Great depression & financial crisis

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  • Rakshit
  • Rakshit
  • Rakshit
  • Rakshit
  • Saxena
  • Saxena
  • Saxena
  • Saxena
  • Saxena
  • Saxena
  • Saxena
  • Saxena
  • Saxena
  • Saxena
  • M. King Hubbert, Saxena
  • Saxena
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  • Gandhi
  • Gandhi
  • Gandhi
  • Gandhi
  • Gandhi
  • Gandhi
  • Gandhi
  • Gandhi
  • Gandhi
  • Gandhi
  • Gandhi
  • Gandhi
  • Gandhi
  • Gandhi
  • Soumyajit
  • Soumyajit
  • Soumyajit
  • Soumyajit
  • Soumyajit
  • Soumyajit
  • Soumyajit
  • Soumyajit
  • Soumyajit
  • Soumyajit
  • Soumyajit
  • Soumyajit
  • Soumyajit
  • Soumyajit
  • Soumyajit
  • Soumyajit
  • Soumyajit
  • Anand
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  • Anand
  • Anand
  • Bhoomi
  • Bhoomi
  • Bhoomi
  • Bhoomi
  • Great depression & financial crisis

    1. 1. Saturday, March 16, 2013 Group 4 _ Section C Anand Kumar 12P127 Bhoomi Ashwin 12P131 Chirayu Gandhi 12P135 Rakshit Sharma 12P160 Saurabh Saxena 12P167 Soumyajit Sengupta 12P171 1
    2. 2. Saturday, March 16, 2013 Background Causes/Triggers Impact Recovery Steps Recovery • Differences Comparison • Similarities 2
    3. 3. Saturday, March 16, 2013 3
    4. 4. Saturday, March 16, 2013  Severe economic depression which preceded World War II  Started in the US on October 29th , 1929 with the fall of US stock market  Impacted the major European and Asian economies of the world  Lasted till early 1940’s – longest, most widespread and deepest depression of 20th century 4
    5. 5. Saturday, March 16, 2013 High Tariff Barriers Monetary Stock Market Policy crash Great Depression Over Inequality Production 5
    6. 6. Saturday, March 16, 2013  Farm:  The production rose to very high level to meet the demand during WW-I but the consumption dropped in 1902’s  The prices of the agricultural land and crops fell and the average annual income of farmers dropped to $273  30% of Americans were dependent on farming  Industry:  Factories were producing products at a higher rate but the wages of workers were not increasing in the same proportion  Consumers were buying less than the and their was overproduction 6
    7. 7. Saturday, March 16, 2013  Monetary contraction, the consequence of poor policy-making by the American Federal Reserve System and continued crisis in the banking system responsible for Great Depression  The Federal Reserve, by not acting, allowed the money supply to shrink by one-third, transforming a normal recession into the Great Depression  Led to the closure of more than 11000 banks and increased conservatism in remaining banks in extending credit 7
    8. 8. Saturday, March 16, 2013  The American stock markets were the most visible symbol of prosperous American economy in 1920’s  Stock prices rose steadily in 1920’s and in 1929 Dow peaked at its highest level of 381 points  The industries were not performing well and in the stock market there were 2 major problems:  Speculation  Margin  On October 29th, 1929 the stock market plummeted leading to a loss of $30 billion 8
    9. 9. Saturday, March 16, 2013  Nation’s wealth grew steadily in 1920’s but it was not distributed evenly  The income rose to 75% for the top 1% and for the remaining it was only 9%  80% of Americans had no savings at all  70% of families had annual earning < $2500 9
    10. 10. Saturday, March 16, 2013  During initial stages of Great Depression, the USAs main goal emerged to protect American jobs and farmers from foreign competition  So, the Smoot-Hawley Tariff Act was enacted in 1930  But it led to the worsening of depression by reducing international trade and causing retaliatory tariffs in other countries 10
    11. 11. Saturday, March 16, 2013  There are various approaches for explaining the cause of the first downturn in 1929:  Demand-driven Keynesian Breakdown of international trade Debt deflation  Monetarist  Inequality  Productivity shock  Austrian School  New classical approach 11
