The U.S. sub-prime crise developed in the last few months as a dangerous syncope for the entire international financial system, recall for the rethinking of market functionality, revealing the international institutional weakness in financial system supervision on global scale. The mortgage volatility induced by the international dereglementation and derivates contemporary burst, correlated with a relaxed supervision framework, transformed progressively the credit market into a system “bubble”, making possible the distortion of real estates values toward those levels forced by creditors. Throughout a weakness chain, many financial institutions, determined by a savage competition on this sector, left away the prudence and borrowed money from different investors, guarantying the long terms transactions, with short time derivates from speculative short-term market, supplying the bubble. In this context, the paperwork is meant to recall for reinventing the risks models, so that the crises to be anticipated earlier than its development moment.globalization, financial crise, global economy, monetary system, international management

Popa, Catalin C.

English

Research Papers in Economics

FUNCTIONAL OVERVIEW OF FINANCIAL CRISES 
DEVELOPMENT AND PROPAGATION
 
 
 
Cătălin C. POPA, Lecturer, Ph.D. 
 
Naval Academy „Mircea cel Bătrân”, Constantza, Romania 
catalin_popa@anmb.ro 
 
Abstract 
The U.S. sub-prime crise developed in the last few months as a dangerous 
syncope for the entire international financial system, recall for the rethinking of 
market functionality, revealing the international institutional weakness in 
financial system supervision on global scale. The mortgage volatility induced by 
the international dereglementation and derivates contemporary burst, 
correlated with a relaxed supervision framework, transformed progressively the 
credit market into a system “bubble”, making possible the distortion of real 
estates values toward those levels forced by creditors. Throughout a weakness 
chain, many financial institutions, determined by a savage competition on this 
sector, left away the prudence and borrowed money from different investors, 
guarantying the long terms transactions, with short time derivates from 
speculative short-term market, supplying the bubble. In this context, the 
paperwork is meant to recall for reinventing the risks models, so that the crises 
to be anticipated earlier than its development moment.    
 
Keywords: globalization, financial crise, global economy, 
monetary system, international management 
 
  The study is centered on the liquidity risk, considered as far, the 
most important pillar of crises propagation chain, being in the same 
time the most facile element in determining the market pressure as an 
efficient early warning system. Credit risks, exchange rates risks or 
real values depreciation risks are connected to liquidity lacks,  
 the money need being the first moment for crise burst as the liquidity 
is the first step in market stabilization process. The hazardous 
behavior is practically determined by the creditor’s fear to loose the 
possibility for drawing back their investment at those sufficient levels 
to protect their values. 
The credit risks, exchange risks or value market risks are 
fundamental reasons conducting toward liquidity risks, being as well 
the main transmission channels in case of a those crises. The market 
falling and market bubbles start to develop released by credit, 
exchange rates or real values deformation, into a liquidity crise as an 
effect for market equilibrium tendencies. In fact, starting from this 
point of view and describing this situation as a model, the liquidity 
running provokes the market shocks, feed by the speculation behavior 
for investment protection, conducting finally toward market values 
correction.  
Aglietta M. has been observed that „... the market sensibility is 
perennial” at least such time as the financial transactions volume 
exceeds a hundred times the real economy transactions volume [1]. If 
the transaction’s maturity, base on speculation, is shorted more than 
the market can support in terms of liquidity, especially in case of real 
values reappraisal, with disconnecting the long term perspective to 
short perspective, the market will fall facing with an avalanche of 
closing the derivates options. The tendency of short or long position 
closures on financial markets will require huge volumes of liquidity 
throughout a short time interval. Transmitted as a contagious disease, 
the appearance of a system crise will be inevitable and the market will 
ask for and “ultimate borrower” [1].   
Starting from the idea that nobody is able to manage separately a 
market behavior, as sub-prime crise recently underlined, the 
international financial system is a must to improve its institutional 
possibilities for a immediate “financial pull”, based on central banks 
system coordinated by international financial organizations (as 
International Monetary Fund or Bank for International Settlements) 
[6].  
In this perspective, is needed first to redefine, on a theoretical 
level, the mechanism of crise appearance and development. In figure 
1 it have been concentrated representatively the main components of a 
systemic crise from global perspective, putting together the national, regional and international components, under the governance of 
international financial institutional architecture. 
 
