Transcript Financial Crises: History, the Crisis of 2008/09 and the

Andrés Solimano
Prague
November, 2014
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A disruption of the normal functioning of the
financial system or circuit.
The normal process of credit expansion and
debt accumulation and debt servicing is
under stress or interrupted.
Banks and financial intermediaries expand
credit.
Households, firms and the government
increases their indebtedness.
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Debt accumulation by
(a) Household = expenditure – incomes
(b) Firms=outlays – revenues
© Government= fiscal spending – fiscal
revenues.
Capacity to pay related to growth.
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Debt to GDP ratio
Debt growth by new debt accumulation plus
interest rate (r).
GDP growth at the rate of growth of the
economy (g ).
If r> g debt to GDP ratio increases, if r<g the
ratio declines.
Asset prices go up above their “normal”
(historical) levels.
Too much debt is accumulated with respect to
the debt servicing capacity.
 Banks, households, firms and government
become vulnerable to an adverse shock.
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Financial crisis often are followed by a decline
in economic activity (GDP, sales, industrial
production), investment.
In the labor market we see a drop in
employment and a rise in unemployment.
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Early conceptualization: Irving Fisher´s 1933
theory of debt-deflation.
Hyman Minsky´s theory of endogenous
financial fragility. Three profiles of financing:
Hedging financing(cash flows greater than
debt servicing).
Speculative financing (cash flows may be
over or below
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debt servicing capacities.
Ponzi financing: cash flows below debt
servicing. New debt is used to pay old debt,
Explosive path leads to bankruptcy.
Charles Kindleberger´s application of Fisher
and Minsky ideas.
Theories of the financial accelerator.
Bernanke and others.
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Financial crisis under the gold
standard.1870-1913 .
Crisis of 1873 (Vienna, Berlin and Paris, tied
to war reparations and boom in real estate
and railways).
Ramifications to the USA (Coinage act) and
Russia.
Long depression (1873- 1879 (or 1896?)).
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The crisis of Baring bank in 1890 and
origin/effects from/to Argentina.
The crash of 1907, railway and land
speculation (collapse of stock exchange in
the US). It led to the creation of the Federal
Reserve (Central Bank) in 1913.
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The crash of the stock market in 1929.
Banking bankruptcies in the early 1930s
:USA, Europe.
Almost no international financial crises in the
1950s and 1960s (Bretton Woods period).
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The Latin American debt crisis of 1982-83.
The savings and loan crisis in the US in the
late 1980s.
The banking crisis in Nordic countries in the
early 1990s.
The Mexican crisis of 1994-95.
The East Asian crisis of 1997.
The Russian crisis of 1998
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The LTCM crisis of 1998 (USA).
The prickling of the IT bubble in the USA
(the dot.com crisis of 2000),
The Argentinean and Turkish crisis of 2001.
The great financial crisis of 2008-09.
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Low interest rates in the US since 2001.
From a bubble in IT stocks (dot.com
euphoria) to bubble in real estate.
Easy credit and relaxation of requirements for
clients .
Minsky and Kindleberger dynamics of asset
prices.
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Lack of effective financial regulation.
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Macroeconomic imbalances in US, UK, Spain.
Lack of macro discipline in the first world.
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Financial innovation untested and poorly
understood.
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Crisis started in the US and propagated to
Europe. High- income OECD with negative
growth in 2009.
Emerging economies and developing
countries with positive growth in 2009
(around 5 %).
Evolution of terms of trade, international
demand and capital flows will be critical.
High international reserves in developing
countries.
Varying macro-conditions at national level.
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Phase I: Incubation. Easy credit, debt and price bubble.
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Phase II. Stress: pessimist expectations and panic
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Phase III: Sale of assets, decline in asset prices and credit crunch.
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Phase IV: Crash, bankruptcies, insolvencies in the financial sector.
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Phase V: Decline in investment, output and employment
Phase I: easy credit and
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bubble formation
Easy supply
of credit
(mortgages)
High demand
for credit
(housing)
Bubble in
real estate
Bull housing market
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Phase III: Stress in the market and
prices decline
Excess supply of houses and office
space. Prices go down and interest
rates go-up.
Interest
rates
Prices
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Fase IV: Crash.
Sub-prime clients can not serve
their debts and banks cut credit.
Round of foreclosures. Worsening of
bank portfolios. Financial
Vulnerability.
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Initial drop in GDP in core economies
followed by GDP growth below trend.
Decline in investment.
Rise in unemployment.
Source: Geneva Report on the World Economy, 2014.
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The European periphery (Ireland, Portugal,
Spain, Greece) has suffered the most.
Cuts in GDP, investment, rise of
unemployment.
Unemployment in the European
Periphery
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The crisis affected little them for a while.
Now there is a deceleration underway.
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In advanced economies.
In emerging economies.
Adjustment and austerity was oriented to
reduce the debt to GDP ratios. Has it worked?
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Various hypothesis:
(a) Lack of aggregate demand (secular
stagnation?):
Cut in investment and consumption (effects
of inequality on wages and consumption,
excess capacity depresses investment).
Insufficient fiscal stimulus.
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(b) Slow down of innovation (supply side
effect).
Debt overhang.
Policy uncertainty (switch from stimulus to
fiscal austerity in 2010)
Political fractionalization (rise of nationalistic,
anti-foreigner parties) .
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A legitimacy crisis for global capitalism.
Massive socialization of losses after two
decades of privatization of gains.
Need to take financial markets very
seriously. The big risks of financial
deregulation.
Why (almost) everybody failed to anticipate
the crisis of 2008-09? What happened to
the IMF, regulators and Central Banks?
Role of misleading approaches, ideology
and interests.
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The record of free markets macroeconomics:
From the “great moderation” to the big
crash.
Sluggish recovery, stagnation or depression?
Where is the global economy heading?
Stagnant center and lower-growth periphery?
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Failure of BW institutions to impose
financial discipline to the first world before
the crisis.
Role of IMF, ECB and EU in austerity
programs.
Need to revise national and international
financial architecture.
More financial regulation is needed.
Other problems of the global economy:
high international inequality, global
warming, rising migration.