The current worldwide financial and economic crisis
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THE CURRENT WORLDWIDE FINANCIAL AND ECONOMIC CRISIS . MICHAEL D. INTRILIGATOR PROFESSOR OF ECONOMICS, POLITICAL SCIENCE, AND PUBLIC POLICY, UCLA AND SENIOR FELLOW THE MILKEN INSTITUTE. OVERVIEW 1. THE CURRENT CRISIS IN THE LIGHT OF HISTORICAL EXPERIENCE 2. SOME OF THE CAUSES OF THE CRISIS

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THE CURRENT WORLDWIDE FINANCIAL AND ECONOMIC CRISIS

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The current worldwide financial and economic crisis

THE CURRENT WORLDWIDE FINANCIAL AND ECONOMIC CRISIS

MICHAEL D. INTRILIGATOR

PROFESSOR OF ECONOMICS, POLITICAL SCIENCE, AND PUBLIC POLICY, UCLA

AND SENIOR FELLOW

THE MILKEN INSTITUTE


The current worldwide financial and economic crisis 1329930

OVERVIEW

1. THE CURRENT CRISIS IN THE LIGHT OF HISTORICAL EXPERIENCE

2. SOME OF THE CAUSES OF THE CRISIS

3. RECENT ACTIONS HAVE NOT HELPED

4. POLICIES TO DEAL WITH THE CRISIS


1 the current crisis in the light of historical experience

1. THE CURRENT CRISIS IN THE LIGHT OF HISTORICAL EXPERIENCE

• GLOBAL FINANCIAL SYSTEM AS A “HOUSE OF CARDS” THAT COLLAPSED, LEADING TO A “GREAT RECESSION” WITH DECLINES IN U.S., JAPAN, CHINA, EUROPE

• COLLAPSE WILL NOT CORRECT ITSELF QUICKLY, HAVING A “U” SHAPE, WITH A PROLONGED DOWN PERIOD, RATHER THAN A “V” SHAPE, AND TAKING PERHAPS 6-8 YEARS TO RECOVER

• ICELAND’S CURRENT BANKRUPTCY AS THE “CANARY IN THE COAL MINE” WITH POLITICAL EFFECTS

• JAPAN’S 1990’S “LOST DECADE” AFTER ITS REAL ESTATE AND EQUITY BUBBLE. POSSIBLY SIMILAR IMPACTS IN THE U.S. AND A WORLDWIDE “LOST DECADE”


2 causes of the crisis

2. CAUSES OF THE CRISIS

  • DEREGULATION OF FINANCIAL MARKETS IN 1999, LED BY PHIL AND WENDY GRAMM; REPEAL OF THE GLASS-STEAGALL ACT

    • ALAN GREENSPAN ADMITTED IN OCTOBER A FLAW IN HIS MODEL OF CORPORATE SELF-REGULATION

  • ASTRONOMICAL GROWTH OF DERIVATIVES, COLLATERALIZED DEBT OBLIGATIONS, AND CREDIT DEFAULT SWAPS (UNREGULATED INSURANCE AGAINST DEFAULT)

  • LAX REVIEWS BY CREDIT RATING AGENCIES


2 causes of the crisis continued

2. CAUSES OF THE CRISIS, CONTINUED

  • GROWTH OF ENORMOUS HEDGE FUNDS

  • ENORMOUS LEVERAGE RATIOS

  • THE FED IGNORED WARNINGS ON SUBPRIME MORTGAGES (FROM GOVERNOR NED GRAMLICH)

  • SECURITIZATION OF FINANCIAL INSTRUMENTS


2 causes of the crisis continued1

2. CAUSES OF THE CRISIS, CONTINUED

• PRESSURES FOR HIGHER AND HIGHER PROFITS

• PRESSURES ON THOSE NEGOTIATING MORTGAGES TO DELIVER MORE AND MORE OF THEM, THAT WERE THEN SECURITIZED, INCLUDING “NINJA” MORTGAGES

• THOSE IN FINANCIAL INSTITUTIONS AND GOVERNMENT AGENCIES NOT SUFFICIENTLY WELL TRAINED

• HERD MENTALITY AND GROUP THINK, LEADING TO CARRYING THINGS TO EXTREMES


2 causes of the crisis continued2

2. CAUSES OF THE CRISIS, CONTINUED

  • 
THE USE BY FINANCIAL FIRMS OF COMPUTER-DRIVEN RISK ASSESSMENT TOOLS; RISKS IN RISK MANAGEMENT BELIEVING IN “BIGGER AND BETTER” MODELS THAT WERE BEYOND UNDERSTANDING

