The U.S. Financial Crisis: The Global Dimension with Implications for U.S. Policy

Prepared for Members and Committees of Congress

What began as a bursting of the U.S. housing market bubble and a rise in foreclosures has
ballooned into a global financial crisis. Some of the largest and most venerable banks, investment
houses, and insurance companies have either declared bankruptcy or have had to be rescued
financially. In October 2008, credit flows froze, lender confidence dropped, and one after another
the economies of countries around the world dipped toward recession. The crisis exposed
fundamental weaknesses in financial systems worldwide, and continues despite coordinated
easing of monetary policy by governments, trillions of dollars in intervention by governments,
and several support packages by the International Monetary Fund.
The process for coping with the crisis by countries across the globe has been manifest in four
basic phases. The first has been intervention to contain the contagion and restore confidence in
the system. This has required extraordinary measures both in scope, cost, and extent of
government reach. The second has been coping with the secondary effects of the crisis,
particularly the slowdown in economic activity and flight of capital from countries in emerging
markets and elsewhere who have been affected by the crisis. The third phase of this process is to
make changes in the financial system to reduce risk and prevent future crises. In order to give
these proposals political backing, world leaders have called for international meetings to address
changes in policy, regulations, oversight, and enforcement. Some are characterizing these
meetings as Bretton Woods II. On November 15, 2008, a G-20 leaders’ summit recommended
several measures to be implemented by participating countries by March 31, 2009. The fourth
phase of the process is dealing with political and social effects of the financial turmoil.
The role for Congress in this financial crisis is multifaceted. A major issue is how to ensure the
smooth and efficient functioning of financial markets to promote the general well-being of the
country while protecting taxpayer interests and facilitating business operations without creating a
moral hazard. In addition to preventing future crises through legislative, oversight, and domestic
regulatory functions, Congress has been providing funds and ground rules for economic
stabilization packages and informing the public through hearings and other means. The largest
question may be how U.S. regulations should be changed, if necessary, and how closely any
changes are harmonized with international recommendations. Other questions include: should the
United States promote global regulatory standards to be voluntarily adopted by countries or
should a supranational regulatory institution be created that would impose rules on international
financial markets? Where would enforcement authority reside; at the state, national, or
international level? Congress also plays a role in measures to reform international financial
institutions and in recapitalizing the International Monetary Fund. Also, should U.S. policies be
designed to restore confidence in and induce return to the normal functioning of a self-correcting
financial system or has the system, itself, become inherently unstable?
This report will be updated periodically.

Recent Developments and Analysis................................................................................................1
The Global Financial Crisis and U.S. Interests...............................................................................2
Origins, Contagion, and Risk..........................................................................................................6
Risk ........................................................................................................................... ................ 9
The Downward Slide...............................................................................................................10
Effects on Emerging Markets........................................................................................................15
Latin America..........................................................................................................................22
Mexico .............................................................................................................................. 23
Brazil ................................................................................................................................. 24
Arge ntina...................................................................................................................... ..... 25
Russia and the Financial Crisis...............................................................................................26
Effects on Europe and The European Response............................................................................27
The “European Framework for Action”..................................................................................32
The British Rescue Plan..........................................................................................................33
Collapse of Iceland’s Banking Sector.....................................................................................35
Impact on Asia and the Asian Response........................................................................................36
Asian Reserves and Their Impact............................................................................................39
National Responses.................................................................................................................40
Japan .......................................................................................................................... ....... 40
China .......................................................................................................................... ....... 41
South Korea......................................................................................................................43
Paki stan ............................................................................................................................. 44
Other Countries’ Moves....................................................................................................45
New Challenges and Policy in Managing Financial Risk.............................................................46
The Challenges........................................................................................................................46
Policy ...................................................................................................................................... 49
Bretton Woods II...............................................................................................................50
G-20 Meeting....................................................................................................................50
G-7 Meeting......................................................................................................................53
The International Monetary Fund.....................................................................................53
Changes in U.S. Regulations and Regulatory Structure...................................................56
Selected Legislation from the 110th Congress...............................................................................60
2008 ......................................................................................................................................... 64
2007 ......................................................................................................................................... 73
Figure 1. Origins of the Financial Crisis: The Rise and Fall of Risky Mortgage and Other
Debt .............................................................................................................................................. 8
Figure 2. Selected Stock Market Indices for the United States, U.K., Japan, and Russia.............11
Figure 3. Exchange Rate Values for Selected Currencies Relative to the U.S. Dollar..................13
Figure 4. Quarterly (Annualized) Economic Growth Rates for Selected Countries.....................14

Figure 5. Current Account Balances (as a percentage of GDP)....................................................17
Figure 6. Global Foreign Exchange Reserves...............................................................................18
Figure 7. Capital Flows to Latin America (in percent of GDP).....................................................20
Figure 8. Capital Flows to Developing Asia (in percent of GDP).................................................20
Figure 9. Capital Flows to Central and Eastern Europe (in percent of GDP)...............................21
Figure 10. Asian Current Account Balances are Mostly Healthy..................................................37
Table 1. Selected Government Financial Support Actions............................................................14
Table 2. Projections of Economic Growth in 2008 and 2009 and Price Inflation in
Selected Regions and Countries (in percent).............................................................................29
Table 3. Losses on Selected Financial assets.................................................................................30
Table 4. Problems, Targets of Policy, and Actions Taken or Possibly to Take in Response
to the Global Financial Crisis.....................................................................................................58
Appendix A. British, U.S., and European Central Bank Operations, April to Mid-October
2008 ............................................................................................................................................ 62
Appendix B. Major Recent Actions and Events of the International Financial Crisis..................64
Appendix C. G-20 Declaration of November 15, 2008.................................................................75
Author Contact Information..........................................................................................................84

November 15. At a summit of leaders from the G-20 nations (including the G-8, the European
Union, Australia and 10 major emerging economies), leaders agreed to continue taking steps to
stabilize the global financial system and improve the international regulatory framework. The
leaders’ announced action plan (intended to be implemented by national regulators by March 31,

2009) included pledges to (1) address weaknesses in accounting and disclosure standards for off-

balance sheet vehicles; (2) ensure that credit rating agencies meet the highest standards and avoid
conflicts of interest, provide greater disclosure to investors, and differentiate ratings for complex
products; (3) ensure that firms maintain adequate capital, and set out strengthened capital
requirements for banks’ structured credit and securitization activities; (4) develop enhanced
guidance to strengthen banks’ risk management practices, and ensure that firms develop processes
that look at whether they are accumulating too much risk; (5) establish processes whereby
national supervisors who oversee globally active financial institutions meet together and share
information; and (6) expand the Financial Stability Forum to include a broader membership of
emerging economies.
—The crisis in credit markets and the threat of bankruptcy by major financial institutions still
continues with a financial support package for Citigroup announced on November 24. The
financial crisis, moreover, has evolved into a global macroeconomic downturn. The Euro zone,
Japan, and the United States are officially in recession, and other countries are following to create
a synchronous slowdown in economies worldwide.
—The G-20 summit illustrated the growing complexity, interconnectedness, and shifting balance
of economic power in the world. China with its nearly $2 trillion in foreign exchange reserves,
along with a rising India, reassertive Russia, and reformed Brazil all had seats at the table with
the usual financial leaders. It wasn’t apparent, however, that the developing world pushed for a
broadly different agenda from advanced nations. The financial crisis and its aftermath has been
remarkably indiscriminate. It has struck nearly all countries regardless of political system or size
and even those not exceptionally exposed to risky debt.
—In many countries, the policy issues have expanded to include what to do about non-financial
industries that are hard hit by recession and sagging demand and prices. The United States has
provided a $17.4 billion loan package to General Motors and Chrysler. Canada also is providing
$3.29 billion in loans to the Canadian subsidiaries of the two companies. Indonesia, Russia,
France, Argentina, and Brazil reportedly are pursuing a variety of policies designed to protect
domestic companies from import competition or from foreign takeovers.

1 For a more complete list of major developments and actions, see Appendix B.

What began as a bursting of the U.S. housing market bubble and a rise in foreclosures has
ballooned into a global financial and economic crisis. Some of the largest and most venerable
banks, investment houses, and insurance companies have either declared bankruptcy or have had
to be rescued financially. In October 2008, credit flows froze, lender confidence dropped, and one
after another the economies of countries around the world dipped toward recession. The crisis
exposed fundamental weaknesses in financial systems worldwide, and despite coordinated easing
of monetary policy by governments and trillions of dollars in intervention by central banks and
governments, the crisis seems far from over.
This financial crisis which began in industrialized countries quickly entered a second phase in
which emerging market and other economies have been battered. Investors have pulled capital
from countries, even those with small levels of perceived risk, and caused values of stocks and
domestic currencies to plunge. Also, slumping exports and commodity prices have added to the
woes, pushing economies world wide toward recession. The global crisis now seems to be played
out on two levels. The first is among the industrialized nations of the world where most of the
losses from subprime mortgage debt, excessive leveraging of investments, and inadequate capital
backing credit default swaps (insurance against defaults and bankruptcy) have occurred. The
second level of the crisis is among emerging market and other economies who may be “innocent
bystanders” to the crisis but who also may have less resilient economic systems that can often be
whipsawed by actions in global markets. Most industrialized countries (except for Iceland) seem
to able to finance their own rescue packages by borrowing domestically and in international
capital markets, but emerging market economies may have insufficient sources of capital and may
have to turn to help from the International Monetary Fund (IMF) or from capital surplus nations,
such as Russia, Japan, and the European Union.
For the United States, the financial turmoil touches on the fundamental national interest of
protecting the economic security of Americans. It also is affecting the United States in achieving
national goals, such as stability, maintaining cooperative relations with other nations, and
supporting a financial infrastructure that allows for the smooth functioning of the international
economy. Reverberations from the financial crisis, moreover, are not only being felt on Wall
Street and Main Street but are being manifest in world flows of exports and imports, rates of
growth and unemployment, and government revenues and expenditures. The rapidity with which
growth is slowing in countries seems to indicate that this global downturn is not a just a phase in
the usual cycle of business.
A single global financial market now seems to be an economic reality, and financial troubles also
affect the goods-and-services-producing sectors of the economy. As the force of the effects of the
global financial market are felt, popular and congressional concern may grow. Is the system too
complex to be controlled, or is it an insider’s game at the expense of Main Street? Opposition to
globalization from various quarters may work to shape the debate over rewriting U.S. and
international financial rules.

2 Prepared by Dick K. Nanto, Specialist in Industry and Trade, Foreign Affairs, Defense, and Trade Division.

The global financial crisis has brought home an important point: the United States is still a major
center of the financial world. Regional financial crises (such as the Asian financial crisis, Japan’s
banking crisis, or the Latin American debt crisis) can occur without seriously infecting the rest of
the global financial system. But when the U.S. financial system stumbles, it may bring major 3
parts of the rest of the world down with it. The reason is that the United States is the main
guarantor of the international financial system, the provider of dollars widely used as currency
reserves and as an international medium of exchange, and a contributor to much of the financial
capital that sloshes around the world seeking higher yields. The rest of the world may not
appreciate it, but a financial crisis in the United States often takes on a global hue. Emerging
market economies, in particular, have not de-coupled from the U.S. economy.
The process as it has played out in countries across the globe has been manifest in four basic
phases. The first phase has been intervention to stop the financial bleeding, to coordinate interest
rate cuts, and pursue actions to restart and restore confidence in credit markets. This has involved
decisive (and, in cases, unprecedented) measures both in scope, cost, and extent of government
reach. Actions taken include the rescue of financial institutions considered to be “too big to fail,”
injections of capital, government takeovers of certain financial institutions, government
guarantees of bank deposits and money market funds, and government facilitation of mergers and
acquisitions. (See Tables 3 and 5.)
The second phase of this process is less innovative as countries cope with the macroeconomic
impact of the crisis on their economies, firms, and investors. Many of these countries, particularly
those with emerging markets, have been pulled down by the ever widening flight of capital from
risk and by falling exports and commodity prices. Governments have turned to traditional
monetary and fiscal policies to deal with recessionary economic conditions, declining tax
revenues, and rising unemployment, and several have turned to funding from the International
Monetary Fund (IMF), World Bank, and capital surplus countries. The IMF and others are in the
process of providing financing packages for Iceland ($2.1 billion), Ukraine ($16.5 billion),
Hungary ($25.1 billion), and Pakistan ($7.6 billion). Other countries, such as Belarus, are in talks
with the IMF. In addition, nations, both industrialized and emerging, facing difficult economic
conditions include some other countries of the Former Soviet Union, Mexico, Argentina, South
Korea, Indonesia, Spain, and Italy. Some countries have raised import barriers (so far, arguably
within the limits of World Trade Organization rules) in an attempt to compensate for falling
demand and prices.
The third phase of the process—to decide what changes may be needed in the financial system—
is also underway. While monetary authorities battled the financial conflagration and slowdown in
economic growth, the question of what changes are necessary to prevent future crises had been
left primarily to observers and academics. As the triage has been applied and the crisis has ebbed
somewhat, attention now has turned to long-term solutions to the problems. In order to give these
proposals political backing, world leaders began a series of international meetings to address
changes in policy, regulations, oversight, and enforcement. Some are characterizing these 4
meetings as Bretton Woods II. The G-20 leaders’ Summit on Financial Markets and the World

3 See, for example, Friedman, George and Peter Zeihan. “The United States, Europe and Bretton Woods II.” A Strafor
Geopolitical Intelligence Report, October 20, 2008.
4 The Bretton Woods Agreements in 1944 established the basic rules for commercial and financial relations among the
world’s major industrial states and also established what has become the World Bank and International Monetary Fund.

Economy that met on November 15, 2008, in Washington, DC, was the first of a series of
summits to address these issues. (See Appendix C.)
In this third phase, the immediate issues to be addressed by the United States center on “fixing the
system” and preventing future crises from occurring. Much of this involves the technicalities of
regulation and oversight of financial markets, derivatives, and hedging activity, as well as
standards for capital adequacy and a schema for funding and conducting future financial
interventions, if necessary. Some of the short-term issues that have been raised (and are discussed
later in this paper or other CRS reports) include:
• weakness in fundamental underwriting principles,
• the build-up of massive risk concentrations in firms,
• the originate-to-distribute model of mortgage lending,
• insufficient bank liquidity and capital buffers,5
• no overall regulatory structure for banks, brokerages, insurance, and futures,
• lack of a regulatory ties between macroeconomic variables and prudential
oversight, and
• how financial rescue packages should be structured.
For the United States, the fundamental issues may be the degree to which U.S. laws and
regulations are to be altered to conform to international norms and standards and the degree to
which the country is willing to cede authority to an international watchdog and regulatory agency.
What form should any new international financial architecture take? Should the Bretton Woods
system be changed from one in which the United States is the buttress of the international
financial architecture to one in which the United States remains the buttress but its financial
markets are more “Europeanized” (more in accord with Europe’s practices) and more constrained
by the broader international financial order? Should the international financial architecture be 6
merely strengthened or include more control, and if more controls, then by whom? What is the
time frame for a new architecture that may take years to materialize?
Some of these issues are being addressed by the President’s Working Group on Financial Markets
(consisting of the U.S. Treasury Secretary, Chairs of the Federal Reserve Board, the Securities
and Exchange Commission, and the Commodity Futures Trading Commission. On the
international side, the G-20 nations, the International Monetary Fund, the Financial Stability
Forum, and the Bank for International Settlements also are seeking solutions.
The fourth phase of the process is dealing with political and social effects of the financial turmoil.
These are secondary effects that relate to the role of the United States on the world stage, its
leadership position relative to other countries, and the political and social impact within countries
affected by the crisis. For example, European leaders (particularly British Prime Minister Gordon
Brown, French President Nicolas Sarkozy, and German Chancellor Angela Merkel) have been
playing a major role during the crisis, particularly in Europe, and have been influential in crafting

5 Wellink, Nout.Responding to Uncertainty,” Remarks by the Chairman of the Basel Committee on banking
supervision at the International Conference of Banking Supervisors 2008, Brussels, September 24, 2008.
6 Friedman, George and Peter Zeihan. “The United States, Europe and Bretton Woods II.” A Strafor Geopolitical
Intelligence Report, October 20, 2008.

international policies to deal with adverse effects of the crisis as well as proposing long-term
solutions. The end-of-term status of President George W. Bush may have contributed to this
situation, but over the longer-run, will the financial crisis work to diminish the influence of the
United States and its dollar in financial circles relative to Europe and its Euro/pound? This may
occur in spite of the “flight to safety” into dollar assets during the crisis. Dealing with the
financial crisis also may enable countries with rich currency reserves, such as China, Russia, and
Japan, to assume higher political profiles in world financial circles. The inclusion of China, India,
and Brazil in the G-20 Summit on Financial Markets and the World Economy rather than just the
G-7 or G-8 countries as originally proposed, seems to indicate the growing influence of the non-7
industrialized nations in addressing global financial issues.
The effects of the crisis also may impede the ability of the United States to carry out certain U.S.
goals. For example, the financial crisis comes at time of global food shortages and has been
causing recessions in countries or at least their growth rates to decline. As economic conditions in
developing countries worsen, requests for economic and humanitarian assistance are likely to
increase. This coincides, however, with a slowdown in government revenues and huge costs for
financial rescue packages that may reduce the U.S. ability to increase funding for aid or other
programs. Also, if China helps to finance the various rescue measures in the United States,
Washington may lose some leverage with Beijing in pursuing human and labor rights, product
safety, and other pertinent issues. The precipitous drop in the price of oil, moreover, holds
important implications for countries, such as Russia, Mexico, Venezuela, and other petroleum
exporters, who were counting on oil revenues to continue to pour into their coffers to fund
activities considered to be essential to their interests. While moderating oil prices may be a
positive development for the U.S. consumer and for the U.S. balance of trade, it also may affect
the political stability of certain petroleum exporting countries. The concomitant drop in prices of
commodities such as rubber, copper ore, iron ore, beef, rice, coffee, and tea also carries dire 8
consequences for exporter countries in Africa, Latin America, and Asia.
The decline in oil prices may be particularly troubling in oil-dependent Yemen, a country with a
large population of unemployed young people and a history of support for militant Islamic
groups. Also, in Pakistan, a particular security problem exacerbated by the financial crisis could
be developing. Although the IMF and Pakistan have agreed in principle to a $7.6 billion loan, the
country faces serious problems economic problems at a time when the country is dealing with
challenges from suspected al Qaeda and Taliban sympathizers in the country and a budget 9
shortfall that may curtail the ability of the government to continue its counterterror operations.
The role for Congress in this financial crisis is multifaceted. The overall issue seems to be how to
ensure the smooth and efficient functioning of financial markets to promote the general well-
being of the country while protecting taxpayer interests and facilitating business operations

7 The G-7 includes Canada, France, Germany, Italy, Japan, United Kingdom, and the United States. The G-8 is the G-7
plus Russia. The G-20 adds Argentina, Australia, Brazil, China, India, Indonesia, Mexico, Saudi Arabia, South Africa,
South Korea, and Turkey.
8 Johnston, Tim.Asia Nations Join to Prop Up Prices,” Washington Post, November 1, 2008, p. A10.Record Fall in
NZ Commodity Price Gauge,” The National Business Review, November 5, 2008.
9 Joby Warrick, “Experts See Security Risks in Downturn, Global Financial Crisis May Fuel Instability and Weaken
U.S. Defenses, Washington Post, November 15, 2008. P. A01. Bokhari, Farhan,Pakistan’s War On Terror Hits
Roadblock, Global Economic Crisis Prompts Military To Consider Spending Cutbacks,” CBS News (online version),
October 28, 2008.

without creating a moral hazard.10 In addition to preventing future crises through legislative,
oversight, and domestic regulatory functions, Congress has been providing funds and ground
rules for economic stabilization packages and informing the public through hearings and other
means. Congress also plays a role in measures to reform the international financial system and in
recapitalizing international financial institutions such as the International Monetary Fund.

Financial crises of some kind occur sporadically virtually every decade and in various locations
around the world. Financial meltdowns have occurred in countries ranging from Sweden to
Argentina, from Russia to Korea, from the United Kingdom to Indonesia, and from Japan to the 12
United States. As one observer noted: as each crisis arrives, policy makers express ritual shock,
then proceed to break every rule in the book. The alternative is unthinkable. When the worst is 13
passed, participants renounce crisis apostasy and pledge to hold firm next time.
Each financial crisis is unique, yet each bears some resemblance to others. In general, crises have
been generated by factors such as an overshooting of markets, excessive leveraging of debt, credit
booms, miscalculations of risk, rapid outflows of capital from a country, mismatches between
asset types (e.g., short-term dollar debt used to fund long-term local currency loans),
unsustainable macroeconomic policies, off-balance sheet operations by banks, inexperience with
new financial instruments, and deregulation without sufficient market monitoring and oversight.
As shown in Figure 1, the current crisis harkens back to the 1997-98 Asian financial crisis in
which Thailand, Indonesia, and South Korea had to borrow from the International Monetary Fund
to service their short-term foreign debt and to cope with a dramatic drop in the values of their 14
currency and deteriorating financial condition. Determined not to be caught with insufficient
foreign exchange reserves, countries subsequently began to accumulate dollars, Euros, pounds,
and yen in record amounts. This was facilitated by the U.S. trade (current account) deficit and by 15
its low saving rate. By mid-2008, world currency reserves by governments had reached $4.4
trillion with China’s reserves alone approaching $2 trillion, Japan’s nearly $1 trillion, Russia’s 16
more than $500 billion, and India, South Korea, and Brazil each with more than $200 billion.
The accumulation of hard currency assets was so great in some countries that they diverted some

10 A moral hazard is created if a government rescue of private companies encourages those companies and others to
engage in comparable risky behavior in the future, since the perception arises that they will again be rescued if
necessary and not have to carry the full burden of their losses.
11 Prepared by Dick K. Nanto. See also, CRS Report RL34730, The Emergency Economic Stabilization Act and
Current Financial Turmoil: Issues and Analysis, by Baird Webel and Edward V. Murphy.
12 For a review of past financial crises, see Luc Laeven and Fabian Valencia. “Systemic Banking Crises: A New
Database,” International Monetary Fund Working Paper WP/08/224, October 2008. 80p.
13 Gelpern, Anna. “Emergency Rules,The Record (Bergen-Hackensack, NJ), September 26, 2008.
14 During the Asian financial crisis in 1997, the IMF, World Bank, Asian Development Bank, the United States, and
Japan provided financial support packages to Thailand ($17.2 billion), Indonesia ($42.3 billion), and South Korea
($58.2 billion).
15 From 2005-2007, the U.S. current account deficit (balance of trade, services, and unilateral transfers) was a total of
$2.2 trillion.
16 Reuters. FactboxGlobal foreign exchange reserves. October 12, 2008.

of their reserves into sovereign wealth funds that were to invest in higher yielding assets than 17
U.S. Treasury and other government securities.
Following the Asian financial crisis, much of the world’s “hot money” began to flow into high
technology stocks. The so-called “dot-com boom” ended in the spring of 2000 as the value of
equities in many high-technology companies collapsed.
After the dot-com bust, more “hot investment capital” began to flow into housing markets—not
only in the United States but in other countries of the world. At the same time, China and other
countries invested much of their accumulations of foreign exchange into U.S. Treasury and other
securities. While this helped to keep U.S. interest rates low, it also tended to keep mortgage 18
interest rates at lower and attractive levels for prospective home buyers. This housing boom
coincided with greater popularity of the securitization of assets, particularly mortgage debt 19
(including subprime mortgages), into collateralized debt obligations (CDOs). A problem was
that the mortgage originators often were mortgage finance companies whose main purpose was to
write mortgages using funds provided by banks and other financial institutions or borrowed. They
were paid for each mortgage originated but had no responsibility for loans gone bad. Of course,
the incentive for them was to maximize the number of loans concluded. This coincided with
political pressures to enable more Americans to buy homes, although it appears that Fannie Mae
and Freddie Mac were not directly complicit in the loosening of lending standards and the rise of 20
subprime mortgages.

