Financial Crises: Can They Be Prevented?

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Financial Crises Can They Be Prevented?

• Prof. Mohd Nazari Ismail
• Faculty of Business and Accounting
• University of Malaya

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• Prof. Paul Krugman , Princeton U.Winner of 2008
  Nobel Prize for Economics

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Alan GreenspanChairman of US Federal Reserve
Board, 1987-2006
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Prof. Jeffrey SachsDirector Earth Institute,
Columbia University
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Plenty of brains still cannot solve problem? So
how?
         Massachusetts Institute of Technology
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Hmmm.. How are we gonna solve this problem?
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I dont have a clue too
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Presentation Outline

• Reasons for concern
• Different types of financial crises
• History of finance industry
• Central argument
• Conclusion

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CENTRAL ARGUMENT

• .financial crises at their core are outcomes of
  over-lending and over-borrowing and are thus
  integral to the industry itself.

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Asian Financial Crisis Worse Economic Damage
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compared to the Asian Tsunami !
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US Sub-prime crisis
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impact in all corners of the world
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We are victims of the Jews .
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Honest, it wasnt me
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Financial Crisis
a disturbance to financial markets, associated
typically with falling asset prices and
insolvency among debtors and intermediaries,
which spreads through the financial system,
disrupting the markets capacity to allocate
capital B. Eichengreen, 1986
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Economics Crisis
Financial crisis
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Other Causes of Economics Crises

• Wars
• Earthquakes
• Floods
• Draughts
• Plagues

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Types of Financial Crises

• Currency crisis
• Banking crisis
• Market crashes

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Asian Financial Crisis
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Overinvestment in Real Estate
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Asian Financial Crisis
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Inflow of foreign funds prior to crisis
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Bank Run
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Source Worldbank
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Argentina

• Fiscal indiscipline
• Public debt
• 1983 USD46 billion
• 1989 USD65 billion
• 1999 USD130 billion
• Trade deficit
• Bank run

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Argentina riots
Sorry, you cannot withdraw any money today
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Open up the bank! We want our money back.
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USD127 billion!

• Argentina Foreign Debt in 2007

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Market Crash
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Bubble
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Examples of Market Crash

• Japanese property crash (1990)
• Dot.Com crash (2000)
• Sup-prime mortgage crash (2007)

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Japanese Crash A Puzzle?

• Successful exporter
• Trade surplus
• High savings rate
• Hardworking and skilled workforce

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Japanese problem

• banks
• over-borrowing
• debt
• speculation

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Here is how it happened
Savings/funds deposited into banks
Banks increased lendings
Asset prices skyrocketed
?
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land surrounding the Imperial Palace in Tokyo
estimated to be worth more than whole of
California
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.created a massive bubble
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(No Transcript)
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which soon burst!
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Effect of Bubble Burst

• Trillions of yens wiped out in markets
• Spending slowed down
• Economy sputtered to a halt

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Japanese Poorest and Weakest
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A side of Japan that is not often seen
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Sub-prime Mortgage Crisis
Low interest rates, excess liquidity in 1990s
Banks lent to Sub-prime borrowers
Housing boom
CDOs act as booster
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Sub-prime Mortgage Crisis (cont.)
Housing prices skyrocketed
Interest rates rose
CRASH!
Borrowers go bust
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Total UK and US debt to GDP ratio of 300
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20 of total economic output used to pay
interest
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Sub-prime Mortgage Crisis (cont.)
Housing prices skyrocketed
Interest rates rose
CRASH!
Borrowers go bust
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Sub-prime Mortgage Crisis (cont.)
Lenders go bust
Credit Crunch
Global Recession?
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All in Serious Trouble
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How serious is current crisis?

