Abstract: The global financial crisis clearly started with problems in the U.S. subprime sector
and spread across the world from there. But was the direct exposure of foreigners to the U.S.
financial system a key driver of the crisis, or did other factors account for its rapid contagion
across the world? To answer this question, we assessed whether countries that held large
amounts of U.S. mortgage-backed securities (MBS) and were highly dependent on dollar funding experienced a greater degree of financial distress during the crisis. We found little evidence of such “direct contagion” from the United States to abroad. Although CDS spreads generally rose higher and bank stocks generally fell lower in countries with more exposure to U.S. MBS and greater dollar funding needs, these correlations were not robust, and they fail to explain the lion’s share of the deterioration in asset prices that took place during the crisis.
Accordingly, channel of “indirect contagion” may have played a more important role in the global spread of the crisis:
- a generalized run on global financial institutions, given the opacity of their balance sheets;
- excessive dependence on short-term funding;
- vicious cycles of mark-to-market losses driving fire sales of MBS;
- the realization that financial firms around the world were pursuing similar (flawed) business models; and
- global swings in risk aversion.
Download the paper here: http://www.federalreserve.gov/pubs/ifdp/2010/994/ifdp994.pdf