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In January 1998, the British weekly The Economist called the British bank Lloyds a “money machine”. Such an outcome was far from inevitable for a bank that had been one of the hardest hit victims of the 1982 sovereign debt crisis, when most developing countries found themselves unable to repay debts accumulated over the course of the 1970s. Having overextended itself in the developing world, it took Lloyds more than a decade to return to profitability. This result was the consequence of a complete transformation of the bank’s business and management model. Branches and international loans were sidelined, as was the investment banking business, deciding to focus its activities on domestic banking. The article analyses the reasons behind the transformation of Lloyds Bank from a national bank to an international power in the 1970s and, therefore, the reverse process between the 1980s and 1990s following the sovereign debt crisis. Thanks to the examination of archival documents recently opened for consultation, the article sheds new light on various issues analysed from banking and business history, in particular on how risk is calculated, how innovative decisions are made in a context of crisis and on the role of managers in shaping and changing the culture of these institutions.

This paper provides an introduction to the special issue on international lending of last resort. Starting from debates about rescue operations and unconventional policies of major central banks in the contexts of the Global Financial Crisis and the European Debt Crisis, it draws attention to recurring controversies about trade-offs between averting critical contagion in financial markets and avoiding moral hazard. The need for international lending of last resort in strongly interconnected financial systems is more than ever evident, but there is no clear consensus on how to manage it. The contributions to this special issue put relevant issues in historical and theoretical perspectives.

The author argues that the idea, that the Bank of England accepted Walter Bagehot's recommendations from around the 1870s onwards and adopted the role of lender of last resort for the British financial markets, is a misconception. The published balance sheets give this impression, but a closer analysis of the balance sheet shows that the Bank of England never lost sight of the profit motive and had tied its own hands through the composition of its asset portfolio in order to be able to intervene effectively in the case of crisis. Even the only serious threat to financial market stability in the period under review, the Baring crisis of 1890, could only be mastered thanks to a broad rescue operation, coordinated solely by the Bank of England. This experience obviously did not contribute to a lasting change in the orientation of the Bank’s business policy until the First World War.

When the Great Depression struck the United States, O.M.W. Sprague was America’s foremost expert on financial crises. His History of Crises under the National Banking System is a frequently cited classic. Had he diagnosed a banking panic and called for an aggressive response by the Federal Reserve, it might have made a difference; but he did neither. Sprague’s misdiagnosis had, I argue, two causes. First, the crisis lacked the symptoms of a panic, such as high interest rates in the New York money market, which Sprague had identified from his studies of previous crises. Second, Sprague’s macro-economic ideas led him to conclude that increasing the stock of money would be of little help once a depression was underway. Sprague’s main concern was that abandoning the gold standard would intensify the crisis, a concern that led him to resign his position as advisor to the U.S. Treasury to protest Roosevelt’s gold policy.

We identify two approaches to financial crises in the history of political economy, namely, the exogenous approach whereby financial crises are sudden events, and the endogenous approach whereby they arise from a long process. In focusing on the endogenous approach, we study the contributions by Thomas Tooke, Ralph Hawtrey, Hyman Minsky and Charles Kindleberger to the lender-of-last-resort theory, especially in international contexts, under the gold standard and the dollar system. The function of the lender of last resort broadens institutionally (depending on the type of securities and on the institutions issuing or holding them) and internationally (depending on jurisdiction and on the type of institutions ultimately requiring international liquidity).

The functioning of multi-nation monetary unions with several central banks is conditioned by many factors and considerations, such as the capacity to deal with crises, the political will and operational skill to foster financial integration and to develop a mix of rules and discretion in the cooperation between the central banks. The Scandinavian monetary union (SMU) between 1873 and 1931 is a case in point for illustrating the importance of these factors and considerations. We examine the policies implemented in the Scandinavian countries to deal with asymmetries of payments flows and with financial crises at three levels: in an account of major crises that required lending of last resort, in a study of the clearing and settlement mechanism established in the union, and in a survey of contemporary economists’ views on lending of last resort and cooperation in the SMU.

CDO tranche spreads (and prices of related portfolio-credit derivatives) depend on the market’s perception of the future loss distribution of the underlying credit portfolio. Applying Sklar’s seminal decomposition to the distribution of the vector of default times, the portfolio-loss distribution derived thereof is specified through individual default probabilities and the dependence among obligors’ default times. Moreover, the loss severity, specified via obligors’ recovery rates, is an additional determinant. Several (specifically univariate) credit derivatives are primarily driven by individual default probabilities, allowing investments in (or hedging against) default risk. However, there is no derivative that allows separately trading (or hedging) default correlations; all products exposed to correlation risk are contemporaneously also exposed to default risk. Moreover, the abstract notion of dependence among the names in a credit portfolio is not directly observable from traded assets. Inverting the classical Vasicek/Gauss copula model for the correlation parameter allows constructing time series of implied (compound and base) correlations. Based on such time series, it is possible to identify observable variables that describe implied correlations in terms of a regression model. This provides an economic model of the time evolution of the market’s view of the dependence structure. Different regression models are developed and investigated for the European CDO market. Applications and extensions to other markets are discussed. [ABSTRACT FROM AUTHOR]

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