Consequences of Financial Crises
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These are the slides from a revision webinar for A Level economics that looked at some of the major consequences of financial crises.
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Consequences of Financial Crises
- 2. A disturbance / shock to financial markets, associated typically with falling asset prices and insolvency amongst debtors and intermediaries, which ramifies through the financial system, disrupting the market’s capacity to allocate capital.
- 3. Financial Crises in Developed / Emerging Countries • Recent developed markets crises • US housing and sub-prime crisis in 2006-2008 • Global Financial Crisis (GFC) of 2008-2009 • Sovereign debt crises and economic crisis in the Eurozone (2010-2013): Greece, Ireland, Portugal, Spain, Italy, Cyprus + continuing Grexit Risk. • (Brexit: a shock rather than a crisis) • Recent emerging market crises: • East Asia (1997-98), Russia (1998), Argentina (2001) • China’s 2015-16 financial market turmoil • Turkey currency turmoil in 2016-17
- 4. On 15 September 2008, Lehman Brothers filed for Chapter 11 bankruptcy in a New York courtroom in the United States. Panic ensued. Uncertainty about its causes and contagious consequences brought many financial markets to a standstill.
- 5. Evaluating the Impact of a Financial Crisis Economic • Investment • Productivity • Trend growth • Jobs • Real incomes Social • Inequality • Poverty reduction • Social tensions • Political stability Long Term • Pressure for economic reform • Risk of hysteresis • Legacy of debt • Protectionism
- 6. Evaluating the Impact of a Financial Crisis Economic • Investment • Productivity • Trend growth • Jobs • Real incomes Social • Inequality • Poverty reduction • Social tensions • Political stability Long Term • Pressure for economic reform • Risk of hysteresis • Legacy of debt • Protectionism
- 7. Evaluating the Impact of a Financial Crisis Economic • Investment • Productivity • Trend growth • Jobs • Real incomes Social • Inequality • Poverty reduction • Social tensions • Political stability Long Term • Pressure for economic reform • Risk of hysteresis • Legacy of debt • Protectionism
- 8. Evaluating the Impact of a Financial Crisis Economic • Investment • Productivity • Trend growth • Jobs • Real incomes Social • Inequality • Poverty reduction • Social tensions • Political stability Long Term • Pressure for economic reform • Risk of hysteresis • Legacy of debt • Protectionism The consequences of a financial crisis depend in part on what caused it
- 9. Evaluating the Impact of a Financial Crisis Economic • Investment • Productivity • Trend growth • Jobs • Real incomes Social • Inequality • Poverty reduction • Social tensions • Political stability Long Term • Pressure for economic reform • Risk of hysteresis • Legacy of debt • Protectionism The consequences of a financial crisis depend in part on what caused it Consequences also depend on effectiveness of policies designed to stabilize confidence and reform markets
- 10. The Long Sweep of History
- 11. Subprime Mortgages Sub-prime lending is lending money, usually to buy a house, to people who are risky to lend to. To compensate for risk, commercial banks charge higher interest rates.
- 12. Aspects of the US Sub-Prime Mortgage Lending Crisis Mortgage delinquency rates for subprime loans in USA from 2000 to 2014 11.9% 10.8% 19.9% 25.5% 25.9% 23% 20.6% 21% 19.1% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 2000 2005 2008 2009 2010 2011 2012 2013 2014 Delinquencyrates
- 13. Foreclosure rates of Subprime Housing Loans 3.3% 4.5% 8.7% 13.7% 15.1% 14.5% 14.7% 13% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 2005 2006 2007 2008 2009 2010 2011 2012 Foreclosurerates
- 14. Externalities from a Financial Crisis US housing and mortgage bust Liquidity and credit crunch spread to all credit and financial markets Economy-wide recession in the United States Sharp fall in global trade and investment Recession in most advanced economies Banking crisis led to a growing sovereign debt crisis Big rise in national debt Pressure on governments to use fiscal austerity Long period of slow growth in countries burdened by debt
- 15. Bailout Loans from the US Federal Reserve 2007-2010 66 77.2 77.8 84.5 91.4 99.5 107.3 0 20 40 60 80 100 120 Deutsche Bank UBS State Street Royal Bank of Scotland Bank of America Citigroup Morgan Stanley LoansinbillionU.S.dollars
- 16. Financial Crisis and Contagion Effects Sub prime mortgages Mortgage companies Lenders & Home builders Financial markets US economy Global economy
