Caveats Themes are moving targets FC of 2008 is not identical/coincidental but co ‐ relational to Euro crisis Causes of the Euro crisis vary between the countries Effects, for the most part, early to measure of steps taken to deal both issues Not all ROs have mandate on issues of financial surveillance and banking (EU, CEMAC’s COBAC) Finally work in progress to further map competences of ROs in this area
Main questions What were causes, effects and responses of the FC of 2008 and of the Euro zone sovereign debt crisis? What did regional (financial) organisations do to address the problems? What are dangers of these problems not being addressed?
Practical goal This discussion is meant to provoke further reflections on the current situation and especially for participants to reflect on the implications of the crisis on their own research themes
Structure The 2008 crisis: causes; effects; reactions The Euro Sovereign Debt Crisis: causes; effects and reactions The RFOs Their actions in response to the 2008 crisis Challenges and prospects
The 2008 FC: Quid? Regarded as the greatest economic crisis since the Great Depression of the 1930s. The financial crisis itself ended between end 2008 and mid 2009 but the aftershocks continue to reverberate.
Main stimulant Construction boom since 1980s with Fed maintaining low interests and foreign cheap money coming into the US there was a sense of debt financed consumption: easy credit for cars, mortgages, credit cards As the housing boom surged so too did mortgaged backed securities (MBS) and collaterized debt obligations (CDOs) whose value is a function of the housing prices. With bursting of the bubble, housing prices declined and those who had invested in MBS and CDOs reported serious loses Falling housing prices meant prices of many houses became less in value than the mortgage loan hence foreclosures. Defaults in the housing market expanded to other sectors of the economy
Sub causes Housing bubble and sub prime predatory lending: Between 1997 and 2006 the value of a typical US house increased by 124 per cent. As a result people started getting into second mortgages etc. Then Wall Street suddenly realized that trillions of outside money was looking for investment options in the US and so MBS and CDOs developed. This extended the bubble. By September 2009 over 14% of US mortgages were either delinquent or in foreclosure.
Sub causes Deregulation that did not keep pace with the shadow banking system, derivatives (Buffett’s financial WMDs); off balance sheet financing. Deregulation examples included 1982 Garn St Germain Depository Institutions Act introducing ARMs; 1999 Gramm ‐ Leach ‐ Bliley Act that amended Glass Steagall of 1933 removing separation between commercial and investment banks; 2004 SEC introduced Net Capital Rule that increased levels of debt that investment banks could take on board
Sub causes Too much debt and leverage both by companies and consumers. Eg in 1981 US private debt was 123% of GDP. That figure was 290% by third quarter of 2008. Lack of transparency in the modus operandi of banks (especially in terms of debt levels; likes of Maddoff) and also the boom of the shadow banking system through which bad mortgages were financed (Geithner and Krugman point to these as the key issues)
Sub causes Very high increase in commodity prices that followed the housing bubble: the price of oil moved from about 50 US $ in 2007 to about 147 US $ p/b in 2008. This helped constrict economic growth in oil importing countries. Also from start 2004 to 2008 price of a tonne of copper moved from 1600 to 7040 US $. Some like Ravi Batra (systemic); John Bogle (huge exco compensation; manager’s capitalism; failure of gate keepers); Robert Reich (fall in wages of hourly workers 80% forcing debt accumulation) argue that the crisis is simply symptom of deeper structural and systemic problems faced by financial capitalism.
Summary of causes The Phil Angelides Commission issued its report in 2011 and had very harsh conclusions: “the crisis was avoidable and was caused by: Widespread failures in financial regulation, including the Federal Reserve’s failure to stem the tide of toxic mortgages; Dramatic breakdowns in corporate governance including too many financial firms acting recklessly and taking on too much risk; An explosive mix of excessive borrowing and risk by households and Wall Street that put the financial system on a collision course with crisis; Key policy makers ill prepared for the crisis, lacking a full understanding of the financial system they oversaw; and systemic breaches in accountability and ethics at all levels.”
Summary of Causes by Congress The Levin ‐ Coburn report revealed that the crisis was caused by high risk complex financial products; undisclosed conflicts of interests; failure of regulators and credit rating agencies; and failure of the market itself to control excesses of Wall Street.
Unpredicted ? Some like Robert Shiller, Nassem Taleb and Nouriel Roubini predicted the crisis but Roubini was castigated by the likes of the Guardian and the New York Times.
Main Effects (US)? In the US the DJIA peaked 14000 points in October 2007. Fell in 2008 and by March of 2009 was 6600 (more than 50% fall) but regained steam in 2011 and 2012 due to Fed actions. From Jan 2007 to Sept 2009 US banks lost 1 trillion dollars of toxic assets due to bad loans. These figures sharply increased in post 2009 period. Some of the banks failed or were basically seized by Government: AIG; Lehman Brothers; Wachovia, Citigroup, Washington Mutual etc.
Main Effects (US) ? Huge bank runs and frozen lending; housing prices plummeted; retirement assets tanked. All placed at 8.3 trillion US $. In US economic activity declined and by Oct 2009 unemployment was 10.1% the worst since 1983 and almost twice the rate before the crisis.
Main Effects (Beyond US)? Derivatives and CDOs were bought and held globally. For EU banks first victim was Northern Rock that was eventually nationalized in 2008 by the UK Government. So there have been bank failures in Europe; decline in stock indexes and steep reduction in market value of equities. Iceland suffered most in terms of the banking crisis and the effects have been hard. Serious decline in GDP in many countries including 9.8% decline in 2009 in Euro area. In developing countries growth also fell due in part to low demand from the West and also due to low levels of remittances all these leading to increased levels of those living below the poverty line.
Responses (US)? General trend has been: fiscal stimulus, monetary policy expansion and bailout of institutions. In September 2008 Bernanke and Paulson proposed 700 $ billion emergency bailout warning US law makers that failure to act posed an existential threat to US’ economy. In October 2008 the Troubled Asset Relief Program became law. Under the Fraud Enforcement and Recovery Act (Public Law 111 ‐ 21) of 2009 signed by President Obama a Commission was created to investigate the causes of the crisis of 2007 ‐ 2010.
Responses (US)? For the long haul, the Obama Administration embraced the Volcker Rule (tougher bank financial requirements and prudential standards; check on executive pay; control of derivatives and shadow banking and enhanced powers of Fed to wind down institutions too big to fail) Adoption in July 2010 of Dodd ‐ Frank Wall Street Reform and Consumer Protection Act on Bank reform and financial regulation (which Republicans have vowed to repeal)
Responses Beyond the US ? In Europe Basel III regulations were adopted amongst others to reduce leveraging; reduce counter party risks and introduced new liquidity conditions. ** The approaches used by Brazil especially in the context of the crisis can be summarized as: raising of the minimum wage; more capital controls (marked by 2002 national rather than international sale of bonds); very strong use of industrial policy to push foreign policy goals; aggressive use of the WTO and conservative monetary policy.
Popular Reactions to Responses ? Occupy wall street and demonstrations against bankers: as the governments pumped money into the economy to boost spending the banks instead used the money to invest internationally especially in emerging markets and also in foreign currencies and in some cases pay executives bonuses
Real danger ? Call for more stimulus have been led by Krugman but there are some (Buchanan and Smith) who believe that more stimulus will extend current account deficits and retard growth In the throes of this sense of indecision as to what to do many fear that if the global economy fails to improve many economies may face sovereign default Which leads us to the discussion on Euro zone sovereign debt crisis
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