17 See CRS Report RL34336, Sovereign Wealth Funds: Background and Policy Issues for Congress, by Martin A.
18 See U.S. Joint Economic Committee,Chinese FX Interventions Caused international Imbalances, Contributed to
U.S. Housing Bubble,” by Robert OQuinn. March 2008.
19 For further analysis, see CRS Report RL34412, Containing Financial Crisis, by Mark Jickling, U.S. Joint Economic
Committee,The U.S. Housing Bubble and the Global Financial Crisis: Vulnerabilities of the Alternative Financial
System,” by Robert OQuinn. June 2008.
20 Fannie Mae (Federal National Mortgage Association) is a government-sponsored enterprise (GSE) chartered by
Congress in 1968 as a private shareholder-owned company with a mission to provide liquidity and stability to the U.S.
housing and mortgage markets. It operates in the U.S. secondary mortgage market and funds its mortgage investments
primarily by issuing debt securities in the domestic and international capital markets. Freddie Mac (Federal Home Loan
Mortgage Corp) is a stockholder-owned GSE chartered by Congress in 1970 as a competitor to Fannie Mae. It also
operates in the secondary mortgage market. It purchases, guarantees, and securitizes mortgages to form mortgage-
backed securities. For an analysis of Fannie Mae and Freddie Macs role in the subprime crisis, see David Goldstein
and Kevin G. Hall, “Private sector loans, not Fannie or Freddie, triggered crisis,” McClatchy Newspapers, October 12,

Figure 1. Origins of the Financial Crisis: The Rise and Fall of Risky Mortgage and Other Debt

In order to cover the risk of defaults on mortgages, particularly subprime mortgages, the holders 21
of CDOs purchased credit default swaps (CDSs). These are a type of insurance contract (a
financial derivative) that lenders purchase against the possibility of credit event (a default on a
debt obligation, bankruptcy, restructuring, or credit rating downgrade) associated with debt, a
borrowing institution, or other referenced entity. The purchaser of the CDS does not have to have
a financial interest in the referenced entity, so CDSs quickly became more of a speculative asset
than an insurance policy. As long as the credit events (defaults) never occurred, issuers of CDSs
could earn huge amounts in fees relative to their capital base (since these were technically not
insurance, they did not fall under insurance regulations requiring sufficient capital to pay claims,
although credit derivatives requiring collateral became more and more common in recent years).
The sellers of the CDSs that protected against defaults often covered their risk by turning around
and buying CDSs that paid in case of default. As the risk of defaults rose, the cost of the CDS
protection rose. Investors, therefore, could arbitrage between the lower and higher risk CDSs and
generate large income streams with what was perceived to be minimal risk.
In 2007, the notional value (face value of underlying assets) of credit default swaps had reached 22
$62 trillion, more than the combined gross domestic product of the entire world ($54 trillion),
although the actual amount at risk was only a fraction of that amount. By July 2008, the notional
value of CDSs had declined to $54.6 trillion and by October 2008 to an estimated $46.95 23
trillion. The system of CDSs generated large profits for the companies involved until the default
rate, particularly on subprime mortgages, and the number of bankruptcies began to rise. Soon the
leverage that generated outsized profits began to generate outsized losses, and in October 2008,
the exposures became too great for companies such as AIG.
The origins of the financial crisis point toward three developments that increased risk in financial
markets. The first was the originate-to-distribute model for mortgages. The originator of
mortgages passed them on to the provider of funds or to a bundler who then securitized them and
sold the collateralized debt obligation to investors. This recycled funds back to the mortgage
market and made mortgages more available. However, the originator was not penalized, for
example, for not ensuring that the borrower was actually qualified for the loan, and the buyer of
the securitized debt had little detailed information about the underlying quality of the loans.
Investors depended heavily on ratings by credit agencies.
The second development was a rise of perverse incentives and complexity for credit rating
agencies. Credit rating firms received fees to rate securities based on information provided by the

21 A credit default swap is a credit derivative contract in which one party (protection buyer) pays a periodic fee to
another party (protection seller) in return for compensation for default (or similar credit event) by a reference entity.
The reference entity is not a party to the credit default swap. It is not necessary for the protection buyer to suffer an
actual loss to be eligible for compensation if a credit event occurs. The protection buyer gives up the risk of default by
the reference entity, and takes on the risk of simultaneous default by both the protection seller and the reference credit.
The protection seller takes on the default risk of the reference entity, similar to the risk of a direct loan to the reference
entity. See CRS Report RS22932, Credit Default Swaps: Frequently Asked Questions, by Edward V. Murphy.
22 Notional value is the face value of bonds and loans on which participants have written protection. World GDP is
from World Bank. Development Indicators.
23 International Swaps and Derivatives Association, ISDA Applauds $25 Trn Reductions in CDS Notionals, Industry
Efforts to Improve CDS Operations. News Release, October 27, 2008.

issuing firm using their models for determining risk. Credit raters, however, had little experience
with credit default swaps at the “systemic failure” tail of the probability distribution. The models
seemed to work under normal economic conditions but had not been tested in crisis conditions.
Credit rating agencies also may have advised clients on how to structure securities in order to
receive higher ratings. In addition, the large fees offered to credit rating firms for providing credit
ratings were difficult for them to refuse in spite of doubts they might have had about the
underlying quality of the securities. The perception existed that if one credit rating agency did not
do it, another would.
The third development was the blurring of lines between issuers of credit default swaps and
traditional insurers. In essence, financial entities were writing a type of insurance contract without
regard for insurance regulations and requirements for capital adequacy (hence, the use of the term
“credit default swaps” instead of “credit default insurance”). Much risk was hedged rather than
backed by sufficient capital to pay claims in case of default. Under a systemic crisis, hedges also
may fail. However, although the CDS market was largely unregulated by government, more than
850 institutions in 56 countries that deal in derivatives and swaps belong to the ISDA
(International Swaps and Derivatives Association). The ISDA members subscribe to a master
agreement and several protocols/amendments, some of which require that in certain
circumstances companies purchasing CDSs require counterparties (sellers) to post collateral to 24
back their exposures. The blurring of boundaries among banks, brokerage houses, and insurance
agencies also made regulation and information gathering difficult. Regulation in the United States
tends to be functional with separate government agencies regulating and overseeing banks,
securities, insurance, and futures. There is no suprafinancial authority.
The plunge downward into the global financial crisis did not take long. It was triggered by the
bursting of the housing bubble and the ensuing subprime mortgage crisis in the United States, but
other conditions have contributed to the severity of the situation. Banks, investment houses, and
consumers carried large amounts of leveraged debt. Certain countries incurred large deficits in
international trade and current accounts (particularly the United States), while other countries
accumulated large reserves of foreign exchange by running surpluses in those accounts. Investors
deployed “hot money” in world markets seeking higher rates of return. These were joined by a
huge run up in the price of commodities, rising interest rates to combat the threat of inflation, a
general slowdown in world economic growth rates, and increased globalization that allowed for
rapid communication, instant transfers of funds, and information networks that fed a herd instinct.
This brought greater uncertainty and changed expectations into a world economy that for a half
decade had been enjoying relative stability.
An immediate indicator of the rapidity and spread of the financial crisis has been in stock market
values. As shown in Figure 2, as values on the U.S. market plunged, those in other countries were
swept down in the undertow. By mid-October 2008, the stock indices for the United States, U.K.,
Japan, and Russia had fallen by half or more relative to their levels on October 1, 2007.

24 For information on the International Swaps and Derivatives Association, see In 2008, credit
derivatives had collateralized exposure of 74%. See ISDA, Margin Survey 2008. Collateral calls have been a major
factor in the financial difficulties of AIG insurance.

Figure 2. Selected Stock Market Indices for the United States, U.K., Japan,
and Russia
Stock Market Indices (1 Oct 2007 = 100)
Se v e r e
Russian RTSGlobalContagion
Dow Jones Industrials

60Japans Nikkei 225

Mild Global Contagion
0 7 v -0 7 c- 07 n -0 8 b -0 8 r-0 8 r -08 y -0 8 n -0 8 l -0 8 g -0 8 p -0 8 t-0 8 v -0 8 c -0 8
c t- o De J a Fe Ma A p a J u - Ju Au e Oc o e
-O 0 -N 1- 1- 9- 1 - 0 - 0 -M 0 - 3 1 9 - 0 -S 1- 8 -N 6 -D
Source: Factiva database.
Declines in stock market values reflected huge changes in expectations and the flight of capital
from assets in countries deemed to have even small increases in risk. Many investors, who not too
long ago had heeded financial advisors who were touting the long term returns from investing in 25
the BRICs (Brazil, Russia, India, and China), pulled their money out nearly as fast as they had
put it in. Dramatic declines in stock values coincided with new accounting rules that required
financial institutions holding stock as part of their capital base to value that stock according to
market values (mark-to-market). Suddenly, the capital base of banks shrank and severely curtailed
their ability to make more loans (counted as assets) and still remain within required capital-asset
ratios. Insurance companies too found their capital reserves diminished right at the time they had
to pay buyers of credit default swaps. The rescue (establishment of a conservatorship) for Fannie
Mae and Freddie Mac in September 2008 potentially triggered credit default swap contracts with
notional value exceeding $1.2 trillion.
In addition, the rising rate of defaults and bankruptcies created the prospect that equities would
suddenly become valueless. The market price of stock in Freddie Mac plummeted from $63 on
October 8, 2007 to $0.88 on October 28, 2008. Hedge funds, whose “rocket scientist” analysts
claimed that they could make money whether markets rose or fell, lost vast sums of money. The
prospect that even the most seemingly secure company could be bankrupt the next morning

25 Thomas M. Anderson,Best Ways to Invest in BRICs,”, October 18, 2007.

caused credit markets to freeze. Lending is based on trust and confidence. Trust and confidence
evaporated as lenders reassessed lending practices and borrower risk.
One indicator of the trust among financial institutions is the Libor, the London Inter-Bank
Offered Rate. This is the interest rate banks charge for short-term loans to each other. Although it
is a composite of primarily European interest rates, it forms the basis for many financial contracts
world wide including U.S. home mortgages and student loans. During the worst of the financial
crisis in October 2008, this rate had doubled from 2.5% to 5.1%, and for a few days much
interbank lending actually had stopped. The rise in the Libor came at a time when the U.S.
monetary authorities were lowering interest rates to stimulate lending. The difference between
interest on Treasury bills (three month) and on the Libor (three month) is called the “Ted spread.”
This spread averaged 0.25 percentage points from 2002 to 2006, but in October 2008 exceeded

4.5 percentage points. By the end of December, it had fallen to about 1.5%. The greater the 26

spread, the greater the anxiety in the marketplace.
As the crisis has moved to a global economic slowdown, many countries have pursued
expansionary monetary policy to stimulate economic activity. This has included lowering interest
rates and expanding the money supply.
Currency exchange rates serve both as a conduit of crisis conditions and an indicator of the
severity of the crisis. As the financial crisis hit, investors fled stocks and debt instruments for the
relative safety of cash—often held in the form of U.S. Treasury or other government securities.
That increased demand for dollars, decreased the U.S. interest rate needed to attract investors, and
caused a jump in inflows of liquid capital into the United States. For those countries deemed to be
vulnerable to the effects of the financial crisis, however, the effect was precisely the opposite.
Demand for their currencies fell and their interest rates rose.
Figure 3 shows indexes of the value of selected currencies relative to the dollar for countries in
which the effects of the financial crisis have been particularly severe. For much of 2007 and
2008, the Euro and other European currencies, including the Hungarian forint had been
appreciating in value relative to the dollar. Then the crisis broke. Other currencies, such as the
Korean won, Pakistani rupee, and Icelandic krona had been steadily weakening over the previous
year and experienced sharp declines as the crisis evolved. Recently, however, they have recovered
For a country in crisis, a weak currency increases the local currency equivalents of any debt
denominated in dollars and exacerbates the difficulty of servicing that debt. The greater burden of
debt servicing usually has combined with a weakening capital base of banks because of declines
in stock market values to further add to the financial woes of countries. National governments
have had little choice but to take fairly draconian measures to cope with the threat of financial
collapse. As a last resort, some have turned to the International Monetary Fund for assistance.

26 For these and other indicators of the crisis in credit, see

Figure 3. Exchange Rate Values for Selected Currencies Relative to the U.S. Dollar
Currency Exchange Rates in Dollars (Oct 1, 2007 = 100)

140 Se v e r e

Hungarian ForintGlobal

120 Eu r o Co nt ag ion


60Icelandic KronaPakistani Rupees

South Korean Won
Mild Global Contagion
07 2007 2007 2008 2008 2008 2008 2008 2008 2008 200 8 2008 2008 2008 2008
/20 0/ 1/ 1/ 9/ 1/ 0/ 0/ 0/ 1/ 9/ 0/ 1/ 8/ 4/
/31 1/3 2/3 1/3 2/2 3/ 3 4/3 5/3 6/3 7/3 8/2 9/ 3 0/3 1/2 2/2
Source: Data from PACIFIC Exchange Rate Service, University of British Columbia.
Figure 4 shows the effect of the financial crisis on economic growth rates in selected nations of
the world. The figure shows the difference between the 2001 recession that was confined
primarily to countries such as the United States, Mexico, and Japan and the current financial
crisis that pulling down growth rates in a variety of countries. The slowdown is global. The
implication of this synchronous drop in growth rates is that the United States and other nations
may not be able to export their way out of recession. Even China is experiencing a “growth
recession.” There is no major economy that can play the role of an economic engine to pull out
economies that are in recession.

Figure 4. Quarterly (Annualized) Economic Growth Rates for Selected Countries
20Percent Growth in GDP
Ac t ual Forecast
15 2001
Re ce ss io n F inancial
S. Korea
5 Br a zi lU. S.
Japan, Mexic o
Rus s ia
Ge r m any
U. S.
-5 J apanGerm an y
Me x i c oU. K.
-1 0
United StatesMexicoGermanyUnited KingdomRussia
ChinaJapanSouth KoreaBrazil
-1 5
200 0 200 1 20 02 20 03 20 04 200 5 2006 200 7 2008 20 09 20 10
Year (4th quarter)
Source: Data and forecasts by Global Insight.
Details of many of the actions by other countries to address the effects of the financial crisis are
outlined in the sections below dealing with geographical regions and countries. Table 1 provides
a summary of costs of major actions taken so far by national governments.
Table 1. Selected Government Financial Support Actions
(in billions of U.S. dollars)
Bank Injections Purchases of Other
Guarantees Capital Assets
United Kingdom $450 $90 $349
United States 1,400 250 450 198
Austria 127 23
Belgium 7 4
France 62 400
Germany 600 190
Greece 23 8
Ireland Banks’ wholesale debt
Netherlands 300 70
Portugal 30
Spain 150 75

Bank Injections Purchases of Other
Guarantees Capital Assets
Norway 60
Sweden 214
Switzerland 5 60
Canada Banks’ wholesale debt 26
Denmark Banks’ wholesale debt
Iceland Nationalization of Glitner, Landsbanki, and Kaupthing Banks
Australia Banks’ wholesale debt 7
South Korea 100 1 1
Total dollars $5,269 711 1,357 1,357
Source: The Bank of England. Financial Stability Report, Oct 2008, p. 33.

The global credit crunch that began in August 2007 has led to a financial crisis in emerging
market countries (see box) that is being viewed as greater in both scope and effect than the East
Asian financial crisis of 1997-98 or the Latin American debt crisis of 2001-2002, although the
impact on individual countries may have been greater in previous crises. Of the emerging market
countries, those in Central and Eastern Europe appear, to date, to be the most impacted by the
financial crisis.
The ability of emerging market countries to borrow from global capital markets has allowed
many countries to experience incredibly high growth rates. For example, the Baltic countries of
Latvia, Estonia, and Lithuania experienced annual economic growth of nearly 10% in recent
years. However, since this economic expansion was predicated on the continued availability of
access to foreign credit, they were highly vulnerable to a financial crisis when credit lines dried

27 Prepared by Martin A. Weiss, Specialist in International Trade and Finance, Foreign Affairs, Defense, and Trade

What are Emerging Market Countries?
There is no uniform definition of the term “emerging markets.” Originally conceived in the early 1980s, the term is
used loosely to define a wide range of countries that have undergone rapid economic change over the past two
decades. Broadly speaking, the term is used to distinguish these countries from the long-industrialized countries, on
one hand, and less-developed countries (such as those in Sub-Saharan Africa), on the other. Emerging market
countries are located primarily in Latin America, Central and Eastern Europe, and Asia.
Since 1999, the finance ministers of many of these emerging market countries began meeting with their peers from
the industrialized countries under the aegis of the G-20, an informal forum to discuss policy issues related to global
macroeconomic stability. The members of the G-20 are the European Union and 19 countries: Argentina, Australia,
Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South
Korea, Turkey, the United Kingdom and the United States.
For more information, see “When are Emerging Markets no Longer Emerging?, Knowledge@Wharton, available at
Of all emerging market countries, Central and Eastern Europe appear to be the most vulnerable.
On a wide variety of economic indicators, such as the total amount of debt in the economy, the
size of current account deficits, dependence on foreign investment, and the level of indebtedness
in the domestic banking sector, countries such as Hungary, Ukraine, Bulgaria, Kazakhstan,
Kyrgyzstan, Latvia, Estonia, and Lithuania, rank among the highest of all emerging markets.
Throughout the region, the average current account deficit increased from 2% of GDP in 2000 to

9% in 2008. In some countries, however, the current account deficit is much higher. Latvia’s 28

estimated 2008 current account deficit is 22.9% of GDP and Bulgaria’s is 21.4%. The average
deficit for the region was greater than 6% in 2008 (Figure 5).

28 Mark Scott, “Economic Problems Threaten Central and Eastern Europe, BusinessWeek, October 17, 2008.

Figure 5. Current Account Balances (as a percentage of GDP)
Source: International Monetary Fund
Due to the impact of the financial crisis, several Central and Eastern European countries have
already sought emergency lending from the IMF to help finance their balance of payments. On
October 24, the IMF announced an initial agreement on a $2.1 billion two-year loan with Iceland
(approved on November 19). On October 26, the IMF announced a $16.5 billion agreement with
Ukraine. On October 28, the IMF announced a $15.7 billion package for Hungary. On November 29

3, a staff-level agreement on an IMF loan was reached with Kyrgyzstan, and on November 24,

the IMF approved a $7.6 billion stand-by arrangement for Pakistan to support the country’s 30
economic stabilization.
The quickness with which the crisis has impacted emerging market economies has taken many
analysts by surprise. Since the Asian financial crisis, many Asian emerging market economies
enacted a policy of foreign reserve accumulation as a form of self-insurance in case they once
again faced a “sudden stop” of capital flows and the subsequent financial and balance of 31
payments crises that result from a rapid tightening of international credit flows. Two additional
factors motivated emerging market reserve accumulation. First, several countries have pursued an
export-led growth strategy targeted at the U.S. and other markets with which they have generated

29 Information on ongoing IMF negotiations is available at
30 International Monetary Fund, “IMF Executive Board Approves Stand-by Arrangement for Pakistan.” Press Release
No. 08/303, November 24, 2008.
31 Reinhart, Carmen and Calvo, Guillermo (2000): When Capital Inflows Come to a Sudden Stop: Consequences and
Policy Options. Published in: in Peter Kenen and Alexandre Swoboda, eds. Reforming the International Monetary and
Financial System (Washington DC: International Monetary Fund, 2000) (2000): pp. 175-201.

trade surpluses.32 Second, a sharp rise in the price of commodities from 2004 to the first quarter
of 2008 led many oil-exporting economies, and other commodity-based exporters, to report very
large current account surpluses. Figure 6 shows the rapid increase in foreign reserve
accumulation among these countries. These reserves provided a sense of financial security to EM
countries. Some countries, particularly China and certain oil exporters, also established sovereign 33
wealth funds that invested the foreign exchange reserves in assets that promised higher yields.
Figure 6. Global Foreign Exchange Reserves
($ Trillion)
Source: IMF
While global trade and finance linkages between the emerging markets and the industrialized
countries have continued to deepen over the past decade, many analysts believed that emerging
markets had successfully “decoupled” their growth prospects from those of industrialized
countries. Proponents of the theory of decoupling argued that emerging market countries,
especially in Eastern Europe and Asia, have successfully developed their own economies and
intra-emerging market trade and finance to such an extent that a slowdown in the United States or
Europe would not have as dramatic an impact as it did a decade ago. A report by two economists
at the IMF found some evidence of this theory. The authors divided 105 countries into three
groups: developed countries, emerging countries, and developing countries and studied how
economic growth was correlated among the groups between 1960 and 2005. The authors found
that while economic growth was highly synchronized between developed and developing

32 “New paradigm changes currency rules,Oxford Analytica, January 17, 2008.
33 See CRS Report RL34336, Sovereign Wealth Funds: Background and Policy Issues for Congress, by Martin A.

countries, the impact of developed countries on emerging countries has decreased over time,
especially during the past twenty years. According to the authors:
In particular, [emerging market] countries have diversified their economies, attained high
growth rates and increasingly become important players in the global economy. As a result,
the nature of economic interactions between [industrialized and emerging market] countries 34
has evolved from one of dependence to multidimensional interdependence.
Despite efforts at self-insurance through reserve accumulation and evidence of economic
decoupling, the U.S. financial crisis, and the sharp contraction of credit and global capital flows
in October 2008 affected all emerging markets to a degree due to their continued dependence on
foreign capital flows. According to the Wall Street Journal, in the month of October, Brazil, India,
Mexico, and Russia drew down their reserves by more than $75 billion, in attempt to protect their 35
currencies from depreciating further against a newly resurgent U.S. dollar.
A key to understanding why emerging market countries have been so affected by the crisis
(especially Central and Eastern Europe) is their high dependence on foreign capital flows to
finance their economic growth (Figure 7-8). Even though several emerging markets have been
able to reduce net capital inflows by investing overseas (through sovereign wealth funds) or by
tightening the conditions for foreign investment, the large amount of gross foreign capital flows
into emerging markets remained a key vulnerability for them. For countries such as those in
Central and Eastern Europe which have both high gross and net capital flows, vulnerability to
financial crisis is even higher.
Once the crisis occurred, it became much more difficult for emerging market countries to
continue to finance their foreign debt. According to Arvind Subramanian, an economist at the
Peterson Institute for International Economics, and formerly an official at the IMF:
If domestic banks or corporations fund themselves in foreign currency, they need to roll
these over as the obligations related to gross flows fall due. In an environment of across-the-
board deleveraging and flight to safety, rolling over is far from easy, and uncertainty about 36
rolling over aggravates the loss in confidence.

34 Cigdem Akin and M. Ayhan Kose, “Changing Nature of North-South Linkages: Stylized Facts and Explanations.”
International Monetary Fund Working Paper 07/280. Available at
35 Joanna Slater and Jon Hilsenrath,Currency-Price Swings Disrupt Global Markets ,” Wall Street Journal, October
25, 2008.
36 Arvind Subramanian , “The Financial Crisis and Emerging Markets, Peterson Institute for International Economics,
Realtime Economics Issue Watch, October 24, 2008.

Figure 7. Capital Flows to Latin America (in percent of GDP)
Source: IMF
Figure 8. Capital Flows to Developing Asia (in percent of GDP)
Source: IMF

Figure 9. Capital Flows to Central and Eastern Europe (in percent of GDP)
Source: IMF
As emerging markets have grown, Western financial institutions have increased their investments 37
in emerging markets. G-10 financial institutions have a total of $4.7 trillion of exposure to
emerging markets with $1.6 trillion to Central and Eastern Europe, $1.5 trillion to emerging Asia,
and $1.0 trillion to Latin America. While industrialized nation bank debt to emerging markets
represents a relatively small percentage (13%) of total cross-border bank lending ($36.9 trillion as
of September 2008), this figure is disproportionately high for European financial institutions and
their lending to Central and Eastern Europe. For European and U.K. banks, cross-border lending
to emerging markets, primarily Central and Eastern Europe accounts for between 21% and 24% 38
of total lending. For U.S. and Japanese institutions, the figures are closer to 4% and 5%. The
heavy debt to Western financial institutions greatly increased central and Eastern Europe’s
vulnerability to contagion from the financial crisis.
In addition to the immediate impact on growth from the cessation of available credit, a downturn
in industrialized countries will likely affect emerging market countries through several other
channels. As industrial economies contract, demand for emerging market exports will slow down.
This will have an impact on a range of emerging and developing countries. For example, growth
in larger economies such as China and India will likely slow as their exports decrease. At the
same time, demand in China and India for raw natural resources (copper, oil, etc) from other
developing countries will also decrease, thus depressing growth in commodity-exporting 39

37 The Group of Ten is made up of eleven industrial countries (Belgium, Canada, France, Germany, Italy, Japan, the
Netherlands, Sweden, Switzerland, the United Kingdom, and the United States).
38 Stephen Jen and Spyros Andreopoulos, “Europe More Exposed to EM Bank Debt than the U.S. or Japan,” Morgan
Stanley Research Global, October 23, 2008.
39 Dirk Willem te Velde,The Global Financial Crisis and Developing Countries,” Overseas Development Institute,
October 2008.

Slower economic growth in the industrialized countries may also impact less developed countries
through lower future levels of bilateral foreign assistance. According to analysis by the Center for
Global Development’s David Roodman, foreign aid may drop precipitously over the next several
years. His research finds that after the Nordic crisis of 1991, Norway’s aid fell 10%, Sweden’s

17%, and Finland’s 62%. In Japan, foreign aid fell 44% between 1990 and 1996, and has never 40

returned to pre-crisis assistance levels.