  • VICIOUS CIRCLE OF LOSSES LEADING TO A FINANCIAL MELTDOWN, WITH THE MOST SEVERE RECESSION SINCE WWII, MUCH WORSE AND LONGER THAN THE 1974-75 AND 1980-82 RECESSIONS; POSSIBILITY OF DEBT DEFLATION WITH DEVASTATING RESULTS


3 recent actions have not helped

3. RECENT ACTIONS HAVE NOT HELPED

  • CURRENT RESCUE PLAN (TARP BAILOUT) OF $700 BILLION IS NOT WORKING. THE FIRST HALF RESULTED IN BONUSES, PARTIES, REMODELING OFFICES - EVERYTHING BUT ADDED LENDING - A “FLAW” IN THE GORDON BROWN - HENRY PAULSON MODEL OF BANK RECAPITALIZATION

    • LETTING LEHMAN FAIL IN SEPTEMBER EXACERBATED THE CRISIS

    • CONVERSION OF MORGAN STANLEY AND GOLDMAN SACHS TO COMMERCIAL BANKS MEANS THE END OF INVESTMENT BANKING


3 recent actions have not helped continued

3. RECENT ACTIONS HAVE NOT HELPED, CONTINUED

• CURRENTLY “EVERYTHING IS ON HOLD” WITH CREDIT MARKETS PARALYZED, LEADING TO A DOWNWARD SPIRAL; “IT’S THE END OF THE WORLD AS WE KNOW IT”

  • MAJOR CORPORATIONS AT THE BRINK OF FAILING WHILE HEDGE FUNDS AND PRIVATE EQUITY FUNDS ARE UNWINDING

  • PRESIDENT OBAMA’S ECONOMIC STIMULATION PLAN, H.R. 1, THE AMERICAN RECOVERY AND REINVESTMENT ACT (ARRA), WHILE DOING MANY USEFUL AND OVERDUE THINGS, WILL NOT STOP THE DOWNWARD SPIRAL DUE TO THE CREDIT CRUNCH


4 policies to address the crisis

4 POLICIES TO ADDRESS THE CRISIS

• REQUIRE GREATER TRANSPARENCY AND LIMITS ON LEVERAGE FOR BANKS AND OTHER FINANCIAL INSTITUTIONS

• RETHINK THE RECAPITALIZATION OF THE BANKS FOR THE REMAINDER OF TARP, NOT ONLY WITH LIMITS ON BONUSES AND EXECUTIVE COMPENSATION BUT ALSO REQUIRING SPECIFIC ACTIONS, INCLUDING NEW INVESTMENTS

• REQUIRE BANKS SEEKING FUNDING TO SUBMIT PROPOSALS FOR HOW THEY WOULD BE USED, WHERE THEY HAVE TO REVIEW THE PROPOSALS OF THE OTHERS


4 policies to address the crisis continued

4 POLICIES TO ADDRESS THE CRISIS - CONTINUED

  • CONSIDER PROVIDING GOVERNMENT GUARANTEES FOR A PORTION OF BANK LOANS, AS IN SMALL BUSINESS ADMINISTRATION GUARANTEES

  • IF BANKS DON’T START TO PROVIDE CREDIT USE CLOSER SUPERVISION BY THE FED, WITH THEIR RESTRUCTURING VIA RECEIVERSHIP OR NATIONALIZATION AS A LAST RESORT


4 policies to address the crisis continued1

4 POLICIES TO ADDRESS THE CRISIS - CONTINUED

  • INTERNATIONAL COOPERATION TO RETHINK INTERNATIONAL FINANCE (BRETTON WOODS II)

  • 
A NATIONAL HEALTH PROGRAM: MEDICARE EXPANSION, WHERE ULTIMATELY EVERYONE IS IN MEDICARE

  • 50 MANHATTAN PROJECTS TO DEVELOP INNOVATIVE APPROACHES TO ENERGY, TRANSPORTATION, ENVIRONMENT, RECOVERY FROM NATURAL DISASTERS AND TERRORIST ATTACKS, PANDEMICS, ETC.


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