The financial crisis 2007-2009 International finance 120181-1165

Lecture outline

 Definitions  The origins of the crisis  Possible explanations of the crisis- empirical evidence  Preventing financial crises International finance 120181-1165

Financial crisis- definition  Powerful shocks within the financial system which trigger a decrease or a deepening of the already ongoing production decrease International finance 120181-1165

Stock market crunches

 Rational expectations  Growing productivity- assumptions  Behavioral finance International finance 120181-1165

Stock market crunches

 The source of speculative purchases  Loans- payback constraints  Influence on domestic demand International finance 120181-1165

Speculative bubbles

 Growing deviation of the present values of prices/ER from their theoretical values till the moment of price collapse International finance 120181-1165

Banking crises

 The willingness of banks to grant loans  Information concerning the situation of enterprises  Moral hazard  Negative selection of the borrowers International finance 120181-1165

Banking crises

 „

Toxic debt

”  The solvency of the banks  Financial accelerator  Credit amount expansion International finance 120181-1165

Currency crises

 Will the CB be able to maintain the ER?

 3 generations of currency crises  1 generation- Krugman  2 generation- Obstfeld  3 generation- eclectic model International finance 120181-1165

Currency crises

 Banking supervision  Official foreign reserves shifts  The development of financial markets International finance 120181-1165

Speculative attacks  Speculation against fixed ER  The mechanism of the attack  The consequences of the attack  Example: speculative attack on GBP in 1992 International finance 120181-1165

The origins of the crisis 2007-2009  Excessive CA deficit in the USA  Twin deficits in the USA  Issuance of governement bonds- main purchaser- China International finance 120181-1165

The origins of the crisis 2007-2009  Expansionary monetary policy of the FED  Law level of i%  Low credit costs International finance 120181-1165

Expansionary monetary policy of the FED

International finance 120181-1165

The origins of the crisis 2007-2009  Petrodollars as a source of global liquidity  Supply shocks on the oil market  Inflationary impulses  i% increase  difficulties to pay back loans  Decrease of real estate prices International finance 120181-1165

The origins of the crisis 2007-2009  Speculative bubble on the US housing market International finance 120181-1165

The origins of the crisis 2007-2009  International banking deregulation  Non- banking institutions- no regulation  Subprime loans 

Adjustable rate mortgages



Mortgage backed securities

 CDO  C

redit risk swap

International finance 120181-1165

The origins of the crisis 2007-2009  Financial innovations  Leverages  New risk management techniques International finance 120181-1165

The origins of the crisis 2007-2009  The collapse of the bubble  immediate real estate prices decrease  Large losses in the financial sector  Housing market crunch  banking crisis  economic crisis International finance 120181-1165

The origins of the crisis 2007-2009  Credibility crisis on the banking market  Liquidity crisis  Insolvency menace of numerous institutions  FED rescue plans International finance 120181-1165

The origins of the crisis 2007-2009  Global unequilibrium  Financing US investments from foreign savings  global financial crisis International finance 120181-1165

The effects of the crises  Decrease of i% by many CB  CB actions coordination- market signaling  Expansion of the crisis into the real economy International finance 120181-1165

The effects of the crises  The spread between LIBOR and the FED reference i%  Paulson plan  Rescue plans in Europe International finance 120181-1165

From stock market crunch to debt crisis  Reinhart, Rogoff 2010  Debt as a signal of banking crises  Governements fuelling credit booms  Banking crises as a signal of debt crises  Hidden debt as accelerator International finance 120181-1165

The governement’s and CB’s actions  Taylor 2009  The expansionary monetary policy of the FED as the main reason for the crisis  Global saving glut ???

 What prolonged the crisis?

International finance 120181-1165

„

No boom no bust

”

• Source: Taylor, op. cit International finance 120181-1165

Global saving glut???

Source: Taylor, op. cit International finance 120181-1165

What prolonged the crisis?

 Lack of liquidity?

 Credibility crisis?

 Risk premium explaning the spread between LIBOR and the reference i% International finance 120181-1165

The excessive/insufficient regulation paradox  Aizenman 2009  Regulation thresholds  Dependence of the regulation strictness on the length of the period without a crisis 

Regulatory behaviour

 2 paradoxes International finance 120181-1165

The excessive/insufficient regulation paradox  Possible solutions  Information disclosure  Independence of regulatory authorities  Regulation centralization  Global standards International finance 120181-1165

Early warning indicators

 Frankel ,Saravelos (2010)  Explainig the crises with several economic values fluctuations  Past ER developments  The level of foreign reserves International finance 120181-1165

Behavioral finance  Szyszka (2009)  An alternative approach to financial markets analysis  Mistakes of market participants  Psychological aspect International finance 120181-1165

Behavioral finance

 Gready investors  Risk underestimation  Herding  Limited rationality  Mistakes of rating agencies International finance 120181-1165

Preventing financial crises  Preventing the occurence of bubbles  Preventing banking crises  Preventing currency crises International finance 120181-1165

Summing up

 The definitions and elements of the financial crisis  The origins of the fiancial crisis 2007-2009  The role of the governements, CB and regulatory authorities  Changes in financial supervision International finance 120181-1165

Summing up

 Behavioral approach to the crisis  Financial market psychology  Preventing crises International finance 120181-1165

References

       A. Sławiński, Rynki finansowe, PWE, Warszawa 2006 P. Krugman, M.Obstfeld, International economics: theory and policy, Pearson, Addison Wesley, Boston 2009, J. A. Frankel, G. Saravelos, Are Leading Indicators of Financial Crises Useful for Assessing Country Vulnerability? Evidence from the 2008-09 Global Crisis, NBER Working Paper No. 16047, Cambridge 2010, J. Aizenman, Financial Crisis and the Paradox of Under- and Over-Regulation, NBER Working Paper No. 15018, Cambridge 2009, J. B. Taylor, The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong, NBER Working Paper No. 14631, Cambridge 2009, C. M. Reinhart, K. S. Rogoff, From Financial Crash to Debt Crisis, NBER Working Paper No. 15795, Cambridge 2010 A. Szyszka, Behawioralne aspekty kryzysu finansowego, Bank i Kredyt 40 (4), Warszawa 2009 International finance 120181-1165