Understanding the Root Causes Of The global financial crisis - PowerPoint PPT Presentation

Loading...

PPT – Understanding the Root Causes Of The global financial crisis PowerPoint presentation | free to download - id: 54509f-ZGM0Z



Loading


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation
Title:

Understanding the Root Causes Of The global financial crisis

Description:

Understanding the Root Causes Of The global financial crisis A fatal combination Financial globalization Great increase in (two-way) capital flows across national ... – PowerPoint PPT presentation

Number of Views:222
Avg rating:3.0/5.0
Slides: 24
Provided by: Hani1
Learn more at: http://www.swissecon.ch
Category:

less

Write a Comment
User Comments (0)
Transcript and Presenter's Notes

Title: Understanding the Root Causes Of The global financial crisis


1
Understanding the Root Causes Of The global
financial crisis
2
A fatal combination
  • Financial globalization
  • Great increase in (two-way) capital flows across
    national borders
  • Net flows from emerging market economies to
    advanced economies (especially, U.S.)
  • Financial deregulation
  • Blurring of lines between commercial and
    investment banking
  • Free international capital mobility across as a
    norm
  • Allowing big banks to use their own risk models
    in determining leverage
  • The rise of an unregulated shadow banking
    system
  • Lack of regulation of new financial products
  • Financial innovation, esp. securitization
  • Colletarallized debt obligations (CDO),
    credit-default swaps (CDS)
  • Greater liquidity and lower returns on
    traditional investments spur risk-taking and high
    leverage.

3
Financial globalization United States
flows
Source Maurice Obstfeld (2011)
4
Financial globalization Iceland and Ireland
stocks
Source Maurice Obstfeld (2011)
5
Historical relationship between capital mobility
and crises
Source Reinhart and Rogoff (2008)
6
The U.S. as a borrower twin deficits
Source Econbrowser, http//www.econbrowser.com/ar
chives/2011/09/lost_decades_th.html
7
The appeal of financial innovation in housing
  • Who wouldnt want credit markets to serve the
    cause of home ownership? So
  • introduce some real competition into the mortgage
    lending business by allowing non-banks to make
    home loans
  • let them offer creative, more affordable
    mortgages to prospective homeowners not well
    served by conventional lenders.
  • enable these loans to be pooled and packaged into
    securities that can be sold to investors
  • reducing risk in the process.
  • divvy up the stream of payments on these home
    loans further into tranches of varying risk
  • compensating holders of the riskier kind with
    higher interest rates
  • call on credit rating agencies to certify that
    the less risky of these mortgage-backed
    securities are safe enough for pension funds and
    insurance companies to invest in
  • just in case anyone is still nervous, create
    derivatives that allow investors to purchase
    insurance against default by issuers of those
    securities.

8
How did financial innovation work?
Source http//www.thedeal.com/newsweekly/features
/chain-of-fools.php
9
The result a housing bubble
Source Robert Shiller, http//www.irrationalexube
rance.com/.
10
How the crisis plays out the collapse of
confidence and contagion
  • The death spiral
  • reduction in housing prices
  • defaults on mortgages
  • reduction in CDO values and loss of confidence
  • reduction collateral values
  • reduction in ability to borrow short-term
  • need to sell off assets (deleveraging)
  • further reduction in asset values
  • freezing of financial markets no-one want to
    lend to anyone else (flight to safety)

11
Who or what is the culprit? (1)
  • unscrupulous mortgage lenders who devised credit
    terms?
  • such as teaser interest rates and prepayment
    penalties
  • perhaps, but these strategies would not have made
    sense for lenders unless they believed house
    prices would keep on rising
  • a housing bubble that developed in the late
    1990s?
  • and the reluctance of Alan Greenspans Fed to
    burst it?
  • even so, the explosion in collateralized debt
    obligations (CDOs) and other securities went far
    beyond what was needed to sustain mortgage
    lending
  • especially true of credit default swaps, which
    became an instrument of speculation instead of
    insurance
  • Irresponsible financial institutions of all types
    leveraging themselves to the hilt in pursuit of
    higher returns?
  • credit rating agencies that fell asleep on the
    job?