Financial crises are not new to Latin America, but the current one has two unusual dimensions.
First, as substantiated earlier in this report, it originated in the United States, with Latin America
suffering shocks created by collapses in the U.S. housing and credit markets, despite minimal
exposure to the assets in question. Second, it spread to Latin America in spite of recent strong
economic growth and policy improvements that have increased economic stability and reduced 42
risk factors, particularly in the financial sector. Although repercussions in individual countries
have varied based in part on their policy framework, investors have punished the region as a
whole, perhaps leery of its capacity to weather both financial contagion and a potential global
Latin American economies have grown briskly over the past five years, lending credence to the
recent idea that they may be “decoupling” from slower growing developed economies, 43
particularly the United States. Changes in domestic policy that have led to macroeconomic
stability, lower risk levels of sovereign debt, stronger fiscal positions, and sounder banking
regulation are seen by some as a key to Latin America’s growth with stability. Others note,
however, that Latin America’s recent growth trend is easily explained by international economic
fundamentals, questioning the importance of the decoupling theory. The sharp rise in commodity
prices, supportive external financing conditions, and high levels of remittances contributed
greatly to the region’s improved economic welfare, reflecting gains from a strong global
economy. But all three trends began to reverse even before the financial crisis, suggesting that 44
Latin America remains very much tied to world markets and trends.
Latin America is experiencing two levels of economic problems related to the crisis. First order
effects may be seen in the sudden volatility in the financial sector. All major financial indicators
fell sharply in the third quarter of 2008, as capital sought safe haven in less risky assets, many of
them, ironically, dollar denominated. Currencies in many Latin American countries depreciated
suddenly from flight to the U.S. dollar, reflecting a lack of confidence in local currencies and
portfolio rebalancing, as well as the fall in commodity import revenue related to declining global

40 David Roodman, “History Says Financial Crisis Will Suppress Aid,” Center for Global Development, October 13,
41 Prepared by J. F. Hornbeck, Specialist in International Trade and Finance, Foreign Affairs, Defense, and Trade
42 United Nations. Economic Commission on Latin America and the Caribbean. Latin America and the Caribbean in
the World Economies, 2007. Trends 2008. Santiago: October 2008. p. 28.
43 Decoupling generally refers to economic growth trends in one part of the world, usually smaller emerging
economies, becoming less dependent (correlated) with trends in other parts of the world, usually developed economies.
See Rossi, Vanessa. Decoupling Debate will Return: Emergers Dominate in Long Run. London: Chatham House, 2008.
p. 5.
44 Ocampo, Jose Antonio. The Latin American Boom is Over. REG Monitor. November 2, 2008.

demand and terms of trade. In at least two countries, Mexico and Brazil, large speculative
derivative positions in the currency markets exacerbated the depreciations, compounding losses.
Stock indexes, on average, declined by over 40%, in response to the retreat from equity markets 45
and changes in currency values.
Debt markets followed in kind. Borrowing became more expensive, as seen in widening bond
spreads. Over the past year, bond spreads in the Emerging Market Bond Index (EMBI) and
corporate bond index for Latin America increased by over 600 basis points, half occurring in the
fall of 2008. This trend suggests first, that Latin America was already beginning to experience a
slowdown prior to the financial crisis, and second, that the crisis itself was a sudden shock to the
region. Compared to earlier financial crises when bond spreads on average rose by over 1,000
basis points, Latin America’s stronger economic fundamentals and regulatory regimes helped
cushion many countries from a more severe reaction. The exceptions are Argentina, Peru, and
Venezuela, all of which share a heavy dependence on commodity exports and weak economic
policy frameworks. In each of these countries, bond spreads have risen by well over 1,000 basis 46
points, reflecting a deep lack of confidence in their financial future.
The second order effects related to the financial crisis are deteriorating economic fundamentals,
which could be a major long term problem for Latin America. Financial indicators all point to a
tightening of credit markets and sharp rise in the cost of capital for Latin America, which may
dampen investment. Falling investment and consumption, declining trade surpluses, and
deteriorating public sector budgets all point to broader economic slowdown. Public sector
borrowing is expected to rise and budget constraints may reduce spending on social programs,
with a predictably disproportional effect on the poor. The magnitude of these trends will vary by
country, depending on economic fundamentals and policy choices, as three examples discussed
below illustrate.
Mexico faces two problems: one short term, the other long-term, but both tied to its dependence
on the U.S. economy. The United States accounts for half of Mexico’s imports, 80% of its
exports, and most of its foreign investment. Therefore, Mexico, despite its relatively strong fiscal
position and solid macroeconomic fundamentals, has begun to suffer first from direct links to the
U.S. financial fallout, and second, from its vulnerability to a protracted U.S. recession.
In the short term, Mexico experienced a run on the peso, which was particularly severe in October

2008. It fell at one point by 40% from its August 2008 high. This was not due to exposure to U.S.

mortgage-backed securities, but rather, the re-balancing of investor portfolios away from
emerging markets, and the fall in commodity prices. The currency also suffered because Mexican
firms had apparently taken to heart the notion of “decoupling,” believing that the peso’s strength
would not be seriously challenged by the U.S. crisis. Many firms went beyond hedging in the
currency market and bet heavily on the future strength of the peso by taking large derivative
positions in the currency. As the peso began to depreciate, companies had to unwind these large
(off balance sheet) speculative positions, accelerating its fall. One large firm had losses exceeding
$1.4 billion and filed for bankruptcy, indicative of the severity of the problem. The Mexican

45 Latin American Newsletters. Latin American Economy and Business. London: October 2008. pp. 1-3.
46 International Monetary Fund. Regional Economic Outlook. Western Hemisphere: Grappling with the Global
Financial Crisis. Washington, D.C. October 2008. pp. 7-10.

government responded by selling billions of dollars of reserves and entering into an agreement 47
with the U.S. Federal Reserve for a new $30 billion currency swap arrangement.
The swap arrangement is intended to undergird liquidity in the Mexican financial system and
ensure dollar financing for the large trade volume conducted between the two countries. The
long-term challenge to Mexico’s exports to the United States will hinge on U.S. aggregate
demand. Because Mexico has a poorly diversified trade regime, the effects could be significant,
and have already been compounded by the fall in remittances from Mexican workers living in the
United States. In October 2008, remittances fell by over 12%, the largest year-over-year decline
since 1995, when records began. In the short-term, it will be important to evaluate Mexico’s
ability to counter the peso’s decline and maintain liquidity to support both domestic financing and
its trade with the United States. In the medium term, the depth of Mexico’s economic slowdown 48
in response to the U.S. recession will be the most telling benchmark of its economic future.
Like Mexico, Brazil entered the financial crisis from a position of macroeconomic and fiscal
strength. The Brazilian government, nonetheless, found itself in a similar position of having to
sell billions of dollars to fight a rapidly depreciating currency (the real), which fell at one point by
over 35% from its August high. The real has since regained 10% of its value, but volatility
remains a concern. Brazil also has a large currency derivative market, where speculative trades
contributed to the real’s decline, although to a lesser degree than in Mexico. Brazil has over $200
billion in international reserves, a sound banking system, an experienced Central Bank staff that
has taken decisive action to maintain liquidity in the financial markets, suggesting the country
stands a good chance of weathering short-term repercussions of the global financial crisis, 49
depending on its severity.
In addition to injecting billions of dollars into the banking system, the government of Brazil has
taken many other measures to soften the effects of the financial crisis. These include stricter
accounting rules for derivatives, extension of credit directly to firms from the National
Development Bank (BNDES) and the Central Bank, authorization for state-owned banks to
purchase private banks, exemption of foreign investment firms from the financial transaction tax,
and utilization of a new $30 billion currency swap arrangement as provided in an agreement with 50
the U.S. Federal Reserve.
Despite such strong policy responses, Brazil’s stock market index tumbled by half in 2008,
investment in both public and private projects appears to be on hold and projections of economic
growth are being revised downward. Over half of Brazil’s exports are commodities, suggesting its
trade account will likely deteriorate, although the depreciated real may offset some of this effect.
Capital inflows are also expected to slow, despite Brazil’s solid macroeconomic performance and
its investment grade rating. As with other countries, the extent to which global demand
diminishes will ultimately affect all these variables. Brazil has a large internal market and is well-

47 Latin American Economy and Business, October 2008, p. 3 and the Wall Street Journal. Mexico and Brazil Step In to
Fight Currency Declines, October 24, 2008.
48 Latin American Newsletters. Latin American Mexico and NAFTA Report. London: November 2008. p. 14.
49 Global Insight. Brazil Real Depreciates 6.8% in One Day. October 23, 2008 and Canuto, Otaviano. Emerging
Markets and the Systemic Sudden Stop. RGE Monitor. November 12, 2008.
50 Brazil-U.S. Business Council. Brazil Bulletin. October 27, 2008.

positioned on macroeconomic and fiscal fronts, which may soften effects of the global financial 51
crisis, depending, as with other countries, on the severity of the recession.
Argentina, because of its economic and financial position at the beginning of the crisis, is in poor
shape to deal with the crisis compared to other Latin American countries. Although it has
experienced dramatic economic growth since 2002, this reflects a rebound from the previous
severe financial crisis begun in December 2001. The other side of the story is Argentina’s litany
of questionable policy choices beginning with its 2002 historic sovereign debt default and failure
to renegotiate with Paris Club countries and private creditor holdouts. Others include government
interference in the supposedly independent government statistics office (particularly with respect
to inflation reporting), market intervention, adoption of export taxes, and most recently, its move 52
to nationalize private pension funds to bolster public finances.
The sum total of these policies characterize an economy that is isolated from international capital
markets, and prone to price distortions, continued debt buildup, a high dependency on commodity
exports, and inadequate levels of investment. From an international perspective, Argentina
entered the financial crisis with little credibility in its economic policies and hence is unlikely to
obtain needed external financial assistance, as have Mexico and Brazil from the United States.
Argentina, by all indications, is poorly situated to respond to crisis.
Argentina’s currency has not fallen significantly, largely due to strong management of the
exchange rate. In selling dollars to protect the peso’s value, however, Argentina has so far used up
over 15% of its one-time $54 billion in foreign reserves, forced interest rates skyward, and made 53
exports less competitive. Given the importance of export taxes for revenue, public sector
revenues are expected to fall precipitously, a serious problem given Argentina’s fiscal situation
was already far more precarious than either Brazil’s or Mexico’s.
Risk assessment has been swift and punishing. Bond ratings have fallen and yields on short-term
public debt exceed 30%. The stock market has declined by over 60% since May 2008 and the
interest rate spread on Argentina’s bonds rose by over 500 basis points for the year ending
September 2008. Since then, they have increased by an additional 1,700 basis points, reflecting 54
Argentina’s high risk investment profile and ostracization from the capital markets. Given
Argentina’s large public spending needs for the coming year, the high and growing cost of its
debt, and its inability to access international credit markets, it may become the first full scale
casualty in Latin America of the global financial crisis.

51 Latin American Economy and Business, October 2008, pp. 8-10.
52 Benson, Drew and Bill Farles. Argentine Bonds, Stocks Tumble on Pension Fund Takeover Plan. Bloomberg.
October 21, 2008.
53 Global Insight. Argentina: S&P Lowers Argentina’s Rating to B-. November 3, 2008.
54 International Monetary Fund. Regional Economic Outlook. Western Hemisphere: Grappling with the Global
Financial Crisis. Washington, D.C. October 2008. p. 8.

Russia tends to be in a category by itself. Although by some measures, it is an emerging market, it
also is highly industrialized. Until recently, Russia had been experiencing impressive economic
success. In 2008, however, Russia has faced a triple threat with the financial crisis coinciding
with a rapid decline in the price of oil and the aftermath of the country’s military confrontation
with Georgia over the break-away areas of South Ossetia and Abkhazia. These events have
exposed three fundamental weaknesses in the Russian economy despite its success over the past
decade: substantial dependence on oil and gas sales for export revenues and government
revenues; rise in foreign and domestic investor concerns; and a weak banking system.
The decline in world oil prices has hit Russia hard. Oil, natural gas, and other fuels account for 56
about 65% of Russia’s export revenues (2007). In addition, the Russian government is
dependent on taxes on oil and gas sales for more than half of its revenues. Should the price of oil 57
go below $60/barrel, the government budget would go into deficit. Should the price drop to $30-58
$35/barrel, the Russian economy would stop growing, according to one estimate. As of
December 12, 2008, the price of Urals-32 was $39.77, a 71.1% drop from its July 4, 2008, peak 59
of $137.61.
Another sign of financial trouble for Russia has been the rapid decline in stock prices on Russian
stock exchanges. (See Figure 2.) At the close of business on December 23, 2008, the RTS index 60
had lost 72.5% of its value from its peak reached on May 19, 2008. (The decline was the largest
since Russia experienced a financial crisis in August 1998.) On September 16, 2008 alone, the
RTS index lost 11.5% of its value leading the government to close stock markets for two days.
The overall drop in equity prices has been blamed on the loss of investor confidence in the wake
of the August 2008 conflict between Russia and Georgia but also because of the decline in oil
prices and as a result of the credit crisis that has affected markets throughout the world. In
addition, the ruble has been declining in nominal terms because foreign investors have been
pulling capital out of the market to shore up domestic reserves putting downward pressure on the
ruble. The ruble had declined 11% in terms of the dollar in the three months prior to the end of 61
the dollar and was showing signs of further depreciation. Russian official reserves have declined
substantially in part because of Russian Central Bank intervention to defend the ruble although
the government has allowed some gradual depreciation. Between July 31 and November 30,

2008, the reserves declined from $596.6 billion to $455.7 billion, or 23.6%, still considered an 62

adequate level of reserves.
Russia’s banking system remains immature, and high interest rates prevail. Russian companies,
therefore, have relied on foreign bank loans for financing rather than equity-based financing or

55 Prepared by William H. Cooper, Specialist in International Trade and Finance, Foreign Affairs, Defense, and Trade
56 Economist Intelligence Unit.
57 Open Source Center. Government Bails Out Oil Companies Suffering From World Financial Crisis. October 30,
58 Economist Intelligence Unit. Monthly Report—Russia. October 2008. p. 7.
59 U.S. Department of Energy. Energy Information Administration.
60 RTS.
61 Economist Intelligence Unit. Monthly Report—Russia. December 2008. p. 16.
62 Central Bank of Russia.

domestic bank loans. However, these foreign loans were secured with company stocks as
collateral. Because of the drop in stock values and because of the overall tightening of credit
availability, foreign banks have declined to rollover loans.
The Russian government, led by President Medvedev and Prime Minister Putin, has implemented
several packages of measures to prop up the stock market and the banks. The packages, valued at
around $180 billion, are proportionally larger in terms of GDP than the U.S. package that 63
Congress approved in September 2008. In mid-September, the government made available $44
billion in funds to Russia’s three largest state-owned banks to boost lending and another $16
billion to the next 25 largest banks. It also lowered taxes on oil exports to reduce costs to oil
companies and made available $20 billion for the government to purchase equities on the stock
market. In late September, the government announced that an additional $50 billion would be
available to banks and Russian companies to pay off foreign debts coming due by the end of the
year. On October 7, 2008, the government announced another package of $36.4 billion in credits 64
to banks. In November 2008, the Russian government announced a group of tax cuts to boost
business activity, including a cut from 24% to 20% in the corporate tax rate, up to 4 percentage
point cuts in regional taxes depending on the discretion of regional officials, and a cut from 15% 65
to 5% in the business income tax. Russia has also begun to impose protectionist measures, 66
including higher tariffs on foreign cars.

Financial markets in the United States and Europe have become highly integrated as a result of
cross-border investment by banks, securities brokers, and other financial firms. As a result of this
integration, economic and financial developments that impact national economies are difficult to
contain and are quickly transmitted across national borders, as attested to by the financial crisis of
2008. As financial firms react to a financial crisis in one area, their actions can spill over to other
areas as they withdraw assets from foreign markets to shore up their domestic operations. Banks
and financial firms in Europe have felt the repercussions of the U.S. financial crisis as U.S. firms
operating in Europe and as European firms operating in the United States have adjusted their
operations in response to the crisis.
Within Europe, national governments and private firms have taken noticeably varied responses to
the crisis, reflecting the unequal effects by country. While some have preferred to address the
crisis on a case-by-case basis, others have looked for a systemic approach that could alter the
drive within Europe toward greater economic integration. Great Britain has proposed a plan to
rescue distressed banks by acquiring preferred stock temporarily. Iceland, on the other hand, has
had to take over three of its largest banks in an effort to save its financial sector and its economy
from collapse. The Icelandic experience raises important questions about how a nation can protect
its depositors from financial crisis elsewhere and about the level of financial sector debt that is
manageable without risking system-wide failure.

63 Ibid. 6-7.
64 Economist Intelligence Unit. Monthly Report—Russia. October 2008. p. 6.
65 Ibid. p. 13.
66 Financial Times.
67 Prepared by James K. Jackson, Specialist in International Trade and Finance, Foreign Affairs, Defense, and Trade

According to a recent report by the International Monetary Fund, many of the factors that led to 68
the financial crisis in the United States are driving a similar crisis in Europe. Essentially, the
causes were low interest rates, growing complexity in mortgage securitization, and loosening in
underwriting standards combined with expanded linkages between national financial centers that
spurred a broad expansion in credit and economic growth. This rapid rate of growth pushed up
the values of equities, commodities, and such tangible assets as real estate. As the combination of
higher commodity higher prices, including the price of crude oil and housing, rose to historically
high levels, consumer budgets were pinched, and consumers began to pare back on their
expenditures. In July 2007, these factors combined to undermine the perceived value of a range of
financial instruments and other assets and increased the perception of risk of financial instruments
and the credit worthiness of a broad range of financial firms.
As creditworthiness problems in the United States began surfacing in the subprime mortgage
market in July 2007, the risk perception in European credit markets followed. The financial
turmoil quickly spread to Europe, although European mortgages initially remained unaffected by
the collapse in mortgage prices in the United States. Another factor in the spread of the financial
turmoil to Europe has been the linkages that have been formed between national credit markets
and the role played by international investors who react to economic or financial shocks by
rebalancing their portfolios in assets and markets that otherwise would seem to be unrelated. The
rise in uncertainty and the drop in confidence that arose from this rebalancing action undermined
the confidence in major European banks and disrupted the interbank market, with money center
banks becoming unable to finance large securities portfolios in wholesale markets. The increased
international linkages between financial institutions and the spread of complex financial
instruments has meant that financial institutions in Europe and elsewhere have come to rely more
on short-term liquidity lines, such as the interbank lending facility, for their day-to-day 69
operations. This has made them especially vulnerable to any drawback in the interbank market.
Recent IMF estimates indicate that economic growth in Europe is expected to slow sharply in
2009, while the threat of inflation is expected to lessen, as indicated in Table 2. Economic
growth, as represented by the rate of increase in gross domestic product (GDP) for the Euro area
countries is projected to fall to 1.4% in 2009 from 3.9% in 2007. Iceland, which has been
particularly hard hit by the financial crisis, is expected to experience a negative rate of growth of
-3.1% in 2009. These estimates may be a bit too pessimistic given the sharp drop in the price of
oil and that of other commodities in September and October 2008, which likely would help to
improve the rate of economic growth.

68 Regional Economic Outlook: Europe, International Monetary Fund, April, 2008, p. 19-20.
69 Frank, Nathaniel, Brenda Gonzalez-Hermosillo, and Heiko Hesse, Transmission of Liquidity Shocks: Evidence from
the 2007 Subprime Crisis, IMF Working Paper #WP/08/200, August 2008, the International Monetary Fund.

Table 2. Projections of Economic Growth in 2008 and 2009 and Price Inflation in
Selected Regions and Countries (in percent)
Real GDP Growth CPI Inflation
2006 2007 2008 2009 2006 2007 2008 2009
Actual Projected Actual Projected
United States 2.8 2 1.6 0.1 3.2 2.9 4.2 1.8
Europe 4.1 3.9 2.6 1.4 3.6 3.6 5.8 4.2
Advanced economies 3.0 2.8 1.3 0.2 2.2 2.1 3.5 2.2
Emerging economies 7.0 6.5 5.7 4.3 7.5 7.5 11.5 9.2
European Union 3.3 3.1 1.7 0.6 2.3 2.4 3.9 2.4
Euro Area 2.8 2.6 1.3 0.2 2.2 2.1 3.5 1.9
Austria 3.4 3.1 2 0.8 1.7 2.2 3.5 2.5
France 2.2 2.2 0.8 0.2 1.9 1.6 3.4 1.6
Germany 3.0 2.5 1.8 0 1.8 2.3 2.9 1.4
Italy 1.8 1.5 -0.1 -0.2 2.2 2.0 3.4 1.9
Netherlands 3.4 3.5 2.3 1.0 1.7 1.9 2.9 2.8
Spain 3.9 3.7 1.4 -0.2 3.6 2.8 4.5 2.6
Other EU
Sweden 4.1 2.7 1.2 1.4 1.5 1.7 3.4 2.8
United Kingdom 2.8 3.0 1.0 -0.1 2.3 2.3 3.8 2.9
Non-EU Advanced
Iceland 4.4 4.9 0.3 -3.1 6.8 5.0 12.1 11.2
Norway 2.5 3.7 2.5 1.2 2.3 0.8 3.2 2.7
Switzerland 3.4 3.3 1.7 0.7 1.0 0.7 2.6 1.5
Source: World Economic Outlook, the International Monetary Fund, October 2008, p. 6.
As Table 3 indicates, the amount of losses that can be traced to the financial crisis varies across
countries. Not all have been affected to the same degree. Mortgage markets vary starkly across
Europe, depending on national laws and local mortgage practices. In addition, mortgage financing
laws were relaxed in some markets, but not in all, to allow for refinancing of mortgages and to
allow homeowners to withdraw equity to use for other purposes. Such laws were eased in Great
Britain and Ireland where the financial crisis has had an especially heavy cost. According to the
Bank of England, the financial crisis has cost the British economy more than $200 billion in lost
assets, compared with nearly $1.6 trillion in the United States. For the Euro area as a whole, the
Bank of England estimated the losses to be at $1.1 trillion.

Table 3. Losses on Selected Financial assets
(in billions of U.S. dollars)
Losses as
Outstanding Losses as of of October
amounts April 2008 2008
United Kingdom
Prime residential mortgage-backed securities $346.8 $14.7 $31.3
Non-conforming residential mortgage-backed securities 70.1 3.9 13.8
Commercial mortgage-backed securities 59.3 5.5 7.9
Investment-grade corporate bonds 808.6 83.0 155.4
High-yield corporate bonds 26.9 5.3 11.8
Total 112.7 220.3
United States
Home equity loan asset-backed securities (ABS)(c) $757.0 $255.0 $309.9
Home equity loan ABS collateralized debt obligations
(CDOs)(c)(d) 421.0 236.0 277.0
Commercial mortgage-backed securities 700.0 79.8 97.2
Collateralized loan obligations 340.0 12.2 46.2
Investment-grade corporate bonds 3,308.0 79.7 600.1
High-yield corporate bonds 692.0 76 246.8
Total 738.8 1,577.0
Euro area
Residential mortgage-backed securities(e) $553.4 $30.7 $55.6
Commercial mortgage-backed securities(e) 48.6 4.0 5.9
Collateralized loan obligations 147.3 9.7 32.6
Investment-grade corporate bonds 7613.3 405.8 919.3
High-yield corporate bonds 250.3 41.6 108.5
Total 492.1 1,122.0
Source: Financial Stability Report, October 2008, Bank of England, p. 14.
Note: Losses estimated as of mid-October 2008. $1.43 dollars per euro; 1.797 pounds per dollar.
Central banks in the United States, the Euro zone, the United Kingdom, Canada, Sweden, and
Switzerland staged a coordinated cut in interest rates on October 8, 2008, and announced they had 70
agreed on a plan of action to address the ever-widening financial crisis. The actions, however,
did little to stem the wide-spread concerns that were driving financial markets. Many Europeans
were surprised at the speed with which the financial crisis spread across national borders and the
extent to which it threatened to weaken economic growth in Europe. This crisis did not just
involve U.S. institutions. It has demonstrated the global economic and financial linkages that tie

70 Hilsenrath, Jon, Joellen Perry, and Sudeep Reddy, Central Banks Launch Coordinated Attack; Emergency Rate Cuts
Fail to Halt stock Slide; U.S. Treasury Considers Buying Stakes in Banks as Direct Move to Shore Up Capital, the Wall
Street Journal, October 8, 2008, p. A1.

national economies together in a way that may not have been imagined even a decade ago. At the
time, much of the substance of the European plan was provided by the British Prime Minister 71
Gordon Brown, who announced a plan to provide guarantees and capital to shore up banks.
Eventually, the basic approach devised by the British arguably would influence actions taken by
other governments, including that of the United States.
On October 10, 2008, the G-7 finance ministers and central bankers,72 met in Washington, DC, to
provide a more coordinated approach to the crisis. At the Euro area summit on October 12, 2008,
Euro area countries along with the United Kingdom urged all European governments to adopt a 73
common set of principles to address the financial crisis. The measures the nations supported are
largely in line with those adopted by the U.K. and include:
• Recapitalization: governments promised to provide funds to banks that might be
struggling to raise capital and pledged to pursue wide-ranging restructuring of the
leadership of those banks that are turning to the government for capital.
• State ownership: governments indicated that they will buy shares in the banks
that are seeking recapitalization.
• Government debt guarantees: guarantees offered for any new debts, including
inter-bank loans, issued by the banks in the Euro zone area.
• Improved regulations: the governments agreed to encourage regulations to permit
assets to be valued on their risk of default instead of their current market price.
In addition to these measures, on October 16, 2008, European Union leaders agreed to set up a 74
crisis unit and to hold a monthly meeting to improve financial oversight. Josse Manuel Durao
Barroso, President of the European Commission, urged the EU members to develop a “fully
integrated solution” to address the global financial crisis. While continuing to rely on the current
method that has each EU country develop and implement its own national regulations regarding
supervision over financial institutions, the European Council stressed the need to strengthen the
EU-wide supervision of the European financial sector. The EU statement urged the development 75
of a “coordinated supervision system at the European level.”
European leaders, meeting prior to the November 15, 2008 G-20 economic summit in
Washington, DC, agreed that the task of preventing future financial crisis should fall to the 76
International Monetary Fund, but they could not agree on precisely what that role should be.
The leaders set a 100-day deadline to draw up reforms for the international financial system.
British Prime Minister Gordon Brown reportedly urged other European leaders to back fiscal
stimulus measure to support the November 6, 2008 interest rate cuts by the European Central
Bank, the Bank of England, and other central banks. Reportedly, French Prime Minister Nicolas
Sarkozy argued that the role of the IMF and the World Bank needed to be rethought. French and

71 Castle, Stephen, British Leader Wants Overhaul of Financial System, The New York Times, October 16, 2008.
72 The G-7 consists of Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.
73 Summit of the Euro Area Countries: Declaration on a Concerted European Action Plan of the Euro Area Countries,
European union, October 12, 2008.
74 EU Sets up Crisis Unit to Boost Financial Oversight, Thompson Financial News, October 16, 2008.
75 Ibid.
76 Hall, Ben, George Parker, and Nikki Tait, European Leaders Decide on Deadline for Reform Blueprint, Financial
Times, November 8, 2008, p. 7.

