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Financial Crises - the core

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The core of the sub-prime crisis

The core of the sub-prime crisis

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  • 1. The Financial System in Crisis Lecture 9: International Political Economy
  • 2. Financial crises
    • Debt crisis (1980s)
    • Asian crisis (1997-98)
    • Subprime crisis (current)
    Financial Crises IPE Discussion Group
  • 3. Economist: World on the edge Financial Crises IPE Discussion Group
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  • 49. Subprime crisis
    • Lenders have spread risk over many investors
    • Too much lending, too much risk
    • Mortgage takers fail to repay
    • Unexpected insolvencies: banks short of funds
    Financial Crises International Political Economy
  • 50.
    • Banks have higher outstanding loans to collateral ratio than previously estimated
    • Banks need more funds
    • Everyone needs more funds; no one trusts any bank with one’s money anymore
    • Funds are withdrawn and credit dries up:
      • no new loans
      • Real economy dragged down
      • no new mortgages
      • falling share prices
            • More money evaporates in financial sector
      • Bankruptcies
    Credit crisis Financial Crises International Political Economy
  • 51. The political-economic impact of the bailout
    • Bailout would reduce pressure on financial institutions, get credit flowing again
    • Credit is necessary to avoid recession
    • Bailout creates Moral Hazard problem
      • Should renumeration of ‘financial talent’ be capped?
    • Bailout is transfer from poor to rich
      • Counterargument: government invests rather than spends
    • Bailout amounts to socialism
    Financial Crises International Political Economy
  • 52. Is crisis the problem?
    • Structuralist perspective:
    • - Capitalism is inherently unstable
      • Profit-seeking causes overproduction, booms and busts
      • Speculation
    • Question is: why did we believe the system was stable?
      • Central Banks have delayed big crisis (Niall Ferguson)
      • Capitalism needs peaceful labour and willing consumers
      • Tendency to think “this boom is different”
    Financial Crises International Political Economy
  • 53. Political-economic impact: Historical parallels
    • Long waves?
    Financial Crises International Political Economy
  • 54. Historical Pattern: Crises followed by change in ‘economic regime’
    • 1870-1932: Neoclassical economics, Liberalism
            • Free markets
            • Centred on entrepreneur
            • - Focus on individual, micro-level
    • 1936-1973: Keynesian economics, Welfare states/Development Economics
            • Government steering
            • Centred on consumers and labourers
            • Focus on aggregate, macro level
    • 1980-2008: Supply side economics, Neoliberalism
      • - Created markets
      • - Centred on entrepreneurs
      • - Focus on individual, micro-level
    • 2008- : ?
      • - Government regulation
    Financial Crises International Political Economy
  • 55. Debt crisis (early 1980s)
    • 1970s:
    • Oil crisis: increasing costs of production & consumption
    • Stagflation in developed world
    • Cheap Credit-fuelled expansion in developing world
    • 1980s:
    • Thatcherism & Reagonomics
    • Rising interest rates
    • Consequence:
    • Inflation tamed
    • Unemployment in developed world
    • Defaults in developing world (Mexico 1982): credit withdrawn
    Financial Crises International Political Economy
  • 56. Asian crisis (1997-1998): Causes
    • No Fundamental macro-economic problems
      • Enough foreign reserves
      • Exports surpassed imports
      • Fiscal policies sound
    • Institutional, regulatory problems
      • Fixed exchange rates had seemingly reduced risks of foreign borrowing
      • Short-term foreign borrowing, long-term domestic investment
      • Property market bubbles
      • ‘ Streets of Asia are paved with gold’: Lack of detailed information
      • Lax oversight, close connections between investors and politicians
    • Self-fulfilling speculation
      • Contagion
    • ‘ Consensus’: financial liberalisation without proper regulation
    Financial Crises International Political Economy
  • 57. Asian crisis (1997-1998): Development
    • What happened:
      • Investors massively withdraw funds from Asia
      • Currencies devalue sharply
      • Domestic businesses see (dollar-denominated) loans increase
      • Credit crunch
    • IMF response:
      • Let insolvent banks and financial institutions fail
        • Avoid moral hazard
        • Avoid political interference in markets
        • Break up links politics & business
      • Raise interest rates
        • Shore up currency
        • Penalize insolvent companies
      • Allow foreign take-overs
        • - Break up links politics & business: worldmarket efficiency instead
    Financial Crises International Political Economy
  • 58. Asian crisis (1997-1998): Consequences
    • Political upheaval
      • Malaysia: DPM Anwar Ibrahim jailed for corruption and ‘sodomy’
      • Indonesia: fall of Suharto
    • Major recession
      • Took about 8 years to reach pre-1997 income levels again, Indonesia even longer
    • Alternative reactions?
      • Malaysia did not turn to IMF
      • Imposed capital controls
      • Came off relatively easy
    Financial Crises International Political Economy
  • 59. Questions
    • What way now for capitalism?
    • Financial systems and Capital flows: should they be regulated and limited?
    • Who was gaining from previous situation? How were they making sure situation persisted?
    • Has crisis caused a shift in power, making a change of regime likely?
    Financial Crises International Political Economy