deficient insolvency laws for the banking sector all contributed to the financial disarray.
Despite this, this could be possible to support the spillovers from the crisis beyond the financial sectors of the industrial countries and the housing sectors of the united states and a few Europe. Associated with that the credit boom that found a finish in 2007 didn’t bring about major excesses in physical capital formation (fixed investment), except in the financial sectors all over the place and in the residential construction sectors of a few countries, like the US, Spain, Ireland, the Baltic states and Bulgaria. The saving-investment balances and balance sheets of non-financial corporates stay healthy. The financial imbalances are mainly in the financial sector (excessive leverage, deficient liquidity, insufficient capital and the necessity for massive write-downs of assets – specialty CDOs and other complex securitised structures) also to a smaller extent in family members sector (financial deficits, excessive mortgage debt, unsecured personal debt and the necessity to take large hits on the valuation of key assets, especially residential property). While a slowdown is unavoidable – and, regarding the united states, necessary and desirable because for the restauration of external balance – a recession isn’t.