German officials have argued that the IMF should assume a larger role in financial market
regulation, acting as a global supervisor of regulators. Prime Minister Sarkozy also argued that
the IMF should “assess” the work of such international bodies as the Bank of International
Settlements. Other G-20 leaders, however, reportedly have disagreed with this proposal, agreeing
instead to make the IMF “the pivot of a renewed international system,” working alongside other
bodies. Other Ministers also were apparently not enthusiastic toward a French proposal that
Europe should agree to a more formalized coordination of economic policy.
Appendix B outlines the main operations the Bank of England, U.S. Federal Reserve, and the
European Central Bank have taken to address the financial crisis. Several agreements between the
U.S. Federal Reserve and the European Central Bank have expanded, and these three banking
institutions have announced joint lending operations and other measures to increase the 77
availability of dollar funding.
Other national governments have acted to stem the financial crisis and to protect their national
economies. For instance, Germany was the first to implement a comprehensive rescue package,
which could cost up to $750 billion. The German package provided $600 billion in bank
guarantees and as much as $150 billion in state funds. Of the money being offered in state funds,
$120 billion was to be available for recapitalization, while $30 billion was to be a provision for
the bank guarantees.
France, which has been leading efforts to develop a coordinated European response to the
financial crisis, offered a package of measures that is expected to cost over $500 billion. The
French government is creating two state agencies that will provide funds to where they are
needed. One entity is to issue up to $480 billion in guarantees on inter-bank lending issued before
December 31, 2009, and valid for five years. The other entity is to use a $60 billion fund to
recapitalize struggling companies by allowing the government to buy equity stakes.
Italy has not created a fund for its rescue plan, but the Italian government has announced a
package of measures, including Treasury guarantees for new bonds issued by banks until
December 31, 2009, and valid for five years. The guarantees are to be supplied at market prices
and require the approval of the Bank of Italy.
On October 29, 2008, the European Commission released a “European Framework for Action” as
a way to coordinate the actions of the 27 member states of the European Union to address the 78
financial crisis. The EU also announced that on November 16, 2008, the Commission will
propose a more detailed plan that will bring together short-term goals to address the current 79
economic downturn with the longer-term goals on growth and jobs in the Lisbon Strategy. The
short-term plan revolves around a three-part approach to an overall EU recovery action
plan/framework. The three parts to the EU framework are:

77 The Bank of England. Financial Stability Report, October 2008, p. 18.
78 Communication From the Commission, From Financial Crisis to Recovery: A European Framework for Action,
European Commission, October 29, 2008.
79 The Lisbon Strategy was adopted by the EU member states at the Lisbon summit of the European Union in March
2001 and then recast in 2005 based on a consensus among EU member states to promote long-term economic growth
and development in Europe.

A new financial market architecture at the EU level. The basis of this architecture
involves implementing measures that member states have announced as well as providing for
(1) continued support for the financial system from the European Central Bank and other
central banks; (2) rapid and consistent implementation of the bank rescue plan that has been
established by the member states; and (3) decisive measures that are designed to contain the
crisis from spreading to all of the member states.
Dealing with the impact on the real economy. The policy instruments member states can
use to address the expected rise in unemployment and decline in economic growth as a
second-round effect of the financial crisis are in the hands of the individual member states.
The EU can assist by adding short-term actions to its structural reform agenda, while
investing in the future through: (1) increasing investment in R&D innovation and education; 80
(2) promoting flexicurity to protect and equip people rather than specific jobs; (3) freeing
up businesses to build markets at home and internationally; and (4) enhancing
competitiveness by promoting green technology, overcoming energy security constraints,
and achieving environmental goals. In addition, the Commission will explore a wide range of
ways in which EU members can increase their rate of economic growth.
A global response to the financial crisis. The financial crisis has demonstrated the growing
interaction between the financial sector and the goods-and services-producing sectors of
economies. As a result, the crisis has raised questions concerning global governance not only
relative to the financial sector, but the need to maintain open trade markets. The EU would
like to use the November 15, 2008 multi-nation G-20 economic summit in Washington, DC,
to promote a series of measures to reform the global financial architecture. The Commission
argues that the measures should include (1) strengthening international regulatory standards;
(2) strengthen international coordination among financial supervisors; (3) strengthening
measures to monitor and coordinate macroeconomic policies; and (4) developing the
capacity to address financial crises at the national regional and multilateral levels. Also, a
financial architecture plan should include three key principles: (1) efficiency; (2)
transparency and accountability; and (3) the inclusion of representation of key emerging
Within Europe, the British have been especially active in developing a plan to address the credit
market aspects of the crisis. The plan promoted by British Prime Minister Gordon Brown
involves having the central government acquire preferred shares in distressed banks for a
specified amount of time, rather than acquiring the non-performing loans of the banks. This
approach is being followed in some cases by other countries.
On October 8, 2008, the British Government announced a $850 billion multi-part plan to rescue
its banking sector from the current financial crisis. Details of this plan are presented here to
illustrate the varied nature of the plan. The Stability and Reconstruction Plan followed a day
when British banks lost £17 billion on the London Stock Exchange. The biggest loser was the
Royal Bank of Scotland, whose shares fell 39%, or £10 billion, of its value. In the downturn,
other British banks lost substantial amounts of their value, including the Halifax Bank of Scotland
which was in the process of being acquired by Lloyds TSB.
The British plan included four parts:

80 The combination of labor market flexibility and security for workers.

• A coordinated cut in key interest rates of 50 basis, or one-half of one percent
(0.5) between the Bank of England, the Federal Reserve, and the European
Central Bank.
• An announcement of an investment facility of $87 billion implemented in two
stages to acquire the Tier 1 capital, or preferred stock, in “eligible” banks and
building societies (financial institutions that specialize on mortgage financing) in
order to recapitalize the firms. To qualify for the recapitalization plan, an
institution must be incorporated in the UK (including UK subsidiaries of foreign
institutions, which have a substantial business in the UK and building societies).
Tier 1 capital often is used as measure of the asset strength of a financial
• The British Government agreed to make available to those institutions
participating in the recapitalization scheme up to $436 billion in guarantees on
new short- and medium-term debt to assist in refinancing maturing funding
obligations as they fall due for terms up to three years.
• The British Government announced that it would make available $352 billion
through the Special Liquidity Scheme to improve liquidity in the banking
industry. The Special Liquidity Scheme was launched by the Bank of England on
April 21, 2008 to allow banks to temporarily swap their high-quality mortgage-81
backed and other securities for UK Treasury bills.
In addition to this four-part plan, the Bank of England announced on October 16, 2008, that it had
developed three new proposals for its money market operations. First, the establishment of
operational standing facilities to address technical problems and imbalances in the operation of
money markets and payments facilities but not provide financial support. Second, the
establishment of a discount window facility which will allow banks to borrow government bonds
or, at the Bank’s discretion, cash, against a wide range of eligible collateral to provide liquidity
insurance to commercial in stress. Third, a permanent open market for long-term repurchase
agreements (securities sold for cash with an agreement to repurchase the securities at a specified
time) against broader classes of collateral to offer banks additional tools for managing their 82
The British plan was quickly implemented with the UK government taking a controlling interest
in the Royal Bank of Scotland (RBS) and Hallifax Bank of Scotland. The move was prompted by
news that RBS was seeking £20 billion from the British government effectively giving the
government a controlling 60% stake in the bank, with £5 billion issued in preferred shares and
£15 billion underwritten by the government. The amount of capital that was raised was almost
twice the market value of RBS, which had lost 61% of its stock value by October 10, 2008. In
addition, market observers were speculating that HBOS was planning to ask the government for
£12 billion to facilitate the merger between HBOS and Lloyds TSB.

81 The Bank of England, Financial Stability Report, April 2008, p. 10.
82 Ibid., p. 31.

The failure of Iceland’s banks raises questions of bank supervision and crisis management for
governments in Europe and the United States. As Icelandic banks began to default, Britain used
an anti-terrorism law to seize the deposits of the banks to prevent the banks from shifting funds 83
from Britain to Iceland. This incident raises questions about how national governments should
address the issue of supervising foreign financial firms operating within their borders and whether
they can prevent foreign-owned firms from withdrawing deposits in one market to offset losses in
another. In addition, the case of Iceland raises questions about the cost and benefits of branch
banking across national borders where banks can grow to be so large that disruptions in the
financial market can cause defaults that outstrip the resources of national central banks to address.
On November 19, 2008, Iceland and the International Monetary Fund (IMF) finalized an
agreement on an economic stabilization program supported by a $2.1 billion two-year standby 84
arrangement from the IMF. Upon approval of the IMF’s Executive board, the IMF released $827
million immediately to Iceland with the remainder to be paid in eight equal installments, subject
to quarterly reviews. As part of the agreement, Iceland has proposed a plan to restore confidence
in its banking system, to stabilize the exchange rate, and to improve the nation’s fiscal position.
Also as part of the plan, Iceland’s central bank raised its key interest rate by six percentage points 85
to 18% on October 29, 2008, to attract foreign investors and to shore up its sagging currency.
The IMF’s Executive Board had postponed its decision on a loan to Iceland three times,
reportedly to give IMF officials more time to confirm loans made by other nations. Other
observers argued, however, that the delay reflected objections by British, Dutch, and German
officials over the disposition of deposit accounts operated by Icelandic banks in their countries.
Iceland reportedly smoothed the way by agreeing in principle to cover the deposits, although the
details had not be finalized. In a joint statement, Germany, Britain, and the Netherlands said on
November 20, 2008, that they would “work constructively in the continuing discussions” to reach 86
an agreement. Following the decision of IMF’s Executive Board, Denmark, Finland, Norway,
and Sweden agreed to provide an additional $2.5 billion in loans to Iceland.
Between October 7 and 9, 2008, Iceland’s Financial Supervisory Authority (FSA), an independent
state authority with responsibilities to regulate and supervise Iceland’s credit, insurance,
securities, and pension markets took control, without actually nationalizing them, of three of
Iceland’s largest banks: Landsbanki, Glitnir Banki, and Kaupthing Bank prior to a scheduled vote
by shareholders to accept a government plan to purchase the shares of the banks in order to head
off the collapse of the banks. At the same time, Iceland suspended trading on its stock exchange 87
for two days. In part, the takeover also attempted to quell a sharp depreciation in the exchange
value of the Icelandic krona.
The demise of Iceland’s three largest banks is attributed to an array of events, but primarily stems
from decisions by the banks themselves. Some observers argued that the collapse of Lehman

83 Benoit, Bertrand, Tom Braithwaaite, Jimmy Burns, Jean Eaglesham, et. al., Iceland and UK clash on Crisis,
Financial Times, October 10, 2008, p. 1.
84 Anderson, Camilla, Iceland Gets Help to Recover From Historic Crisis, IMF Survey Magazine, November 19, 2008.
85 Iceland Raises Key Rate by 6 Percentage Points, The New York Times, October 29, 2008.
86 Jolly, David, Nordic Countries Add $2.5 Billion to Iceland’s Bailout, The New York Times, November 20, 2008.
87 Wardell, Jane, Iceland’s Financial Crisis Escalates, BusinessWeek, October 9, 2008; Pfanner, Eric, Meltdown of
Iceland’s Financial system Quickens, The New York Times, October 9, 2008.

Brothers set in motion the events that finally led to the collapse of the banks,88 but this conclusion
is controversial. Some have argued that at the heart of Iceland’s banking crisis is a flawed
banking model that is based on an internationally active banking sector that is large relative to the 89
size of the home country’s GDP and to the fiscal capacity of the central bank. As a result, a
disruption in liquidity threatens the viability of the banks and overwhelms the ability of the
central bank to act as the lender of last resort, which undermines the solvency of the banking
On October 15, 2008, the Central Bank of Iceland set up a temporary system of daily currency
auctions to facilitate international trade. Attempts by Iceland’s central bank to support the value
of the krona are at the heart of Iceland’s problems. Without a viable currency, there was no way to
support the banks, which have done the bulk of their business in foreign markets. The financial
crisis has also created problems with Great Britain because hundreds of thousands of Britons hold
accounts in online branches of the Icelandic banks, and they fear those accounts will default. The
government of British Prime minister Gordon Brown has used powers granted under anti-
terrorism laws to freeze British assets of Landsbanki until the situation is resolved.

Many Asian economies have been through wrenching financial crises in the past 10-15 years.
Although most observers say the region’s economic fundamentals have improved greatly in the
past decade, this crisis provides a worrying sense of deja vu, and an illustration that Asian policy
changes in recent years—including Japan’s slow but comprehensive banking reforms, Korea’s
opening of its financial markets, China’s dramatic economic transformation, and the enormous
buildup of sovereign reserves across the region—have not fully insulated (and, so far, cannot
fully insulate) Asian economies from global contagion.
To date, Asia has not suffered a large-scale bankruptcy or had to come to the rescue of a major
financial institution. With only a few exceptions—most notably in South Korea—leverage within
Asian financial systems is comparatively low, and bank balance sheets were comparatively
healthy at the outset of the crisis. Nearly all East Asian nations run current account surpluses, a
reversal from their state during the Asian financial crisis of the late 1990s. These surpluses have
been one reason for the buildup of enormous government reserves in the region, including
China’s $1.9 trillion and Japan’s $996 billion—the two largest reserve stockpiles in the world.
Such reserves give Asian governments resources to provide fiscal stimulus, inject capital into
their financial systems, and provide backstop guarantees for private financial transactions where
needed. So overall, Asian economies are much `healthier than they were before the Asian
Financial Crisis of 1997-1998, when several Asian countries burned through their limited reserves
quickly trying to defend currencies from speculative selling.

88 Portes, Richard, The Shocking Errors Behind Iceland’s Meltdown, Financial Times, October 13, 2008, p. 15.
89 Buiter, Willem H., and Anne Sibert, The Icelandic Banking Crisis and What to Do About it: The Lender of Last
Resort Theory of Optimal Currency Areas. Policy Insight No. 26, Centre for Economic Policy Research, October 2008.
p. 2.
90 Prepared by Ben Dolven, Asia Section Research Manager, Foreign Affairs, Defense, and Trade Division.

Figure 10. Asian Current Account Balances are Mostly Healthy
Source: Merrill Lynch
Still, Asia has not been insulated. The initial stage of the crisis, which centered around losses
directly from subprime assets in the United States, has given way to a broader global crisis
marked by slowing economies and dried-up liquidity. Asia and the United States are deeply linked
in many ways, including trade (primarily Asian exports to the United States), U.S. investments in
the region, and financial linkages that entwine Asian banks, companies and governments with
U.S. markets and financial institutions. As a result, even though Asian banks disclosed relatively
low direct exposures to failed institutions and toxic assets in the United States and Europe, Asian
economies appear caught in a second phase of the crisis. With Western economies slowing and
global investors short of cash and pulling back from any markets deemed risky, Asian economies
appear extremely vulnerable—and that threatens deeper damage to Asian financial systems and
then, in turn, to markets for U.S. exports and investments.
The signs of distress in Asia are legion. Japan’s government officially forecasts zero growth for
2009. The Nikkei-225 Index has lost half its value over the course of 2008, exacerbated by a
surge by the yen to its highest level against the dollar since 1982. The yen’s strength (which
analysts say is largely the result of international investors forced to buy yen to square trading 91
positions that had taken advantage of low Japanese interest rates) makes Japanese exports more
expensive and adds to the damage that slowing economies around the world are already expected
to inflict on Japan’s export-led economy. Japan entered a recession in the July-September 2008
quarter, contracting for the second straight quarter. And in November, Japanese exports fell by

26.7%, the largest year-on-year decline on record, leaving Japan with a trade deficit for the 92

second straight month – the first time that has happened since 1980.
Meanwhile, South Korea’s stock market and currency have plunged precipitously, as South
Korean companies have hoarded dollars because of substantial dollar debts. Chinese GDP

91 Crisis Deals New Blow to Japan, The Wall Street Journal, October 28, 2008.
92 Japan Logs Trade Deficit on Slumping World Demand, Reuters, November 22, 2008.

growth, while still strong, slowed from 10.4% in the April-June quarter to 9.0% in the July-
September period. Further slowing in China seems inevitable. In November, Chinese exports
dropped 2.2%, the first monthly decline in seven years, while imports plunged by 18% in the
month, reflecting a substantial decline in domestic Chinese demand. This has raised concerns that
further slowing could lead to unemployment and social unrest, key concerns of the Chinese
government. Such concerns prompted the government to announce a $586 billion stimulus
package in early November 2008, although the measures included many policies that had
previously been announced. Smaller economies dependent on the financial and trading sectors,
such as Hong Kong and Singapore, have been hammered—Singapore is already in a recession,
and Hong Kong’s government has announced it will guarantee all the $773 billion in Hong Kong
bank deposits through 2010.
One of the most worrying developments in Asia is that Pakistan, already coping with severe
political instability, has been forced to seek emergency loans from the IMF because of dwindling
government reserves. This points to the limits of bilateral solutions to the crisis: For much of
October and early November, Pakistan reportedly sought support from China, Saudi Arabia and 93
other Middle Eastern states before being forced to the IMF. On November 13, well into
discussions with the IMF, Pakistan officials announced they had received a $500 million aid
package from Beijing, far short of the $10 billion-$15 billion that Pakistani leaders say they need 94
over the next two years. Then on November 15, Pakistani and IMF officials confirmed that
Pakistan would receive $7.6 billion in emergency loans, including $4 billion immediately to 95
avoid sovereign default. But this remains short of what Pakistan says it needs.
Since the outset of the crisis, governments in Japan, South Korea, Hong Kong, Singapore,
Malaysia, Australia, New Zealand, Indonesia and elsewhere have been forced into a range of
moves to support domestic financial systems, pumping money into financial markets, issuing
guarantees for bank deposits, and providing fiscal stimulus to shore up economic growth and
slow declines in local stock markets. In several instances, including in Japan and South Korea,
initial interventions failed to staunch financial market declines, leading authorities to broaden
their support moves as the crisis deepened.
So in Asia, a belief that held sway in recent years that Asian economies were starting to
“decouple” from the United States and Europe, generating growth that didn’t depend on the rest
of the world, has given way to a realization that a crisis that originated in the West can sweep up
the region as well. Declines in Asian stock markets are similar in scale to, or larger than, those in
the U.S. and Europe, despite the lack of bankruptcies and failed institutions in Asia. Throughout
the crisis thus far, Asian economies have experienced a so-called “flight to quality,” in which
lenders and investors have sought safe investments and moved out of those perceived as risky.
This has so far included the majority of Asia’s emerging economies. Some economists, however,
believe that Asia’s reserves and current account surpluses may recover more strongly than other 96
emerging markets once the crisis stabilizes.

93 Despite Ambivalence, Pakistan May Wrap Deal by Next Week, The Wall Street Journal, October 28, 2008.
94 IMF ‘Has Six Days to Save Pakistan,’ Financial Times, October 28, 2008.
95 Pakistan Says it will Need Financing Beyond IMF Deal, The Wall Street Journal, November 17, 2008.
96 See, for instance, Morgan Stanley report, “EM Currencies, No Differentiation in the Sell-Off, October 23, 2008.

Some analysts argue that substantial Asian reserves could be one source of relief for the global 97
economy. Japan has contributed funding for the IMF support package of Iceland, and on
November 14, Prime Minister Taro Aso said Japan would lend the IMF $100 billion to support 98
further packages that might be needed before the IMF increases its capital in 2009. Many
wonder if China and other reserve-rich developing nations will find ways to use those reserves to
support financially-strapped governments. As noted previously, Pakistan reportedly has
approached China and several Gulf states for such support.
One key question is whether Asian countries will seek to play a larger role in setting multilateral
moves to shore up regulation, and international support for troubled countries. Five Asian
countries—Japan, China, South Korea, India and Indonesia, were present at the G-20 summit. But
Asian approaches to multilateral regulation are still unclear. At an October 25-26 meeting of the
Asia Europe Forum (ASEM), Chinese Premier Wen Jiabao said China generally agrees with
many European governments which seek an expansion of multilateral regulations. “We need
financial innovation, but we need financial oversight even more,” Wen reportedly told a press 99
Previous Asian attempts to play a leadership role have been unsuccessful. In 1998, in the midst of
the Asian Financial Crisis, Japan and the Asian Development Bank proposed the creation of an
“Asian Monetary Fund” through which wealthier Asian governments could support economies in
financial distress. The proposal was successfully opposed by the U.S. Treasury Department,
which argued that it could be a way for countries to bypass the conditions that the IMF demands
of its borrowers and go straight to “easier” sources of credit.
Two years later, in 2000, Finance Ministers from the ASEAN+3 nations (the 10 members of the 100
Association of Southeast Asian Nations, plus Japan, South Korea and China) announced the
Chiang Mai Initiative (CMI), whose primary measure was to provide a swap mechanism that
countries could tap to cover shortfalls of foreign reserves. This was a less aggressive proposal
than the Asian Monetary Fund. Although a small portion of the swap lines could be tapped in an 101
emergency, most would likely be subject to IMF conditions for recipients.
On October 26, Japan, China, South Korea, and ASEAN members agreed to start an $80 billion
multilateral swap arrangement in 2009, which would allow countries with substantial balance of
payments problems to tap the reserves of larger economies. There remains, however,
disagreement within the region about whether the IMF should play an active role in setting
conditions for countries that use these swap lines.

97 See, for instance, Jeffrey Sachs, The Best Recipe for Avoiding a Global Recession, Financial Times, October 27,
98 The moved was announced in a November 14 opinion piece by Japanese Prime Minister Taro Aso, Restoring
Financial Stability, printed in The Wall Street Journal.
99 Leaders of Europe and Asia Call for Joint Economic Action, New York Times, October 25, 2008.
100 ASEANs members are Indonesia, Singapore, Malaysia, Thailand, the Philippines, Brunei, Vietnam, Cambodia,
Laos and Burma (Myanmar).
101 For a fuller discussion of the Chiang Mai Initiative, see East Asian Cooperation, Institute of International

Asian leaders have sought to start other regional discussions. On October 22, a Japanese
government official floated the idea of a pan-Asian financial stability forum, modeled after the
Financial Stability Forum at the BIS, which was discussed in May at a meeting of Finance 102
Ministers from Japan, South Korea and China. On December 13, the leaders of Japan, China,
and South Korea held a trilateral summit in Fukuoka, Japan, agreeing on bilateral swap lines
between South Korea and the two others – a new renminbi-won swap line worth the equivalent of 103
$28 billion and an expansion of an existing yen-won swap line to the equivalent of $20 billion.
Beyond this measure of support for South Korea, however, the summit did not provide broader
multilateral initiatives.
So far, the national-level responses among Asian governments include the following:
Japan was part of the early moves among major economies to flood markets with liquidity, in the
“crisis containment” part of the global response, and the Bank of Japan has continued its
aggressive monetary stimulus in the months since. Alongside other major central banks, the Bank
of Japan pumped tens of billions of dollars into financial markets in late September and early
October. It followed these moves with an announcement on October 14 that it would offer an
unlimited amount of dollars to institutions operating in Japan, to ensure that Japanese interbank
credit markets continued to function. The BOJ did not lower interest rates in the crisis’s early
stages, but on October 31, it joined other global central banks, including the U.S. Federal
Reserve, by cutting a key short-term interest rate to 0.3%, from 0.5%, and on December 19 it cut
the rate to 0.1%.
For a time, Japan was considered relatively insulated, because of its well capitalized banks,
substantial reserves and current account surplus. Japan spent nearly $440 billion between 1998
and 2003 to assist and recapitalize its banking system, and most observers say Japan’s financial
system emerged from the experience fairly sound. Healthy capital positions helped Mitsubishi
UFG Group, Japan’s largest bank, and Nomura, the country’s largest brokerage, to buy pieces of
distressed U.S. investment banks as the crisis was deepening in October. Mitsubishi UFG bought
21% of Morgan Stanley for $9 billion, and Nomura purchased the Asian, European and Middle
Eastern operations of Lehman Brothers.
But as Western economies began to slow, Japan’s financial insulation thinned. The Japanese
economy is highly exposed to slowdowns in export markets, particularly in the U.S. and Europe.
The U.S. accounted for 20.1% of Japan’s exports in 2007. Japan has sought to provide fiscal
stimulus: The government unveiled a $107 billion stimulus package in August, and on October
31, Prime Minister Taro Aso announced a second set of stimulus measures, valued at another
$51.5 billion.
There have been signs of stress in the Japanese financial system in the weeks following the
Nomura and Mitsubishi UFG purchases. In October, Yamato Insurance, a mid-sized insurance

102 Japan, China, S. Korea Eye Financial Stability Forum, Reuters, October 20, 2008.
103 Asian Leaders See Growth Driver, The Wall Street Journal, December 15, 2008.

company, filed for bankruptcy, with $2.7 billion in liabilities. Then, in late October, with share
prices tumbling, the much larger Mitsubishi UFG Group—which just two weeks earlier was
sufficiently capitalized that it had bought the Morgan Stanley stake—said it would raise as much
as $10.7 billion to improve its capital base. Many analysts say smaller banks may need direct help
from the government. Japan’s two largest political parties, the ruling Liberal Democratic Party
and the main opposition Democratic Party of Japan, have agreed on the need to re-authorize
expired legislation that would allow the government to purchase equity to support private banks,
and Japanese media reports say this is expected to be passed in December. This move would
restart a program first authorized in 2002 as part of the bank recapitalization process.

