This summer’s financial turbulences

August 27, 2007

Sorry, I will not write an “essay” on this summer’s financial makret turmoil triggered by the sub-prime mortgage crisis in the US. But since it is relevant to this blog, here a few links to interesting articles published on the matter:

For German readers, an analysis from Die Zeit earlier this month, on the “maturity test” the global financial system is currently undergoing.   It includes an interview with Barry Eichengreen, the big scholar specialising in the history of global financial integration. He warns that the crisis could spread further if the corporate sector starts being affected by the credit crisis that so far has “only” affected financial institutions.

Gillian Tett at the FT has an excellent piece today looking more into history:

“this decade’s burst of market innovation had rewritten the rules of finance. For as financiers have created products that distribute credit risk across the capital markets, this has altered the way the financial system works. That in turn, may have changed the way the credit cycle works – or so some optimists believed until very recently. However, this summer’s market swings are now blowing apart many of these cosy assumptions. (…)”

Looking back:

(…) Though financial markets have only existed for a few centuries, they have already delivered a truly dazzling array of storms. Lehman Brothers, for example, reckons that the first financial crash in the Western world can be dated back to 1622, when the Holy Roman Empire debased its coins, triggering the equivalent of a modern banking panic.

That was followed by the 1637 tulip boom-and-bust in Holland and the 1720 South Sea bubble – an event that spawned the first literary analysis of crashes.

Eight more crashes then occurred in the 18th century, culminating in the Hamburg commodities bubble of 1799. Then in the 18th century, the pace of financial disaster speeded up, with 18 financial storms erupting in Europe, and increasingly in the US too.

These included bank crises that hit the US in 1819, 1837, 1847, 1857, 1873, 1884, 1890 and 1896, several of which were linked to booms and bust in the commodities sphere, or railroad sector.

However, these events contributed to regular bank runs in Europe too, and a financial crisis even struck Australia in 1893.

It was the 20th century, however, which produced the most dazzling array of financial turbulence, with 33 market storms, according to Lehman Brothers. The best known of these are the stock market crashes of 1929 and 1987; however, the Japanese bank turmoil of the 1990s also caused deep economic distress, as did the savings and loan crisis in America in the 1980s – and the bank run of 1907.

Meanwhile, another, lesser-known period which some analysts think carries lessons for banks today was a stock market crash in London in 1974, which was accompanied by a banking crunch.

By the standard of many of these market storms, the recent turmoil still looks pretty modest. Indeed, it is arguable that the only reason the price swings have generated so much shock among investors is that markets have been unusually quiet during most of this decade.

Nevertheless, the one factor that does make this summer’s events different from previous cycles is the degree to which the events have played out in the capital markets, rather than the banking world. That is largely because credit risk has been distributed to a much wider pool of investors than before.


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