    12. 12. Saturday, March 16, 2013  Keynesian:  Lower aggregate expenditures in the economy contributed to a massive decline in income and to employment that was well below the average  To keep people fully employed, governments have to run deficits when the economy is slowing  Debt deflation:  Predominant factor leading to the Great Depression was over-indebtedness and deflation  Margin requirements were only 10% - People took the loan to invest in stock market, but when the market crashed they were unable to repay these loans – leading to default  Breakdown of international trade:  American Smoot-Hawley Tariff Act responsible for worsening the situation of the crisis  American exports declined from about $5.2 billion in 1929 to $1.7 billion in 1933 12
    13. 13. Saturday, March 16, 2013  Monetary contraction, the consequence of poor policy-making by the American Federal Reserve System and continued crisis in the banking system responsible for Great Depression  The Federal Reserve, by not acting, allowed the money supply to shrink by one-third, transforming a normal recession into the Great Depression  The Federal Reserve Act limited the amount of credit the Federal Reserve could issue 13
    14. 14. Saturday, March 16, 2013  Root Cause: Global over-investment in heavy industry capacity compared to wages and earnings from independent businesses  Solution: Redistribute purchasing power, maintain the industrial base, but re-inflate prices and wages to force as much of the inflationary increase in purchasing power into consumer spending 14
    15. 15. Saturday, March 16, 2013  The first three decades of 20th century witnessed rapid growth in productivity and production capacity  According to this school of thought “The Great Depression” was a result of these long term trends 15
    16. 16. Saturday, March 16, 2013  Austrian School:  The key cause of the Depression was the expansion of the money supply in the 1920s that led to an unsustainable credit-driven boom  This inflation of the money supply that led to an unsustainable boom in both asset prices by the late 1920’s and led to economic contraction  New classical approach:  Initial severe decline but rapid recovery in productivity, relatively little change in the capital stock, and a prolonged depression in the labor force  focuses on the decline in productivity that caused the initial decline in output and a prolonged recovery due to policies that affected the labor market 16
    17. 17. Saturday, March 16, 2013 17
    18. 18. Saturday, March 16, 2013 Change in Economic Indicators from 1929-1932 United States Great Britain France Germany Industrial –46% –23% –24% –41% production Wholesale –32% –33% –34% –29% prices Foreign trade –70% –60% –54% –61% Unemployme +607% +129% +214% +232% nt 18
    19. 19. Saturday, March 16, 2013  In March 1933, the country was virtually leaderless  The banking system had collapsed.  He provided dynamic leadership in a time of crisis  Series of economic programs enacted in the USA between 1933 and 1936 3R’s - Relief, Recovery and Reforms  Relief for the unemployed and poor  Recovery of the economy to normal levels  Reform of the financial system to prevent a repeat depression 19
    20. 20. Saturday, March 16, 2013  Specialists and experts, mostly college professors, idea men  New Economists: government spending, deficit spending and public works, government should prime economic pump  Roosevelt Cabinet: included conservatives, liberals, Democrats, Republicans, inflationists, anti-inflationists -- often conflicting, compromising, blending ideas 20
    21. 21. Saturday, March 16, 2013  Primary Aim of this Deal was to Achieve Economic Recovery  Philosophy: economic nationalism and economic scarcity (i.e., raise prices by creating the illusion of scarcity)  Objectives: higher prices for agriculture and business  Beneficiaries: big business and agricultural business 21
    22. 22. Saturday, March 16, 2013  Purpose: recovery of industry  Created a partnership of business, labor, and government to attack the depression with such measures as price controls, high wages, and codes of fair competition Purpose: relief Gave money to states and municipalities so they could distribute money, clothing, and food to the unemployed 22
    23. 23. Saturday, March 16, 2013  Purpose: the recovery of agriculture  Paid farmers who agreed to reduce production of basic crops such as cotton, wheat, tobacco, hogs, and corn  Money came from a tax on processors such as flour millers and meat packers who passed the cost on to the consumer 23