The extent of China’s exposure to the current global financial crisis, in particular from the fallout
of the U.S. sub-prime mortgage problem, is mixed but is believed to be relatively small. China’s
numerous restrictions on capital flows to and from China limit the ability of individual Chinese
citizens and many firms to invest their savings overseas. Thus, the exposure of Chinese private
sector firms and individual investors to sub-prime U.S. mortgages is likely to be rather small. On
the other hand, the exposure of Chinese government entities, such as the State Administration of
Foreign Exchange, the China Investment Corporation (a $200 billion sovereign wealth fund 105
created in 2007), state banks, and state owned enterprises), may be more exposed and may
have suffered losses from troubled U.S. mortgage securities. The Chinese government generally
does not release detailed information on the holdings of its financial entities, although some of its
banks have reported on their supposed level of exposure to sub-prime U.S. mortgage securities.
Such entities have generally reported that their exposure to troubled sub-prime U.S. mortgages
has been minor relative to their total investments, that they have liquidated such assets or have 106
written off losses, and that they continue to earn high profit margins.
However, Chinese banks are not immune to financial problems. Several indicators show that an
economic slowdown has been occurring in China over the past several months that could threaten
stability within the banking system. For example, the real estate market in several Chinese cities
has exhibited signs of a bubble that is bursting, including a slowdown in construction, falling
prices and growing levels of unoccupied buildings. This has increased pressure on the banks to
lower interest rates further to stabilize the market, but has raised concerns that doing so could
result in higher inflation. In addition, the value of China’s main stock market index, the Shanghai
Stock Exchange Composite Index, fell by 67.2% from January 1 to October 27, 2008. Finally,
China’s media reports that export orders have declined sharply. More than half of China’s toy
exporters shut down in the first seven months of 2008, and toy exports from January to August 107

2008 were 20.8% lower than they were during the same period in 2007. On November 3, 2008,

Chinese Premier Wen Jiabao warned that 2008 would be the “worst in recent times” for China’s

104 The section on China was prepared by Wayne M. Morrison, Specialist in Asian Trade and Finance, Foreign Affairs,
Defense, and Trade Division.
105 For an overview of the China Investment Corporation, see CRS Report RL34337, China’s Sovereign Wealth Fund,
by Michael F. Martin.
106 Chinas holdings of Fannie Mae and Freddie Mac securities are likely to be more substantial, but less risky
(compared to other sub-prime securities), especially after these two institutions were placed in conservatorship by the
Federal Government in September 2008.
107 Global Insight, Country Intelligence Analysis, China, October 20, 2008.

economic development. As a result, Chinese banks may face a new wave of non-performing
China has responded to the crisis on a number of fronts. On September 27, 2008, Chinese Premier
Wen Jiabao reportedly stated in a speech that “What we can do now is to maintain the steady and
fast growth of the national economy and ensure that no major fluctuations will happen. That will 108
be our greatest contribution to the world economy under the current circumstances.” On
October 8, 2008, China’s central bank announced plans to cut interest rates and the reserve-
requirement ratio in order to help stimulate the economy. The announcement coincided with
announcements by the U.S. Federal Reserve and other central banks of major economies around
the world to lower their benchmark interest rates, although, neither China’s central bank or the
media stated that these measures were taken in conjunction with the other major central banks.
On October 21, 2008, China’s State Council announced it was considering implementing a new
economic stimulus package, which would include an acceleration of construction projects, new
export tax rebates, a reduction in the housing transaction tax, increased agriculture subsidies, and 109
expanding lending to small and medium enterprises. On November 9, 2008 the Chinese
government announced it would implement a two-year $586 billion stimulus package, mainly
dedicated to infrastructure projects. The package would finance programs in 10 major areas,
including affordable housing, rural infrastructure, water, electricity, transport, the environment,
technological innovation and rebuilding areas hit by disasters (especially, areas that were hit by 110
the May 12, 2998 earthquake). On November 14, 2008, China reportedly provided $500
million in aid to Pakistan. On November 15, 2008, Chinese President Hu Jintao attended the G-20
Analysts debate what role China might play in responding to the global financial crisis, given its
nearly $2 trillion in foreign exchange reserves. Some have speculated that China could use some
of these reserves to shore up financial institutions around the world, particularly in the United
States. Others have contended that China could, in order to help stabilize its largest export market
(the United States), use its reserves to purchase some of the large amount of U.S. debt securities
that are expected to be issued to help fund the hundreds of billions of dollars that are expected to 111
be spent by the U.S. government to purchase troubled assets and stimulate the economy.
On September 21, 2008, the White House indicated that President Bush had called President Hu
to discuss the global financial crisis and steps the United States planned to take to address the
crisis. An unnamed Chinese trade official reportedly stated that “the purpose of that call was to
ask for China’s help to deal with this financial crisis by urging China to hold even more U.S.
Treasury bonds and U.S. assets.” The official was further quoted as saying that China recognized
that it “has a stake” in the health of the U.S. economy, both as a major market for Chinese exports
and in terms of preserving the value of U.S.-based assets held by China.” and that a stabilized 112
U.S. economy was in China’s own interest. On November 18, 2008, the Treasury Department

108 Chinaview, September 27, 2008.
109 Global Insight, Country Intelligence Analysis, China, October 20, 2008.
110 China Xinhua News Agency, November 12, 2008.
111 Such a move would help keep U.S. interest rates relatively low. If China decided not to sharply increase its
purchases of U.S. securities, U.S. interest rates could go up.
112 Inside U.S. Trade, China Trade Extra, September 24, 2008.

announced that in September 2008, China overtook Japan to become the largest foreign holder of 113
U.S. Treasury securities, at $585 billion.
On the other hand, there are a number of reasons why China might be reluctant to boost
significantly its purchases of U.S. assets. One concern would be whether increased Chinese
investments in the U.S. economy would produce long-term economic benefits for China. Some
Chinese investments in U.S. financial companies have fared poorly, and Chinese officials might
be reluctant to put additional money into investments that were deemed to be too risky. Secondly,
a sharp economic slowdown in the Chinese economy would increase pressure to invest money at
home rather than overseas. Many analysts (including some in China) have questioned the wisdom
of China’s policy of investing a large level of foreign exchange reserves in U.S. government
securities, which offer a relative low rate of return, when China has such huge development
needs. China may also be reluctant to boost investment in U.S. companies, due to concerns that
doing so would be risky or could come under unfavorable scrutiny by Congress.
Some U.S. policymakers have expressed concern that increased Chinese purchases of U.S. debt
would give it greater political leverage over the United States. They contend this would
undermine the ability of the United States to press China to reform various aspects of its 114
economy, such as its currency policy.
South Korea, Asia’s fourth largest economy, has been deeply affected by the crisis, with both the
South Korean stock market and the won tumbling throughout recent months, sometimes
precipitously. On October 28, the won reached its lowest point since 1998, when South Korea
was in the middle of its IMF support package. Oxford Analytica estimates that foreign investors 115
withdrew a net $25 billion from the Korean stock market between January and late September.
Experts say South Korean banks have large dollar-denominated debts, and therefore need to
protect their holdings of dollars. This has contributed to the won’s fall, and in early October,
President Lee Myung-bak invoked patriotism to encourage Korean banks to stop hoarding dollars 116
and buy won.
South Korea has announced several packages to stimulate the economy and shore up the domestic
banking industry. The government announced a broad economic rescue package on October 19,
2008, promising to guarantee $100 billion in South Korean banks’ foreign-currency debt and
provide another $30 billion to directly support South Korean banks. (The total amount was
equivalent to 14% of the country’s GDP.) Struggling with its plunging stock market and currency,
President Lee’s government has also announced policies to spend up to $9.2 billion to support
real-estate developers struggling with unsold apartments, and to provide further financial support
to small businesses. On October 27, Korea’s central bank cut its prime interest rate by 0.75
percentage points to 4.25%, the largest cut it has made since it began setting base interest rates in

113 See CRS Report RL34314, China’s Holdings of U.S. Securities: Implications for the U.S. Economy, by Wayne M.
Morrison and Marc Labonte.
114 For additional information, see CRS Report RS22984, China and the Global Financial Crisis: Implications for the
United States, by Wayne M. Morrison.
115 SOUTH KOREA: Seoul Faces Growth and Liquidity Tests, Oxford Analytica, October 8, 2008.
116 Lee Warns Against Dollar Hoarding, Korea Times, October 8, 2008.

1999. The rate has since been cut two more times, to 3%. On December 17, the government said
it would launch a $15 billion fund to boost the capital of Korean banks.
South Korea has been an enormous economic success, and has bounced back strongly from the
Asian Financial Crisis that forced it to turn to the IMF for a $58 billion support package in
December 2007. After contracting by 6.9% in 1998, South Korea’s GDP bounced back by 9.5%
and 8.5% in the ensuing two years. Since 2002, GDP growth has been in the 3%-6% range.
However, President Lee has said the current situation is more severe than the 1997 crisis.
Economically, South Korea is an outlier within Asia. It is one of the few Asian countries that is
running a current account deficit ($12.6 billion in January-August 2008). Its banks are unusually
leveraged, with loan-deposit ratios of more than 130%, higher than that in the United States and 117
the EU, and the only East Asian country over 100%.
Pakistan’s economy went into a steady decline in 2008. After several years of strong and 118
comparatively stable growth, Pakistan quickly slid into a severe economic crisis in 2008.
Growth in real GDP declined sharply from about 8% to 3-4%; inflation rose to nearly 24%; and
Pakistan’s rupee depreciated by over 23% against the U.S. dollar. Pakistan’s unemployment rate
rose, and the United Nations reported that 10 million Pakistanis were undernourished. In the
words of Pakistan President Asif Ali Zardari, “The greatest challenge this government faces is an 119
economic one.”
Rising trade and current account deficits generated a “capital crisis” in the autumn of 2008.
Pakistan’s foreign reserves slid from $14.2 billion in October 2007 to $4.1 billion at the end of
October 2008. According to President Zardari’s chief economic advisor, Shaukat Tarin, Pakistan
needed $4 to $5 billion by the end of November 2008 to avoid defaulting on maturing sovereign
debt obligations. In addition, even if Pakistan does secure the money it needs by the end of
November, Tarin stated that Pakistan requires $10 to $15 billion in assistance over the next two to 120
three years to continue to service its account deficits and outstanding debt.
Several factors, in addition to the current global financial crisis, are contributing to the recent
downturn in Pakistan’s economy. Pakistan’s continuing struggle against Islamist militancy in its
tribal areas along the border with Afghanistan has led to high federal deficits and uncertainty
about the stability of the Pakistan government. A recent escalation of bombings and violence in
Pakistan has raised the risk for and scared off many foreign investors and businesses. This has
worsened the nation’s capital shortage. In addition, the flight from risk that has followed the U.S.
financial crisis has apparently contributed to some capital flight from Pakistan, especially among
overseas Pakistanis and investors from the Middle East.
Pakistan has sought the required assistance from several countries (including China, Saudi
Arabia, and the United States), international financial institutions (including the Asian
Development Bank (ADB), the International Monetary Fund (IMF), the Islamic Development

117 See Merrill Lynch, “Asia: Risks Rising, October 3, 2008.
118 For more information about Pakistans economic crisis, see CRS Report RS22983, Pakistan’s Capital Crisis:
Implications for U.S. Policy, by Michael F. Martin and K. Alan Kronstadt.
119Pakistan’s Zardari to Give Up Powers,” AFP, September 20, 2008.
120 Simon Cameron-Moore,Pakistan Needs $10-15 Bln Fast, Says PMs Adviser, Reuters, October 21, 2008.

Bank (IDB), and the World Bank), and an informal group of nations called the “Friends of
Pakistan.” Although the ADB, the World Bank and others did offer some support, the total
amount was insufficient to avoid the default risk. As a consequence, Pakistan reluctantly began
negotiating a loan with the IMF. On November 15, Tarin announced that Pakistan had reached a 121
tentative agreement with the IMF to borrow $7.6 billion over the next 23 months. The first
installment of the loan—up to $4 billion—was expected by the end of November; Pakistan is to 122
repay the loan by 2016.
Assuming Pakistan and the IMF formally conclude the agreement, the $7.6 billion loan is well
short of the estimated $10 billion to $15 billion Pakistan says it needs over the next two years to
avoid a financial crisis. Some observers speculate that the IMF agreement will spur help from
other potential donors, such as China, Saudi Arabia, and the United States. However, given the
continuing economic problems of the potential donor nations, Pakistan may not be able to secure
the full amount of assistance it says it needs. As a result, the IMF loan may end up being only a
short-term patch to a long-term economic problem.
In the meantime, Pakistan has announced some changes in economic policy designed to alleviate
their capital crisis. On September 19, 2008, acting finance minister Naveed Qamar released new
economic policies designed to bring about macroeconomic stability and avoid seeking IMF
assistance that included the elimination of fuel, electricity and food subsidies, and a reduction in 123
the government deficit. On November 3, 2008, Tarin announced reforms of Pakistan’s tax
system, including the politically sensitive taxation of large landowners, to reduce the incidence of 124
tax evasion. There has also been talk of cutting Pakistan’s defense budget.
According to some analysts, the new economic policies may foster popular discontent and
threaten political stability. The elimination of fuel, electricity and food subsidies may cause
significant harm to Pakistan’s poor, many of whom are already undernourished. The tax on large
landowners may undermine support for Zardari’s Pakistan People’s Party among its party
members and its coalition partners. A cut in Pakistan’s defense budget also could harm its military
efforts against Islamist militants and weaken the military’s political support for the current
coalition government.
Governments around the region have been affected by the crisis, and have issued a range of
rescue measures to keep financial markets functioning and shore up economic growth. Other
moves include:
Australia, which had seen one of the largest jumps in housing prices in the world in recent years,
has seen property prices tumble, leading to a spike in bad loans among Australian banks.
Australia’s commodities-dependent economy has also been hurt by declining commodities prices,
and the Australian dollar has declined substantially in recent weeks. In response, the government

121 “IMF Okays $7.6 Bln Package for Pakistan: Tareen, Associated Press of Pakistan, November 15, 2008.
122 Jamie Anderson, “Pakistan Turns to IMF for Financial Aid,” Money Times, November 16, 2008.
123Pakistan Unveils Package for Economic Stability,” Reuters, September 19, 2008.
124 Farhan Bokhari,Pakistan Vows to Target Rich Tax Evaders as IMF Concludes Talks on Vital Loan, Financial
Times, November 3, 2008.

issued a full guarantee on all bank deposits in early October, and added a $7 billion fiscal
stimulus plan on October 14.
On October 14, The Hong Kong Monetary Authority said it would provide government backing
for all of the $773 billion in Hong Kong bank deposits through 2010 as government assistance for
banks in Europe and the United States put pressure on Asian regulators to follow suit even though
Asian banks tended to be better capitalized. The authority also said that it was prepared to provide
capital to the 23 locally incorporated banks if they needed it, following the examples of the
United States and Britain.
Many countries have seen trade volumes fall—both because of slowing global demand but also
because domestic banks have been wary of issuing trade finance. India’s central bank, the
Reserve Bank of India, announced emergency measures on November 15 to support Indian banks
who issue letters of credit for Indian exporters. The central bank more than doubled the level of 125
funds it makes available for banks to refinance export credits at favorable rates. The
availability of trade finance has become a regional problem that further threatens export-led Asian
economies, as evidenced by a call from the Asian Development Bank on November 16 for Asian 126
banks to unfreeze credit to borrowers seeking to continue doing business.

So far, the actions of the United States and other nations in coping with the global financial crisis
have been primarily to contain the contagion, minimize losses to society, restore confidence in
financial institutions and instruments, and lubricate the wheels of the system in order for it to
return to full operation. There is considerable uncertainty, however, over whether the worst of the
crisis has passed, how nations will cope with second phase of the crisis (global recession and the
spread of the crisis to emerging markets), and whether the current crisis is an aberration that can
be fixed by tweaking the system, or whether it reflects systemic problems that require major
surgery. The challenges of the third phase still remain. They arguably are to change regulatory
structure and regulations and the global financial architecture to ensure that future crises do not
occur or, at least, to mitigate their effects. The fourth phase is to cope with long-term political and
social effects of the financial crisis and ensuing slow down in economic growth.
On a more philosophical plane, the fundamental assumption that markets are self correcting and
that individuals pursuing their own financial interests like an “invisible hand” tend also to
promote the good of the global community has been questioned. Will the losses of this financial
crisis hurt investors and institutions enough that the system will become more prudent in the
future, or is further regulation and oversight necessary to fill gaps in information and technical
expertise to compensate for faulty or incomplete methods of modeling risk, and to provide more

125 India Acts to Avert Liquidity Crunch, Financial Times, November 16, 2008
126 Ibid.
127 Prepared by Dick K. Nanto, Specialist in Industry and Trade, Foreign Affairs, Defense, and Trade Division.

resilience in the system to offset human error? A related question is whether there should be a
system of controls on flows of capital during a financial crisis that would be aimed at temporarily
calming markets.
At the G-20 Summit on Financial Markets and the World Economy on November 15, 2008, in
Washington, DC, the leaders of these nations seem to have concluded that major changes are
needed in the global financial system. The G-20 recommendations imply that most saw the
system as functional but major measures were needed to reduce risk, to provide oversight, and to
establish an early warning system of impending financial crises. The G-20 leaders also agreed,
however, that “needed reforms will be successful only if they are grounded in a commitment to
free market principles, including the rule of law, respect for private property, open trade and
investment, competitive markets, and efficient, effectively-regulated financial systems.” (See
Appendix C and section of this report on the G-20.)
A related philosophical question for the United States deals with the nature of capitalism. Should 128
U.S. government ownership of stock in private corporations also provide Washington a voice in
how the corporations are managed? What conditions should be attached to large loans provided to
corporations? A key dispute in the Cold War was capitalism versus socialism. Should major
companies in the economy be owned by private investors and entrepreneurs or should they be
national assets owned and managed by the government? Should the main objective of large
companies be to maximize returns to shareholders, or should the government use its investment in
company shares to turn management objectives more toward maximizing the national well being?
Should limits, for example, be placed on executive compensation in companies that receive
government assistance? Also, should the government be in the business of “picking winners and
losers” in the process that the economist Joseph Schumpeter described as creative destruction in 129
capitalism? Should the government “prop up companies” that should actually be “destroyed”
so that stronger and more innovative companies can emerge? Is there really a company that is
“too big to fail?” This question is being raised in conjunction with proposals to provide loans to
U.S. automobile makers.
For other nations of the world, what has become clear from the crisis is that U.S. financial
ailments can be highly contagious. Foreign financial institutions are not immune to ill health in
American banks, brokerage houses, and insurance companies. The financial services industry
links together investors and financial institutions in disparate countries around the world.
Investors seek higher risk-adjusted returns in any market. For example, in the “carry trade,”
investors borrow funds in a country with low interest rates (such as Japan and Switzerland) and
invest in higher yielding securities in another country (such as New Zealand, Australia, or the
United States). This trade has involved amounts estimated in the hundreds of billions of dollars
and has been a major factor in the appreciation of the yen in late 2008 as investors unwound yen 130
carry trade positions. In financial markets, moreover, innovations in one market quickly spread
to another, and sellers in one country often seek buyers in another. AIG insurance, for example,
appears to have been brought down primarily by its London office, an operation that engaged

128 Does not include government sponsored enterprises, such as Fannie Mae and Freddie Mac.
129 Creative destruction is a term coined by Joseph Schumpeter to describe what he considered the driving force of
capitalism, a process of industrial innovation in which new technologies and firms revolutionize the economy by
incessantly destroying the existing economic structure and creating a new one in the process.
130 Gabriele Galati, Alexandra Heath, and Patrick McGuire. “Evidence of Carry Trade Activity,BIS Quarterly Review,
September 2007.

heavily in credit default swaps.131 The revolution in communications, moreover, works both
ways. It allows for instant access to information and remote access to market activity, but it also
feeds the herd instinct and is susceptible to being used to spread biased or incomplete
The linking of economies also transcends financial networks. Flows of international trade both in
goods and services are affected directly by macroeconomic conditions in the countries involved.
In the second phase of the financial crisis, markets all over the world have been experiencing
historic declines. Precipitous drops in stock market values are being mirrored in currency and
commodity markets. Not only are world prices for petroleum and copper plummeting, but major
exporting countries and companies are facing weak markets for their industrial and consumer
Given the international nature of financial markets, the rapid movement of capital and
information, and the secondary effects of financial problems on the services-and-production side
of the economy, there seems to be no international architecture capable of coping with and
preventing global crises from erupting. The financial space above nations basically is anarchic
with no supranational authority with firm oversight, regulatory, and enforcement powers. There
are international norms and guidelines, but most are voluntary, and countries are slow to
incorporate them into domestic law. As such, the system operates largely on trust and confidence
and by hedging financial bets. The financial crisis has been a “wake-up call” for investors who
had confidence in, for example, credit ratings placed on securities by credit rating agencies
operating under what some have referred to as “perverse incentives and conflicts of interest.”
After such trusted AAA and AA ratings led to investments of hundreds of billions of dollars in
toxic securities, what will be necessary to restore confidence in the system?
The G-20 Summit on Financial Markets and the World Economy took some steps toward more
international supervision of financial markets. The leaders agreed that national financial
supervisors should establish Colleges of Supervisors consisting of national financial supervisory
agencies that oversee globally active financial institutions. These colleges of supervisors, are to
meet together to share information and strengthen the surveillance of cross-border firms. In
banking, for example, major global banks would meet regularly with their supervisory college for
comprehensive discussions of the firm’s activities and assessment of the risks it faces. The G-20
also recommended that the Financial Stability Forum be expanded to include broader membership
of emerging economies. (See Appendix C and section of this report on the G-20.)
The crisis also has shown that the International Monetary Fund, the international lender of last
resort, has limited capital to cope with a large financial crisis that spans both developed and
emerging market countries. Its current $200 billion in available (loanable) capital (of which $50
billion is from borrowed resources) is dwarfed by the various rescue packages announced by
national governments. As the crisis has spread to smaller countries more within the purview of
IMF activities (Iceland, Hungary, Ukraine, and Pakistan), however, the IMF is playing its
traditional role in providing stabilization loan packages.
Another issue is the mismatch between regulators and those being regulated. The policymakers
can be divided between those of national governments and, to an extent, those of international

131 Morgenson, Gretchen, “Behind Insurer’s Crisis, Blind Eye to a Web of Risk, The New York Times (Internet
edition), September 27, 2008.

institutions, but the resulting policy implementation, oversight, and regulation almost all rests in
national governments (as well as sub-national governments such as states for insurance
regulation). Yet many of the financial and other institutions that are the object of new oversight or
regulatory activity may themselves be international in presence. They tend to operate in all major
markets and congregate around world financial centers (i.e., London, New York, Zurich, Hong
Kong, Singapore, Tokyo, and Shanghai) where client portfolios often are based and where
institutions and qualified professionals exist to support their activities. The major market for
derivatives, for example, is London, even though a sizable proportion of the derivatives,
themselves, may be issued by U.S. companies based on U.S. assets. A similar issue exists on the
tangible product side of the economy. Multinational producers of consumer and industrial goods
can transfer production among supply bases all over the world, but most manufacturing is tied to
capital equipment that is fixed in place. Financial transactions, in contrast, can nominally occur
anywhere. Unless regulations and constraints apply to other markets as well, transactions can, for
example, easily move from New York to London, Zurich, or elsewhere. Could tighter regulations
in the United States, for example, induce transactions to move to London?
A related issue is the functional nature of U.S. regulation. Separate regulatory agencies oversee
each line of financial service: banking, insurance, securities, and futures. Hence, no single
regulator possesses all of the information and authority necessary to monitor systemic risk or the
potential that seemingly isolated events could lead to broad dislocation and a financial crisis so
widespread that it affects the real economy. Also no single regulator can take coordinated action
throughout the financial system. Other countries have addressed their own versions of this
problem. The United Kingdom, for example, created a tripartite regulatory and oversight system
consisting of the Bank of England, the H.M. Treasury, and a Financial Services Agency (a
national regulatory agency for all financial services). Australia and the Netherlands have created
systems in which one financial regulatory agency is responsible for prudential regulation of
relevant financial institutions and a separate and distinct regulatory agency is responsible for 132
business conduct and consumer protection.
In making policy changes, Congress faces several fundamental issues. First is whether any long-
term policies should be designed to restore confidence and induce return to the normal
functioning of a self-correcting system or whether the policies should be directed at changing a
system that may have become inherently unstable, a system that every decade or so creates 133
bubbles and then lurches into crisis. For example, in Congressional testimony on October 23,
2008, former Federal Reserve Chairman Alan Greenspan stated that a “once-in-a-century credit
tsunami”‘ had engulfed financial markets, and he conceded that his free-market ideology 134
shunning regulation was flawed. In a recent book, the financier George Soros stated that the
currently prevailing paradigm, that financial markets tend towards equilibrium, is both false and
misleading. He asserted that the world’s current financial troubles can be largely attributed to the
fact that the international financial system has been developed on the basis of that flawed

132 U.S. Department of the Treasury. The Department of the Treasury Blueprint for a Modernized Financial Regulatory
Structure. March 2008. 217 p.
133 For an analysis of bubbles, see CRS Report RL33666, Asset Bubbles: Economic Effects and Policy Options for the
Federal Reserve, by Marc Labonte.
134 Lanman, Scott and Steve Matthews.Greenspan Concedes to ‘Flaw in His Market Ideology, Bloomberg News
Service, October 23, 2008.

paradigm.135 Could this crisis mark the beginning of the end of “free market capitalism?” On the
other hand, the International Monetary Fund has observed that market discipline still works and
that the focus of new regulations should not be on eliminating risk but on improving market
discipline and addressing the tendency of market participants to underestimate the systemic 136
effects of their collective actions.
A second question deals with what level any new regulatory authority should reside. Should it
primarily be at the state, national, or international level? If the authority is kept at the national
level, how much power should an international authority have? Should the major role of the IMF,
for example, be informational, advisory, and technical, or should it have enforcement authority?
Should enforcement be done through a dispute resolution process similar to that in the World
Trade Organization, or should the IMF or other international institution be ceded oversight and
regulatory authority by national governments?
The second question above is central for those calling for a new Bretton Woods conference. U.K.
Prime Minister Gordon Brown called for such a conference to have the specific objective of 137
remaking the international financial architecture. In the declaration of the G-20 Summit on
Financial Markets and the World Economy, world leaders stated:
We underscored that the Bretton Woods Institutions must be comprehensively reformed so that
they can more adequately reflect changing economic weights in the world economy and be more
responsive to future challenges. Emerging and developing economies should have greater voice
and representation in these institutions. (See Appendix C.)
On November 15, 2008, the G-20 Summit on Financial Markets and the World Economy was
held in Washington, DC. This was billed as the first in a series of meetings to deal with the
financial crisis, discuss efforts to strengthen economic growth, and to lay the foundation to
prevent future crises from occurring. This summit included emerging market economies rather
than the usual G-7 or G-8 nations that periodically meet to discuss economic issues. It was not
apparent that the agenda of the emerging market economies differed greatly from that of Europe,
the United States, or Japan.
The G-20 is an informal forum that promotes open and constructive discussion between industrial
and emerging-market countries on key issues related to global economic stability. The members
include the finance ministers and central bankers from the member nations. A G-20 leaders’
summit is a new development.

