Transcript The crisis

THE BUSINESS CYCLE
Good news or bad news for the GDP?
recession
peak
expansion
upturn
depression
downturn
contraction
trough
downswing
recovery
slump
boom
The economy ...
... grows
...peaks
...contracts
...bottoms out
...recovers
...expands
...booms
..works at full capacity/at below its potential
MK, pp.114-115
The Business Cycle
Pg.1:
Pg.2:
Pg.3
general information (def. + stages)
internal causes of the cycle
external causes of the cycle
Notes on text (more detailed, pgs.2-3)
CAUSES
a) internal
e.g. interest rates up→more expensive loan
repayment→less money available→lower
consumption→lower output →lower
employment→even lower spending → …
b) external
(e.g. elections, natural disasters, “creative
destruction”, …)
Keynesianism & Monetarism
Make full sentences:
1. lead / market system / full employment
2. durable equilibrium/produce/high unemployment /
market forces /reduced income and investment
3. counteract the business cycle/ manage the demand/
governments/
4. excess savings / interest rates / cause / in the long
run / investment / fall / increase
5. dead / in the long run
6. neutral / money supply / constant / non-inflationary /
government / money /output & employment /no effect
7. governments / too late / fiscal & monetary measures
/ recession / foresee / take effect.
MK, pp.117-118
Keynesianism & Monetarism
Make full sentences:
1. lead / the market system / full employment (M)
2. durable equilibrium/produce/high unemployment /
market forces /reduced income and investment (K)
3. counteract the business cycle/ managing the
demand/ governments/ (K)
4. excess savings / interest rates / cause / in the long
run / investment / fall / increase (M)
5. dead / in the long run (K)
6. neutral / money supply / constant / non-inflationary /
government /money /output & employment /no
effect (M)
7. governments / too late / fiscal & monetary measures
/ recession / foresee / take effect. (M)
The Crisis
The Subprime Crisis
The Economist, 20 Sept 2008
“Ten short days saw the nationalisation, failure or rescue of what was once the
world’s biggest insurer, two of the world’s biggest investment banks, and two giants
of America’s mortgage markets”
“Regulation is necessary and much must now be done to improve the laws of
finance: better oversight, more transparency, supervision of giants, accounting that
values risk better, safer financial transactions (derivatives)”.
Source: The Economist, 20 Sept 2008 http://www.economist.com/node/12263158?story_id=12263158
What is the chronology of the
events below?
1. Poor borrowers go bankrupt, so houses are
returned to lenders.
2. Central banks help to prevent system collapse.
3. Poor borrowers can no longer repay their
loans.
4. Some lenders go bust as they cannot sell the
property, and some lenders sell loan
obligations to investors.
5. Poor borrowers buy houses with loans.
6. Because of low interest rates, it is easy to
borrow.
7. But after some time, interest rates go up.
(RB:p.80)
The Financial Crisis
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Mortgage lenders
Subprime borrowers
Hedge funds
Default (n.), to default on mortgage (v.)
To release liquidity
RB: p. 80
What is the chronology of the
events below?
Replace the red parts with the words from before:
1. Poor borrowers go bankrupt, so houses are returned
to lenders.
2. Central banks help to prevent system collapse.
3. Poor borrowers can no longer repay their loans.
4. Some financial institutions go bust as they cannot
sell the property, and some lenders sell loan
obligations to investors.
5. Poor borrowers buy houses with loans.
6. Because of low interest rates, it is easy to borrow.
7. But after some time, interest rates go up.
(RB:p.80)
http://www.businesspundit.com/sub-prime/page3.php
http://www.businesspundit.com/sub-prime/page3.php
OPTIONAL READING
Northern Rock:
A case study of a troubled bank
RB: p.59
optional reading
Do you know the meaning of the words
below?
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Shake-out
Credit squeeze
Run on a bank (bank run)
Solvency (being solvent)
Mortgage loan
Deposits
Emergency funding
Which of the previous words are defined
here?
• Government measures designed to limit the supply
of credit in the economy (e.g. by restricting bank
lending)…………..
• A loan to finance the purchase of real
estate………………
• The ability of a corporation to meet its long-term
fixed expenses ……………..
• the decline in the number of commercial banks
(bigger banks acquire weaker competitors who
verge with bankruptcy)………..
• Government measures designed to limit the supply
of credit in the economy (e.g. by restricting bank
lending) CREDIT SQUEEZE
• Loan to finance the purchase of real estate
MORTGAGE
• The ability of a corporation to meet its long-term
fixed expenses SOLVENCY
• The decline in the number of commercial banks
(bigger banks acquire weaker competitors who
verge with bankruptcy) SHAKE-OUT
Northern Rock - Basics
• What happened to Northern Rock?
• What exactly did the bank’s customers do
and why?
• Who helped and how?
Text 2
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Go bust
Securities (e.g. bonds, …)
Bank run
The Treasury
The Chancellor (of the Exchequer)
Subordinated debt
Piece of legislation
Bailout
In a transparent manner
Banking regulator
A banking crisis: the worst-case scenario
Put the following statements in the chronological order:
a. The regulators do not spot the trouble in time.
b. The bank goes bankrupt.
c. The government (the Treasury) steps in and guarantees 100 per
cent of the deposits, but repays only investors who made
unsecured loans to the bank, and not those who bought the
bonds issued by the bank.
d. The bank management borrows over their heads.
So, why did all this happen
to Northern Rock
(and many other players)?
More about the financial crisis
The subprime crisis and the credit crunch (MK, p.75)
http://vimeo.com/3261363 (optional material)
The outcome
• In 2007, Northern Rock received liquidity from the Bank
of England following problems in the credit markets
caused by the US subprime mortgage financial crisis.
• The bank was nationalised in February 2008 as a result
of two unsuccessful bids to take over the bank, neither
being able to fully commit to repayment of taxpayers'
money.
• As of 1 January 2012 Northern Rock has become part of
Virgin Money.
The subprime crisis and the credit crunch
MK, p.75, 76
Find definitions for the following:
subprime borrowers, securitization, MBS and
CDO, toxic debt, credit crunch
Answer the questions:
1. Why did banks buy MBS and CDOs?
2. What happened in the end?
3. What were the consequences of all this?
Joseph Stiglitz
• Nobel Prize in
Economic Sciences
2001
• Columbia University
Optional reading (RB: pp.81-84)
What did Stiglitz say in his text Capitalist Fools
(Vanity Fair, Jan, 2009)?
Give a brief explanation of the five mistakes
covered by the text in RB, pp:82-83, (1-2
sentences for each)