    24. 24. Saturday, March 16, 2013  Purpose: relief  Gave outdoor work to unemployed men between the ages of 17 and 29  They received $30 per month, but $22 went back to the family 24
    25. 25. Saturday, March 16, 2013  Primary aim: permanent reform  Philosophy: international economic cooperation and economic abundance  Objectives: increased purchasing power and social security for public  Beneficiaries: small farmers and labor 25
    26. 26. Saturday, March 16, 2013  Purpose: reform  Gave money to states for aid to dependent children, established unemployment insurance through payroll deduction, set up old-age pensions for retirees. National Labor Relations Act  Purpose: reform  Put restraints on employers and set up a National Labor Relations Board to protect the rights of organized labor to bargain collectively with employers. 26
    27. 27. Saturday, March 16, 2013  Purpose: recovery for agriculture  Paid farmers for conservation practices, but only if they restricted production of staple crops. U.S. Housing Authority  Purpose: recovery and reform  Used federal funds to tear down slums and construct better housing. 27
    28. 28. Saturday, March 16, 2013  Attacked soil erosion  Built dams and planted trees to prevent floods  Reclaimed the grasslands of the Great Plains  Developed water power resources  Encouraged regional reconstruction projects like the TVA and Columbia River project Human Rehabilitation  Established the principle that government has responsibility for the health, welfare, and security, as well as the protection and education of its citizens  Embraced social security, public health, housing  Entered the domain of agriculture and labor 28
    29. 29. Saturday, March 16, 2013  The Depression ended when the U.S. entered World War II in December 1941  Massive war spending doubled the GNP  Military Keynesianism brought Full Employment Military Keynesianism: the position that the government should increase military spending in order to increase economic growth.  The mobilization of manpower following the outbreak of war in 1939 ended unemployment  Spending on the New Deal was far smaller than spending on the war effort, which passed 40% of GNP in 1944  Massive war spending doubled economic growth rates, either masking the effects of the Depression or essentially ending the Depression  Businessmen ignored the mounting national debt and heavy new taxes, redoubling their efforts for greater output to take advantage of generous government contracts. 29
    30. 30. Saturday, March 16, 2013 30
    31. 31. Saturday, March 16, 2013 31
    32. 32. Saturday, March 16, 2013  Worst financial crisis since the Great Depression of the 1930s  Global economic decline which began in August, 2007 after BNP Paribas terminated withdrawals to hedge funds citing a liquidity crunch in the UK. This was the liquidity crisis which marked the beginning of the Financial Crisis.  It took a sharp downturn in September, 2008  Resulted in the threat of total collapse of large financial institutions, bailouts of banks by national governments and stock market crashes  Resulted in prolonged unemployment, decline in consumer wealth and caused the global recession of 2008-2012 and also contributed to the European Sovereign Debt Crisis 32
    33. 33. Saturday, March 16, 2013  Sub-Prime Lending  The term “sub-prime” refers to those borrowers who neither have the assets, nor a reliable income source, hence, have greater chances of loan default  Bankers and the middlemen got carried away to the extent that special financial products were created to cloak the sub-prime loans with respectability 33
    34. 34. Saturday, March 16, 2013  Growth of the Housing Bubble  From 1997 to 2006, the price of the typical American house increased by 124%  Resulted in many homeowners refinancing their homes at lower interest rates or financing consumer spending by taking out second mortgages secured by the price appreciation  By September 2008, average U.S. housing prices had declined by over 20% from their mid-2006 peak  As prices declined, borrowers with adjustable-rate mortgages could not refinance to avoid the higher payments associated with rising interest rates and began to default 34