135 Soros, George. The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What it Means
(PublicAffairs, 2008) p. i. Soros proposes a new paradigm that deals with the relationship between thinking and reality
and accounts for misconceptions and misinterpretations.
136 International Monetary Fund. “The Recent Financial Turmoil—Initial Assessment, Policy Lessons, and Implications
for Fund Surveillance, April 9, 2008.
137 Gerstenzang, James. “Bush will Meet with G-20 After Election,” Los Angeles Times, October 23, 2008.

The G-20 Washington Declaration to address the current financial crisis was both a laundry list of
objectives and steps to be taken and a convergence of attitudes by national leaders that concrete
measures had to be implemented both to stabilize national economies and to reform financial
markets. The declaration established an Action Plan that included high priority actions to be
completed prior to March 31, 2009. Details are to be worked out by the G-20 finance ministers.
The declaration also called for a second G-20 summit no later than April 30, 2009.
The summit reportedly achieved five key objectives.138 The leaders:
• Reached a common understanding of the root causes of the global crisis;
• Reviewed actions countries have taken and will take to address the immediate
crisis and strengthen growth;
• Agreed on common principles for reforming our financial markets;
• Launched an action plan to implement those principles and asked ministers to
develop further specific recommendations that will be reviewed by leaders at a
subsequent summit; and
• Reaffirmed their commitment to free market principles.
The leaders agreed that immediate steps could be taken or considered to restore growth and
support emerging market economies by:
• Continuing to take whatever further actions are necessary to stabilize the
financial system;
• Recognizing the importance of monetary policy support and using fiscal
measures, as appropriate;
• Providing liquidity to help unfreeze credit markets; and
• Ensuring that the International Monetary Fund (IMF), World Bank and other
multilateral development banks (MDBs) have sufficient resources to assist
developing countries affected by the crisis, as well as provide trade and
infrastructure financing.
The leaders agreed on common principles to guide financial market reform:
• Strengthening transparency and accountability by enhancing required disclosure
on complex financial products; ensuring complete and accurate disclosure by
firms of their financial condition; and aligning incentives to avoid excessive risk-
• Enhancing sound regulation by ensuring strong oversight of credit rating
agencies; prudent risk management; and oversight or regulation of all financial
markets, products, and participants as appropriate to their circumstances.
• Promoting integrity in financial markets by preventing market manipulation and
fraud, helping avoid conflicts of interest, and protecting against use of the
financial system to support terrorism, drug trafficking, or other illegal activities.

138 The declaration from the Summit is in Appendix C.

• Reinforcing international cooperation by making national laws and regulations
more consistent and encouraging regulators to enhance their coordination and
cooperation across all segments of financial markets.
• Reforming international financial institutions (IFIs) by modernizing their
governance and membership so that emerging market economies and developing
countries have greater voice and representation, by working together to better
identify vulnerabilities and anticipate stresses, and by acting swiftly to play a key
role in crisis response.
The leaders approved an Action Plan that sets forth a comprehensive work plan to implement
these principles, and asked finance ministers to work to ensure that the Action Plan is fully and
vigorously implemented. The Plan includes immediate actions to:
• Address weaknesses in accounting and disclosure standards for off-balance sheet
• Ensure that credit rating agencies meet the highest standards and avoid conflicts
of interest, provide greater disclosure to investors, and differentiate ratings for
complex products;
• Ensure that firms maintain adequate capital, and set out strengthened capital
requirements for banks’ structured credit and securitization activities;
• Develop enhanced guidance to strengthen banks’ risk management practices, and
ensure that firms develop processes that look at whether they are accumulating
too much risk;
• Establish processes whereby national supervisors who oversee globally active
financial institutions meet together and share information; and
• Expand the Financial Stability Forum to include a broader membership of
emerging economies.
The leaders instructed finance ministers to make specific recommendations in the following
• Avoiding regulatory policies that exacerbate the ups and downs of the business
• Reviewing and aligning global accounting standards, particularly for complex
securities in times of stress;
• Strengthening transparency of credit derivatives markets and reducing their
systemic risks;
• Reviewing incentives for risk-taking and innovation reflected in compensation
practices; and
• Reviewing the mandates, governance, and resource requirements of the
International Financial Institutions.
The leaders agreed that needed reforms will be successful only if they are grounded in a
commitment to free market principles, including the rule of law, respect for private property, open
trade and investment, competitive markets, and efficient, effectively-regulated financial systems.
The leaders further agreed to:

• Reject protectionism, which exacerbates rather than mitigates financial and
economic challenges;
• Strive to reach an agreement this year on modalities that leads to an ambitious
outcome to the Doha Round of World Trade Organization negotiations;
• Refrain from imposing any new trade or investment barriers for the next 12
months; and
• Reaffirm development assistance commitments and urge both developed and
emerging economies to undertake commitments consistent with their capacities
and roles in the global economy.
On October 10, 2008, the G-7 finance ministers and central bankers,139 met in Washington D.C. to
try to provide a more coordinated approach to the crisis. A statement released by the group stated
that the G-7, “agrees today that the current situation calls for urgent and exceptional action.” In
addition, the Group agreed to:
• Take decisive action and use all available tools to support systematically
important financial institutions and prevent their failure.
• Take all necessary steps to unfreeze credit and money markets and ensure that
banks and other financial institutions have broad access to liquidity and funding.
• Ensure that our banks and other major financial intermediaries, as needed, can
raise capital from public as well as private sources, in sufficient amounts to re-
establish confidence and permit them to continue lending to households and
• Ensure that our respective national deposit insurance and guarantee programs are
robust and consistent so that our real depositors will continue to have confidence
in the safety of their deposits.
• Take action, where appropriate, to restart the secondary markets for mortgages
and other securitized assets. Accurate valuation and transparent disclosure of
assets and consistent implementation of high quality accounting standards are 140
Policy proposals for changes in the international financial architecture have included a major role
for the IMF. As a lender of last resort, coordinator of financial assistance packages for countries,
monitor of macroeconomic conditions worldwide and within countries, and provider of technical
assistance, the IMF has played an important role during financial crises whether international or
confined to one member country.

139 The G-7 comprises Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.
140 G-7 Finance Ministers and Central Bank governors Plan of Action, press release HP-1195, October 10, 2008, the
United States Department of the Treasury.

The financial crisis has shown that the world could use a better early warning system that can
detect and do something about stresses and systemic problems developing in world financial
markets. It also may need some system of what is being called a macro-prudential framework for
assessing risks and promoting sound policies. This would not only include the regulation and
supervision of financial instruments and institutions but also would incorporate cyclical and other
macroeconomic considerations as well as vulnerabilities from increased banking concentration 141
and inter-linkages between different parts of the financial system. In short, some institution
could be charged with monitoring synergistic conditions that arise because of interactions among
individual financial institutions or their macroeconomic setting.
However, the IMF’s current system of macroeconomic monitoring tends to focus on the risks to
currency stability, employment, inflation, government budgets, and other macroeconomic
variables. The IMF, jointly with the Financial Stability forum, has recently stepped up its work on
financial markets, macro-financial linkages, and spillovers across countries with the aim of
strengthening early warning systems. The IMF has not, however, traditionally pressed countries
to counter specific risks such as how macroeconomic variables, potential synergisms and blurring
of boundaries among regulated entities, and new investment vehicles affect prudential risk for
insurance, banking, and brokerage houses. The Bank for International Settlements makes
recommendations to countries on measures to be undertaken (such as Basel II) to ensure banking
stability and capital adequacy, but the financial crisis has shown that the focus on capital
adequacy has been insufficient to ensure stability when a financial crisis becomes systemic and
involves brokerage houses and insurance companies as well as banks.
The International Monetary Fund142
The IMF was conceived in July 1944, when representatives of 45 governments meeting in the town of Bretton
Woods, New Hampshire, agreed on a framework for international economic cooperation. The IMF came into
existence in December 1945 and now has membership of 185 countries.
The IMF performs three main activities:
monitoring national, global, and regional economic and financial developments and advising member
countries on their economic policies (surveillance);
lending members hard currencies to support policy programs designed to correct balance of payments
problems; and
offering technical assistance in its areas of expertise, as well as training for government and central bank
The financial crisis has created an opportunity for the IMF to reinvigorate itself and possibly play
a constructive role in resolving, or at the least mitigating, the effects of the global downturn. It
has been operating on two fronts: (1) through immediate crisis management, primarily balance of
payments support to emerging-market and less-developed countries, and (2) contributing to long-

141 Lipsky, John. “Global Prospects and Policies, Speech by John Lipsky, First Deputy Managing Director,
International Monetary Fund, at the Securities Industries and Financial Markets Association, New York, October 28,
2008. World Bank. “The Unfolding Crisis, Implications for Financial Systems and Their Oversight,” October 28, 2008.
p. 8.
142 Prepared by Martin A. Weiss. For further information see CRS Report RS22976, The Global Financial Crisis: The
Role of the International Monetary Fund (IMF), by Martin A. Weiss.

term systemic reform of the international financial system.143 The IMF also has a wealth of
information and expertise available to help in resolving financial crises and has been providing
policy advice to member countries around the world.
IMF rules stipulate that countries are allowed to borrow up to three times their quota144 over a
three-year period, although this requirement has been breached on several occasions in which the
IMF has lent at much higher multiples of quota. In response to the current financial crisis, the
IMF has activated its Emergency Financing Mechanism to speed the normal process for loans to
crisis-afflicted countries. The emergency mechanism enables rapid approval (usually within 48-
72 hours) of IMF lending once an agreement has been reached between the IMF and the national
On October 28, 2008, the IMF, the European Union, and the World Bank announced a joint
financing package for Hungary totaling $25.1 billion to bolster its economy. The IMF is to lend
Hungary $15.7 billion, the EU $8.1 billion, and the World Bank is to provide $1.3 billion. On
October 24, the IMF announced an initial agreement on a $2.1 billion two-year loan with Iceland.
On October 26, the IMF announced a $16.5 billion agreement with Ukraine, on November 3, an
initial agreement with Kyrgyzstan for a $60 million loan, and on November 16, an agreement in
principle with Pakistan on a $7.6 billion loan. On December 19, the IMF announced plans to lend
Latvia $2.4 billion. Belarus has also been in talks with the IMF. Other potential candidates that
have been mentioned for IMF loans include Serbia, Kazakhstan, Lithuania, and Estonia.
The IMF also may use its Exogenous Shocks Facility (ESF) to provide assistance to certain
member countries. The ESF provides policy support and financial assistance to low-income
countries facing exogenous shocks, events that are completely out of the national government’s
control. These could include commodity price changes (including oil and food), natural disasters,
and conflicts and crises in neighboring countries that disrupt trade. The ESF was modified in
2008 to further increase the speed and flexibility of the IMF’s response. Through the ESF, a
country can immediately access up to 25% of its quota for each exogenous shock and an
additional 75% of quota in phased disbursements over one to two years.
On October 29, 2008, the IMF announced that it plans on creating a new three month short-term
lending facility aimed at middle income countries with strong economic fundamentals and a track
record of access to the global capital markets. The IMF plans to set aside $100 billion for the new
Short-Term Liquidity Facility (SLF). In a unprecedented departure from other IMF programs, 145
SLF loans will have no policy conditionality.
The IMF is not alone in making available financial assistance to crisis-afflicted countries. The
International Finance Corporation (IFC), the private-sector lending arm of the World Bank, has
announced that it will launch a $3 billion fund to capitalize small banks in poor countries that are
battered by the financial crisis. The Inter-American Development Bank (IDB) announced on
October 10, 2008 that it will offer a new $6 billion credit line to member governments as an
increase to its traditional lending activities. In addition to the IDB, the Andean Development

143 See CRS Report RS22976, The Global Financial Crisis: The Role of the International Monetary Fund (IMF), by
Martin A. Weiss.
144 Each member country of the IMF is assigned a quota, based broadly on its relative size in the world economy. A
members quota determines its maximum financial commitment to the IMF and its voting power. The U.S. quota of
about $58.2 billion is the largest.
145IMF to Launch New Facility for Emerging Markets Hit by Crisis, IMF Survey Online, October 29, 2008.

Corporation (CAF) announced a liquidity facility of $1.5 billion and the Latin American Fund of
Reserves (FLAR) has offered to make available $4.5 billion in contingency lines. While these
amounts may be insufficient should Brazil, Argentina, or any other large Latin American country
need a rescue package, they could be very helpful for smaller countries such as those in the
Caribbean and Central America that are heavily dependent on tourism and property investments.
Aside from the international financial architecture, a large question for Congress may be how
U.S. regulations might be changed and how closely any changes are harmonized with
international norms and standards. Related to that is whether U.S. oversight and regulatory
agencies, government sponsored enterprises, credit rating firms, or other related institutions
should be reformed, merged, their mandates changed, or rechartered. (Many of these questions 146
are addressed in separate CRS reports.)
One early regulatory change was announced on November 14, 2008, by the President’s Working
Group on Financial Markets (Treasury, Securities and Exchange Commission, Federal Reserve,
and the Commodity Futures Trading Commission). The Working Group is undertaking a series of
initiatives to strengthen oversight and the infrastructure of the over-the-counter derivatives
market. This included the development of credit default swap central counterparties—
clearinghouses between parties that own debt instruments and others willing to insure against 147
As events have developed, policy proposals have been coming forth through the legislative
process and from the Administration, but other proposals are emerging from recommendations by 148149
international organizations such as the IMF, Bank for International Settlements, and 150
Financial Stability Forum.
The IMF has suggested various principles that could guide the scope and design of measures
aimed at restoring confidence in the international financial system. They include:
• employ measures that are comprehensive, timely, clearly communicated, and
operationally transparent;

146 See, for example, CRS Report RL34730, The Emergency Economic Stabilization Act and Current Financial
Turmoil: Issues and Analysis, by Baird Webel and Edward V. Murphy; CRS Report RL34412, Containing Financial
Crisis, by Mark Jickling; CRS Report RL33775, Alternative Mortgages: Causes and Policy Implications of Troubled
Mortgage Resets in the Subprime and Alt-A Markets, by Edward V. Murphy; CRS Report RL34657, Financial
Institution Insolvency: Federal Authority over Fannie Mae, Freddie Mac, and Depository Institutions, by David H.
Carpenter and M. Maureen Murphy; CRS Report RL34427, Financial Turmoil: Federal Reserve Policy Responses, by
Marc Labonte; CRS Report RS22099, Regulation of Naked Short Selling, by Mark Jickling; and CRS Report RS22932,
Credit Default Swaps: Frequently Asked Questions, by Edward V. Murphy.
147 U.S. Treasury,PWG Announces Initiatives to Strengthen OTC Derivatives Oversight and Infrastructure,” Press
Release HP-1271, November 14, 2008.
148 For analysis and recommendations by the International Monetary Fund, seeGlobal Financial Stability Report,
Financial Stress and Deleveraging, Macro-Financial Implications and Policy, October 2008. 246 p.
149 For information on Basel II, see CRS Report RL34485, Basel II in the United States: Progress Toward a Workable
Framework, by Walter W. Eubanks.
150 For recommendations by the Financial Stability Forum, seeReport of the Financial Stability Forum on Enhancing
Market and Institutional Resilience, Follow-up on Implementation,” October 10, 2008. 39 p.

• aim for a consistent and coherent set of policies to stabilize the global financial
system across countries in order to maximize impact while avoiding adverse
effects on other countries;
• ensure rapid response on the basis of early detection of strains;
• assure that emergency government interventions are temporary and taxpayer
interests are protected; and
• pursue the medium-term objective of a more sound, competitive, and efficient 151
financial system.
For the global banking industry, the Basel II framework from the Bank for International
Settlements actually has been on the table for some time awaiting full implementation by
countries of the world. Basel II is aimed at providing a more risk-sensitive approach to financial
market supervision by better aligning capital charges with the underlying risk that banks take on.
It is to help reduce the incentive for banks to shift assets off their balance sheets, and it includes
methodologies to arrive at minimum capital requirements for credit risk, operational risk and 152
market risk; the supervisory review process, and market disclosure. On July 20, 2007, the 153
United States began implementing pertinent parts of Basel II. Some analysts assert that the 154
current financial crisis has already made Basel II obsolete and call for a Basel III. One analyst
considers the Basel capital rules to be an inappropriate basis for an international arrangement 155
among banking supervisors.
On the regulatory level, the Financial Stability forum brings together the major industrialized
countries of the world, international financial institutions, and international standards-setting
organizations to recommend changes to financial and accounting regulations to be adopted by
member countries. It is a voluntary organization whose secretariat is at the Bank for International 156
Settlements. The recommendations of the Financial Stability Forum have dealt with the

151 International Monetary fund. “Global Financial Stability Report: Financial Stress and Deleveraging, Macrofinancial
Implications and Policy (Summary version), October 2008. pp. ix-x.
152 Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Office of the
Comptroller of the Currency, and Office of Thrift Supervision. “Banking Agencies Reach Agreement on Basel II
Implementation.” July 20, 2007.
153 For details on U.S. implementation, see U.S. Federal Reserve,Basel II Capital Accord, Basel I Initiatives, and
Other Basel-Related Matters.”
154 See, for example, Caprio, Gerald, Jr., Ash Demirguc-Kunt, and Edward J. Kane, “The 2007 Meltdown in Structured
Securitization: Searching for Lessons Not Scapegoats,” World Bank Working Paper, September 5, 2008.
155 Tarullo, Daniel K. Banking on Basel, the Future of International Financial Regulation (Peterson Institute for
International Economics, 2008). p. 5.
156 The Financial Stability Forum brings together senior representatives of national financial authorities (e.g., central
banks, supervisory authorities and treasury departments), international financial institutions, international regulatory
and supervisory groupings, committees of central bank experts and the European Central Bank. The FSF is serviced by
a small secretariat housed at the Bank for International Settlements in Basel, Switzerland.
Members include Australia, Canada, France, Germany, Hong Kong, Italy, Japan, Netherlands, Singapore, Switzerland,
United Kingdom, United States (Treasury, Securities & Exchange Commission, and the Federal Reserve System),
International Monetary Fund, World Bank, Bank for International Settlements, Organisation for Economic Co-
operation and Development, the Basel Committee on Banking Supervision, International Accounting Standards Board,
International Association of Insurance Supervisors, International Organisation of Securities Commissions, Committee
on Payment and Settlement Systems, Committee on the Global Financial System, and the European Central Bank.

• strengthened prudential oversight of capital, liquidity, and risk management;
• enhancing transparency and valuation;
• changes in the role and uses of credit ratings;
• strengthening the authorities’ responsiveness to risks; and
• robust arrangements for dealing with stress in the financial system.157
These appear to be the areas for more work by international and national organizations and
Policies to deal with the second phase of the financial crisis, the global slowdown in economic
growth and recessionary economic conditions, also have come sharply into focus. While these
actions tend to rely more on traditional monetary and fiscal policies, there have been calls for
more coordination of various national economic stimulus packages in order to maximize their 158
Table 4 lists the major problems raised by the crisis, the targets of policy, and the policies already
being taken or possibly to take by various entities in response to the global financial crisis. The
long-term policies listed in the table essentially center on issues of transparency, disclosure, risk
management, creating buffers to make the system more resilient, dealing with the secondary
effects of the crisis, and the interface between domestic and international financial institutions.
The length and breadth of the list indicates the extent that the financial crisis has required diverse
and draconian action. The number of policies or actions not yet taken and being considered
indicate that policymakers may still have a long way to go to rebuild the financial system that has
been at the heart of the economic strength of the world.
Table 4. Problems, Targets of Policy, and Actions Taken or Possibly to Take in
Response to the Global Financial Crisis
Problem Targets of Policy Actions Taken or Possibly To Take
Containing the Contagion and Restoring Market Operations
Bankruptcy of financial institutions Financial institution, Financial sector —Capital injection through loans or
stock purchases
—Takeover of company by
government or other company
—Allow to go bankrupt
Excess toxic debt Capital base of debt holding —Writeoff of debt by holding
institution institution
—Purchase of toxic debt by
government at a discount
—Ease mark-to-market accounting

157 These are areas in which the Financial Stability Forum has made recommendations to the G7 Finance Ministers and
central bank Governors on October 10, 2008. SeeThe Report of the Financial Stability Forum on Enhancing Market
and Institutional Resilience, April 7, 2008, 74 p.
158 For a review of U.S. macroeconomic policy, see CRS Report RL34349, Economic Slowdown: Issues and Policies,
by Jane G. Gravelle et al.

Problem Targets of Policy Actions Taken or Possibly To Take
Credit market freeze Lending institutions —Coordinated lowering of interest
rates by central banks/Federal
—Guarantee short-term,
uncollateralized business lending
—Capital injection through loans or
stock purchases
Consumer runs on deposits in banks Banks —Guarantee bank deposits
and money market funds Brokerage houses —Guarantee money market
—Buy underlying money market
securities to cover redemptions
Declining stock markets Investors —Temporary ban on short sales of
Short sellers stock
—Government purchases of stock?

Global recession, rising National governments —Stimulative monetary and fiscal
unemployment, decreasing tax policies
revenues, declining exports —Trade policy?
—Support for unemployed?
Coping with Long-Term, Systemic Problems
Poor underwriting standards Credit rating agencies —More transparency in factors
Overly high ratings of collateralized Bundlers of collateralized debt behind credit ratings and better
debt obligations by rating companies obligations models to assess risk?
Lack of transparency in ratings Corporate leveraged lenders —Regulation of credit rating
—Changes to the IOSCO Code of
Conduct for Credit Rating Agencies?
—Strengthen oversight of lenders?
—Strengthen disclosure
requirements to make information
more easily accessible and usable?
Incentive distortions for originators Mortgage originators —Require loan originators and
of mortgages (no penalty for Fannie Mae/Freddie Mac bundlers to provide initial and
mortgage defaults) All participants in the originate-to-ongoing information on the quality
distribute chain and performance of securitized
—Strengthened oversight of
mortgage originators?
—Penalties for malfeasance by
Shortcomings in risk management Investors —More prudent oversight of capital,
practices Regulatory agencies liquidity, and risk management?
Severe underestimation of —Raise capital requirements for
risks in the tails of default complex structured credit products?
distributions —Strengthen authorities’
responsiveness to risk?
—Set stricter capital and liquidity
buffers for financial institutions?
Banks had weak controls over off-Bank structured investment vehicles —Strengthen accounting and
balance sheet risks Bank sponsored conduits regulatory practices?
—Raise capital requirements for off-

Problem Targets of Policy Actions Taken or Possibly To Take
balance sheet investment vehicles?
Problems for International Policy
Lack of consistency in regulations National regulatory and oversight —Implement Basel II (Bank for
among nations and need for new authorities International Settlements’ capital and
regulations to cope with new risks Bank for International Settlements other requirements for banks)
and exposures International Monetary Fund —Bretton Woods II agreement?
—New recommendations by Financial Stability Forum?
—Establish an Asian or African
counterpart to the Financial Stability
—Greater role for the International
Monetary Fund?
—Establish colleges of national
supervisors to oversee financial
sectors across boundaries (agreed to
by G-20, Nov. 15, 2008)
Countries unable to cope with IMF, Development Banks —IMF rescue packages
financial crisis National monetary authorities and —Loans and swaps by capital surplus
governments countries
—Creation of long-term
international liquidity pools to
purchase assets?
Countries slow to recognize National monetary and banking —Increased IMF surveillance and
emerging problems in financial authorities consultations?
systems Governments —Build more resilience into the
IMF system?
Regional organizations —Increase reporting requirements?
—Establish colleges of national
supervisors to oversee financial
sectors across national borders
(agreed to by G-20, Nov. 15, 2008)
Lack of political support to National political leaders —International summit meetings
implement changes in policy —Bilateral and plurilateral meetings
and events
Source: Congressional Research Service.
Note: In the Actions to Take column, a “?” indicates that the action or policy has been proposed but is still in
development or not yet taken.

H.R. 1424 [110th] Emergency Economic Stabilization Act of 2008. A bill to provide authority for
the Federal Government to purchase and insure certain types of troubled assets for the purposes
of providing stability to and preventing disruption in the economy and financial system and
protecting taxpayers, to amend the Internal Revenue Code of 1986 to provide incentives for
energy production and conservation, to extend certain expiring provisions, to provide individual
income tax relief, and for other purposes. (Kennedy, Patrick J.), introduced 3/9/2007, P.L. 110-

343 (10/3/2008). Note: H.R. 1424 is the vehicle for the 2008 economic rescue legislation.

