Financial Crisis Flashcards
Trade Crisis
Crisis can occur from global trade imbalances
German/Greek Lesson
Insisting on austerity and conventional repayment rather than growth and debtor’s ability to pay means there is a significant risk of debts never being paid off
Finnacial Crisis
Moral hazard within the financial sector can lead to irresponsible lending
Finnance sector Lesson
Missing was consideration of institutional weaknesses on the supply side of finance for irresponsible borrowing cannot occur without irresponsible lending
National Crisis
The assumption that countries are safe creditors as they can never go bust
National debt Lesson
Governments offer no collateral and only honour debts to ensure future funding while there’s no official process to cope with defaults
Stock market Crisis
Stock markets play key role in capital allocation permitting investors to withdraw funds from struggling industry to invest elsewhere
Risk Lesson
Uncertainty is different to risk, as it implies that the probabilities of some events are unknowable, and that therefore mathematical models have there limits
Which lesson did the 2008 crisis result from?
All of them
Which lesson did the Greek crisis result from?
Conventional repayment failure
Why is trade an issue today? (2)
Trade balances should automatically correct themselves in the free market however exporters such as China create an artificially low ER
Trade balances are being invested not spent
Cost of trade imbalance
Surplus- Can create speculative bubbles that are destructive
Deficit- Leakage in circular flow of income
3 risk management strategies
Internal risk assessment of loan
Credit rating agency approval
Bank taking out insurance in case of default (CDS)
Problem with internal risk assessment
Traders have more influence as risk assessment limit the profitability of risk taking
Problem with credit rating agency
As banks own shares in credit raters creating conflict of interest and they’re methods are flawed they often tell traders what they want to hear
Problem with CDS
Price of CDS is the result of speculation and its true value is unkown to the insuror while CDS has no regulation
Too big to fail
Some banks are so large gov’s can’t allow their failure plus they lobby effectively(regulatory capture)
The Basle accord
Requires banks to hold a counter-cyclical amount of capital relative to loans with the ratio rising during boom periods
3 ways the Basle accord should be effective during a boom
Reduce the rate of increase in credit
Encourage smart loans as banks risk their capital
Larger banks’ issues are less likely to compromise others
Keynesian counter cyclical policy
Governments should run budget deficits during booms and avoid austerity during reccesion
3 more ways to regulate banks
Align incentives with long term creation
Regulate credit agencies
Standardise rules and remove loop holes
