mmediate impacts of the crisis
Global Development Finance 2009: Crisis impacts
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What began in the summer of 2007 as an extended period of financial turmoil caused by the losses in the U.S. subprime mortgage market, erupted into a full-blown and global financial crisis in mid-September 2008, precipitated by the failure of the investment bank, Lehman Brothers. The realization that such a key player in the international financial system could fail shook the confidence of bankers, investors, and households alike and reverberated rapidly throughout the global economy. The initial loss of confidence in the financial system provoked a liquidity crunch in the interbank market (these events and their implications for financial flows to developing countries are discussed in further detail in chapter 2). Banks became extremely reluctant to lend to one another, and liquidity dried up rapidly, causing spreads between the interest rates banks charge each other (LIBOR, or the London Interbank Offer Rate for overnight funds) and what they expect to pay central banks (the overnight index swap rate) to jump to unprecedented levels (see first figure shown here). Uncertainty about the future and fears that the crisis could provoke a deep recession or even depression skyrocketed, evidenced, for example, by some 4,500 stories about the financial crisis and its potential negative effects appearing in major English-language print media in September 2008 (see second figure shown here). The sudden drying up of liquidity and increased uncertainty also yielded a change in the pricing of risk throughout the global economy. Interest rate spreads on riskier assets, including the bonds of firms in developing- and high-income countries, and, to a lesser extent sovereign states, increased substantially (see third figure shown here). Increased risk aversion, a reassessment of growth prospects, and the need for firms and investors in high-income countries to strengthen their balance sheets resulted in a large-scale repatriation of capital from developing countries. As a consequence, stock markets the world over lost between 40 and 60 percent of their dollar values—the currencies of almost every country in the world depreciated against the U.S. dollar—implying a massive loss in global wealth.( see 4th figure shown here). Successive interventions by authorities in both high-income Europe and North America (including substantial efforts by the Federal Reserve in the United States to intermediate directly between banks) have helped restore short-term liquidity. As of end-May 2009, interbank spreads are down some 350 basis points since September 2008 in the case of the United States and by 200 basis points in the Euro Area. This, plus the fact that there have been no additional failures of major financial institutions or significant currency crises, has brought about a near-stabilization and even improvement in financial conditions over the period since March 2009. Spreads on developing-country bonds have narrowed (see fifth figure shown here), with the market now distinguishing better between the risks posed by different countries. At the same time, stock market valuations are regaining ground in a number of countries. Still, conditions continue to be tight and markets nervous. Interbank spreads remain above historical levels, and the IMF estimates that only a third of all financial sector losses have been booked at this stage (IMF 2009b). Similarly, developing-country spreads remain high, and, even though the base rates against which these spreads are calculated have declined in response to the post-crisis relaxation of monetary policy in high-income countries, yields and borrowing costs for developing-country firms have increased substantially—doubling in some cases—with potentially important effects on debt sustainability and the profitability of future investment (see below). . http://web.worldbank.org/WBSITE/EXTERNAL/EXTDEC/EXTDECPROSPECTS/EXTGBLPROSPECTSAPRIL/0,,contentMDK:20370624~menuPK:659161~pagePK:2470434~piPK:4977459~theSitePK:659149,00.html