This review was written by Eugene Kernes
Genre = Economics, Finance
“Recognizing these analogies and precedents is an essential step towards improving our global financial system, both to reduce the risk of future crisis and to better handle catastrophes when they happen.” – Carmen Reinhart, and Kenneth Rogoff, Preface, Page xxv
“Debt intolerance is defined as the extreme duress many emerging markets experience at external debt levels that would seem quite manageable by the standards of advanced countries.” – Carmen Reinhart, and Kenneth Rogoff, Chapter 2: Debt Intolerance: The Genesis of Serial Default, Page 21
“The fact that lenders depend on a sovereign nation’s willingness to repay, not imply its ability to repay, implies that sovereign bankruptcy is a distinctly different animal than corporate bankruptcy.” – Carmen Reinhart, and Kenneth Rogoff, Chapter 4: A Digression On The Theoretical Underpinnings Of Debt Crises, Page 52
Overview:
Before a financial crisis, there is often a perception that this time is different. A belief that crises are a part of the past, or only other places suffer them. This happens to be a very costly piece of investment advice. The claim partly stems from improved evaluation techniques, that previous rules of valuation are not applicable, which is heavily backed up by rigorous analysis. Along with thinking that the lessons from prior failures have been learned, and that the boom being experienced has appropriate fundamentals and is built on good policy. This is one similar feature that occurs before a crisis. Another similar feature between various crises is excessive debt accumulation. Each crisis might appear different, but they have many similar features. Understanding these similar features, means being able to reduce the risk of future crisis and to better handle each crisis. The authors utilize various quantitative methods to show the general trends within crises.
Financial crises have been around since the development of money and financial markets. Highly indebted institutions, whether public or private, can keep credit rolling until confidence in them has collapsed, and lenders disappear, creating a crisis. During a crisis, investors withdraw from risk taking generally, rather than specific sources. Even countries face that problem as their credit can be taken away if other countries with similar issues are having problems.
Fickle expectations that destabilize banks, also apply to governments especially when they are borrowing external debt. It is normal for emerging markets to have sovereign external debt defaults. Development of their social, political, and economic aspects into becoming an advanced market can take a while, but will graduate away from defaults. Governments have found ways to rid themselves of serial default on sovereign debt or very high inflation. But serial banking crisis still remain.
Normal function of a bank is to borrow short term, and lend long term. A crisis can occur if they cannot fund their short-term obligation, with the illiquid long-term assets. Some governments borrow with short term maturities because of the benefit of lower interest rate. The problem of relying on short term borrowing is that confidence can change, and remove a source of funding.
Although there are similarities between private and public financial crisis, there are differences as well. Governments do not default in the same manner that private institutions do. Governments do not cease to exist with a default, and defaulting requires more considerations than economic and financial cost-benefit analysis as social and political factors needs to be considered.
Private institutions and individuals have clearly defined rights, such as assets being taken over when undergoing bankruptcy. Creditors do not necessarily have that option with governments, even if on paper they do. For sovereign nations, it is not just ability to repay debt that matters, but also willingness.
Caveats?
This is primarily a quantitate account of crises. Looking at statistical trends rather than detailed descriptions of various crisis. There are very brief descriptions of various crises. The general explanations of various aspects of a crisis are short, and might need more research to understand the problems. A basic understanding of finance and statistics would help in reading the book.
As the book looks at trends in data, what the authors recognize is the need for better data. Much of the data was hard to obtain, contains suspect data, and lot of missing data. Improving the quality of the data, can improve an understanding of particular trends within the data.
