For Perry Mehrling, professor at Colombia University and author of The New Lombard Street (2010) the global crisis has its roots in financial globalization which has integrated national, monetary and capital markets in a global context. Stock exchanges have become global, where investors from all over the world find the highest returns, just as money markets have become global, where those looking for loans can find what the national market cannot offer.
In the past, the crises deriving from financial globalization have been minor and have involved peripheral countries as happened in Mexico or Asia; the bailout, typically a flood of dollars, was handled in tandem by the United States and the IMF. In today's crisis, central banks are the protagonists. Subprime mortgages were the fuse in the United States, while in Europe it is public debt, but in both cases central banks were immediately involved: a large part of the debt was financed on the short-term money market and the first response of the banks central banks has been to intervene in the money market; unfortunately it was not enough to stem the collapse of the securities.
The problem, Mehrling explains, lies in the collateral: both in the United States and in Europe it is long-term debt, very different from the kind of short-term trade credit at the center of Bagehot's classic 1873 book, (to which Mehrling inspired) in analyzing the behavior of a central bank in the face of a crisis. In today's world, the liquidity crisis has manifested itself not only in a sudden increase in the demand for money, but also in a sharp fall in the prices of securities, which greatly reduces their potential as collateral. When nobody wants to accept assets that have become illiquid as collateral anymore, the money market stops working.
Both the Fed and the ECB can do no more than extend their function of "lender of last resort" to what Mehrling calls "buyer of last resort". They have intervened in both the money and capital markets, buying up certain types of assets, whenever their price has fallen far below what they believed to be their true value. Thus central banks have become not only Banks of banks, but Agents of stockbrokers; they did something radically new: to use wartime finance to bail out private finance and to use national finance to bail out financial globalization. What future awaits us? According to Mehrling, as the global contraction persists, we may see financial de-globalization looming. Every debt restructuring blows like a head wind and in the face of the change in the relationship between private finance and the national state, landing in the port of economic recovery is very difficult.