    35. 35. Saturday, March 16, 2013  Easy Credit Conditions  Lower interest rates encouraged borrowing(Between 2000 to 2003, the Federal Reserve lowered the federal funds rate target from 6.5% to 1.0%)  downward pressure on interest rates was created by the high and rising U.S. current account deficit, which peaked along with the housing bubble in 2006  Weak and Fraudulent Underwriting Practices  loans not meeting an issuers minimal underwriting standards were subsequently securitized and sold to investors 35
    36. 36. Saturday, March 16, 2013  Predatory Lending  Practice of unscrupulous lenders, enticing borrowers to enter into "unsafe" or "unsound" secured loans for inappropriate purposes  Example  Advertisement stated that 1% interest would be charged but the consumer would be put into an adjustable rate mortgage (ARM) in which the interest charged would be greater than the amount of interest paid. This created negative amortization, which the credit consumer might not notice until long after the loan transaction had been consummated  Deregulation  Regulatory framework did not keep pace with financial innovation 36
    37. 37. Saturday, March 16, 2013  Over-Leveraging/Increased Debt Burden  Financial institutions were over burdened with debt, increasing their appetite for risky investments and reducing their resilience in case of losses.  Incorrect Risk Pricing  Risk Pricing refers to the incremental compensation required by investors for taking on additional risk, which may be measured by interest rates or fees  Lack of transparency about banks risk exposures prevented markets from correctly pricing risk before the crisis 37
    38. 38. Saturday, March 16, 2013  Financial Innovation/Complexity  Development of financial products designed to achieve particular client objectives, such as offsetting a particular risk exposure (such as the default of a borrower) or to assist with obtaining financing  Examples  Adjustable-rate mortgage(ARM)  Bundling of subprime mortgages into mortgage-backed securities (MBS)  Collateralized debt obligations (CDO) for sale to investors, a type of securitization  Form of credit insurance called credit default swaps (CDS) 38
    39. 39. Saturday, March 16, 2013  Boom & Bust of Shadow Banking  The riskiest, worst performing mortgages were funded through the "shadow banking system“  Competition from the shadow banking system pressured the more traditional institutions to lower their own underwriting standards and originate riskier loans  Run on the shadow banking system was the "core of what happened" to cause the crisis  These entities became critical to the credit markets underpinning the financial system, but were not subject to the same regulatory controls  Further, these entities were vulnerable because of maturity mismatch of short term borrowings and long term investments 39
    40. 40. Saturday, March 16, 2013  Commodities Boom  Rapid increases in a number of commodity prices followed the collapse in the housing bubble  The price of oil nearly tripled from $50 to $147 from early 2007 to 2008, before plunging as the financial crisis began to take hold in late 2008  An increase in oil prices tends to divert a larger share of consumer spending into gasoline, which creates downward pressure on economic growth in oil importing countries, as wealth flows to oil- producing states 40
    41. 41. Saturday, March 16, 2013  Global Economy contracted by 3% in 2009  2nd quarter,2008: Greece, Estonia, Latvia, New Zealand, Ireland  3rd quarter,2008: Japan, Sweden, Hong Kong, Singapore, Italy, Turkey and Germany(fifteen nations in the EU went into recession)  4th quarter,2008: United States, Switzerland, Spain and Taiwan  Ukraine went into Depression in 2008 at -20% GDP growth  China and India experienced a slowdown 41
    42. 42. Saturday, March 16, 2013  Real GDP decreased by 6% y-o-y in 2008-09  Domestic demand decreased at record pace-2.6% q-o-q  Inflation rose to 5.6% in 2008 from 4% in 2007  Capital investment declined y-o-y at levels unprecedented since the post war levels of 1957-58  Unemployment rate increased to 10.1% in early 2009, from 5% in early 2008  Average work hours per week declined to 33 hours, lowest since 1964 42