• USD16.3 trillion wiped out
• deep and prolonged recession
• Major economies slowing down

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US700 billion bail-out plan
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US federal governments total accumulated debt is
now more than USD10 trillion
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Japans public debt more than 195.5 of its GDP
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If bailout plan does not work? Global
Recession
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starvations, homelessness, chaos
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Financial crises how and when did they all start?
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600 years ago
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Human existence started 2 million years ago
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Human History of 2 million yrs
no finance industry
16th century
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During previous 99.97 of human history there was
no legitimate finance industry!
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USURY

• In ancient India it was looked down upon by both
  Buddhists and Hindus.

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Ancient Philosophers against Usury
Cato the Elder
Aristotle
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"...those who ply sordid trades, pimps and all
such people, and those who lend small sums at
high rates. For all these take more than they
ought, and from the wrong sources. What is common
to them is evidently a sordid love of gain...
Aristotle
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what do you think of usury?" - "What do you
think of murder?Cato the Elder
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USURY

• Judaism forbids it (if practiced among fellow
  Jews)

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interest-charging same as people who have shed
bloodEzekiel
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USURY

• The medieval Christian church condemned it

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Now money, according to the Philosopher was
invented chiefly for the purpose of exchange and
consequently the proper and principal use of
money is its consumption or alienation whereby it
is sunk in exchange. Hence it is by its very
nature unlawful to take payment for the use of
money lent, which payment is known as usury and
just as a man is bound to restore other
ill-gotten goods, so is he bound to restore the
money which he has taken in usuryThomas Aquinas
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Old Testaments descriptions of usury
practitioners

• Sabbath-breakers
• who vex the fatherless and widows
• dishonor parents
• liar
• the unrighteous
• the backbiter
• the slanderer and perjurer
• the meanest and lowest of men
• the vilest of criminals

• shedder of blood
• the defiler of his neighbor's wife
• the oppressor of the poor
• the spoiler by violence
• the violator of the pledge
• the idolater
• extortionists

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Islam condemns usury
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USURY in Islam

• Those who charge usury are in the same position
  as those controlled by the devil's influence.
  This is because they claim that usury is the same
  as commerce. However, God permits commerce, and
  prohibits usury. Thus, whoever heeds this
  commandment from his Lord, and refrains from
  usury, he may keep his past earnings, and his
  judgment rests with God. As for those who persist
  in usury, they incur Hell, wherein they abide
  forever
• (Quraan 2275)

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USURY in Islam

• God condemns usury, and blesses charities. God
  dislikes every disbeliever, guilty. O you who
  believe, you shall observe God and refrain from
  all kinds of usury, if you are believers. If you
  do not, then expect a war from God and His
  messenger. But if you repent, you may keep your
  capitals, without inflicting injustice, or
  incurring injustice. If the debtor is unable to
  pay, wait for a better time. If you give up the
  loan as a charity, it would be better for you, if
  you only knew.
• (Quraan 2276)

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John Eck (1486-1543)
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John Calvin (1509-1564)
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Adam Smith (1723-1790)
Jeremy Bentham (1748-1832)
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The interest or the use of moneyis the
compensation which the borrower pays to the
lender, for the profit which he has an
opportunity of making by the use of the money.
Part of that profit naturally belongs to the
borrower who runs the risk and takes the trouble
of employing it and part to the lender, who
affords him the opportunity of making this
profit Adam Smith 1776
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debt forgiveness is not in our vocabulary. But
we can help them by giving them additional
loans.Senior executive, ADB
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John Whipple
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"If 5 English pennies ... had been ... at 5 per
cent compound interest from the beginning of the
Christian era until the present time, it would
amount in gold of standard fineness to
32,366,648,157 spheres of gold each eight
thousand miles in diameter, or as large as the
earth."  

