01.2 Overview of Financial Crises Flashcards
Common elements of financial crises
* … to the economy
* …
* Exploring a new continent, new trade routes, new mine and precious metals etc
* Electricity, automobile, new production technologies, internet, financial innovation
* …
* Expansion of …
Positive shock
Productivity enhancing innovations
Financial liberalization policies
credit and debt
Common elements
* Productivity is …
* Output and incomes increase.
* …
* …
* Life is Beautiful!
* This time it is different syndrome!
enhanced.
Increasing asset prices.
Credit standards relaxed.
Common elements
* … speculation.
* …
* Over expansion of credit.
* …
* NINJA loans–>
Things turn into
Asset bubbles
Worst loans are given in good times!
No income, no job, no asset: a loan extended to a borrower with little or no attempt by the lender to verify the applicant’s ability to repay
Explain the tulipmania bubble..
Tulips were a symbol of wealth/status.
Contracts for tulip bulb purchases were often made on leverage, i.e. buyers put down only a portion of the bulb price in anticipation of reselling at a profit. When prices began to fall, many were unable to meet contract terms, triggering defaults and market collapse.
South Sea Bubble (UK, 1711-1720)
Background: The South Sea Company was a British joint-stock company granted a monopoly on trade in South America in exchange for taking on government debt.
Regulatory Lapses and Moral Hazard: Some members of the British government were invested in the company, influencing oversight. Weak regulatory frameworks and limited shareholder protections enabled these practices.
The company’s value was inflated by speculation on its monopoly rights. Investors were drawn by promises of high returns, but the company’s actual trading opportunities were far less lucrative than advertised. Information asymmetry, where insiders had better access to the company’s limited trade potential, led to widespread overvaluation.
The South Sea Company engaged in stock price manipulation, lending money to investors to buy shares, artificially inflating demand. This self-reinforcing mechanism is a classic Ponzi-like financing structure, unsustainable over time.
Great Depression 1929-1933
* Mother of all crises with devastating effects:
* … fell from $700 to $400 (%43).
* … rose to %25.
* Thousands of …. 4000 only in 1933.
* New York Stock Exchange fell …(>%85).
Per capita income
Unemployment
banks were closed
from 400 to 50
South Sea bubble (1711-1720)
* South Sea Company established in 1711.
* … from Africa to South America.
* Shares price increases when …
* Share price peaks in 1720, only to …
* Sir Isaac Newton: Sells his shares at £7,000, profiting £3,500.
* Price continues to increase.
* Re-enters the market, only to lose £20,000.
* “I can calculate the motions of the heavenly bodies, but not the madness of people”
* Not only …
Monopoly on slave trade
the company expands into other lines of business such as government bonds.
burst in a short period of time.
fundamentals but actions of players!
2023: Silicon Valley Bank, First Republic, Credit Suisse
* March 10th, 2023, Silicon Valley Bank (SVB) failed after a …
* 16th largest bank in US, $209 billion in assets.
* …since the Global Financial Crisis, 2nd largest failure in U.S. history (after Washington Mutual)
* First Republic Bank failed, on May 1, 2023, closed and sold to JPMorgan Chase.
* Credit Suisse nearly failed and got bought by UBS.
* Globally systemically important bank.
bank run.
Largest bank failure
2023 Failures and Interest Rate Risk
* … during the Global Financial Crisis, more so during the pandemic
* … that have not been seen in 40 years
* Fed start to … in March 2022 (also ECB)
* Rates reaching 5.25%
* High rates …
* SVB had a big portfolio of …
* Interest rate and duration risk leads to failure of SVB
Ultra loose monetary policy
Inflation reaching levels
increase interest rates
decrease the value of fixed income securities
fixed income securities like government bonds