Division A is the Emergency Economic Stabilization Act of 2008; Division B is the Energy

Improvement and Extension Act of 2008; and Division C is the Tax Extenders and Alternative
Minimum Tax Relief Act of 2008.
H.R. 3221 [110th] Housing and Economic Recovery Act of 2008. (Pelosi), introduced 7/30/2007.
P.L. 110-289 (7/30/2008). For analysis, see CRS Report RL34623, Housing and Economic
Recovery Act of 2008, by N. Eric Weiss et al.
H.R. 3666 [110th] Foreclosure Prevention and Homeownership Protection Act (Sutton),
introduced 9/25/2007.
H.R. 3915 [110th] Mortgage Reform and Anti-Predatory Lending Act of 2007 (Miller, Brad),
introduced 10/22/2007, passed House 11/15/2007, referred to Senate 12/3/2007.
H.R. 6482 [110th] To direct the Securities and Exchange Commission to establish both a process
by which asset-backed instruments can be deemed eligible for NRSRO ratings and an initial list
of such eligible asset-backed instruments. (Ackerman), introduced 7/14/2008.
H.R. 6230 [110th] Credit Rating Agency Transparency and Disclosure Act. (McHenry),
introduced 6/10/2008.
H.R. 7104 [110th] National Commission on Financial Collapse and Recovery Act of 2008 (Porter,
Jon C.), introduced 9/25/2008.
S. 2595 [110th] S.A.F.E. Mortgage Licensing Act of 2008, (Feinstein), introduced 2/6/2008.
S. 3652 [110th] Financial Market Investigation, Oversight, and Reform Act of 2008. (Cantwell),
introduced 9/29/2008.
S. 3677 [110th] Financial Crimes Accountability Act of 2008 (Snowe), introduced 10/1/2008.

Bank of England Federal Reserve European Central Bank Central Bank
May Announced that Expanded size of Expansion of
expanded three-Term Auction agreements between
month long-term Facility (TAF). Federal Reserve and
repos would be Extended collateral European Central
maintained in June of Term Securities Bank.
and July. Lending Facility
July Introduced 84-day Announced that it
TAF. would conduct
Primary Dealer operations under the 84-day TAF to
Credit Facility provide US dollars
(PDCF) and TSLF to European Central
extended to January Bank counterparties.
Authorized the Announced that supplementary
auction of options three-month longer-
for primary dealers term refinancing
to borrow Treasury operations (LTROs)
securities from the would be renewed in
TSLF. August and
Sept. Announced that Expanded collateral Announced six-Expansion of
expanded three-of PDCF. month LTROs would agreement between
month long-term Expanded size and be renewed in Federal Reserve and
repos would be collateral of TSLF. October, and three-European Central
maintained in month LTROs would Bank.
September and Announced be renewed in Establishment of
October. provision of loans to November and swap agreements
Announced long-banks to finance purchase of high December. between Federal
term repo quality asset-backed Conducted Special Reserve and the
operations to be commercial paper Term Refinancing Bank of England,
held monthly. from money market Operation. subsequently
Extended mutual funds. expanded.
drawndown period Bank of England and
for Special Liquidity European Central
Scheme 9SLS). Bank, in conjunction
with the Federal
Reserve, announced
operation to lend
U.S. dollars for one
week, subsequently
extended to
scheduled weekly

Bank of England Federal Reserve European Central Bank Central Bank
Oct. Extended collateral Announced payment Increased size of six-Announced
for one-week U.S. of interest on month schedules for TAFs
dollar repos and for required and excess supplementary and Forward TAFs
three-month long-reserve balances. LTROs. for auctions of U.S.
term repos. Increased size of Announced a dollar liquidity during
Extended collateral TAFs. reduction in the the fourth quarter.
of all extended-Announced creation spread of standing European Central
collateral sterling of the Commercial facilities from 200 and Bank of England
long-term repos, paper Funding basis points to 100 announced tenders
U.S. dollar repo Facility. basis points around of U.S. dollar funding
operations, and the the interest rate on at 7-day, 28-day, 84-
SLS to include bank-the main refinancing day maturities at
guaranteed debt operation. fixed interest rates
under the UK Introduced swap for full allotment.
Government bank agreements with the Swap agreements
debt guarantee Swiss National Bank. increased to
scheme. accommodate
Announced required level of funding.
Operations Standing
Facilities and a
Discount Window
Facility, which
together replace
existing Standing
Source: Financial Stability Report, October 2008, the Bank of England. p. 18.

December 30. South Korea reported that the industrial output index declined by 14.1%
annually and by 10.7% monthly. The monthly contraction was the largest in 21 years. The slump
in production is closely tied with the sharp reverse in exports, which fell by 18.3%.
December 30. Monetary Union Pact approved by Gulf Cooperation Council (GCC)—Bahrain,
Kuwait, Qatar, Saudi Arabia, and the United Arab Emirates. Representatives from five of the six
members of the GCC approved a draft accord for a monetary union yesterday at a summit in
Muscat. GCC finance ministers did not agree on the ultimate location of the future central bank.
The draft accord prepares for the creation of a monetary council, and the framework for a future
monetary union.
December 26. The Japanese Ministry of Economy, Trade and Industry released preliminary
figures showing that industrial production shrank at a record rate and unemployment rose. Total
industrial output contracted 8.1% from October to November 2008. This marked the largest
decline in industrial production in 55 years.
December 23. Poland’s Monetary Policy Council reduced its main policy rate by 75 basis
points. The Polish main policy rate has been reduced by 1% in two months, and now stands at


December 23. Japanese Cabinet approves record fiscal plan for FY2009. The ¥88.5 trillion
(US$980.6 billion) fiscal package for FY2009, which begins April 1, 2009, marks a 6.6%
increase in spending from initial targets.
December 23. After the IMF submitted a positive review of Iraq’s economic reconstruction, the
Paris Club of sovereign lenders completed the third and final step of debt forgiveness for Iraq,
reducing Iraq’s public external debt with its members by 20% or US$7.8 billion. Most of Iraq’s
remaining debt consists of official loans from Gulf Arab states and former communist countries,
which may be forgiven or discounted if Iraq’s economy continues to improve. Under former
President Saddam Hussein, Iraq’s debt totaled $125 billion.
December 23. New Zealand Real GDP declined 0.4% in quarterly seasonally adjusted terms.
This marks the third consecutive quarterly decline in Real GDP. The economy fell into its first
recession in more than a decade in the March, 2008. The rate of contraction deepened from the
first two quarters of the year during which growth shrank by 0.3% and 0.2% respectively. In
annual terms, the economy grew 1.7% in the year through September 2008.
December 23. The central People’s Bank of China lowered interest rates for the fifth time in
four months. Benchmark one-year lending and deposit rates were both lowered by 27 basis points

159 Prepared by J. Michael Donnelly, Information Research Specialist, Knowledge Services Group. Source: Various
news reports and press releases.

to 5.31% and 2.25% respectively. These rates were lowered by their biggest margin in 11 years a
month ago, lowered by 108 basis points.
December 22. U.K. Real GDP contracted by 0.6% quarterly in the third quarter of 2008. The
Office for National Statistics (ONS) revised the decline in real GDP from its previous estimate of
0.5% quarterly. This marks the first time that the British economy has contracted since the second
quarter of 1992. It had stagnated in the second quarter of 2008 and is therefore on the brink of
recession, defined as two successive quarters of contracting quarterly GDP. Prior to that, GDP
growth had moderated to 0.4% in the first quarter of 2008 from 0.6% in the fourth quarter of 2007
and 0.8% in the third quarter. Annual GDP growth fell to a 16-year low of 0.3% in the third
quarter of 2008 from 1.7% in the second quarter and a peak of 3.3% in the second quarter of

2007. Industrial production contracted by 1.4% quarterly, and 2.5% annually in the third quarter,

with manufacturing output down by 1.6% quarterly and 2.3% annually. This marks the third
successive quarterly decrease in industrial production, meaning that the sector is already in
December 22. Russia reports that industrial output growth slowed to 0.6% annual growth in
October, then contracted by 8.7% annually in November, the worst monthly report since the
economic collapse which followed the ruble crisis of 1998. Critical to Russia’s economic
slowdown is the unwillingness of Russian banks, which are heavily exposed to foreign currency
denominated external debt, to lend.
December 21. Eurostat reports that Eurozone industrial orders fell 5.4% monthly in September
and 4.7% monthly and 15.1% annually in October.
December 21. Canada reports that its federal government and the province of Ontario will
contribute some C$4 billion (US$3.3 billion) to the short-term automotive rescue announced by
the U.S. administration. The United States will provide US$13.4 billion in emergency loans to
General Motors and Chrysler. General Motors is to receive C$3 billion of the Canadian funds,
while Chrysler is to receive C$1 billion. Ford declines injections. Limits on executive
compensation are a requirement for funds.
December 21. Zimbabwe reports its domestic debt level increased from Z$1 trillion on August 8
to Z$179.6 trillion (US$194 million at the current official inter-bank exchange rate) on September
8. This represents a monthly increase of 17,800%. Interest payments now account for roughly

90% of total debt.

December 19. President Bush announced an automotive rescue plan for General Motors and
Chrysler LLC that will make $13.4 billion in federal loans available almost immediately. The
money will come from the $700 billion fund set aside to rescue banks and investment firms in
December 19. An international rescue package of 7.5 billion euro (US$10.6 billion) for Latvia
was announced. The IMF reports a 27-month stand by arrangement between Latvia and the IMF,
worth 1.7 billion euro (US$2.4 billion). The remainder of the rescue package includes 3.1 billion
euro from the European Union (EU), 1.8 billion euro from Nordic countries, 400 million euro
from the World Bank, 200 million euro from the Czech Republic, and 100 million euro each from
the European Bank of Reconstruction and Development, Estonia and Poland. Latvia nationalized
its second largest bank, Parex Bank. Latvia will implement measures to tighten fiscal policy and
stabilize its economy.

December 19. The Bank of Japan lowered the benchmark rate by 20 basis points to 0.3%. This
marks the second consecutive monthly cut.
December 18. Turkey reduces rates for the second consecutive month. The Central Bank of the
Republic of Turkey (CBRT) announced a 125-basis-point cut to their overnight borrowing rate
from 16.25% to 15.00%, and their overnight lending rate by 125 basis points, from 18.75% to

17.50%. Turkish interest rates are the highest in Europe, even after the rate cuts.

December 18. Mexican industrial output decreased an annual 2.7% in October, the sixth
consecutive monthly decline. More than 80% of Mexico’s exports go to the United States.
December 18. Norwegian Central Bank cut its main policy interest rate by 175 basis points to

3.0%, the third decrease since October.

December 17. U.S. housing starts plummeted 18.9% in November, to a seasonally adjusted
annual rate of 625,000 units. This was a record monthly low.
December 16. The U.S. Federal Open Market Committee (FOMC) voted unanimously to lower
its target for the federal funds rate more than 75 basis points, to a range of 0.0% to 0.25%. Long
term bond yields dropped from 2.50% to 2.35%.
December 15. The Bank of Japan’s tankan survey of business confidence fell from minus 3 in
the third quarter to minus 24 points in the fourth quarter of the year. The 21 point contraction was
the steepest in the index since the oil shocks of the 1970s, and marked the lowest level in the
index since 2002.
December 12. Ecuador’s President Rafael Correa announced that Ecuador will stop honoring its
external debt; the country should expect lawsuits from bondholders in the short term. This is not
the same as declaring the entire Ecuadorean economy in default.
December 11. 27 European Union (EU) governments’ leaders approved a 200 billion euro
(US$269 billion) economic stimulus package. The cost is approximately 1.5% of the EU’s total
GDP. Member states will pay major shares; supranational EU institutions, such as the European
Investment Bank (EIB), will contribute the remaining 30 billion euro.
December 11. Taiwan’s central bank cut its leading discount rate by three quarters of a
percentage point to 2.0%, marking the biggest reduction since 1982. It was also the fifth rate cut
in two-and-a-half months.
December 11. The central Bank of Korea reduced the seven-day repurchase rate by one
percentage point to a record low of 3.00%. Interest rates have been reduced by 225 basis points in
two months, 100 basis points in October and 125 basis points in November.
December 5. November U.S. nonfarm employment loss of 533,000 jobs was the largest in 34
years, compared with the 602,000 decline in December 1974. The U.S. Bureau of Labor Statistics
also reported the unemployment rate rose from 6.5 to 6.7 percent. November’s drop in payroll
employment followed declines of 403,000 in September and 320,000 in October, as revised.

November 25. U.S. real GDP fell 0.5% in the third quarter of 2008. The announcement by the
U.S. Bureau of Economic Analysis also reported U.S. second quarter GDP increased 2.8%. BEA
attributed the third quarter decline to a contraction in consumer spending and deceleration in
November 24. The U.K. announced a fiscal stimulus package valued at £20 billion (US$30.2
billion) aimed at limiting the length and depth of the apparent U.K. recession. The package
included a temporary reduction of value-added tax from 17.5% to 15.0%.
November 24. The IMF Executive Board approved a 23-month Stand-By Arrangement for
Pakistan in the amount of $7.6 billion to support the country’s economic stabilization program.
November 24. The Central Bank of Iceland’s currency swap arrangement with Sweden,
Norway, and Denmark is extended through December 2009. On the same date, Standard & Poor’s
Ratings Services, S&P, reduced its long-term Iceland sovereign credit rating from BBB to
BBB-, while maintaining its short-term Iceland sovereign currency rating at A-3.
November 24. The U.S. Treasury, Federal Reserve, and Federal Deposit Insurance Corp. said that
they will protect Citigroup against certain potential losses and invest an additional $20 billion
(on top of the previous $25 billion) in the company. The government is to receive $7 billion in
preferred shares in the company.
November 19. The IMF Executive Board agreed to a $2.1 billion loan for Iceland. Following the
decision of IMF’s Executive Board, Denmark, Finland, Norway, and Sweden agreed to provide
an additional $2.5 billion in loans to Iceland.
November 15. At a G-20 (including the G-8, 10 major emerging economies, Australia and the
European Union) summit in Washington, the G-20 leaders agreed to continue to take steps to
stabilize the global financial system and improve the international regulatory framework.
November 15. Japan announced that it would make $100 billion from its foreign exchange
reserves available to the IMF for loans to emerging market economies. This was in addition to $2
billion that Japan is to invest in the World Bank to help recapitalize banks in smaller, emerging
market economies. Also, the IMF and Pakistan agreed in principle on a $7.6 billion loan package
aimed at preventing the nation from defaulting on foreign debt and restoring investor confidence.
November 14. The President’s Working Group on Financial Markets (Treasury, Securities and
Exchange Commission, Federal Reserve, and the Commodity Futures Trading Commission)
announced a series of initiatives to strengthen oversight and the infrastructure of the over-the-
counter derivatives market. This included the development of credit default swap central
counterparties—clearinghouses between parties that own debt instruments and others willing to
insure against defaults.
November 13. The African Development bank conference on the financial crisis ended with a
pessimistic outlook for Sub-Saharan Africa, due to declines in foreign capital, export markets
and commodity-based exports.
November 13. Eurostat declared that Eurozone GDP declined by 0.2% in the third quarter of
2008, as well as the second quarter. Since recession is defined as two successive quarters of
contracting GDP, this means that the Eurozone is technically in recession.

November 12. United States Treasury Secretary Paulson announced a change in priorities for
the US$700 billion Troubled Asset Relief Program (TARP) approved by Congress in early
October. The first priority remains to provide direct equity infusions to the financial sector.
Roughly US$250 billion has been allocated to this sector. This scope was broadened to include
non-banks, particularly insurance companies such as AIG, which provide insurance for credit
defaults. Paulson noted that TARP would be used to purchase bank stock, not toxic assets.
Paulson’s new plan also would provide support for the asset-backed commercial paper market,
particularly securitized auto loans, credit card debt, and student loans. Between August and
November 2007 asset-backed commercial paper outstanding contracted by nearly US$400 billion.
Paulson rejected suggestions that TARP funds be made available to the U.S. auto industry.
November 12. The Central Bank of Russia raised key interest rates by 1%. Swiss Economics
Minister announced the Swiss government would inject 341 million Swiss Francs/US$286.6
million for economic stimulus. The State Bank of Pakistan raised interest rates by 2%, to reduce
inflation. It also injected 320 billion rupees/US$4 billion into the Pakistan banking system.
November 11. IMF deferred their decision to approve US$2.1 billion loan for Iceland. This
was the third time the IMF board scheduled then failed to discuss the Iceland proposal. The
tentative Iceland package required Iceland to implement economic stabilization. That economic
stabilization was the required trigger for implementation of EU loans to Iceland from Norway,
Poland and Sweden. Iceland is reportedly involved in disputes over deposit guarantees with
British and Dutch depositors in Icelandic banks.
November 10. The United States government announced further aid to American International
Group, AIG. AIG’s September $85 billion loan was reduced to $60 billion; the government
bought $40 billion of preferred AIG shares, and $52.5 billion of AIG mortgage securities. The
U.S. support of AIG increased from September’s $85 billion to $150 billion.
November 7. Iceland’s President Grimsson reportedly offered the use of the former U.S. Air
Force base at Keflavik to Russia. The United States departed Keflavik in 2006.
November 3. IMF announced agreement with Kyrgyzstan on arrangement under the Exogenous
Shocks Facility to provide at least U.S. $60 million. The agreement requires the approval of the
IMF Executive Board to become final.
November 9. G-20 meeting of finance ministers and central bank governors in Sao Paulo, Brazil,
concluded with a communiqué calling for increased role of emerging economies in reform of
Bretton Woods financial institutions, including the World Bank and the International Monetary
November 9. China announced a 4 trillion Yuan/U.S. $587 billion domestic stimulus package.
primarily aimed at infrastructure, housing, agriculture, health care, and social welfare spending.
This program represents 16% of China’s 2007 GDP, and roughly equals total Chinese central and
local government outlays in 2006.
November 8. Latvian government took over Parex Bank, the second-largest bank in Latvia.
November 7. United States October employment report revealed a decline of 240,000 jobs in
October, and September job losses revised from 159,000 to 284,000. The U.S. unemployment rate
rose from 6.1% to 6.5%, a 14-year high.

November 7. Moody’s sovereign rating for Hungary is reduced from A2 to A3. Despite IMF
assistance, financial instability may require “severe macroeconomic and financial adjustment.”
Moody’s reduced its ratings of Latvia from A3 to A2, before the Latvian statistical office
announced Latvian GDP fell at a 4.2% annual rate in the third quarter of 2008. Moody’s also
announced an outlook reduction for Estonia and Lithuania.
November 6. IMF approved SDR 10.5 billion/U.S. $15.7 billion Stand-By Arrangement for
Hungary. U.S. $6.3 billion is to be immediately available.
November 6. International Monetary Fund announced its updated World Economic Outlook.
Main findings include that “global activity is slowing quickly”, and “prospects for global growth
have deteriorated over the past month.” The IMF now projects global GDP growth for 2009 at
2.2% , 3/4 of a percentage point lower than projections announced in October, 2008. It projects
U.S. GDP growth at 1.4% in 2008 and -0.7% in 2009.
November 6. The European Central Bank, ECB, reduced its key interest rate from 3.75% to
3.25%. In two months the ECB has reduced this rate from 4.25% to 3.25%. The Danish Central
Bank lowered its key lending rate from 5.5% to 5%. The Czech National Bank reduced its
interest rate from 3.5% to 2.75%. In South Korea, the Bank of Korea reduced its key interest rate
from 4.25% to 4%. During October the Bank of Korea reduced its rate from 5.25% to 4.25%.
November 4. United States Institute of Supply Management’s manufacturing index fell 4.6
points in October to 38.9, after previously falling in September. The export orders component of
the manufacturing index fell 11 points in October to 41, following a drop of 5 points in
September. 41 is the lowest level in this export index in 20 years. Exports have been the
strongest sector in U.S. manufacturing during the past year.
November 4. Australia. Reserve Bank of Australia lowered its overnight cash rate by 75 basis
points to 5.25%, the lowest Australian rate since March 2005.
November 4. Indian Prime Minister Manmohan Singh established a Cabinet-level committee to
evaluate the effect of the financial crisis on India’s economy and industries. This follows the
November 2 Indian and Pakistani Central banks’ actions to boost liquidity. India cut its short-
term lending rate by 50 basis points to 7.5% and reduced its cash reserve ratio by 100 basis points
to 5.5%.
November 4. Chilean President Michelle Bachelet announced a U.S. $1.15 billion stimulus
package to boost the housing market and channel credit into small and medium businesses.
November 3. Russian Prime Minister Vladimir Putin reported measures to support the real
economy. The measures will include temporary preferences for domestic producers for state
procurement contracts, subsidizing interest rates for loans intended to modernize production; and
tariff protection for a number of industries such as automobiles and agriculture. The new policy
aims to support exporters.
October 31. Three of the six Gulf Cooperation Council, GCC, countries, Bahrain, Kuwait and
Saudi Arabian central banks reduced interest rates to follow the actions of the U.S. Federal
Reserve and other central banks.
October 31. Kazakhstan government will make capital injections into its top four banks,
Halyk Bank, Kazkommertsbank, Alliance Bank and BTA Bank.

October 31. The U.S. Commerce Department reported that consumer spending fell 0.3% in
September after remaining flat in the previous month. On a year-to-year basis, spending was
down 0.4%, the first such drop since the recession of 1991. Consumer spending has not grown
since June.
October 30. The U.S. Bureau of Economic Analysis reported that U.S. real gross domestic
product decreased 0.3 per cent in the third quarter of 2008 after increasing 2.8 per cent in the
second quarter of 2008.
October 29. The U.S. Federal Reserve lowered its target for the federal funds rate 50 basis
points to 1 per cent. It also approved a 50 basis point decrease in the discount rate to 1.25 per
cent. The Federal Reserve also announced establishment of temporary reciprocal currency
arrangements, or swap lines, with the Banco Central do Brasil, the Banco de Mexico, the Bank of
Korea, the Monetary Authority of Singapore, and the Reserve Bank of New Zealand. Swap lines
are designed to help improve liquidity conditions in global financial markets.
October 29. IMF approved the creation of a Short-Term Liquidity Facility, established to
support countries with strong policies which face temporary liquidity problems.
October 28. The IMF, the European Union, and the World Bank announced a joint financing
package for Hungary totaling $25.1 billion to bolster its economy. The IMF is to lend Hungary
$15.7 billion, the EU $8.1 billion, and the World Bank $1.3 billion.
October 28. The U.S. Conference Board said that its consumer confidence index has dropped to
an all-time low, from 61.4 in September to 38 in October.
October 27. Iceland’s Kaupthing Bank became the first European borrower to default on yen-
denominated bonds issued in Japan (samurai bonds).
October 26. The IMF announced it is set to lend Ukraine $16.5 Billion.
October 24. IMF announced an outline agreement with Iceland to lend the country $2.1 billion
to support an economic recovery program to help it restore confidence in its banking system and
stabilize its currency.
October 23. President Bush called for the G-20 leaders to meet on November 15 in Washington,
DC to deal with the global financial crisis.
October 22. Pakistan sought help from the IMF to meet balance of payments difficulties and to
avoid a possible economic meltdown amid high fuel prices, dwindling foreign investment and
soaring militant violence.
G-20. The Group of 20 Finance Ministers and Central Bank Governors from industrial and
emerging-market countries is to meet in Sao Paulo, Brazil on November 8-9, 2008, to discuss key
issues related to global economic stability.
October 20. The Netherlands agreed to inject 10 billion ($13.4 billion) into ING Groep NV, a
global banking and insurance company. The investment is to take the form of nonvoting preferred
shares with no maturity date (ING can repay the money on its own schedule and will have the
right to buy the shares back at 150% of the issue price or convert them into ordinary shares in
three years). The government is to take two seats on ING’s supervisory board; ING’s executive-

board members are to forgo 2008 bonuses; and ING said it would not pay a dividend for the rest
of 2008.
October 20. Sweden proposed a financial stability plan, which includes a 1.5 trillion Swedish
kronor ($206 billion) bank guarantee, to combat the impact of the economic crisis.
October 20. The U.N.’s International Labor Organization projects that the global financial
crisis could add at least 20 million people to the world’s unemployed, bringing the total to 210
million by the end of 2009.
October 19. South Korea announced that it would guarantee up to $100 billion in foreign debt
held by its banks and would pump $30 billion more into its banking sector.
October 18. President Bush, President Nicolas Sarkozy of France, and the president of the
European Commission issued a joint statement saying they agreed to “reach out to other world
leaders” to propose an international summit meeting to be held soon after the U.S. presidential
election, with the possibility of more gatherings after that. The Europeans had been pressing for a
meeting of the Group of 8 industrialized nations, but President Bush went one step further, calling
for a broader global conference that would include “developed and developing nations”—among
them China and India.
October 17. The Swiss government said it would take a 9% stake ($5.36 billion) in UBS, one of
the country’s leading banks, and set up a $60 billion fund to absorb the bank’s troubled assets.
UBS had already written off $40 billion of its $80 billion in “toxic American securities.” The
Swiss central bank was to take over $31 billion of the bank’s American assets (much of it in the
form of debt linked to subprime and Alt-A mortgages, and securities linked to commercial real
estate and student loans).
October 15. The G8 leaders (Canada, France, Germany, Italy, Japan, Russia, the United Kingdom
and the United States, and the European Commission) stated that they were united in their
commitment to resolve the current crisis, strengthen financial institutions, restore confidence in
the financial system, and provide a sound economic footing for citizens and businesses. They
stated that changes to the regulatory and institutional regimes for the world’s financial sectors are
needed and that they look forward to a leaders’ meeting with key countries at an appropriate time st
in the near future to adopt an agenda for reforms to meet the challenges of the 21 century.
October 14. In coordination with European monetary authorities, the U.S. Treasury, Federal
Reserve, and Federal Deposit Insurance Corporation announced a plan to invest up to $250
billion in preferred securities of nine major U.S. banks (including Citigroup, Bank of America,
Wells Fargo, Goldman Sachs and JPMorgan Chase). The FDIC also became able to
temporarily guarantee the senior debt and deposits in non-interest bearing deposit transaction 160
accounts (used mainly by businesses for daily operations).
October 13. U.K. Government provided $60 billion and took a 60% stake in Royal Bank of
Scotland and 40% in Lloyds TSB and HBOS.

