For decades, cross-border capital flows—including lend-ing, foreign direct investment flows, and purchases of equities and bonds—advanced relentlessly, reflecting the increasing integration of national capital markets into one single massive global system. Cross-border capital flows surged from $0.5 trillion in 1980 to a peak of $11.8 trillion in 2007; then they collapsed. By 2014, cross-border capital flows were around 66 percent below their former peak. The global capital market, it seemed, was in retreat.To understand why we have to go back to 2008 when a major crisis swept through the global capital market that very nearly froze the financial pipes that lubricate the wheels of the global economy. Financial institutions and corporations around the world routinely lend and borrow trillions of dollars between themselves. Most banks and corporations issue unsecured notes known as commercial paper with a fixed maturity of between 1 and 270 days. This is a way for those firms to get access to cash to meet short-term obligations, such as meeting payroll and paying suppliers. Because the notes are unsecured, and not backed by any specific assets, only banks and corporations with excellent credit ratings are able to sell their commercial paper at a reasonable price. This price is set with reference to the London Interbank Offered Rate (LIBOR). The LIBOR is the rate at which banks lend to each other. In normal times, the LIBOR is very close to the rate charged by national central banks, such as the U.S. Federal Reserve for the dollar.Early in 2008 banks in several countries had started to run into trouble as it became clear that the value of the mortgage-backed securities that they held was collapsing. This was due to a fall in housing prices, and rising default rates on mortgages, most notably in the United States and Great Britain, where lenders had written increasingly risky mortgages over the preceding few years. These mortgages were bundled into securities and then sold to other financial institutions. Also, many institutions held complex derivatives, the value of which was tied to the underlying value of mortgage-backed securities. Now, these institutions were facing large write-offs on their portfolios of mortgage-backed securities and the associated derivatives. One of these institutions, Lehman Brothers, had taken aggressive positions in the market for mortgage-backed securities. In September 2008, the firm collapsed into bankruptcy after the U.S. government decided not to step in and save the company.The bankruptcy of Lehman sent shock waves through the global financial markets. In effect, the U.S. government had stated it was prepared to let large financial institutions fail. Immediately, banks reduced their short-term loans. They did this for two reasons. First, they felt a need to hoard cash because they no longer knew the value of the mortgage-backed securities they held on their own balance sheets. Second, they were afraid to lend to other banks because those banks might fail and they might not get their money back.As a result, the LIBOR quickly spiked. The dollar rate, for example, had been 0.2 percent above the rate on three-month U.S. Treasury bills in 2007, which is a normal spread. However, the spread increased to 3.3 per-cent by late 2008, raising the cost of short-term borrow-ing some 16-fold. Many corporations found that they could not raise capital at a reasonable price. Money market funds, which in normal times are large buyers of commercial paper, fled to ultra-safe assets, such as U.S. Treasury bills. This pushed the yield on three-month Treasury bills down to historic lows, and also led to a sharp rise in the value of the U.S. dollar. In essence, the financial plumbing of the global economy was freezing up. If nothing was done about it, many firms would be unable to borrow to service their short-term financing needs. They would rapidly become insolvent, and a wave of bankruptcies could sweep around the globe, plunging the world into a serious recession, or even a depression.At this point, several national governments stepped into the breach. The U.S. Federal Reserve entered the commercial paper market, setting up a fund to purchase commercial paper at rates close to the rates for U.S. Treasury bills. Central banks in Japan, Great Britain, and the European Union took similar action. Once participants in the global capital markets saw that national governments were willing to enter the commercial paper market, they too started to ease their lending restrictions, and the LIBOR started to fall again. The U.S. government established the Troubled Asset Relief Program (TARP), allowing the U.S. Treasury to purchase or insure up to $700 billion in “troubled assets.” Under TARP, the government began to inject capital into troubled banks by purchasing assets from them that were difficult to value, such as mortgage-backed securities. This signaled there would be no more bankruptcies such as Lehman’s. This too helped unfreeze the market for commercial paper. A major crisis had been averted, but only just. Although the $700 billion price tag for TARP stunned people, most of the money lent to banks under TARP was quickly paid back with interest, and by late 2012, estimates suggest that the total cost to the taxpayer would be close to $24 billion.Five years after the crisis hit, the global capital market had still not fully recovered from its 2007 peak. Does this signal a retreat from the globalization of capital or merely a reset? Most observers believe the latter is the case. Since 2008, the world economy has grown slowly, and economic troubles persist in many regions, particularly Europe, where several national governments are burdened with high levels of sovereign debt that limits their ability to deal with persistently slow growth and high unemployment. Notwithstanding this, the world economy continues to become more integrated, propelled by stronger growth in some developing nations, and as this process unfolds, global capital markets will inevitably start to expand again to support cross-border trade in goods and services, as well as cross-border investments.

What actions do you think a multinational firm can take to limit the impact of future crises in the global financial system on the ability of the enterprise to raise capital to pay its short-term bills and fund long-term investments? Please be sure to consider both its global effect and its the effect upon cross-border lending.

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For decades cross-border capital flows—including lend-ing foreign direct investment flows and purchases of equities


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