ABSTRACT
When the real estate boom in the US turned to a bust, the investment bank Lehman Brothers went under. Lehman had a vast portfolio of complex contracts and derivatives deals with counterparties around the world, so financiers and bankers didn’t know which other banks might be rendered insolvent by Lehman’s failure to repay its creditors and settle its debts. Unable to assess which banks were solvent and which were not, banks stopped lending to each other – especially banks in the US and Europe whose portfolios were closely interconnected by myriad deals. A liquidity crisis resulted as banks tried to call in loans while hitting the brakes on making new loans. Acting on the resulting expectation of a weakening global economy, policy-makers first reacted with caution, then with public spending programmes, extensive liquidity facilities (like TARP) and a comprehensive national deposit guarantee scheme. Germany’s ‘cash for clunkers’ programme, which offered people a subsidy if they traded in old cars and bought new ones instead, was set up to increase consumption spending. The measure was part of a package of successful measures, which also included government subsidies to firms to encourage them to retain workers on shorter hours rather than laying them off altogether. After the crisis year 2009, Germany’s rate of economic growth turned positive in 2010. However, elsewhere the situation deteriorated more and more quickly. After Europe’s political elite agreed – wrongly – on government debt as the cause of the crisis, Greece, Ireland and Portugal were punished with austerity policies. Governments of these countries were cut-off from financial markets, and had to rely on help from public sector international financial institutions. A ‘troika’ of institutions consisting of the EC, ECB and IMF forced the respective governments to enact drastic measures, which supposedly were needed to bring these economies back on track. The new loans granted to the countries in trouble were largely used to pay off older loans. Therefore, these loans had the character of a bail-out. Had they not accepted the loans, the countries at risk would have had to declare at least a partial default on their debt. This policy was not successful. The economic growth rate collapsed in the bailed-out countries, and government debt increased further. Greece has by now written off half of the debt it had owed private investors when the crisis broke out.