160 U.S. Treasury. “Joint Statement by Treasury, Federal Reserve and FDIC. Press Release HP-1206, October 14,

October 12-13. Several European countries (Germany, France, Italy, Austria, Netherlands,
Portugal, Spain, and Norway) announced rescue plans for their countries worth as much as
$2.7 trillion. The plans were largely consistent with a U.K. model that includes concerted action,
recapitalization, state ownership, government debt guarantees (the largest component of the
plans), and improved regulations.
October 8. In a coordinated effort, the U.S. Federal Reserve, the European Central Bank, the
Bank of England and the central banks of Canada and Sweden all reduced primary lending
rates by a half percentage point. Switzerland also cut its benchmark rate, while the Bank of
Japan endorsed the moves without changing its rates. The Chinese central bank also reduced its
key interest rate and lowered bank reserve requirements. The Federal Reserve’s benchmark short-
term rate stood at 1.5% and the European Central Bank’s at 3.75%.
October 5. The German government moved to guarantee all private savings accounts and
arranged a bailout for Hypo Real Estate, a German lender. A week earlier, Fortis, a large
banking and insurance company based in Belgium but active across much of Europe, had
received 11.2 billion ($8.2 billion) from the governments of the Netherlands, Belgium and
Luxembourg. On October 3, the Dutch government seized its Dutch operations and on October 5,
the Belgian government helped to arrange for BNP-Paribas, the French bank, to take over what
was left of the company.
October 3. U.S. House of Representatives passes 110th Congress bill H.R. 1424, Financial
Institutions Rescue bill, clearing it for Presidential signing or veto. President signs bill into law,
P.L. 110-343, the Emergency Economic Stabilization Act of 2008, sometimes referred to as the
Troubled Assets Relief Program, TARP. The new bill’s title includes its purpose:
“A bill to provide authority for the Federal Government to purchase and insure certain types of
troubled assets for the purposes of providing stability to and preventing disruption in the economy
and financial system and protecting taxpayers ... ”
October 3. Britain’s Financial Services Authority said it had raised the amount guaranteed in
savings accounts to £50,000 ($88,390) from £35,000. Greece also stated that it would guarantee
savings accounts regardless of the amount.
October 3. Wells Fargo Bank announced a takeover of Wachovia Corp, the fourth-largest U.S.
bank. (Previously, Citibank had agreed to take over Wachovia.)
October 1. U.S. Senate passed H.R. 1424, amended, Financial Institutions Rescue bill.
September/October. On September 30, Iceland’s government took a 75% share of Glitnir,
Iceland’s third-largest bank, by injecting 600 million ($850 million) into the bank. The following
week, it took control of Landsbanki and soon after placed Iceland’s largest bank, Kaupthing,
into receivership as well.
September 26. Washington Mutual became the largest thrift failure with $307 billion in assets.
JPMorgan Chase agreed to pay $1.9 billion for the banking operations but did not take
ownership of the holding company.
September 22. Ireland increased the statutory limit for the deposit guarantee scheme for banks
and building societies from 20,000 ($26,000) to 100,000 ($130,000) per depositor per

September 21. The Federal Reserve approved the transformation of Goldman Sachs and
Morgan Stanley into bank holding companies from investment banks in order to increase
oversight and allow them to access the Federal Reserve’s discount (loan) window.
September 18. Treasury Secretary Paulson announced a $700 billion economic stabilization
proposal that would allow the government to buy toxic assets from the nation’s biggest banks, a
move aimed at shoring up balance sheets and restoring confidence within the financial system. An
amended bill to accomplish this was passed by Congress on October 3.
September 16. The Federal Reserve came to the assistance of American International Group,
AIG, an insurance giant on the verge of failure because of its exposure to exotic securities known
as credit default swaps, in an $85 billion deal (later increased to $123 billion).
September 15. Lehman Brothers bankruptcy at $639 billion is the largest in the history of the
United States.
September 14. Bank of America said it will buy Merrill Lynch for $50 billion.
September 7. U.S. Treasury announced that it was taking over Fannie Mae and Freddie Mac,
two government-sponsored enterprises that bought securitized mortgage debt.
August 12. According to Bloomberg, losses at the top 100 banks in the world from the U.S.
subprime crisis and the ensuing credit crunch exceeded $500 billion as write downs spread to
more asset types.
May 4. Finance ministers of 13 Asian nations agreed to set up a foreign exchange pool of at least
$80 billion to be used in the event of another regional financial crisis. China, Japan and South
Korea are to provide 80% of the funds with the rest coming from the 10 members of ASEAN.
March. The Federal Reserve staved off a Bear Stearns bankruptcy by assuming $30 billion in
liabilities and engineering a sale of Bear Sterns to JPMorgan Chase for a price that was less than
the worth of Bear’s Manhattan office building.
February 17. The British government decided to “temporarily” nationalize the struggling
housing lender, Northern Rock. A previous government loan of $47 billion had proven
ineffective in helping the company to recover.
January. Swiss banking giant UBS reported more than $18 billion in writedowns due to
exposure to U.S. real estate market. Bank of America acquired Countrywide Financial, the
largest mortgage lender in the United States.
July/August. German banks with bad investments in U.S. real estate are caught up in the
evolving crisis, These include IKB Deutsche Industriebank, Sachsen LB (Saxony State Bank)
and BayernLB (Bavaria State Bank).
July 18. Two battered hedge funds worth an estimated $1.5 billion at the end of 2006 were
almost entirely worthless. They had been managed by Bear Stearns and were invested heavily in
subprime mortgages.

July 12. The Federal Deposit Insurance Corp. took control of the $32 billion IndyMac Bank
(Pasadena, CA) in what regulators called the second-largest bank failure in U.S. history.
March/April. New Century Financial corporation stopped making new loans as the practice of
giving high risk mortgage loans to people with bad credit histories becomes a problem. The
International Monetary Fund warned of risks to global financial markets from weakened US
home mortgage market.

1. We, the Leaders of the Group of Twenty, held an initial meeting in Washington on November
15, 2008, amid serious challenges to the world economy and financial markets. We are
determined to enhance our cooperation and work together to restore global growth and achieve
needed reforms in the world’s financial systems.
2. Over the past months our countries have taken urgent and exceptional measures to support the
global economy and stabilize financial markets. These efforts must continue. At the same time,
we must lay the foundation for reform to help to ensure that a global crisis, such as this one, does
not happen again. Our work will be guided by a shared belief that market principles, open trade
and investment regimes, and effectively regulated financial markets foster the dynamism,
innovation, and entrepreneurship that are essential for economic growth, employment, and
poverty reduction.
3. During a period of strong global growth, growing capital flows, and prolonged stability earlier
this decade, market participants sought higher yields without an adequate appreciation of the risks
and failed to exercise proper due diligence. At the same time, weak underwriting standards,
unsound risk management practices, increasingly complex and opaque financial products, and
consequent excessive leverage combined to create vulnerabilities in the system. Policy-makers,
regulators and supervisors, in some advanced countries, did not adequately appreciate and address
the risks building up in financial markets, keep pace with financial innovation, or take into
account the systemic ramifications of domestic regulatory actions.
4. Major underlying factors to the current situation were, among others, inconsistent and
insufficiently coordinated macroeconomic policies, inadequate structural reforms, which led to
unsustainable global macroeconomic outcomes. These developments, together, contributed to
excesses and ultimately resulted in severe market disruption.
5. We have taken strong and significant actions to date to stimulate our economies, provide
liquidity, strengthen the capital of financial institutions, protect savings and deposits, address
regulatory deficiencies, unfreeze credit markets, and are working to ensure that international
financial institutions (IFIs) can provide critical support for the global economy.

6. But more needs to be done to stabilize financial markets and support economic growth.

Economic momentum is slowing substantially in major economies and the global outlook has
weakened. Many emerging market economies, which helped sustain the world economy this
decade, are still experiencing good growth but increasingly are being adversely impacted by the
worldwide slowdown.

7. Against this background of deteriorating economic conditions worldwide, we agreed that a
broader policy response is needed, based on closer macroeconomic cooperation, to restore
growth, avoid negative spillovers and support emerging market economies and developing
countries. As immediate steps to achieve these objectives, as well as to address longer-term
challenges, we will:
• Continue our vigorous efforts and take whatever further actions are necessary to
stabilize the financial system.
• Recognize the importance of monetary policy support, as deemed appropriate to
domestic conditions.
• Use fiscal measures to stimulate domestic demand to rapid effect, as appropriate,
while maintaining a policy framework conducive to fiscal sustainability.
• Help emerging and developing economies gain access to finance in current
difficult financial conditions, including through liquidity facilities and program
support. We stress the International Monetary Fund’s (IMF) important role in
crisis response, welcome its new short-term liquidity facility, and urge the
ongoing review of its instruments and facilities to ensure flexibility.
• Encourage the World Bank and other multilateral development banks (MDBs) to
use their full capacity in support of their development agenda, and we welcome
the recent introduction of new facilities by the World Bank in the areas of
infrastructure and trade finance.
• Ensure that the IMF, World Bank and other MDBs have sufficient resources to
continue playing their role in overcoming the crisis.
8. In addition to the actions taken above, we will implement reforms that will strengthen financial
markets and regulatory regimes so as to avoid future crises. Regulation is first and foremost the
responsibility of national regulators who constitute the first line of defense against market
instability. However, our financial markets are global in scope, therefore, intensified international
cooperation among regulators and strengthening of international standards, where necessary, and
their consistent implementation is necessary to protect against adverse cross-border, regional and
global developments affecting international financial stability. Regulators must ensure that their
actions support market discipline, avoid potentially adverse impacts on other countries, including
regulatory arbitrage, and support competition, dynamism and innovation in the marketplace.
Financial institutions must also bear their responsibility for the turmoil and should do their part to
overcome it including by recognizing losses, improving disclosure and strengthening their
governance and risk management practices.
9. We commit to implementing policies consistent with the following common principles for
• Strengthening Transparency and Accountability: We will strengthen financial
market transparency, including by enhancing required disclosure on complex
financial products and ensuring complete and accurate disclosure by firms of
their financial conditions. Incentives should be aligned to avoid excessive risk-

• Enhancing Sound Regulation: We pledge to strengthen our regulatory regimes,
prudential oversight, and risk management, and ensure that all financial markets,
products and participants are regulated or subject to oversight, as appropriate to
their circumstances. We will exercise strong oversight over credit rating agencies,
consistent with the agreed and strengthened international code of conduct. We
will also make regulatory regimes more effective over the economic cycle, while
ensuring that regulation is efficient, does not stifle innovation, and encourages
expanded trade in financial products and services. We commit to transparent
assessments of our national regulatory systems.
• Promoting Integrity in Financial Markets: We commit to protect the integrity of
the world’s financial markets by bolstering investor and consumer protection,
avoiding conflicts of interest, preventing illegal market manipulation, fraudulent
activities and abuse, and protecting against illicit finance risks arising from non-
cooperative jurisdictions. We will also promote information sharing, including
with respect to jurisdictions that have yet to commit to international standards
with respect to bank secrecy and transparency.
• Reinforcing International Cooperation: We call upon our national and regional
regulators to formulate their regulations and other measures in a consistent
manner. Regulators should enhance their coordination and cooperation across all
segments of financial markets, including with respect to cross-border capital
flows. Regulators and other relevant authorities as a matter of priority should
strengthen cooperation on crisis prevention, management, and resolution.
• Reforming International Financial Institutions: We are committed to advancing
the reform of the Bretton Woods Institutions so that they can more adequately
reflect changing economic weights in the world economy in order to increase
their legitimacy and effectiveness. In this respect, emerging and developing
economies, including the poorest countries, should have greater voice and
representation. The Financial Stability Forum (FSF) must expand urgently to a
broader membership of emerging economies, and other major standard setting
bodies should promptly review their membership. The IMF, in collaboration with
the expanded FSF and other bodies, should work to better identify vulnerabilities,
anticipate potential stresses, and act swiftly to play a key role in crisis response.
10. We are committed to taking rapid action to implement these principles. We instruct our
Finance Ministers, as coordinated by their 2009 G-20 leadership (Brazil, UK, Republic of Korea),
to initiate processes and a timeline to do so. An initial list of specific measures is set forth in the
attached Action Plan, including high priority actions to be completed prior to March 31, 2009.
In consultation with other economies and existing bodies, drawing upon the recommendations of
such eminent independent experts as they may appoint, we request our Finance Ministers to
formulate additional recommendations, including in the following specific areas:
• Mitigating against pro-cyclicality in regulatory policy;
• Reviewing and aligning global accounting standards, particularly for complex
securities in times of stress;

• Strengthening the resilience and transparency of credit derivatives markets and
reducing their systemic risks, including by improving the infrastructure of over-
the-counter markets;
• Reviewing compensation practices as they relate to incentives for risk taking and
• Reviewing the mandates, governance, and resource requirements of the IFIs; and
• Defining the scope of systemically important institutions and determining their
appropriate regulation or oversight.

11. In view of the role of the G-20 in financial systems reform, we will meet again by April 30,

2009, to review the implementation of the principles and decisions agreed today.

12. We recognize that these reforms will only be successful if grounded in a commitment to free
market principles, including the rule of law, respect for private property, open trade and
investment, competitive markets, and efficient, effectively regulated financial systems. These
principles are essential to economic growth and prosperity and have lifted millions out of poverty,
and have significantly raised the global standard of living. Recognizing the necessity to improve
financial sector regulation, we must avoid over-regulation that would hamper economic growth
and exacerbate the contraction of capital flows, including to developing countries.
13. We underscore the critical importance of rejecting protectionism and not turning inward in
times of financial uncertainty. In this regard, within the next 12 months, we will refrain from
raising new barriers to investment or to trade in goods and services, imposing new export
restrictions, or implementing World Trade Organization (WTO) inconsistent measures to
stimulate exports. Further, we shall strive to reach agreement this year on modalities that leads to
a successful conclusion to the WTO’s Doha Development Agenda with an ambitious and
balanced outcome. We instruct our Trade Ministers to achieve this objective and stand ready to
assist directly, as necessary. We also agree that our countries have the largest stake in the global
trading system and therefore each must make the positive contributions necessary to achieve such
an outcome.
14. We are mindful of the impact of the current crisis on developing countries, particularly the
most vulnerable. We reaffirm the importance of the Millennium Development Goals, the
development assistance commitments we have made, and urge both developed and emerging
economies to undertake commitments consistent with their capacities and roles in the global
economy. In this regard, we reaffirm the development principles agreed at the 2002 United
Nations Conference on Financing for Development in Monterrey, Mexico, which emphasized
country ownership and mobilizing all sources of financing for development.
15. We remain committed to addressing other critical challenges such as energy security and
climate change, food security, the rule of law, and the fight against terrorism, poverty and disease.
16. As we move forward, we are confident that through continued partnership, cooperation, and
multilateralism, we will overcome the challenges before us and restore stability and prosperity to
the world economy.

This Action Plan sets forth a comprehensive work plan to implement the five agreed principles
for reform. Our finance ministers will work to ensure that the tasks set forth in this Action Plan
are fully and vigorously implemented. They are responsible for the development and
implementation of these recommendations drawing on the ongoing work of relevant bodies,
including the International Monetary Fund (IMF), an expanded Financial Stability Forum (FSF),
and standard setting bodies.
Strengthening Transparency and Accountability
Immediate Actions by March 31, 2009
• The key global accounting standards bodies should work to enhance guidance for
valuation of securities, also taking into account the valuation of complex, illiquid
products, especially during times of stress.
• Accounting standard setters should significantly advance their work to address
weaknesses in accounting and disclosure standards for off-balance sheet vehicles.
• Regulators and accounting standard setters should enhance the required
disclosure of complex financial instruments by firms to market participants.
• With a view toward promoting financial stability, the governance of the
international accounting standard setting body should be further enhanced,
including by undertaking a review of its membership, in particular in order to
ensure transparency, accountability, and an appropriate relationship between this
independent body and the relevant authorities.
• Private sector bodies that have already developed best practices for private pools
of capital and/or hedge funds should bring forward proposals for a set of unified
best practices. Finance Ministers should assess the adequacy of these proposals,
drawing upon the analysis of regulators, the expanded FSF, and other relevant
Medium-term actions
• The key global accounting standards bodies should work intensively toward the
objective of creating a single high-quality global standard.
• Regulators, supervisors, and accounting standard setters, as appropriate, should
work with each other and the private sector on an ongoing basis to ensure
consistent application and enforcement of high-quality accounting standards.
• Financial institutions should provide enhanced risk disclosures in their reporting
and disclose all losses on an ongoing basis, consistent with international best
practice, as appropriate. Regulators should work to ensure that a financial
institution’ financial statements include a complete, accurate, and timely picture
of the firm’s activities (including off-balance sheet activities) and are reported on
a consistent and regular basis.

Enhancing Sound Regulation
Regulatory Regimes
Immediate Actions by March 31, 2009
• The IMF, expanded FSF, and other regulators and bodies should develop
recommendations to mitigate pro-cyclicality, including the review of how
valuation and leverage, bank capital, executive compensation, and provisioning
practices may exacerbate cyclical trends.
Medium-term actions
• To the extent countries or regions have not already done so, each country or
region pledges to review and report on the structure and principles of its
regulatory system to ensure it is compatible with a modern and increasingly
globalized financial system. To this end, all G-20 members commit to undertake
a Financial Sector Assessment Program (FSAP) report and support the
transparent assessments of countries’ national regulatory systems.
• The appropriate bodies should review the differentiated nature of regulation in
the banking, securities, and insurance sectors and provide a report outlining the
issue and making recommendations on needed improvements. A review of the
scope of financial regulation, with a special emphasis on institutions,
instruments, and markets that are currently unregulated, along with ensuring that
all systemically-important institutions are appropriately regulated, should also be
• National and regional authorities should review resolution regimes and
bankruptcy laws in light of recent experience to ensure that they permit an
orderly wind-down of large complex cross-border financial institutions. *
Definitions of capital should be harmonized in order to achieve consistent
measures of capital and capital adequacy.
Prudential Oversight
Immediate Actions by March 31, 2009
• Regulators should take steps to ensure that credit rating agencies meet the highest
standards of the international organization of securities regulators and that they
avoid conflicts of interest, provide greater disclosure to investors and to issuers,
and differentiate ratings for complex products. This will help ensure that credit
rating agencies have the right incentives and appropriate oversight to enable them
to perform their important role in providing unbiased information and
assessments to markets.
• The international organization of securities regulators should review credit rating
agencies’ adoption of the standards and mechanisms for monitoring compliance.
• Authorities should ensure that financial institutions maintain adequate capital in
amounts necessary to sustain confidence. International standard setters should set
out strengthened capital requirements for banks’ structured credit and
securitization activities.

• Supervisors and regulators, building on the imminent launch of central
counterparty services for credit default swaps (CDS) in some countries, should:
speed efforts to reduce the systemic risks of CDS and over-the-counter (OTC)
derivatives transactions; insist that market participants support exchange traded
or electronic trading platforms for CDS contracts; expand OTC derivatives
market transparency; and ensure that the infrastructure for OTC derivatives can
support growing volumes.
Medium-term actions
• Credit Ratings Agencies that provide public ratings should be registered.
• Supervisors and central banks should develop robust and internationally
consistent approaches for liquidity supervision of, and central bank liquidity
operations for, cross-border banks.
Risk Management
Immediate Actions by March 31, 2009
• Regulators should develop enhanced guidance to strengthen banks’ risk
management practices, in line with international best practices, and should
encourage financial firms to reexamine their internal controls and implement
strengthened policies for sound risk management.
• Regulators should develop and implement procedures to ensure that financial
firms implement policies to better manage liquidity risk, including by creating
strong liquidity cushions.
• Supervisors should ensure that financial firms develop processes that provide for
timely and comprehensive measurement of risk concentrations and large
counterparty risk positions across products and geographies.
• Firms should reassess their risk management models to guard against stress and
report to supervisors on their efforts.
• The Basel Committee should study the need for and help develop firms’ new
stress testing models, as appropriate.
• Financial institutions should have clear internal incentives to promote stability,
and action needs to be taken, through voluntary effort or regulatory action, to
avoid compensation schemes which reward excessive short-term returns or risk
• Banks should exercise effective risk management and due diligence over
structured products and securitization.
Medium -term actions
• International standard setting bodies, working with a broad range of economies
and other appropriate bodies, should ensure that regulatory policy makers are
aware and able to respond rapidly to evolution and innovation in financial
markets and products.

• Authorities should monitor substantial changes in asset prices and their
implications for the macroeconomy and the financial system.
Promoting Integrity in Financial Markets
Immediate Actions by March 31, 2009
• Our national and regional authorities should work together to enhance regulatory
cooperation between jurisdictions on a regional and international level.
• National and regional authorities should work to promote information sharing
about domestic and cross-border threats to market stability and ensure that
national (or regional, where applicable) legal provisions are adequate to address
these threats.
• National and regional authorities should also review business conduct rules to
protect markets and investors, especially against market manipulation and fraud
and strengthen their cross-border cooperation to protect the international
financial system from illicit actors. In case of misconduct, there should be an
appropriate sanctions regime.
Medium-term actions
• National and regional authorities should implement national and international
measures that protect the global financial system from uncooperative and non-
transparent jurisdictions that pose risks of illicit financial activity.
• The Financial Action Task Force should continue its important work against
money laundering and terrorist financing, and we support the efforts of the World
Bank-U.N. Stolen Asset Recovery (StAR) Initiative.
• Tax authorities, drawing upon the work of relevant bodies such as the
Organization for Economic Cooperation and Development (OECD), should
continue efforts to promote tax information exchange. Lack of transparency and a
failure to exchange tax information should be vigorously addressed.
Reinforcing International Cooperation
Immediate Actions by March 31, 2009
• Supervisors should collaborate to establish supervisory colleges for all major
cross-border financial institutions, as part of efforts to strengthen the surveillance
of cross-border firms. Major global banks should meet regularly with their
supervisory college for comprehensive discussions of the firm’s activities and
assessment of the risks it faces.
• Regulators should take all steps necessary to strengthen cross-border crisis
management arrangements, including on cooperation and communication with
each other and with appropriate authorities, and develop comprehensive contact
lists and conduct simulation exercises, as appropriate.

Medium-term actions
• Authorities, drawing especially on the work of regulators, should collect
information on areas where convergence in regulatory practices such as
accounting standards, auditing, and deposit insurance is making progress, is in
need of accelerated progress, or where there may be potential for progress.
• Authorities should ensure that temporary measures to restore stability and
confidence have minimal distortions and are unwound in a timely, well-
sequenced and coordinated manner.
Reforming International Financial Institutions
Immediate Actions by March 31, 2009
• The FSF should expand to a broader membership of emerging economies.
• The IMF, with its focus on surveillance, and the expanded FSF, with its focus on
standard setting, should strengthen their collaboration, enhancing efforts to better
integrate regulatory and supervisory responses into the macro-prudential policy
framework and conduct early warning exercises.
• The IMF, given its universal membership and core macro-financial expertise,
should, in close coordination with the FSF and others, take a leading role in
drawing lessons from the current crisis, consistent with its mandate.
• We should review the adequacy of the resources of the IMF, the World Bank
Group and other multilateral development banks and stand ready to increase
them where necessary. The IFIs should also continue to review and adapt their
lending instruments to adequately meet their members’ needs and revise their
lending role in the light of the ongoing financial crisis.
• We should explore ways to restore emerging and developing countries’ access to
credit and resume private capital flows which are critical for sustainable growth
and development, including ongoing infrastructure investment.
• In cases where severe market disruptions have limited access to the necessary
financing for counter-cyclical fiscal policies, multilateral development banks
must ensure arrangements are in place to support, as needed, those countries with
a good track record and sound policies.
Medium-term actions
• We underscored that the Bretton Woods Institutions must be comprehensively
reformed so that they can more adequately reflect changing economic weights in
the world economy and be more responsive to future challenges. Emerging and
developing economies should have greater voice and representation in these
• The IMF should conduct vigorous and even-handed surveillance reviews of all
countries, as well as giving greater attention to their financial sectors and better
integrating the reviews with the joint IMF/World Bank financial sector
assessment programs. On this basis, the role of the IMF in providing macro-
financial policy advice would be strengthened.

• Advanced economies, the IMF, and other international organizations should
provide capacity-building programs for emerging market economies and
developing countries on the formulation and the implementation of new major
regulations, consistent with international standards.
Dick K. Nanto, Coordinator Martin A. Weiss
Specialist in Industry and Trade Analyst in International Trade and Finance, 7-7754, 7-5407
James K. Jackson Ben Dolven
Specialist in International Trade and Finance Section Research Manager, 7-7751, 7-7626
Wayne M. Morrison William H. Cooper
Specialist in Asian Trade and Finance Specialist in International Trade and Finance, 7-7767, 7-7749
J. Michael Donnelly J. F. Hornbeck
Information Research Specialist Specialist in International Trade and Finance, 7-8722, 7-7782