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105 4 Emerging Contours of Financial Regulation: Challenges and Dynamics rakesh mohan In 2008–09 the world experienced the most severe financial and economic crisis since the Great Depression. Although the crisis originated in the subprime mortgage market in the United States, it spread to Europe and later to the rest of the world. The speed of the contagion that spread across the world was perhaps unprecedented. What started off as a relatively limited crisis in the U.S. housing mortgage sector turned successively into a widespread banking crisis in the United States and Europe, the breakdown of both domestic and international financial markets, and then later into a full-blown global economic crisis. Interestingly , however, although the emerging market economies in Asia and Latin America also suffered severe economic impacts from the crisis, their financial sectors exhibited relative stability. No important financial institutions in these economies were affected in any significant fashion. So it really should be dubbed the North Atlantic financial crisis rather than a global financial crisis. The severity of the crisis can be gauged through a number of metrics. From an average annual growth rate of 4.1 percent between 2001 and 2008, world GDP growth fell to –0.8 percent in 2009 and was projected by the International The author gratefully acknowledges the assistance of Anand Sinha, Prashant Saran, P.R. Ravi Mohan, T. Gopinath, and Muneesh Kapur in the preparation of this chapter. The chapter has also benefited from the Group of Twenty Working Group 1 report on “Enhancing Sound Regulation and Strengthening Transparency.” 106 rakesh mohan Monetary Fund (IMF) to recover to 3.9 percent in 2010.1 That the world was taken by surprise by the developments in 2008 and 2009 is shown by the fact that as late as July 2008, the IMF expected world GDP to grow by 3.9 percent in 2009.2 The reversal in expectations was so sudden that exactly a year later the forecast had been reversed to –1.4 percent for 2009.3 Similarly, the growth forecast for 2010 was as low as 1.9 percent in April 2009; the speed of the recovery that took place in 2010 was also unexpected.4 Optimism regarding the world economy continued until mid-2008. In fact, global market capitalization fell by 53 percent between the end of October 2007 and the end of March 2009, and in April 2009 losses on U.S.-originated credit assets were estimated by the IMF to amount to $2.7 trillion. As economies have contracted, unemployment has increased to levels in excess of 10 percent in North America and Europe, and there is as yet little sign of recovery in employment . The decline in property prices has led to a severe reduction in household wealth. Global credit write-downs were estimated by the IMF at $2.8 trillion in the October 2009 Global Financial Stability Report.5 Of these only about $500 billion were outside the North Atlantic advanced economies. Almost all governments and central banks around the world were busy during 2008 and 2009 trying to contain the effects of the crisis through both fiscal and monetary policy measures, respectively. The fiscal effort, which has been largely successful in containing the economic effects of the crisis, has been massive. Fiscal expansion of the Group of Twenty (G20) countries, relative to their 2007 levels, was approximately 6 percent of their GDP in both 2009 and 2010; U.S. fiscal expansion has been much higher, at just under 10 percent of its GDP. In containing the emerging North Atlantic financial crash in 2008–09, the total support given to the financial sector in advanced economies was approximately $7 trillion, including capital injections into financial institutions by governments , the purchase of assets by treasuries, central bank liquidity injections, and other upfront government financing. Some of these expenditures will, of course, be recovered.6 So the cost of this crisis has been massive for the global economy, and its fiscal effects will be felt for some time to come. Just as the global nature of the crisis has been unprecedented, so has the global nature of the response, as exemplified by the G20’s commitment to coordinated action. Along with the coordinated fiscal and monetary policy actions, a comprehensive re-examination of the financial regulatory and supervisory framework is also 1. IMF (2010b). 2. IMF (2008). 3. IMF (2009a). 4. IMF (2010b). 5. IMF (2009b ). 6. IMF (2009d, 2010a). [3.135...

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