GENERAL PRESENTATION: FINANCIAL INNOVATION AND THE 2008FINANCIAL CRISIS Rogério Sobreira De Boeck Supérieur | Journal of Innovation Economics & Management 2010/2 - n° 6pages 3 à 7

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Journal of Innovation Economics & Management, 2010/2 n° 6, p. 3-7. DOI : 10.3917/jie.006.0003

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n° 6 – Journal of Innovation Economics 2010/2 3

GENERAL PRESENTATION:FINANCIAL INNOVATION

AND THE 2008 FINANCIALCRISIS

Rogério SOBREIRAEconomist

The 2007/08 financial crisis was, doubtless, the most criti-cal crisis that happened since the Great Depression of 1930.The real GDP growth in the advanced economies in 2008 wasonly 0.5% and in 2009 those economies faced a fall in the realGDP of 3.2% (IMF, 2010a, p. 45). Even the so-called westernhemisphere economies – which include Brazil – faced a fall intheir real GDP in 2009 of 1.8%. The outstanding exceptionwas Asian economies – mainly China and India – whose realGDP growth in 2009 was 3.5%. Taking China and India alone,this growth was astonishing 6.6%. Although some signs ofrecovery can be seen in the horizon – the International Mone-tary Fund expects a 4.5% real growth in the world GDP in2010 – the recovery in the vast majority of countries is stilldependent on highly accommodative macroeconomic policiesand, as a consequence, is still subject to downside risks, not tomention the fact that this recovery unfolds unevenly. Addi-tionally, the crisis in Europe is far from being solved, mainlybecause its banking system is still at stake (Münchal, 2010),and the recovery of the US economy is still surrounded byuncertainties, since there is a great deal of probability the USeconomy slip back into recession in the second semester of2010. To get things worst, households in US and Europe do notseem willing to increase their indebtness and recover consumerspending. Finally, China’s imports seem to face a (temporary)surge, helping to increase the uncertainties regarding therecovery of the world economy (The Economist, 2010).

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Rogério SOBREIRA

4 Journal of Innovation Economics 2010/2 – n° 6

The above paragraph pinpoints the effects of the crisis inthe so-called real world. However, in order to discuss properlythe possibilities regarding the recovery of the world economy,it is necessary to pay attention to the health and behavior ofthe banks in the main economies – and, in a lesser degree, insome developing economies – since their financial system wasmuch more affected than the financial system of developingeconomies. In this aspect, the recovery tends to be even moreslow in comparison to the one observed in the real world, sincemarkets are less willing and able to support leverage and “theprivate credit demand is likely to rebound weakly as house-holds restore their balance sheets” (IMF, 2010b, p. 3). The cri-sis, thus, has exposed underlying vulnerabilities in the bankingsystem of the major economies and, in a lesser degree, in thebanking system of some developing economies through spill-overs. As a consequence, the recovery of the banking system ofmajor economies has a great deal of possibility to not unfoldsmoothly, leaving the systems surrounded by huge uncertain-ties in the near future.

These uncertainties are even more difficult to handle as oneknows that some seeds that initially caused the problems in theUS financial system and, later, in the financial systems of themajor economies are still there. In other words, the huge finan-cial innovation process that took place after the liberalizationof the major financial systems in the 1980s that led to highleverage and risk taking by banks as if the business cycle hasover was not deeply changed (Morris, 2008). Aside from thisliberalization, the prudential regulation rules (Basel I and II)implemented in end of the 1980s also helped banks to embarkin a fierce financial innovation and risk taking process with thedecisive help of the rating agencies (Morris, idem). Thechanges in these rules announced in last September, however,did not seem to improve the solidity of the banks since theyraise great uncertainties regarding the ability of some countrybanks to raise enough capital to meet the new rules, regardlessthe time to adopt the new rules given by regulators (FT, 2010).Moreover, incentive-type rules such as Basle, seem do not pre-vent the emergence of toxic products as banks envisage greatprofit opportunities in booms.

This special issue of the Journal of Innovation Economicsspecifically addresses these aspects of the 2007/08 global crisis.

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General presentation

n° 6 – Journal of Innovation Economics 2010/2 5

This issue takes a look at the various dimensions possessed bythis crisis. The main aspect treated here is the financial inno-vation dimension and its connection with this and other finan-cial crisis, both historically and theoretically since a typicalcapitalist crisis evolves through financial innovations thatinflates banking credit and, finally, led banks and other financialinstitutions to take too much risk through speculative and ponzifinancial relations, as posed by Minsky (1986). Under such cir-cumstances, financial innovation plays a key role since it helpsbanks and other financial institutions to not only reach newniches in the economy, but also to bypass some restrictionsimposed by regulators. In this aspect, it is important to noticethat the financial liberalization, in a broad sense, also plays adecisive role since it helps capital to flight from one country toanother, creating difficulties for the international financial sys-tem to absorb and efficiently allocate it. These negatives effectsare helped by global imbalances created by the huge interna-tional capital inflows generated by the capital account sur-pluses of China and other emerging countries. These are thethemes treated by Pinto and Sobreira’s “Financial Innovation,Crisis and Regulation: Some Assessments.” On the other hand,Altuzarra et al., in “The Role of Global Imbalances as a Causeof the Current Crisis” deals specifically with how the imbal-ances referred above can help to explain the current crisis.

