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Economic crisis of 2008


Households: From the household creditst 60% of mortgages, 73% of consumer credits, 68,5% of all credits is in foreign currencis (6.552 billion Ft) As a result of ... – PowerPoint PPT presentation

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Title: Economic crisis of 2008

Economic crisis of 2008
  • I. part Causes and processes

Is an economic crisis surprising?
  • How we define crisis?
  • USA Bureau of Statistics the
  • Recession the GDP falls in two consecutive
  • Depression the aggregate fall exceeds 10
  • The straight line development of the economy is
    a human invention
  • 1854-2001 32 cycles
  • 1930-2008 16 years when US GDP falls...

How did the deepest crisis ever looked like?
During the 1929-33 crisis the GDP was almost
halved, it reached the previous maximum (1929
level) by 1940...
Explanations of economic crisis
  • Economists explain the 1929-33 crises according
    their theoretical background. Among the causes
    may one can find
  • Underconsumption
  • (keynesians)
  • Tight monetary policy in 1928-29
  • (monetarists)
  • Loose monetary policy before 1928
  • (austrian school)
  • Overproduction
  • (marxists)
  • etc.
  • There are several explanations
  • of the today crisis too...

Simple explanations of todays crisis
  • They explain with one simple cause
  • The greed of capitalism
  • But human greed is eternal its like
    gravitation its always with us...
  • The neoliberal economic policy
  • Serious deregulation in 1982 and in 1999. Does it
    take such a long time to have an effect?
  • The behavior of fin. institutions
  • Its not sufficient as a cause in itself no one
    is forced to borrow money or to make an

The reality is more complex
  • The crises is not monocausal
  • individual and
  • institutional
  • decisions, behavior etc. are behind it..

The background of decisions
  • From the 1990s
  • Propensity to risk increases, perception
  • of risk changes
  • In the investment market owners disappear or
    remain hidden the market are often moved
  • by special managerial interests

Sweeping financial innovation, legging state
Institutional background
  • Political aims
  • Decent housing for low income
  • families, stimulated by state guarantees
  • New lending techniques
  • securitization, credit risk management
  • credit quality improvement, rating agencies
  • Capital abundance
  • Enormous USD reserves in countries with trade
    surplus (BRIC countries)
  • Low interest rate credits are flooding
    the financial markets

Institutional factors political causes
  • The keyword (from Clinton to Bush)
  • monetary policy Its good for the economy
  • The output of construction and other industries
  • The over-spilling effects generate further growth
  • But not everyone is qualified for credit!!!
  • What can we do to reach the aims?

Institutional factors what are the US mortgage
takers like?
  • Prime debtors (cca. 80 of all debts)
  • Good credit quality and history
  • Well documented income
  • Proper collateral and downpayment
  • Jumbo and near-prime (cca. 6)
  • Above 417 000, but with government guarantee, or
  • Slightly above qualification level and/or
    unstable income
  • Nonprime (subprime) (cca. 14)
  • Bad credit history, low credit qualification
  • Instable income perspectives
  • Low or missing down payment, no proper collateral
  • In 2006 40 of all new mortgages is subprime!!!
    They represent high risk and would get credit
  • for higher (or changing) interest. The aim cant
    be reached...

Institutional factors how to make the borrowing
  • Special guarantees
  • Banks cant take this risk, if they can they
    have to charge high interest rates
  • In order to avoid it
  • The mortgage bonds issued by banks, are
    guaranteed by quasi-governmental financial
    institutions (Fannie Mae, Freddie Mac, Ginnie Mae)

Institutional factors how the changes of the
financial system make this possible?
  • New financial techniques
  • Methods successfully applied in car financing
    have been taken over
  • (i.e. zero down-payment)
  • Financial innovation for risk management and
    interest rate decrease
  • securitization
  • repackaging
  • New financial theories (new methods of risk
    analysis and portfolio building)
  • New regulations of financial activity and
  • Specialized institutions are replaced by
    universal ones
  • all activities under the same roof - financial
  • The spread of new collective investment forms
  • Investment funds, mutual funds, etc..
  • hedge funds
  • Enormous leverage, gigantic investments with high
    risk and small capital
  • At the height more than 3.000 billion (25 times
    the Hungarian GDP)
  • They represent more than half of the total world
    financial turnover...

