slide1 n.
Download
Skip this Video
Loading SlideShow in 5 Seconds..
Financial Crises, Financial Frictions, and Lost Decades PowerPoint Presentation
Download Presentation
Financial Crises, Financial Frictions, and Lost Decades

Loading in 2 Seconds...

play fullscreen
1 / 30

Financial Crises, Financial Frictions, and Lost Decades - PowerPoint PPT Presentation


  • 137 Views
  • Uploaded on

Financial Crises, Financial Frictions, and Lost Decades. The Great Depression, 1929 – 1939 Emerging Market Crises 1980s Third World Debt Crisis 1994-5 Tequila Crisis 1997-8 East Asia Financial Crisis The Great Recession, 2007 – . Financial Friction

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'Financial Crises, Financial Frictions, and Lost Decades' - ina


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
slide1

Financial Crises, Financial Frictions, and Lost Decades

  • The Great Depression, 1929 – 1939
  • Emerging Market Crises
    • 1980s Third World Debt Crisis
    • 1994-5 Tequila Crisis
    • 1997-8 East Asia Financial Crisis
  • The Great Recession, 2007 –
slide2

Financial Friction

Combating adverse selection and moral hazard

Screening/Monitoring

:

:

Cost of Credit Intermediation

Reduced frictions via:

Collateral

Net Worth (=$Assets - $Liabilities)

Net Worth – – The Foundation of Credit

stylized first world financial crises
Stylized First World Financial Crises
  • Stage One
  • Mismanagement of financial liberalization and innovations
  • Asset price boom & bust
  • Spikes in interest rates
  • Increase in uncertainty

Stage two: Banking Crisis

Stage three: Debt Deflation

factors causing financial crises
Factors Causing Financial Crises

Asset Values Drop: Net Worth Down

Stock market decline  Decreases net worth of corporations.

Unanticipated deflation  Debt burdens up/net worth down

Unanticipated depreciation  $debts up/net worth down

Asset write-downs (bad debts)  Net worth down

Deterioration in Financial Institutions’ Balance Sheets

Capital Ratios Down  Decline in lending.

Interest Rates Rise

Worsens adverse selection (who would pay the high rates?)

Increases business needs for external funds

 worsens adverse selection and moral hazard problems.

Government Fiscal Imbalances

Fear default of government debt Capital flight…Currency crisis

Banking Crises

Loss of information production / disintermediation.

Increases in UncertaintyDecline in lending.

slide6

Crises (and Threatened Crises) We Have Known

  • The L o n g Depression, 1873 – 1896
  • The Great Depression, 1929 – 1939
  • Mexican Default, 1982
  • Continental Illinois, 1984…Oil patch loans…TBTF
  • Third World Debt Crisis, 1980s  Lost Decade
  • Savings & Loan Debacle, 1986 – 1990
  • Black Monday, October 19, 1987
  • Tequila Crisis, 1994 – 1995
  • East Asia Financial Crisis, 1997 - 1998
  • Long Term Capital Management, 1998
  • dot.com bust, 2000
  • 911, 2001
  • Subprime-triggered crisis – Run on shadow banks
  •  The Great Recession, 2007 –
slide7

The Great Depression: Mother of all Crises

Stock Market Crash  Spending cutback

Friedman & Schwartz:

Great Contraction

Bank Panic  Monetary Contraction

Bank Failures  Reduced Lending

Bernanke:

Credit Channel

Declining Net Worth  Reduced Lending

Price Deflation/Deflationary Expectations  Debt Deflation

slide8

Onset of the Depression:

Persistent Deflation…Persistent Job Loss

Manufacturing Employment

$/pound

DJIA

villain gold
Villain Gold
  • Dysfunctional interwar gold-exchange standard

Deficit/surplus country asymmetry World Msdown

US and France sterilized gold inflows

Deficit countries forced to contract Ms

Lack of central bank cooperation

Britain weak/US clueless/France irresponsible

  • Dysfunctional gold standard mindset

Liquidationist mantra...deflation welcomed/oppose militant labor

Defend gold reserves...even if you’ve left gold standard

Real bills doctrine...if economy tanks, who needs money?