    43. 43. Saturday, March 16, 2013  Housing Prices declined by 20% in 2009  Aviation sector gravely impacted: 4 airlines closed down in a week’s span  Wealth decreased by over 25% for all Americans combined  63% of ALL Americans had a decrease in net worth  77% of the RICHEST Americans had a decrease in net worth  50% of the POOREST Americans had a decrease in net worth  Stock Market  DOW JONES Industrial Average declined to 6600 in 2009 from a high of 14000 in 2007(a fall of more than 50% in 18 months)  S&P 500 declined by 45% in 2008 from its 2007 high 43
    44. 44. Saturday, March 16, 2013  Numerous financial institutions went under or were bailed out, the most prominent among them being:  New Century Financial(Largest Sub-Prime Lender)  Bear Sterns(consequently acquired by JPMC after it lost $15billion in 2 days)  Citibank($18.1billion write-down in its sub-prime mortgage exposure)  Merrill Lynch($14.1billion write-down, acquired by BoA for $50billion)  Freddie Mac & Fannie Mae(Largest bailout in history after the US Government took over)  Lehman Brothers(filed for bankruptcy in 2008 after share prices decreased by 85% and acquisition talks with BoA failed)  AIG(Losses due to $11billion of CDS portfolios, US Government took over with a stake of 80% after loaning it $85billion) 44
    45. 45. Saturday, March 16, 2013  Median Income declined to $49,445 in 2010 from a high of $52,823 in 2007 leading to an increase in the BPL families in USA 54000 52823 53000 52000  National Income Pie 51000 49445 2007 50000  Upper Class: 29% in 1969 to 46% in 2010 2010 49000  Middle Class: 61% in 1969 to 45% in 2010 48000 47000  Lower Class: 10% in 1969 to 9% in 2010 Median Income Income-1969 Income-2010 10% 9% 29% Upper Class Upper Class 46% Middle Class Middle Class Lower Class 45% Lower Class 61% 45
    46. 46. Saturday, March 16, 2013  Stock prices CRASHED worldwide leading to eroding of investor wealth and confidence  Run on Financial Institutions leading to their bankruptcy  Led to the Political and Economic Instability of the European Union  European Sovereign Debt Crisis is still an issue  Countries like Jamaica, Estonia, Latvia which relied heavily on foreign investment suffered when credit inflow dried up and their debt levels rose to unprecedented levels 46
    47. 47. Saturday, March 16, 2013  Iceland faced both stagflation and depression which led to national bankruptcy and ultimately the fall of the government in 2009  Countries like Japan, which were dependant on exports to US and UK also suffered due to decreased demand for its goods  Countries like India and China, however were insulated from the worst effects of the crisis, primarily due to high domestic demand and lower cost manufactured goods exports respectively  Composition of world financial holdings has shifted away from equity investments like stocks and toward government debt 47
    48. 48. Saturday, March 16, 2013  Government announced a package consisting of tax breaks and government backed refinancing to help homeowners avoid foreclosures in August, 2007  US Federal Reserve resorted to an expansionary monetary policy by cutting interest rates in 2007 from 5.25% to 4.75% and further to 4.5% and injected $41billion in the banking system  US Treasury announced a $50billion package to insure investments in a bid to stop a potential run on money-market mutual funds  Temporary exemptions allowing financial groups to share funds more easily among its members 48
    49. 49. Saturday, March 16, 2013  Termination of short-selling of financial stocks  Tightened rules on sub-prime lending  Announced a $150billion stimulus package and interest rates were cut to 3.5% after the stock market crashed on Jan 21, 2008 which was further reduced to 3% in Feb, 2008  $700billion package to buyout toxic loans of banks in 2009 and finally interest rates were reduced to 0.25% following which they lost the most important regulatory tool 49
    50. 50. Saturday, March 16, 2013  USA proposed a regulatory plan in which the Federal Reserve was given more powers as a market regulator. The Plan proposed the following:  Fed Reserve allowed to examine the books of any financial institution  Organization would be set up which will oversee and regulate all the banks  Another body will regulate business conduct, consumer protection and investor protection.  A commission would be created to establish stricter criteria for firms involved in the mortgage market.  Securities and Exchange Commission, which regulates companies with publicly traded shares, would be merged with the Commodities Futures Trading Commission, which oversees commodities trading 50