Despite the wave of financial liberalization that took placethe vast majority of west countries since mid 1980s, the imple-mentation of more restrictive prudential regulation in somecountries seems helped to avoid partially some negativeimpacts of the crisis or, at least, helped the impacts of the crisisto last only for a short period. These are the topics treated inRamos-Tallada’s “Financial Distress and Banking Regulation:What’s Different About Spain”, where the author shows thatstricter capital adequacy ratios and the consolidation account-ing rules related to off-balance sheet securitization, togetherwith the fact that banks were required to make dynamic provi-sions on the basis of the business cycle average by raising thereserves cushion against loans losses during the phase of highliquidity and fast credit growth helped to explain the absence ofmajor bailouts in Spain in the aftermath of the crisis. Sobreiraand de Paula, in “The 2008 Financial Crisis and Banking Behav-ior in Brazil: The Role of the Prudential Regulation” also show

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Rogério SOBREIRA

6 Journal of Innovation Economics 2010/2 – n° 6

how a stricter prudential regulation that obliges banks to fol-low a capital adequacy ratio of 11% instead of 8% as suggestedin the original Basel Agreement, and a deep adjustment imple-mented in the aftermath of the real plan make the Brazilianbanking system more resilient and more resistant to the nega-tive impacts of the crisis.

On the other hand, when we look at Europe, it is shownthat some fiscal rules implemented in order to create somedegree of coordination in the European fiscal front did not helpsome countries to avoid the so-called second wave of impact ofthe crisis – that is, a confidence crisis triggered precisely byweaker fiscal outlooks (IMF, 2010b, idem, p. 7) as a conse-quence of increasing fiscal deficits partially used to offset thenegative impacts of the crisis. Thus, Creel and Sarraceno in“European Fiscal Rules after the Crisis” question the relevanceof trying to strength this fiscal framework – namely the Stabil-ity and Growth Pact (SGP) – which has been ineffective overthe years. The authors argue for a reform of SGP that wouldlead EU countries to adopt a golden rule of public finance.

The final papers of this issue do not deal specifically withmacroeconomic aspects of the current crisis as described above.These papers are more akin to sectoral answers to the effects ofthe crisis or, generally speaking, financing strategies. Thus, Ashtaand Assadi’s “Should Online Micro-Lending be for Profit or forPhilanthropy? DhanaX and Rang De” show the importance ofdevelop micro-lending platforms for poor people that, typi-cally, do not have access to credit in normal times and whosecredit access is even worst in times of crisis. The authors stud-ied the case of the two micro-lending website showing theirimportance as mechanisms for poverty alleviation. Matouk’s“Financing Innovation: A Historical Approach”, on the otherhand, travels in the history of financing innovation, depictingtwo eras in the history of innovation, the era of the inventorand the era of the researcher, and shows how the financing ofinnovation models evolved under these eras. In this aspect, it isimportant to show that crises such as the 2008 crisis could blurthe view of financial system and check their willingness toadvance credit for innovation that is typically more risky thancredit for “normal” business and, as such, requires a more longrun perspective. Finally, Boya and Monino’s paper present atest model that develops the possibility to examine the whole

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General presentation

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of exogenous information on the Stock Exchange variations.The statistic performance of the model during the empiricapplication shows its ability to anticipate correctly the move-ments of prices of the underlying credit which is of great impor-tance as a policy tool.

REFERENCES

FT (2010), Basel Should Stand Firm on Capital, London, Financial Times,Friday, September 10, p. 8.

IMF (2010a), World Economic Outlook, Washington D.C., InternationalMonetary Fund, April.

IMF (2010b), Global Financial and Stability Report, Washington D.C., Inter-national Monetary Fund. April.

MINSKY, H. P. (1986), Stabilizing An Unstable Economy, New Haven, YaleUniversity Press.

MORRIS, C. (2008), The Trillion Dollar Meltdown, New York, PublicAffairs.

MÜNCHAL, W. (2010), A Eurozone Banking Crisis Left Unresolved,London, Financial Times, Monday, September 13, 9.

The Economist (2010), Are We There Yet?, London, The Economist, Sep-tember 18, 11.

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