 
 
Credit risks 
Exchange risks 
Value risks 
Financial markets 
 
LIQUIDITIES 
 
 
 
FUNCTIONAL CRISES 
 
 
SYSTEM CRISES  
Indebt Crises 
Monetary Crises 
Market-values Crises 
Global informational system 
Macroeconomic evolution 
 
 
 
International 
financial 
institutions 
 
 
International 
Monetary Funds
 
 
Bank for 
International   
Settlements 
 
 
Central Bank 
System 
 
L
i
q
u
i
d
i
t
y
 
r
i
s
k
s
 
A
B
D
C
Early 
warning 
systems 
 
Financial-
banking 
system 
regulation 
and 
supervision 
 
Capital 
structure 
arbitrage 
Figure 1: The financial crisis functional model 
 
 
Facing with this conceptual global risks mechanism, the 
international financial institutions have only two strategies. First to 
improve the supervision policies and instruments for a proper 
detection of those risks capable to evolve into liquidity syncope, and 
second to conduct the global market interventions, before or in time of 
a crise happening. The crise acting behavior (in terms of prevention, 
crise governance and finally decrement of negative effects), is 
explained by an ensemble of an international policies and strategies, 
based on four market priority vectors, as follows: global information 
symmetrical system (A), supervision policies (B), intervention 
mechanism (C) and global macro economical supervision and 
adjusting mechanism (D). 
The preventive attitude should be based more on global criteria 
for warning against speculative behavior deviations on markets in 
relation with reasonable values limits for titles or mortgages. If we 
understand the financial world as Soros G. presents in his last work (“The New Paradigm of Financial Markets”), being a reflexive sum of 
speculative behaviors, then the preventive attitude should combine the 
supervision with active governance based on a Central Bank System 
action, unfortunately inexistent as a coherent structure for now.  
The prevention should take as main pillar the supervision of 
financial system policy in terms of Basel II Accord, but in a different 
perspective. The capital requirements should be harmonized with 
traditional values in new risk limits, without any chance for hiding the 
market bubbles in appraisal. Derivates should be interdicted in 
guarantying credit processes and the specialized option market should 
be separated from banking system action. In fact the main reason 
itself for present financial crise is the miss-understanding of the 
separation between real economy and financial markets in terms of 
speculation and investment ration of financial instruments.  
The bad mix of long term titles designed for investment’s credit 
with speculative derivates meant to protect in chain the same values, 
conducts inevitable toward an over appraising of guarantees brought 
in business and finally toward a functional crise of indebts. On the 
edge between real economy, hungered for investments, and the 
financial system, with a huge appetite for speculation, the information 
asymmetry and macro-economical positive statistics can provoke a 
market “euphoria”, corrected finally in case of a liquidity syncope, 
through a general price falling as a functional crise. The generalized 
bad loans collection process over the international banking system 
(the last element of the weakness chain), together with the liquidity 
running will conduct toward a system crise. The banking system 
fundamental role in a moment of crise is to guarantee the loans and 
the deposits with long term values, liquidities or mortgages, not on the 
speculative bases as today does. A functional crise is able to transform 
itself into a system crise just starting from banking system weakness 
as the main transmission agent of a contagious need for liquidity. 
The immediate solution for global financial system problems is 
to reinvent the solid credit base through banking system responsibility 
in according their capital to fundamental values with no interference 
with derivates market or generally with financial short term market, 
sensitive to speculation. The Basel II Accord should approach more 
profound the capital structure from the isolate perspective of banking 
system itself as loan and deposits cautioner not like a speculator of investors’ money. The return to the financial basis theory about the 
primordial role of banking system is the most important pace toward 
simplicity as a requirement into a global world.  
Between real economy and speculative dimension of financial 
markets exists, like a connection interface, the banking system 
governed by central banks. So first, for improving the crise prevention 
and response, we need a coherent trilogy, separately identified trough 
three distinct level of market action, market governance and policy 
framework, as follows: <“International Banking System” ↔ “Central 
Bank System” ↔ “International Financial Institutions”>. These three 
systems working together could assure the stability of international 
financial system better than are doing for now on global level. In this 
perspective the operational actions could be attributed to the 
International Banking System (“healthy” returned to the primary 
value of credit), the governing policy should be assigned to a possible 
Central Bank System, the entire mechanism being harmonized from 
political point of view by the international institutions architecture as 
a cautioner responsible for global equilibrium. 
 
References 
[1]   Aglietta M., “The International Monetary Fund and the International 
Financial Architecture”, C.E.P.I.I. Paper Work No. 08, 2000, pp. 56-81. 
[2]   Aviram A., “Regulation by Networks”, Chicago Working Paper Series, 
2003, pp.67-73. 
[3]   Levine R., “Finance and Growth”, N.B.E.R. Working Paper, 2004,  
pp.11-37. 
[4]   Merton R., Bodie  Z., “The Design of Financial System”, I.M.F. Working 
Paper, 2005, pp.10-45. 
[5]   Popescu I. [et al.], “Globalization. Myth and Reality”, Economica 
Publishing House, Bucharest, 2004, pp.132-164. 
[6]   Stiglitz J., “Making Globalization Work”, Penguin Publishing House, 
2006, pp.34-38. 
[7]   Teunissen  J., “The Management of Global Financial Markets”, 
FONDAD, Hague, 2000, pp.31-43. 

Functional overview of financial crises development and propagation

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