**2.5 The Argentine 2001/2 crisis<sup>6</sup>**

Due to political and monetary instability, Argentina had a record of extremely high and persistent inflation in the post-WW II period. Numerous efforts at inflation stabilization quickly failed due to undisciplined fiscal institutions and political interference at the CB. When inflation reached over 3000% per year, plans for economic stabilization and liberalization were deployed in 1989. The reforms included the privatization of state-owned enterprises, the deregulation of the economy, lower trade barriers state reform, and, last but not least, the Convertibility Plan of 1991, which fixed the Argentine peso one-to-one to the US Dollar. Under this currency board, Argentines could now freely convert their pesos into dollars. From then on, bank deposits and loans in dollars became widespread. Moderately expansive fiscal policy stimulated the economy and helped restore economic growth.

With the implementation of the reforms, Argentina won great commendation, especially from the IMF. On Wall Street, Argentina became one of the most favorite emerging markets and became the biggest issuer of emerging markets debt in the late nineties. This made the country increasingly dependent on foreign capital. Following the implementation of reforms, the Argentine economy entered a period of economic growth between 1991 and 1997. Only in 1995 output growth was negative, due to the

<sup>4</sup> This subsection draws on FRB of Dallas [6].

<sup>5</sup> The primary deficit was much smaller.

<sup>6</sup> This subsection partially draws on Ref. [7].

so-called Tequila crisis in Mexico. But the quick return of high economic growth in 1996 suggested that the Argentine economy was strong enough to counter external shocks. This further strengthened the confidence in the implemented policies, including the Convertibility Plan.

The outbreak of currency crises in Asia, Russia, and Brazil in 1997/1998 increased the borrowing costs for emerging markets, including Argentina. Furthermore, in 1998 when Brazil, a major trading partner of Argentina, ended its own peg to the US dollar, Argentina became less competitive. In addition, the prices of Argentina's agricultural export products fell and the US dollar appreciated reaching its highest level in 15 years. All this led to a sharp reduction in exports. As a result, Argentina's current account deficit rose and the country went into recession in the autumn of 1998.

Initially, Argentina maintained its peg, but this left it unable to respond to the growing economic imbalances. The fact that the exchange rate peg was not supported by nominal price and wage flexibility further reduced Argentina's means to deal with the currency overvaluation and decreased the credibility of the fixed exchange rate regime. As a consequence, foreign investors lost confidence in the Argentine economy, the country experienced a strong increase in borrowing costs and, by July 2001, the country had fully lost its access to international financial markets. This untenable problem was aggravated further by a procyclical fiscal policy.

At the end of December 2001, in a climate of severe political and social unrest, Argentina partially defaulted on its USD 93 billion international debt and 2 months later formally abandoned the Convertibility Plan. The pesofication of bank deposits and loans at two different exchange rates and prize freezes for utility companies caused a wave of defaults and liquidity problems at Argentine companies as well as at domestic and foreign banks. Among others, Argentina's largest locally owned privatesector bank, Banco Galicia, and several foreign banks, such as Bank of America, Citigroup, FleetBoston, and J.P. Morgan Chase & Co, suffered heavy losses.

### **2.6 The 2007/2014 global financial crisis (GFC)**

Unlike all the crises described above, the GFC erupted in the US—the epicenter of world financial markets—sending shock waves throughout global financial markets. The crisis was preceded by 20 years of subdued economic fluctuations known as "the great moderation." Between 2004 and 2007, a real estate boom swept the US and other Western economies. During that period, the volume of mortgagebacked securities (MBS) increased by leaps and bounds. MBS are bonds secured by large packages of mortgages that are divided into default risk tranches with higher risk tranches carrying higher rates. This repackaging of mortgages supplied to saving institutions a safe asset at slightly higher rates than other bonds of similar risk and dramatically increased the supply of funds to mortgage banks. Pension funds, insurance companies, and hedge funds all over the world absorbed large quantities of MBS.

The persistently rising real estate properties prior to the crisis led mortgage banks to finance most, and at time all or more, of the acquisition cost of a house. Under those circumstances, mortgage borrowers effectively borrowed with very little or no equity at all. This happy state lasted as long as real estate prices continued to rise. But, when they stopped rising and started to decline in 2006/7, the atmosphere changed. Many mortgage borrowers who had bought second and third homes stopped servicing their debt and returned the keys to their house to banks. In turn, the banks put those houses on the market at dumping prices, strengthening the decrease in prices.

### *Current Challenges to World Financial Stability: To What Extent is the Past a Guide for the… DOI: http://dx.doi.org/10.5772/intechopen.107432*

As this happened, the riskiness of MBS increased, and their prices decreased triggering calls for further funds from affected thrift institutions.7

This process was particularly devastating for highly leveraged hedge funds. Hedge funds owned by major investment banks defaulted pushing their parent companies into default. The most prominent downfalls among those were Bear-Stern in March 2008 and Lehman Brothers in September 2008. Shortly after, it became evident that the American International Group (AIG), a worldwide insurance company, and Fannie Mae and Freddie Mac, which together account for about half of the U.S. mortgage market, were on the verge of collapse endangering the entire US financial system.

On October 3 2008, following desperate and well-documented pleas for fiscal bailouts by Fed Chair Bernanke and Secretary of the Treasury Paulson, Congress created a \$700 billion Troubled Asset Relief Program (TARP) to bailout failing institutions by buying MBS and other securities whose value had decreased dramatically and which became known as "toxic assets."8 In parallel, the Fed reduced the federal funds rate (FFR) to zero and engaged in large scale asset purchases (LSAP) also known as quantitative easing (QE). Since the FFR had been reduced to the zero lower bound (ZLB), QE became the main instrument of monetary policy and was used extensively during the six or so years of the GFC. Congress also approved a separate package to bailout Fannie Mae and Freddie Mac. Within several months, those extraordinary rescue operations stabilized the financial panic that engulfed markets following Lehman's collapse, and within a couple of years, Fannie Mae, Freddie Mac, and AIG repaid all their debts to the federal government. However, unemployment remained above 5% until the end of 2014 ([8], Figure 1). New bond issues and banking credit were also depressed till at least the end of 2014 and, except for an upward blip in 2011, inflation was well below 2%.

In parallel, the Eurozone (EZ) had its own crisis. Summary information on the evolution of the GFC in Europe appears in Ref. [9]. Following the near meltdown of their financial systems, regulators in the U.S. and the EZ recognized the damages that can be inflicted on the economy via the failure of a "too big to fail" institution and the importance of systemic supervision and regulation. This led to a series of regulatory reforms on both sides of the Atlantic, the most important of which is the creation of systemic regulators and the exante identification of systemically important institutions (SIFI). Further details appear in Ref. [10].
