Transcript M09a_FinancialCrisis

Financial Crisis
(addendum)
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1989-91 Savings and Loan Crisis
(the S&L Crisis)
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Deposit insurance creates moral hazard
Relaxed regulation permitted riskier investments
S&L in the U.S. speculated on real-estate loans
Liabilities were savings deposits
Property value bust led 1,043 financial institutions to fail
Total cost of S&L crisis was $153 billion (cost to tax
payer $124 billion); 2.7 percent of GDP
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1992 British Currency Crisis
(Black Wednesday)
• Great Britain joined the European Exchange Rate Mechanism
(ERM), which pegged its currency to the DeutschMark
• Objective was to maintain credibility relative to the DeutschMark
• Germany raised interest rates out of fear of inflation due to German
reunification (1-1 conversion)
• Great Britain was in a recession
• Speculative attack led to large loss of reserves
• Great Britain withdrew from ERM
• Estimated cost of £3.3 billion
• George Soros made over $1 billion by selling Sterling short
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1994 Economic Crisis in Mexico
(Mexican Peso Crisis)
• Low credibility due to hyperinflation from 1985-1993
• Fixed exchange rate to the U.S. Dollar
• Too much stimulation of the economy during 1994
election leading to high spending and deficits
• Speculative attack led to loss of reserves, which were
insufficient to maintain the value of the peso
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1997 Asian Financial Crisis
• Crony capitalism unsound banking led to investments
whose rate of return began to fall
• Fixed exchange rate to the U.S. Dollar
• Banks borrowed in dollars but lent in local currency,
making them susceptible to a currency crisis
• Speculative attack and “bank run” led to loss of reserves
• Dramatic rise in problem loans
• Governments became burdened with bailout expenses
• IMF engineered bailouts tied to a Structural Adjustment
Package requiring reduced govt spending and deficits,
allowing banks to fail, and higher interest rates
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1998 Russian Financial Crisis
(the Ruble Crisis)
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Fixed exchange rate
Chronic fiscal deficit
Declining GDP/productivity; low oil prices
“Bank Run” to dump Ruble led to large loss of
international reserves
• Russia
– Devalued Ruble
– Defaulted on domestic debt
– Moratorium on payments on foreign debt
• Quick recovery due to surge in oil prices
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Value of Russian Rubble
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2001 Argentine Financial Crisis
• Fixed exchange rate to maintain credibility and low
inflation following a period of hyperinflation
• Growing government debt
• GDP began to decline in 1999 (by 4%)
• Loss of confidence and capital flight led to a rise in
interest payments that worsened the fiscal situation
• Domestic run on banks to convert pesos to dollars,
leading eventually to conversion of all dollar accounts to
peso accounts
• IMF provided loans to allow an injection of dollars
• Fixed exchange rate abandoned in Jan 2002
• Led to very severe recession
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2007-08 Global Financial Crisis
• Excessive leverage by financial institutions
• Maturity mismatch and excessive dependence of real
estate
• Credit rating mistakes permitted risky mortgage-related
investments
• Collapse of real estate led to classic “bank run” that dried
up funding by non-bank financial institutions
• Shortage of liquidity
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2010-? European Sovereign Debt Crisis
• Low interest rates due to membership in EU
• Large fiscal deficits and consequent large debt/gdp levels
worldwide, but especially in Portugal, Italy, Greece, and
Spain
• Stagnant GDP growth and weak government response
• Rising interest payments on sovereign debt to reflect
default risk
• Lack of independent monetary policy to stimulate the
economy or devalue the debt
• Reluctance by EU to bailout without significant reforms
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