Balanced budget fetish...cut spending when revenue falls

slide10

$/pound

Producer Price Index

new deal reflation regime change
New Deal Reflation: Regime Change
  • Secure the financial system
      • Reconstruction Finance Corporation (RFC)—Hoover effort
      • Glass-Steagall: separation of commercial banking and investment banking
      • Federal deposit insurance
      • Security and Exchange Commission
  • Dollar devaluation
      • Break golden fetters  Monetary expansion
      • Great expectations...reverse expectations of deflation

 Low and negative real interest rates  Spur to spending

  • Cartelization—National Industrial Recovery Act (NIRA)
      • Recover by limiting supply? Kill the pigs???
      • Great expectations...reverse expectations of deflation
  • Public spending
      • Hoover Dam
      • Works Public Administration (WPA)
      • Civilian Conservation Corp (CCC)
slide12

Retrenchment: The Gold Standard Mindset

 Recession in Depression

dynamics of financial crises in emerging market economies
Dynamics of Financial Crises in Emerging Market Economies

Stage one: Initiation of Financial Crisis.

Path one: mismanagement of financial liberalization

Weak supervision and lack of expertise  lending boom.

Domestic banks borrow from foreign banks.

Fixed exchange rates give a sense of lower risk.

Securities markets not well-developed  Banks important

Path two: severe fiscal imbalances:

Governments force banks to buy government debt.

When government debt loses value, bank net worth down .

Additional factors:

Increase in interest rates (from abroad)

Asset price decrease

Uncertainty linked to unstable political systems

Ms

dynamics of financial crises in emerging market economies1
Dynamics of Financial Crises in Emerging Market Economies

Stage two: currency crisis

Bank losses  currency crises:

Government cannot raise interest rates (doing so forces banks into insolvency)…

… and speculators expect a devaluation.

Foreign and domestic investors sell the domestic currency.

Stage three: Full-Fledged Financial Crisis:

The debt burden in terms of domestic currency up

Banks more likely to fail:

Individuals are less able to pay off their debts (value of assets fall).

Debt denominated in foreign currency increases (value of liabilities increase).

financial crises mexico 1994 1995 tequila
Financial Crises: Mexico 1994-1995 ...Tequila

Financial liberalization in the early 1990s:

Lending boom/weak supervision/lack of expertise.

Banks accumulated losses/net worth declined.

Rise in interest rates abroad.

Increased uncertainty (political instability).

Domestic currency devaluated Dec. 20, 1994.

Tesobono burden

Rise in actual and expected inflation.

financial crises east asia 1997 1998
Financial Crises: East Asia 1997-1998

Financial liberalization in the early 1990s:

Lending boom/weak supervision/lack of expertise.

Banks accumulated losses/net worth declined.

Uncertainty increased

stock market declines and failure of prominent firms

Domestic currencies devaluated (1997).

Rise in actual and expected inflation.

Contagion: Thailand...Indonesia...Korea...Philippines...Malaysia

...Singapore...Taiwan...Brazil...Russia

....Long Term Capital Management

financial crises argentina 2001 2002
Financial Crises: Argentina 2001-2002

Currency board: 1 Peso = $1

Fiscal imbalance

banks coerced to absorb government debt

Appreciation of $ & peso  Argentine recession

Rise in interest rates abroad.

Uncertainty increased (ongoing recession).

Domestic currency devaluated, Jan. 6, 2002

Rise in actual and expected inflation.

slide19

Prelude to Financial Crisis of 2007 – 2009

Simon Johnson, The Quiet Coup. The Atlantic, May 2009

financial crisis of 2007 2009
Financial Crisis of 2007 - 2009

Financial innovations in mortgage markets:

Subprime/Alt-A mortgages/Interest Only/NINJA

Mortgage-backed securities/Collateralized debt obligations (CDOs, CDO2)

Housing price bubble forms

World savings glut

Increase in liquidity from cash flows surging to the US

Subprime mortgage market  housing demand and prices up.

Agency problems arise

“Originate to distribute” … “Moving, not storage”

 principal (investor) agent (mortgage broker) problem.