- 17. Capital Investment Rates for Selected Countries 15 20 25 2000 2003 2006 2009 2012 2015 Greece, Ireland, Italy, Portugal, Spain Rest of Euro Area Percent of GDP
- 18. Uncertainty is the 'new normal' 0 50 100 150 200 250 300 350 400 2000 2000 2001 2001 2002 2002 2003 2004 2004 2005 2005 2006 2007 2007 2008 2008 2009 2009 2010 2011 2011 2012 2012 2013 2014 2014 2015 2015 2016 Global policy uncertainty Global policy uncertainty based on the frequency of articles in domestic newspapers, six- month moving average, last data point November 2016, source: World Bank
- 19. Uncertainty up … confidence in government down
- 20. Impact on Share Prices of Previous Financial Crises Source: www.risk.jbs.cam.ac.uk Multiple financial crises often happen simultaneously. For example, the Global Financial Crisis in 2008 was initially focused on the housing market (an asset price bubble) but then spread into the commercial banking system and onto government debt problems
- 21. Growth of Global Trade in Goods -25.0 -20.0 -15.0 -10.0 -5.0 0.0 5.0 10.0 15.0 20.0 25.0 2006 2006 2006 2007 2007 2008 2008 2008 2009 2009 2010 2010 2011 2011 2011 2012 2012 2013 2013 2013 2014 2014 2015 2015 2016 2016 % change in the volume of global trade in goods, source World Bank Volume 1992-2008 average
- 22. Economic Growth Pre and Post GFC EMDE = emerging market and developing economies. SSA = Sub-Saharan Africa. -2.0 -1.0 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Economic Growth for SSA and EMDE Sub-Saharan Africa EMDE ex. China
- 23. Economic Policy Response to the Global Crisis in 2008 • There were well-founded fears that the world economy was at risk of another depression similar to the 1930s • Macroeconomic policy in many countries responded: 1. Large conventional/unconventional monetary easing involving deep cuts in policy interest rates and quantitative easing 2. Massive fiscal stimulus for a while – especially in China and (to a lesser extent) in the USA 3. Backstop and bailout of the private sector (financial system, households, corporations) - including (in the UK) bail-outs and nationalization of some banks
- 24. Policy Interest Rates in Selected Advanced Economies -1 0 1 2 3 4 5 6 7 2000 2004 2008 2012 2016 2020 United States Euro Area Japan Percent
- 25. Estimated Real Equilibrium Interest Rates -2.0 -1.0 0.0 1.0 2.0 3.0 4.0 1995 1996 1996 1997 1998 1999 2000 2001 2001 2002 2003 2004 2005 2006 2006 2007 2008 2009 2010 2011 2011 2012 2013 2014 2015 2016 Equilibrium Real Interest Rates United States Euro Area Japan The real equilibrium interest rate is the real policy rate that is consistent with full employment, stable prices, and growth at potential, source: World Bank, January 2017
- 26. Share of the World with Negative Interest Rates 0 10 20 30 Jan-14 Jan-15 Jan-16 Latest Policy rate 5-year bond yield Percent of world GDP
- 27. Keynesian v Austrian Perspectives on Policy Response • Provide strong monetary & fiscal stimulus – public sector spending is badly needed when private sector demand is weak • Focus in particular on labour-intensive infrastructure projects • Bailout the private sector to prevent catastrophic job losses • Key is to support animal spirits and prevent a collapse in demand Keynesian approach
- 28. Keynesian v Austrian Perspectives on Policy Response • Avoid bail-outs as they lead to moral hazard and the survival of zombie businesses which ultimately constrains long run growth • Fast-forward reforms to promote competition & raise productivity • Against counter-cyclical macro stimulus - especially ultra-low interest rates as this "distorts" the allocation of capital Austrian approach
- 29. @tutor2ugeoff
Editor's Notes
- The main financial assets are property, pensions, equities, unit trusts and cash.
- Emerging markets - The financial markets of developing countries.
- Number of loans delinquent 30 days or more as percentage of mortgage loans serviced in survey. Annual average of quarterly figures. Delinquency rate does not include loans in the process of foreclosure.
- This statistic shows the foreclosure rates of subprime conventional loans in the United States from 2005 to 2012. In 2008, 13.7 percent of subprime conventional loans were in foreclosure.
- The statistic shows the loans given out by the Federal Reserve the U.S. to banks worldwide from August 2007 to April 2010. The Federal Reserve System is the central bank system in the United States. The U.S. investment bank Morgan Stanley received loans worth 77.2 billion U.S. dollars during that time.
- The main financial assets are property, pensions, equities, unit trusts and cash.