Transcript The Global Financial Crisis

The Global Financial
Crisis of 2008
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“The global pool of money”

Subprime crisis  housing bust  credit
crunch  global financial crisis  Great
Recession
• ¼ of residential mortgages “underwater”
(w/negative equity)
• “real” unemployment is about 17% (counting
discouraged and underemployed workers)
• cuts to public spending (social services) at all
levels
• And now: “foreclosure crisis”
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Role reversal?

In the lead-up to the 2008 global
financial crisis, the “hot money” is
pouring into the US, fueling a
“speculative real estate boom” like
the ones seen in East Asia in the late
90s
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History of US financial regulation

1940s-1970s: Regulatory Expansion

1980s-present: Deregulation

circa 2011?
• uncertainty
• crisis
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Key events in US financial regulation

1940s-1970s - Regulatory Expansion: highly regulated financial
institutions, high capital requirements, capital controls, etc., took us out of
historical boom-bust cycles
• Glass-Steagall Act (1933) mandated a separation between commercial
banking (handling deposits and lending) and investment banking (buying/selling
securities, underwriting, etc.)

1980s-present - Deregulation: placing faith in free markets, regulation
was loosened, regulatory agencies downsized, increasingly leveraged
banks, growth of derivatives, high-frequency trading – highly volatile
•
Sparked by the Reagan revolution, deregulation continued under Democratic and
Republican administrations alike
• Gramm-Leach-Bilely Act (1999): aka the Financial Services Modernization
Act, tore down Glass-Steagall's wall separating commercial and investment
banking

2010: Dodd-Frank Wall Street Reform & Consumer Protection Act
•
•
Critics charge the bill is weak, and many provisions won’t take effect for years
Bill does not fundamentally address incentive structures that promote risk taking
or Too Big To Fail (TBTF) -- systemic risk
 TARP made big banks bigger
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Arguments for separating
commercial & investment banking



Conflicts of interest characterize the granting of credit
(lending) and the use of credit (investing) by the same
entity
Depository institutions possess enormous financial power,
by virtue of their control of other people’s money (O-P-M),
must be limited to ensure soundness and competition in the
market for funds (loans or investments)
Securities activities can be risky, leading to enormous
losses, which could threaten the integrity of deposits
• In turn, the Government insures deposits and could be
required to pay large sums if depository institutions were to
collapse as the result of securities losses

Depository institutions are supposed to be managed to limit
risk, so managers may not be conditioned to operate
prudently in more speculative securities businesses
(http://digital.library.unt.edu/govdocs/crs/permalink/meta-crs-9065:1)
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“Why We Have to Change
Capitalism”
Joseph Stiglitz, Excerpted from
Freefall: Free Markets and the
Sinking of the Global Economy,
2010
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The Great Recession that began in
America in 2008 soon turned global
Millions of Americans lost their
homes & jobs
 Many more saw their retirement and
education investments dwindle in
value
 Soon tens of millions lost their jobs
worldwide

• 20m in China alone
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Economic bubbles

economic bubble: buying and selling in
high volumes in assets with inflated values
(i.e., at prices far in excess of intrinsic
values). Sometimes called speculative
bubbles, they are typically the result of a
"bandwagon effect," where investors,
seeing an upward trend in prices, quickly
enter the market; typically, bubbles are
followed by even faster sell-offs once
prices decline.
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Boom-bust cycle


Boom-bust cycle: a pattern of performance over
time in an economy or an industry that alternates
between extremes of rapid growth (booms) and
extremes of slow growth or decline (busts), as
opposed to sustained steady growth, extreme
form of business cycle
Examples of "Booms & Busts":
•
•
•
•
•
Holland's Tulip mania in the 1630s
California Gold Rush of the late 1840s
Roaring Twenties that led to Wall Street Crash of 1929
Dot-com bubble in the late 1990s
Subprime lending boom in the 1990s and early 2000s,
followed by the Subprime Mortgage Crisis of 2006 and
beyond
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Housing bubbles

In late stages, characterized by:
• rapid increases in valuations of real property until
unsustainable levels are reached (relative to incomes,
price-to-rent ratios, and other indicators of affordability)
• reduction in price levels
• falling home prices put many owners "underwater," in a
position of negative equity (a mortgage debt higher than
the value of the property)

US Housing Bubble:
• At national level in the US, housing prices peaked in
early 2005, and started to decline in 2006
• Underlying causes are complex; factors include
historically low interest rates, lax lending standards
(including predatory lending), and a speculative fever
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Current crisis has uncovered deep flaws in
capitalist system, esp. American-style capitalism

A close look at US economy shows
there are deep problems:
• Even those in middle class have seen
incomes stagnate for at least a decade
• Increasing inequality
• Declining social mobility
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Rugged individualism and market fundamentalism
has undermined community and trust
Even in a market economy, trust is
the grease that makes society
function
 Big lesson of the crisis is that our
complex financial system still
depends on trust – when trust broke
down, financial system froze

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Excessive risk-taking in the
financial sector caused the crisis

The way to curtail it is reinstitute
regulations and change incentive
structures that reward excessive
risk-taking
• reinstitute Glass-Steagall
(some version of it)
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Foreclosure Fraud Chains
From rortybomb.wordpress.com, 10/11/2010
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