Understanding the 2007 Global Financial Crisis

Imported Intermediate Inputs and Equivalent Imports

Imported intermediate inputs refer to the consumption of imported intermediate goods by productive sectors. Equivalent imports refer to the value of imports that are similar to goods and services produced within the sector.

The percentage of production in Sector X is obtained with inputs from internal sources.

The International Financial Crisis

The financial crisis that began in mid-2007 was one of the most serious and intense in recent times. It quickly spread to other U.S. markets and financial intermediaries, subsequently affecting the majority of the world's financial systems. It was, in fact, the first global financial crisis in history. Like all previous crises, this one resulted from a set of imbalances. The factors behind it include:

A. Macroeconomic Environment

This position allowed for a virtuous combination of historically reduced interest rates and generated the illusion that it was not only possible but feasible to maintain high growth rates in the immediate future. The low interest rates (negative in real terms in many cases) led consumers and businesses to significantly increase their levels of indebtedness. In the case of the United States, it also contributed to generating a real estate bubble of considerable size.

B. Innovation and Financial Leverage

The low interest rates also reduced the profit levels of financial entities, thus encouraging the search for new operations that would generate a higher return. One was to grant mortgage loans to families or individuals with poor credit histories. Designing new financial products, more complex and sophisticated, was another way that entities explored.

C. Bugs in the Assessment of Management and Risk

The extreme complexity of the new financial products made it difficult to adequately assess the level of risk entailed. The models used by financial institutions themselves underestimated liquidity risk and the likelihood of common shocks that affect all market participants at the same time. Conflicts of interest faced by rating companies further complicated the issue. Successive rounds of securitization incorporating new financial products generated remarkable opacity and a consequent loss of information for investors. It is no wonder then that when, due mainly to the tightening of U.S. monetary policy, delinquencies on mortgage loans began to increase.

D. Bugs in Regulation and Supervision

The elimination of barriers that hinder the mobility of capital and the non-regulation of certain markets (e.g., derivatives) and activities (such as off-balance sheet operations) prompted a significant expansion and, as importantly, the globalization of financial markets. The scenario changed dramatically in the summer of 2008, when it became clear that the losses of large banks were much higher than initially estimated. Due in large part to the existence of such losses, banks slashed credit. It is no wonder, then, that governments and central banks had to adopt increasingly unorthodox and radical measures to support the financial system. It was, in short, to avoid widespread panic and the ensuing breakdown of the entire international financial system. To cite the most important measures:

• Increase coverage levels of deposit insurance.
• Explicitly avoid the bankruptcy of any entity of "systemic importance."
• Inject more liquidity into the system.
• Strengthen the solvency of entities experiencing difficulties by providing capital and/or acting as insurers of last resort.
• Nationalize entities involved in difficulties.