University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Roots of the Current Crisis and itsImplications

Dr. Robert Sonora

Department of EconomicsSchool of Business Administration

Fort Lewis College

Presented at the University of Osijek

June 23, 2009

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Overview

1 (Sub-Prime) CrisisScenariosHousing and MoneyLiquidity

2 CurrentlyThe MacroeconomyLabor Market and Firm Behavior

3 US City Differences

4 Capital Controls, Deregulation, IntegrationLiberalization of Capital MarketsHistoryCroatia

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Short Run: Scenario One

Consider . . .

Commercial real estate boom

Banking deregulation – risky assets and loans

Asset bubble

Lend “long”– borrow “short”

Inflation ↑⇒short term interest rates↑

Inept banking supervision (regulators ↓)

Forbearance: keep insolvent banks open

Central bank gave money to banks

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Short Run: Scenario 2

or . . .

Deregulation⇒Risky loans ↑Asset bubble

Real estate bubble

Bank capital ↓deposits ↓defaults ↑⇒lending ↓Forbearance: keep insolvent banks open – assets “↑”Central bank gave money to banks

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Short Run

Scenario One US 1989-90 S&L CrisisRecessionResolution Trust Corporation : $124b taxpayermoney≈ 750 failures

Scenario 2 Japanese Financial Crisis: 1995 – 2005-ishTen year recession – RGDP ↑0.9% anddeflationJapan $440b in taxpayer moneyGreater banking regulationsbut Uonly currency to appreciate against thedollar recently

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Short Run

Scenario One US 1989-90 S&L CrisisRecessionResolution Trust Corporation : $124b taxpayermoney≈ 750 failures

Scenario 2 Japanese Financial Crisis: 1995 – 2005-ishTen year recession – RGDP ↑0.9% anddeflationJapan $440b in taxpayer moneyGreater banking regulationsbut Uonly currency to appreciate against thedollar recently

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Housing Market

GS1 = One Year Yield, FEDFUNDS = FFR, MORTG = 30 Year Fixed Mortgage, HOUST(R) = Housing Starts

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

State Housing Price: Bubble?

FLSTHPI = Florida, CASTHPI = California, COSTHPI = Colorado, MISTHPI=Michigan

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Mortgages and Foreclosure

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Excess Reserves and Non-Performing Loans

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Short Run

This is what will concern us over the next 12-24 months

Output Gap, Unemployment, Inflation (Deflation?)

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Short Run: Output Gap

The “Output Gap”

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Short Run: Inflation and Unemployment

CPIAUCNS = Inflation, UNRATE = Unemployment Rate

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Short Run: Consumer Behavior

Home equity prices ↑

Credit Card ↑Borrowing ↑Household spending ↑

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Short Run: Consumer Behavior

Home equity prices ↑Credit Card ↑

Borrowing ↑Household spending ↑

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Short Run: Consumer Behavior

Home equity prices ↑Credit Card ↑Borrowing ↑

Household spending ↑

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Short Run: Consumer Behavior

Home equity prices ↑Credit Card ↑Borrowing ↑Household spending ↑

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Short Run: Consumer Behavior – Debt

TDSP(L) = Household Debt Service Payments as a Percent of Disposable Personal Income, DSPI(R) =

Disposable Personal Income, CMDEBT(R) = Household Sector: Liabilites

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Short Run: Consumer Behavior – Consumption

Consumption – Disposable Income Ratio (and 12 mo. MA)

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Short Run: Consumer Behavior and RetailSales

University of Michigan Index of Consumer Sentiment and Retail Sales

UMCSENT = Consumer Sentiment, RRSFS(r) = Retail Sales

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Food Stamps

Food stamp claims and percent change to July 2009

Date 7/2003 7/2007 6/2008 7/2008 7/2009†Number Claims (mil) 22.0 26.6 28.7 29.1 33.5Population (mil) 290.1 302.0 304.6 304.9 305.1Percent Population 7.58% 8.81% 9.41% 9.53% 10.98%Percent Change 31.82% 9.10% 1.30% – 16.7%Annual Average 6.36% – – 1.30%

