01 Overview of Financial Crises

Question 1

2007-2009 Crisis and Failures
* During the crisis (2007-2009) we observed failure or near-failure of major financial institutions.
* Royal Bank of Scotland (RBS) was the largest bank in the world for a brief period in 2009.
* Crisis around the financial sector: who?
* … to contain the crisis.

Answer 1

Banks, shadow banks, insurance companies

Extra ordinary measures

Question 2

Explain: deposit insurance.

Answer 2

What is Deposit Insurance? Deposit insurance is like a safety net for your money in the bank. If the bank suddenly goes out of business, the government (or a government agency) promises to pay you back up to a certain amount of your deposits.
What Happened in the Crisis? Before the crisis, in the U.S., this protection was up to $100,000 per person per bank. During the crisis, the limit was raised to $250,000. This was done to prevent people from panicking and pulling their money out of banks, which could have made the financial system even more unstable.

Question 2

2007-2009 Crisis and Interventions
* Increase in …
* … on bank debt
* …
* … of last resort facilities
* …

Answer 2

deposit insurance ($100K to $250K in the US)
Blanket government guarantee
Recapitalizing banks
Expanding lender
Quantitative easing and asset purchase programs

Question 3

2. Blanket Government Guarantee on Bank Debt
   What is a Government Guarantee? …
   What Happened in the Crisis? …

Answer 3

A government guarantee means the government promises to pay off certain debts if a bank can’t. It’s a way to make lenders feel safer about giving money to banks because they know the government will back them up.

During the crisis, many banks were struggling to stay afloat. To make sure they could still borrow money, the government said it would cover any debts that the banks couldn’t repay. This helped banks access money they needed to operate and reassured lenders.

Question 4

What Does “Recapitalizing” Mean? Recapitalizing a bank is like giving it a financial “booster shot.” It usually involves …
What Happened in the Crisis? During the crisis, many banks had taken big losses and didn’t have enough money to cover them. …what then?

Answer 4

putting more money into a bank so that it has enough funds to continue lending and operating normally.

Governments stepped in by investing directly in banks (often buying shares in them), giving them a cash infusion so they could survive and keep lending to businesses and individuals.

Question 5

Expanding Lender of Last Resort Facilities
What is a Lender of Last Resort? A lender of last resort is typically … that …

What Happened in the Crisis? During the crisis, the central banks expanded their role as lenders of last resort. They offered …
This helped banks that were …

Answer 5

the central bank (like the Federal Reserve in the U.S.)
provides emergency loans to banks or financial institutions that can’t get money elsewhere.

more types of loans, to more types of financial institutions, and at better terms.

short on cash get the money they needed without collapsing.

Question 6

Quantitative Easing (QE) and Asset Purchase Programs
What is Quantitative Easing? Quantitative Easing, or QE, is when a central bank …This pumps extra money into the economy.

What Happened in the Crisis? In the crisis, central banks used QE to buy huge amounts of financial assets. This was meant to:
x3 things

Each of these measures was designed to stabilize the financial system, restore confidence in banks, and encourage lending and spending to revive the economy.

Answer 6

creates new money (electronically) and uses it to buy financial assets like government bonds or mortgage-backed securities.

Increase the money supply (more money in circulation).
Lower interest rates (making it cheaper to borrow).
Encourage spending and investment to get the economy moving again.

Question 7

Financial Crises
* Banking crises
* Emerging markets:
* Currency crises
* Twin crisis

Answer 7

When banks face severe financial problems, typically because they don’t have enough cash to cover withdrawals or meet their obligations. This can lead to banks going bankrupt or needing help from the government to stay afloat.

A currency crisis happens when a country’s currency suddenly loses a significant amount of its value compared to other currencies. This can make imports very expensive, cause inflation, and hurt the economy.

A twin crisis is when two types of financial crises happen simultaneously: a banking crisis and a currency crisis. It’s a double hit to a country’s financial system, making recovery much harder.

Question 8

Cost of Financial Crisis

Answer 8

• Fiscal costs
• Output loss
• Bank of England: Hoggarth, Reis and Saporta (2001):
  Cumulative output losses equivalent to 15-20% of GDP