12
Who or what is the culprit? (2)
  • high-saving Asian households and dollar-hoarding
    foreign central banks that produced a global
    savings glut?
  • which pushed real interest rates into negative
    territory, in turn stoking the U.S. housing
    bubble while sending financiers on ever-riskier
    ventures
  • macroeconomic policy makers who failed to get
    their act together and move in time to unwind
    large and unsustainable current-account
    imbalances?
  • the U.S. Treasury, which played its hand poorly
    as the crisis unfolded?
  • bad as things were, what caused credit markets to
    seize up was Paulsons decision to make an
    example of Lehman Brothers by refusing to bail it
    out.
  • might it have been better to do with Lehman what
    he had already done with Bear Stearns and would
    have had to do in a few days with AIG save them
    with taxpayer money.
  • all (or none) of the above?

13
The deeper causes of the crisis hypotheses
  • Ideas
  • Economists ideas on market efficiency, the
    virtues of deregulation, and ineffectiveness/ineff
    iciency of government regulation

14
Was it economists and their ideas? (1)
  • The myth of a self-regulating, self-correcting
    market.
  • Example securitization
  • in principle, allows diversification and
    distribution of risk (tranched CDOs)
  • But requires good models of risk, full
    information, absence of agency/incentive
    problems
  • Alan Greenspan
  • "I made a mistake in presuming that the
    self-interests of organizations, specifically
    banks and others, were such that they were best
    capable of protecting their own shareholders and
    their equity in the firms. (October 2008)

15
Was it economists and their ideas? (2)
  • But there was no shortage of research on
    departures from benign view of financial markets.
  • Literatures on
  • emerging market financial crises
  • agency theory
  • asymmetric information
  • financial market bubbles
  • self-fulfilling runs (bank runs)
  • systemic risk
  • behavioral finance
  • Why did economists focus on single model at the
    expense of these alternatives and ignore the
    consequences of their own research?

16
The deeper causes of the crisis hypotheses
  • Ideas
  • Economists ideas on market efficiency, the
    virtues of deregulation, and ineffectiveness/ineff
    iciency of government regulation
  • Interests
  • The capture thesis the role of banks and special
    interests (Simon Johnson)

17
The financial capture thesis
  • Pursuit of policies that advance banks
    interests, due to
  • lobbying
  • financial contributions
  • the revolving door
  • When things go wrong, banks influence ensure
    they get bailed out
  • too big to fail
  • Key a belief system that associates public
    interest with banks interests (S. Johnson)
  • Note role of ideas again

18
The financialization of the economy
Source Johnson (2009)
19
The deeper causes of the crisis hypotheses
  • Ideas
  • Economists ideas on market efficiency, the
    virtues of deregulation, and ineffectiveness/ineff
    iciency of government regulation
  • Interests
  • The capture thesis the role of banks and special
    interests (Simon Johnson)
  • The compensation thesis the role of GSEs
    (Frannie and Freddie) in providing cheap housing
    finance (Raghuram Rajan)

20
Growing inequality
Source Mother Jones online. http//motherjones.c
om/politics/2011/02/income-inequality-in-america-c
hart-graph
21
pushes government to provide cheap housing
finance?
Share of Frannie and Freddie in total outstanding
mortgage backed securities
Source Econbrowser, http//www.econbrowser.com/ar
chives/2008/07/did_fannie_and.html.
22
But much of the dramatic appreciation in house
prices came in the two years after the GSEs began
to contract.
SP/Case-Shiller Composite 10 home price
index Source http//www.econbrowser.com/archives
/2008/07/did_fannie_and.html
23
Questions for future Research
  • What are the fundamental causes of the proclivity
    of modern economies to financial crises?
  • contribution of ideas versus interests
  • What does each theory say about avenues of
    reform?
  • What is/should be the role of economic thought?
About PowerShow.com