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The Small Business Administration (SBA) recently commissioned the Urban Institute (UI) to evaluate four programs, including the 7(a) Loan Guaranty Program, the Certified Development Company (CDC) 504 Loan Program, the Small Business Investment Company (SBIC) Debentures Program, and the MicroLoan Program. This effort was intended to help SBA assess past performance of the designated programs, as well as to test methodologies that can assist the agency in setting meaningful goals/targets as benchmarks for future accomplishments.
The sub-prime crisis emerged in the United States in mid-2007 and spilled over to Europe and other economies. From mid-2007 to mid-2008, the spillovers were relatively modest. The situation began to change in mid-2008. Then, following the bankruptcy of Lehman Brothers in mid September 2008, developments took a dramatic turn leading to a global financial crisis. During the crisis, the US dollar has seen some remarkable swings against major currencies. For example, from September 2007 to March 2008, it depreciated about 16% against the euro and yen, while between March and September 2008, it gained sharply (22%) against the euro. On the other hand, the dollar depreciated against the yen about 21% from August to December 2008, in particular after the Lehman’s default (see Figure 2 below). During this crisis, banks reportedly faced severe liquidity problems. US dollar funding shortages put intense pressure on the balance sheet capacity of the banking sector due to financial sector deleveraging. In response central banks around the world took unprecedented policy measures to supply funds to the banks (see McGuire and von Peter, 2009).
The purpose of this paper is to investigate any link between the market wide liquidity risk caused by the deleveraging process and exchange rate movements during the crisis. Adrian and Shin (2008) document that aggregate liquidity can be understood as the rate of growth of the aggregate financial sector balance sheet. When asset prices increase, financial intermediaries’ balance sheets generally become stronger, and, without adjusting asset holdings, their leverage declines. The financial intermediaries then hold surplus capital which they use to expand their balance sheets. On the liability side, they take on more short term debt. On the asset side, they search for potential borrowers. Aggregate liquidity is intimately tied to how hard the financial intermediaries search for borrowers, including through the interbank market. Conversely, when asset prices decline during a financial crisis, the financial intermediaries’ balance sheets contract and are thus reluctant to lend. Aggregate liquidity then declines.
Few issues in economics have experienced such a grandiose revival as the role of institutions in economic development. The institutional tradition may be traced back to the writings of Thorstein Veblen in the United States at the end of the nineteenth century and to the German Historical School represented by authors such as Schmoller.
The role of institutions was also recognised in the early writings of development economists (Hirschman, 1970). However, it took North’s (1990) formulation for the role of transaction costs, imperfect information and a variety of resulting sociocultural constraints to be fully integrated into the analytical framework of mainstream economics.
