For the global economy, it was the best of times, and then it was the worst of times. Buoyed by very strong growth in emerging markets, the global economy boomed in the mid-2000s. On average, annualised world GDP growth exceeded 5% for the four years leading up to 2007 – a pace of growth that hadn’t been sustained since the early 1970s. But it wasn’t to last. In this post, I illustrate how the failure of Lehman Brothers in September 2008 coincided with the deepest, most synchronised global downturn since World War II. And I describe how after having seen the fallout of the Lehman collapse, macroeconomic forecasters were nevertheless surprised by the magnitude of the ensuing global recession.
Neeltje van Horen
Cross-border bank lending fell dramatically in the aftermath of Lehman Brothers’ failure as funding constraints forced banks to reduce their foreign exposures. While this decline was partly driven by lower demand for international bank credit, it was substantially aggravated by a retrenchment of international banks from cross-border lending. But banks did not cut their cross-border lending in a uniform manner. Instead, they reallocated their foreign portfolios towards countries that were geographically close, in which they had more experience, in which they had close connections with domestic banks or in which they operated a subsidiary. The crisis thus showed that deeper financial integration is associated with more stable cross-border credit when large global banks are hit by a funding shock.
Sterling money markets are a critical part of the plumbing of the UK financial system. They act as the main conduit for short-term borrowing and lending between banks, and a whole range of other institutions, financial and non-financial. And the ebb and flow of activity in sterling money markets is also crucial to the Bank of England as the first stage in the transmission mechanism of monetary policy, linking changes in the Bank’s policy rate – Bank Rate – to activity and prices in the wider economy. So when things go wrong in this market, as they did during the financial crisis, the effects reach into every part of the UK economy and, given the significant role of international banks in London, beyond. So what happened in the autumn of 2008, and why?
Johnny Elliot and Benjamin King
In August 2007 problems were emerging in the US sub-prime mortgage market. Rising numbers of borrowers were getting behind on their repayments, and some investors exposed to the mortgages were warning that they were difficult to value. But projected write-downs were small: less than half a percent of GDP. Just over a year later, Lehman Brothers had failed, the global financial system was on the brink of collapse and the world was plunged into recession. So how did a seemingly small corner of the US mortgage market unleash a global crisis? And what lessons did the turmoil of autumn 2008 reveal about the financial system?
The collapse of Lehman Brothers in September 2008 will forever be remembered as a pivotal moment in the global financial crisis. TV pictures flashed around the world of staff carrying their belongings out of their offices as their employer filed for bankruptcy. But few observers watching at the time foresaw the tumultuous events that would be unleashed in the weeks and months that followed. And the consequences endured: for policymakers, academics and market participants alike, the world was never quite the same again.
In this special series of posts, we turn the clock back to 2008 to look at how the crisis unfolded and what those events revealed about the economic and financial system. This week, we’ll publish four posts, each focussing on a different aspect. Today’s opening post explores how trouble in the subprime US mortgage market ended up creating a global emergency. Subsequent posts will look at the sharp contraction in cross-border lending, the turmoil in money markets, and knock-on effects on the global economy.
The authors take a diverse range of approaches- some draw on earlier academic work, some focus on the evolution of the data, others try to piece together the mechanics of the system. As ever, we welcome your discussion of our work- either using the comments facility at the foot of each post, tagging @BoE_Research on twitter or best of all – via by writing a response on your own blog!
John Lewis, Managing Editor
Antonis Kotidis and Neeltje van Horen
The leverage ratio requires banks to hold capital in proportion to the overall size of their balance sheet. As opposed to the capital ratio, risk-weights are irrelevant to its calculation. The leverage ratio therefore makes it relatively more costly for banks to engage in low margin activities. One such activity – which is crucial to the transmission of monetary policy and financial stability – is repo. This column shows that a tightening of the leverage ratio resulting from a change in reporting requirements incentivised UK dealers to reduce their repo activity, especially affecting small banks and non-bank financial institutions. The UK gilt repo market, however, showed resilience with foreign, non-constrained dealers quickly stepping in.
Felix Ward, Moritz Schularick, Òscar Jordà and Alan M Taylor
In April the Bank hosted a workshop organised jointly with the IMF and ECB, on the theme of “International Spillovers of Shocks and Macroeconomic Policies”. In this guest post, the authors of one of the papers presented look at how and why co-movement of international equity prices has increased over time.
Asset markets in advanced economies have become integrated to a degree never seen before in the history of modern finance. This is especially true for global equities starting in the 1990s. We find that this increase in synchronization is primarily driven by fluctuations in risk-appetite rather than in risk-free rates, or in dividends. Moreover, we find that U.S. monetary policy plays a major role in explaining such fluctuations. This transmission channel affects economies with both fixed and floating exchange rates, although the effects are more muted in floating rate regimes.
Arthur Turrell, Bradley Speigner, James Thurgood, Jyldyz Djumalieva, and David Copple
‘Big Data’ present big opportunities for understanding the economy. They can be cheaper and more detailed than traditional data sources, and on scales undreamt of by survey designers. But they can be challenging to use because they rarely adhere to the nice neat classifications used in surveys. We faced just this challenge when trying to understand the relationship between the efficiency with which job vacancies are filled and output and productivity growth in the UK. In this post, we describe how we analysed text from 15 million job adverts to glean insights into the UK labour market.