Institutional factors how the loaning techniques
have changed?
Classical solution
Mortgage with prime collaterals
Prime mortgage debtors
Savers and investors
Issue purchase of guaranteed securities
Collection of funds with quasi-governmental guaran
Mortgage with prime collaterals
Bankok, jelzálog- hitelintézetek
Issue of non-guaranteed securities
Subprime mortgage
Collection of funds after 2000
Credit rating institutions, credit quality
enhancement, credit insurances, underwriters
Subprime mortgage debtors
Financial innovations credit enhancement,
  • How can we sell risky mortgage assets with low
    returns to the investors?
  • I.e. in form of collaterized debt obligations
  • The cash flow from mortgage pay back is organized
    into packages with different risk, which absorb
    the risk according a prearranged plan
  • The lowest graded package absorbs the risk of
    first nonperforming debts, the higher rated ones
    one by one, later
  • But! All the packages are devalued when the risk
    is higher than the forecasted
  • In most cases they repackage the assets

How repackaging works?
70 000 AAA 0,3 210
50 000 BBB rated RMBS 3 1500
After they are collected re-rated and selected
into new packages
100 000 BBB rated RMBS 3 3000
20 000 BBB 2,8 560
20 000 BBB rated RMBS 3 600
30 000 BBB rated RMBS 3 900
10 000 without rating 2230
RMBS - Residential Mortgage Backed Securities,
the BBB rating means that the probability of
loss is 3, the expected loss is 3 of nominal
Where the investors come from?
  • US savings are very low, in practice zero...
  • Several countries accumulated enormous USD
    reserves and they invest it in the USA
  • I.e. China has 2.000 billion reserves!!
  • This creates the inflow of easy money to US
  • Make for the indebted population
  • The further borrowing and consumption easy
  • The entrepreneurial sector can also be financed

The background of individual decisions
  • Cultural pressure to own a home
  • Its is strengthened by media/promotion
  • Easy access to credits
  • Homes are very good investments, because
  • Interest on bank deposits are low
  • The stock exchange investments are risky the
    memories of dotcom crisis are vivid
  • Home prices increase at an annual rat of a 7-9
    from 1999 to2007!
  • There are tax advantages if you generate revenue
    by selling a home
  • Bubble psychology
  • On the waves of secure, good investments more
    and more, people would like to surf. Everyone who
    can, invests in housing (flock effect)
  • Banks are over-loaning, banks calculating with
    quick price increases

US home price index 1999 100
The direct causes of the crisis
  • The housing bubble deflates...
  • Oversupply makes the prices to fall
  • The collateral value of houses declines
  • The borrowed amount exceeds the collateral value
    of the house
  • Construction of new homes goes down
  • The circumstances of bad debtors deteriorate
  • The bad debtors cease to pay the installments
  • The bank launches a foreclosure process
  • The foreclosed houses increase the supply on the
    market and press the prices down...

Number of homes with foreclosure activity in the
The process of the crisis
Over- supply
Home prices fal
Financing stops
Mortgage crisis
Housing bubble
Fall of construction industry, growing
Losses in the financial sector
Banks investment companies go bankrupt
Investors capital loss
Fall of investments Growth of unemployment Fall
of stock exchanges
Licvidity crisis
The consequences of the crisis
  • Banks raise their funds in the inter-bank capital
  • There the credits are provided without
  • But now they cant calculate the risk, so they
    cant calculate the prices... As a result, no
    credits are offered
  • Banks try to collect funds from their borrowers,
    branches and maiden companies
  • The financing of enterprises stops
  • Consumption credits are tightened or suspended
  • Car car industry
  • Housing construction industry
  • The crisis is overspilling to the real economy
  • In many countries protectionist measures are taken

II. part Effects and therapies
Concrete consequences
  • The poisoned papers generate giant losses
    (bankruptcies, insolvencies)
  • Bear Stearns, Lehman Brothers, Merryll Lynch,
    AIG etc.
  • Interbank markets are paralysed
  • The risks cant be priced
  • Investors escape to safe heavens T-papers, the
    returns fall
  • USA the return is 0,02 on the 3 Month T-notes
    the lowest since 1941!
  • The financing of industrial and service sector

Rescue actions in the world
  • Financial rescue packages to the financial sector
    (USA 700 billion!)
  • State subsidies and supports (capital and credit)
  • Buying out of poisonous, troubled securities
  • Nationalization
  • Loans to companies
  • Consolidation of nonperforming debtors
  • I.e. rescue of non performing mortgagers

Stimulus packages
  • Increase of budget expenditures
  • Increase of the deficit, where possible
  • Living up the reserves, where they have
  • Stimulate entrepreneurs
  • Interest rate decrease
  • FED 0-0,25! ECB 1,0, SNB 0,25, JNB 0,1, Bank
    of England 0,5 - lowest in 315 years...
  • they navigate themselves into a liquidity trap
  • Tax reductions
  • Sales promotion
  • i.e. rust premiums in car markets

US stimulus program
  • Obama Stimulus Plan 787 billion from which
  • Tax reduction 286 billion
  • Infrastructure development 120 billion
  • Social programs, expenditure up by 381 billion
  • Protectionist voices are heard buy American!