• John Whipple (1836) in The Importance of Usury
  laws

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Wow.
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        "the purpose of money is to facilitate
exchange. It was never intended as an article of
trade, as an article possessing an inherent value
in itself, (but) as a representative or test of
the value of all other articles. It undoubtedly
admits of private ownership but of an ownership
that is not absolute, like the product of
individual industry, but qualified and limited by
the special use for which it was
designed....John Whipple 1836
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Crash!
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Innocent victims
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Another victim of financial accident?
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Tulips Mania Crisis 1637
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London in 1720
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South Sea
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Crisis.
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Overend, Gurney Co
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City of Glasgow Bank
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Financial crises in the US, too
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(No Transcript)
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Bond Certificate
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US Stock Market Crash 1929
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The Great Depression
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World War II expenditures moved the US economy
again
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Roaring 1980s

• Stock market boom

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Leveraging!

• Or borrowing

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Franco Modigliani
Merton Miller
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1980sLeverage buyouts, mergers, takeovers and
junk bonds
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Crash! USD500 billion gone!
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Savings and Loan Scandal/Crisis
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Savings and Loan Scandal/Crisis
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Other Financial Crises

• Long Term Capital Management 1998
• Russian currency crisis
• Mexican financial crises 1982 1994-95
• Brazilian Financial crisis 1999
• European financial crisis 1992
• Iceland financial crisis 2008
• Etc., etc., etc.

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Deregulation?
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USA has the Best regulatory framework

• But still failed to prevent occurrences of
  crisis after crisis

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Repeal of 1933 Glass-Steagall Act and Bank
Holding Act in 1999
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Before Heroes of Deregulation Growth
Robert Rubin Former Treasury Secretary
Sanford Weill - Citibank
Alan Greenspan Former Fed Chairman
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After Culprits of the Crisis
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Dr Zeti
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Derivatives? CDOS? CDSS?
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CDS (credit debt swap) US62 trillion at the end
of 2007
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Derivatives is outcome of dynamic and developed
financial markets!
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• Abandonment of Gold Standard?

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Gold standard abandoned completely in 1971
Nixon Vietnam War
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Growth of financial industry require abandonment
of Gold standard
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Gold Standard will constrain growth of finance
industry
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Optimistic Risk-taker?
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Buddies now
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Perception of greed as being responsible for the
current financial crisis is a misplaced
perception.Prof. Barry EichengreenU of
California, Berkeley
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Heroes now..
Nazir Razak, CIMB
Amirsham, Ex-CEO of Maybank
If there is a crisis.. greedy villains?
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Before Admired
John Meriwether, LTCM
Chuck Prince, Citigroup
Dick Fuld, Lehman Bros.
After Greedy
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Clear Cases of Greed
Nick Leeson Baring Bank
Jeff Skilling - Enron
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It's so difficult to pinpoint one person or two
peopleIt really was the whole systemReena
Aggarwal, Professor of Finance, Georgetown
University
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Findings of Study by C. Reinhart K. Roggof

• asset prices
• real economic growth
• and public debt

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Charles P. Kindleberger Ford International
Professor of Economics at MIT
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over-trading
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Financial Distress
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confidence
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Sometimes in the next five years you may kick
yourself for not reading and re-reading
Kindlebergers Manias, Panics and Crashes.Paul
Samuelson, Nobel Laureate and Professor Emeritus
at MIT
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At their core, financial crises are problems of
over-leveraging, over-lending and over-borrowing
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sadly, the problems are not going to go away as
long as the financial industry is legally part of
our life.
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"I've been around long enough to see that we have
these cycles. These guys get their cigars and
champagne. They have a great time. The whole
thing blows up. But then they re-emerge years
later. This one is a really, really bad one. But
I don't think Wall Street is dead

• Andy Serwer, the managing editor of Fortune
  Magazine

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In reality we are not solving the problem but
simply putting off the reckoning to a later date
and to a later generation of citizens.
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THANK YOU
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Financial Crises

• over-lending
• over-borrowing
• integral to the industry itself

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Problems are not going to go away

• My Central Proposition

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as long as financial industry exists.
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Asian financial crisis worse than tsunami

• Asian
  Development Bank

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Here we go again
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Popped!
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When lending (for profit) became a legitimate
industry