Financial Crises - the core


Published on

The core of the sub-prime crisis

Published in: Economy & Finance, Business
  • Be the first to comment

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

Financial Crises - the core

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Funds are withdrawn and credit dries up: 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