Is this a solution?
  • Mixed reception among Nobel-laurates
  • J. Stiglitz and P. Krugman
  • Support it, they want stronger intervention and
    government involvement. Unemployment and
    deficit will go down.
  • R. Lucas, V. Smith, E.C. Prescott, J. Buchanan
  • Are against, it will increase unemployment, and
    the budget deficit...

Legal measures in order to stabilize
  • Increase of bank deposit insurance levels
  • Strengthening the supervision
  • Special governmental entitlements
  • (i.e. right to nationalize)
  • In the EU
  • The joint measures are slowly accepted
  • Budget deficits exceed the Maastricht limits
  • Protectionism, search for individual solutions
    shows up
  • A lot of steps against the treaties ind
  • i.e. subsidies against the regulations in
    competition directive

How the crises affected Hungary a case study?
  • Lack of liquidity, the credit flow stops, because
  • There are no household savings (formerly
    negative real interest...)
  • The banking system cant acquire external
  • Formerly the mother institutions financed them
    from the money they borrowed in international
    markets in foreign exchanges
  • The mother banks ar not able to provide
    sufficient funds
  • Investors trust is falling, foreigners
  • Sell their securities
  • Dont buy the new issues of Hungarian government
  • (October the treasury paper market is literally

The change of forint assets in foreign hands
(source HNB)
One can see when foreign investors started to sell
HNB bonds
  • The first wave of Forint weakening (around 280
  • Natural as lending in FX stops,
  • and foriegn capital is withdrawn
  • Speculative dangers increase
  • Financing of high foreign debt service seems to
    be in danger
  • The weakening HUF increases the foreign debt
  • T-paper returns jump high
  • The market based financing of budget deficit is
    in doubt
  • State bankruptcy was not far...!!!

Reactions and life-belts
  • October 22. the HNB increases the base interest
  • A 20 billion IMF, ECB, IBRD joint credit package
    is quickly organized
  • According to calculations the financial collapse
    of the country
  • is postponed at least till spring of 2010

Second wave
  • Further credit tightening
  • Though the high base rate is decreased
  • Foreign banks Hungarian daughters do not have
    funds to lend
  • The stabile countries suck the resources
  • Erosion of real economy (GDP min. -6,7)
  • export and home markets are shrinking
  • Output is down
  • Unemployment is up
  • Home markets are further shrinking

Further exchange rate erosion
  • Households
  • From the household creditst
  • 60 of mortgages,
  • 73 of consumer credits,
  • 68,5 of all credits is in foreign currencis
    (6.552 billion Ft)
  • As a result of weakening forint
  • The credit stock increases with around1.100
    billion HUF,
  • The bank deposit stock increases with around 230
    billion HUF
  • The state
  • Indebtedness is increasing
  • The foreign debt service is growing...
  • The CDS of new borrowings becomes striking (more
    than 5)

Hungarian therapies...
  • The economic situation forces the government to
    take the opposite of the measures in other EU
  • Base rate increase ...
  • Later as it endangered the operation of
    companies and deepened the crises, a
    radical decrease was going on...
  • ... But it was blocked by the second wave of HUF
    exchange rate fall (more than 310 Ft/)
  • Expenditure reduction
  • Taxes remain the same
  • ... Sometimes we follow the international trends
  • Bank rescue package (HUF 300 billion capital HUF
    300 billion credit guarantee)
  • Financial support to companies

Certain central bank instruments are exhausted by
  • A base interest rate decrease is needed
  • ... but this would weaken the HUF increasing the
    debt burdens and the default risk of mortgage and
    credit holders
  • the high currency risk keeps the foreign
    investors away
  • Neither decrease, nor increase is possible. The
    defense of exchange rate is viable
  • only by market interventions (buying HUF against
  • but the resources may be limited

The economic policy of the government is trapped
  • Further debts are out of reach, reserves are
    limited, so
  • No money to increase the expenditures
  • The need for radical structural change in
    expenditures is inevitable,
  • In the given framework
  • No intention of genuine budgetary reforms
  • To get rid of the risks generated by the high
  • Superficial changes, killing the time, no real
    programs, permanent political crisis

No consensus in the measures to be taken...
  • A radical, paradigmatic change seems to be
  • A serious reduction of redistribution
  • The transformation of social benefit system
  • Transformation of pension system
  • Restructure the social security and health
    service system
  • Transformation of higher educational system
  • Restructuring the subsidies and supports of
  • Tax reform, extend the number of tax subjects
  • Its not viable without conflicts with certain
    social and political groups...