†Estimated

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Jobs Gain/Loss

PAYEMS(L) = Change Nonfarm Payrolls, OUTNFB(R), % Change Output Nonfarm Business Sector

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Short Run: Firm Behavior – Industrial Production, Productivity,

Labor Participation

Industrial Production & Manufacturing Productivity: Annual % Change

OPHMFG(R) = Manufacturing Output per Hour, INDPRO(L) = Industrial Production, CIVPART = Labor

Participation Rate

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Short Run: Rest of the World

Figure: World GDP Growth: EZ, UK, Mexico, Canada, Japan, Australia

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Inflation

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Unemployment

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Composition

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Two questions:

With variety of differences across cities, how do wedesign domestic economic policy?

What about across countries?

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Two questions:

With variety of differences across cities, how do wedesign domestic economic policy?

What about across countries?

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Two questions:

With variety of differences across cities, how do wedesign domestic economic policy?

What about across countries?

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Capital Markets

Allows for free(r) movement of paper and realassets across borders

The less “advertised” part of Globalization

Not to be confused with free trade: tariffs↓, subsidies↓,“non-tariff” barriers↓Prerequisite for entry into many global economicentities: EU, NAFTA, WTO, etc.

Often accompanied by a fixed or “managed float”exchange rate regime⇒inflation stabilization

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Capital Markets: Benefits

Access to financial markets – loans, grants – to beused for creation of real (productive) capital

Access to foreign investors

Domestic access to foreign capital markets

Lower domestic interest rates

Economic stabilization: exchange rates, etc.

Gains in foreign currency reserves

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Capital Markets: Costs

May require painful economic reforms

Extraction of ‘rents’ by . . .

Economic de-stabilization: inflation?

Rapid ‘devestment’ of foreign and domesticholdings of domestic assets: currency crisis and/orcontagion⇒loss of confidence and economycollapses

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Deregulation

Reduces restrictions in domestic financial markets

Increases competition/innovation in financial markets⇒lower interest rates

May increase risk

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Integration

US and EZ

US: Identical Monetary policy, centralized fiscal policy

EZ: Identical Monetary policy, de-centralized fiscalpolicyCountries, different . . .

economic policyriskrates“objective” or “loss functions”Single EZ fiscal authority?

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Integration

US and EZ

US: Identical Monetary policy, centralized fiscal policy

EZ: Identical Monetary policy, de-centralized fiscalpolicyCountries, different . . .

economic policyriskrates“objective” or “loss functions”Single EZ fiscal authority?

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

UK: German Re-Unification

UK Bank Lending Rate and $/£

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Sweden: German Re-Unification

Swedish Overnight Interest Rates

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Mexican Peso Crisis

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

SE Asian Crisis

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Capital Markets: Croatian Precaution

Desire to join EZ

Price stability: managed float exchange rate⇒requiresforeign currency reserves

Removal of many capital restrictions & financialderegulation

Wary of currency crisis

Restrictions on foreign currency holdings: 51% of allforeign currency inflows held in Central Bank Vault⇒protect kuna

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

Capital Markets: Croatian Precaution

Currently: under pressure, difficult to get foreign loans,foreign currency reserves running low (out?), IMF loansto Eastern Europe

What if can’t repay foreign loans? Foreign Debt - GDPratio about 90%

Implications outside of Croatia: Italian, Austrian Banks(Swedish banks in the Baltic countries): Too big to failor too small to care?

House of cards

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

However

Some lessons may have been learned

In Croatia, the “51% rule”

In international community: less taste for financialcollapse (again) – economic and geo-political factors

On the other hand . . .

Last year’s oil price jump⇒global commodityprices↑⇒though short term, exacerbated current crisis

University ofOsijek

Dr. RobertSonora

(Sub-Prime)CrisisScenarios

Housing and Money

Liquidity

CurrentlyThe Macroeconomy

Labor Market andFirm Behavior

US CityDifferences

CapitalControls,Deregulation,IntegrationLiberalization ofCapital Markets

History

Croatia

However

Some lessons may have been learned

In Croatia, the “51% rule”

In international community: less taste for financialcollapse (again) – economic and geo-political factors

On the other hand . . .

Last year’s oil price jump⇒global commodityprices↑⇒though short term, exacerbated current crisis