    51. 51. Saturday, March 16, 2013  Rating Agencies were also reformed and agreements with S&P, Moody’s, Fitch was announced which included:  fee reforms  disclosure reforms  loan originator reforms  due diligence reforms  credit agency independence  representatives and warranties reforms  Increased regulations on shadow banking systems and derivatives 51
    52. 52. Saturday, March 16, 2013  China cut its interest rate in 2008, for the first time since 2002. It announced a $586billion stimulus package in November,2009.  Indonesia cut its repo rate overnight in 2008 to 10.25% from 12.25%  Bank of Japan pumped in $29.3billion on Sep 21, 2008; Reserve Bank of Australia injected $3.45billion on the same day  RBI injected $1.3billion in February,2008, the most in a month ever  European Central Bank injected €95billion into the European Banking System in 2007. Central Banks across the world injected €300billion to prevent a credit market seizure  Household tax rebates were introduced in Europe  European Commission announced a €200billion stimulus package for the EU at the country level in 2009 52
    53. 53. Saturday, March 16, 2013  India cut its repo rate from 9% to 4.75% in 2008-09 and announced a $60billion stimulus package to boost the economy along-with duty cuts in 2009  UK Government announced a ₤500billion bank rescue package in 2009  Basel III norms were implemented which increased capital ratios, limits on leverage, narrow definition of capital (to exclude subordinated debt), limit counter-party risk and new liquidity requirements  G-20 set up to validate the feasibility and conduct discussions among the world’s major economies to find ways to counter the crisis  Pledged to fight against all forms of protectionism  Pledged to maintain trade and foreign investments  Pledged to stimulate demand and employment  Pledged to provide more liquidity and recapitalization of the banking system 53
    54. 54. Saturday, March 16, 2013  By mid-2012, Iceland recovered and is regarded as one of Europes recovery success stories largely as a result of a currency devaluation that has effectively reduced wages by 50%, making exports more competitive  In the United States, jobs paying between $14 and $21 per hour made up about 60% those lost during the recession, but such mid-wage jobs have comprised only about 27% of jobs gained during the recovery through mid-2012. In contrast, lower-paying jobs constituted about 58% of the jobs regained  Unemployment Rates have decreased to 8% from 10% in 2008-09  Anemic recovery that has yet to pull per capita annual real GDP back to the level of 2008 54
    55. 55. Saturday, March 16, 2013  Limited deleveraging of household and government sectors has occurred in the last 5 years  U.S. housing prices are still falling in many areas and credit to small and medium- size businesses is restrained  GNP has increased by 5.5% in the period from 2009-2011 following a fall of 5.6% from 2007 to 2009  Low aggregate demand, uncertainty and government policies are causes for slow speed of recovery 55
    56. 56. Saturday, March 16, 2013 Great Depression Financial Crisis  Stock Market crash was of  Stock Market did not crash as greater magnitude(90% decline much(40% decline in 18 in 33 months) months)  GNP contracted by 30%  GNP contracted by 5.6%  Lasted for 3.5 years(1929-1933)  Lasted for 1.5 years(Dec,07- Jun,09)  Money Supply decreased  Money Supply increased  Unemployment Rate=25%  Unemployment Rate=10%  Debt at 300% of GDP  Debt at 350% of GDP  40% of Banks failed  Very few Banks failed  Regulated Federal Reserve  Deregulated Federal Reserve  Oversupply of Cars and Radios  Oversupply of Houses  WW2 helped the economy  No engine of recovery like WW2  Recovery took 8 years(1933-1941)  Full recovery not in sight yet 56
    57. 57. Saturday, March 16, 2013  Exorbitant rise in asset prices in period prior to event  Cheap credit available  Inadequate regulation  Caused by massive debt  Low aggregate demand due to insufficient stimulus by monetary and fiscal policy(cited by Krugman,2010)  High unemployment rates  Continued uncertainty about economic policy(cited by Pirong- Becker,2011) 57
    58. 58. Saturday, March 16, 2013 58

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