What kind of a crisis is this?

XXVI Meeting of the Latin American Network of Central Bankers and Finance Ministers, October 16,17 2007

Michael Dooley Cabezon Capital and UCSC.

Mid July Subprime Hits the Market

• Bill Pool says those who lose on subprime deserve it.

• Economists are calm but the market sells.

• EM debt spreads jump 50 bp.

• But main problem is in mortgage related assets.

EMBI spread

Spread between conforming and nonconforming mortgages

Credit Crunch in August Three month dollar LIBOR

Why Worry?

• Moving risk from banks to ultimate holders a necessary part of the plumbing of the system.

• The plumbing has worked on very narrow spreads.

• When the garbage disposal backs up dinner is in trouble.

Does size matter?

• Initial estimates of $150 Billion loss seemed trivial.

• But who has the loss?

• If fraud this obvious gets by the rating agencies what else is out there?

• Better to mistrust everyone till everyone marks to market.

What’s new?

• The most directly affected intermediaries do not have access to the discount window.

• Banks could act as conduits but they had their own troubles.

• TED spread still high and a potential problem.

Direct reduction of the policy rate needed?

• Market did not know what the Fed,ECB, BOE would do.

• Moral hazard vs. common sense.

• Common sense won initially in 2 of 3 then in 3 of 3.

Impact on Emerging Markets

• Was this a serious threat to emerging markets?• Two aspects: EM was not strongly affected by

the liquidity crisis in August.• But if liquidity crisis had spread to real activity

EM is still vulnerable.• Our view is we were very close to a very large

sell off of EM debt and equity.• Fed 50 – 50 move was all that prevented this.

Stronger Balance Sheets

• Debt GDP ratios and projections look much better

• Currency mismatches much less of a problem.

Growth still tied to US

• Export markets for Asia.

• Commodity prices.

Real interest rates still low

• BW II still dominates system.

• Asian savings placed in international markets depresses real rates.

• Difficult to have a crisis with this support for asset prices.

• Conclusion August another in a long line of disasters that didn’t happen.