Commercial and investment banks/rating agencies …weak incentives to assess quality of securities

Information problems surface…A “Minsky Moment”

Housing price bubble bursts/Crisis spreads globally

housing prices and the financial crisis of 2007 2009
Housing Prices and the Financial Crisis of 2007–2009

Source: Case-Shiller U.S. National Composite House Price Index; www.macromarkets.com/csi_housing/index.asp.

stock prices and the financial crisis of 2007 2009
Stock Prices and the Financial Crisis of 2007–2009

Source: Dow-Jones Industrial Average (DJIA). Global Financial Data; www.globalfinancialdata.com/index_tabs.php?action=detailedinfo&id=1165.

the shadow banking system a fragile financial infrastructure

The Shadow Banking System: A Fragile Financial Infrastructure

Thus a long-term corporate bond could actually be sold to three different persons. One would supply the money for the bond; one would bear the interest rate risk, and one would bear the (credit) risk of default. The last two would not have to put up any capital for the bond, though they might have to post some collateral.

Fisher Black

Fundamentals of Liquidity, 1970

the shadow banking system a fragile financial infrastructure1

The Shadow Banking System: A Fragile Financial Infrastructure

Banks have public backing…and are heavily regulated

Lender of last resort, the Fed

Bank creditors (depositors) are insured, FDIC

Shadow Banks: Lack Public Backing  Substitutes

Liquidity put

Underlying asset values fall

Short-term funders back off

Sponsor steps in per prior agreement…line of credit

Credit put

Buy Credit Default Swaps from private insurers

Private insurers can’t possibly reserve against systemic risk

the shadow banking system a fragile financial infrastructure2

The Shadow Banking System: A Fragile Financial Infrastructure

Denizens of the shadows

Federal loan programs/GSEs

Investment banks/Pension funds

Finance companies

Monoline insurers/Mortgage insurers

Structured investment vehicles (SIVs)

Conduits (SPVs – liquidity support by bank sponsor)

Achieve regulatory arbitrage—get assets off balance sheet

credit arbitrage conduit (conduit holds credit assets)

securities arbitrage conduit (conduit holds securities)

TRS/repo conduit (finances financial institutions using total return swaps and/or repos)

Credit hedge funds

Money market intermediaries

financial crisis of 2007 2009 cont d
Financial Crisis of 2007 - 2009 (cont’d)

Banks’ balance sheets deteriorate

Write downs

Sale of assets and credit restriction

High-profile firms fail

Bear Stearns (March 2008)

Fannie Mae and Freddie Mac (July 2008)

Lehman Brothers, Merrill Lynch, AIG, Reserve Primary Fund (MMMF) and Washington Mutual (September 2008).

Fed pumps up bank reserves: TARP/TALF,etc.

Lend and lend freely

Bailout package enacted

House votes down the $700 billion bailout package (9/29/08)

 Stock market slumps  Bailout passes on October 3.

Congress approves a $787 billion economic stimulus plan on February 13, 2009.

Recession deepens

responses no bank left behind lender of last resort spender of last resort
Responses: No Bank Left BehindLender of Last Resort / Spender of Last Resort
  • Tax Rebate $124 bil.
  • Fed Fund Rate Cuts
  • Fannie/Freddie $200 bil.
  • Bear-Stearns $29 bil.
  • AIG $174 bil.

Fed “Facilities”

  • Primary Dealer Credit Facility (PDCF) $58 bil.
  • Treasury Security Loan Facility (TSLF) $133 bil.
  • Term Auction Facility (TAF) $416 bil.
  • Asset- Backed Commercial Paper Funding Facility (CPFF) $1,777 bil.
  • Money Market Investor Funding Facility (MMIFF) $540 bil.
  • More Fed Fund Rate Cuts … Hold At ~0%
  • Fed Purchases of Long-Term Securities: GSEs & MBSs $600 bil.
  • Term Asset-Backed Securities Loan Facility (TALF) $200 bil.
  • Emergency Economic Stabilization Act/TARP $700 bil.

Government Loans

Government Equity

  • Stimulus Package $787 bil.

aka The American Recovery and Reinvestment Act

  • TARP II
      • Stress Tests
treasury bill to eurodollar rate ted spread
Treasury Bill–to–Eurodollar Rate (TED) Spread

Source: www.federalreserve.gov/releases/h15/data.htm

credit spreads and the 2007 2009 financial crisis
Credit Spreads and the 2007–2009 Financial Crisis

Source: Federal Reserve Bank of St. Louis FRED database; http://research.stlouisfed.org/fred2/categories/22.