The food and financial crises and complex derivatives: a tale of high stakes innovation and diversification.

Abstract

AbstractThe objective of this chapter is to demonstrate that there is a strong link between the financial crisis and the food price crisis of 2007-2008, and furthermore, that the financial crisis began in earnest with the housing market and moved to commodity markets as financial agents began in 2005-2007 to increasingly diversify away from complex credit default swaps and collaterized debt obligations into commodities, then believed to be more secure and more liquid. This chapter is organized as follows. It first describes the financial market sentiment and activity in the run-up to the crisis, which together formed the 'perfect storm' that precipitated the food crisis and impending financial crisis. These include rapid financial innovation, high risk tolerance by the financial sector demonstrated primarily through mortgage financing activity, a weak dollar, and domestic U.S. policies on ethanol subsidies. The next section reviews the events leading up to the food and financial crisis to establish the links between the two. Following this, the markets for agricultural commodities in Africa are examined to see how these have evolved over the past decade and to observe Africa's growing links to financial markets. Finally, this chapter discusses regulatory progress made since the crisis and suggests ways to ensure that the emerging post-crisis financial regulatory framework and architecture are comprehensive, that they support the development of innovative financial products and are consistent with financial market development in Africa and other developing countries.