Financial Crisis Flashcards
What is a financial crisis?
It is a financial disruption in financial markets, in which financial frictions increase sharply which causes the markets to stop functioning. They are always different. However they have similar features
What do the financial disruptions involve?
Sharp drops in asset prices, like stocks . Failures of financial institutions caused initially be liquidity crisis, but which can easly be transformed into solvency crises and contage the economy.
What is the relation between financial crisis and the economy?
Talk about direct and indirect costs
What were the factors that lead to the US subprime crisis?
Political Factors; Growth of securization and OTD model; Financial innovations in mortage markets; Easy US monetary policy; Global economic cevelopmements; Misaligned incentives
Houses prices appreciated, consumption grew financed with higher borrowing that was supported by rising home prices;
Borrowers borrow due to high prices, even if the couldn’t borrow
what happened in 06-07
House prices deflated -> subprime borrowers hit hard , which lead to mortage defaults and a decrise in mbs prices. Thus the collateral decreased, and with it the interest rates increased . The credit availability decreased and the house prices decreased.
What happened in 07?
Subprime lenders declare bankruptcy, anounce large losses or put themselver up for sale. Problems in the mortage and credit markets contage the interbank market and liquidity crisis arrises. The CB coordinate efforts to increase the liquidity and decrease the interest rates.
What happened in 08?
Financial crisis escalates with collapse of major lender and investors. Exemples: Fed loan to J.P.Morgan Chase to buy falling Bear Stearns; Indy Mac taken ober by the US gov.
In the summer of 08 the fears about the solvency of the financial institutions receced,
In september the Lehman Brother filed for bankruptcy and AIG receives emergency liquidity assistance to avoid bankriptcy. Reserve Primary Fund broke the buck (per share value fell below 1$) -> Runs on MMF
The money markets lost confidence with the broke of the buck and a increase in the funding cost of bonds.
The crisis spread over Europe and CB’s cur rates in a coordinated effort to aid world economy.
What happened in 09?
The financial system begins to recover but broader economy troubled. There is a fear of deflation due to the CB policies. The fed anounces large asset purchase programs. The ECB cut rates massively expanded its refinancing operations, introduced FRFA, lauched CBPP1. Several countries reported Higher than expected increases in deficit/GDP (bust in construction and asset prices and the banking costs increased). Due to this unexpected increase the investors fear that debt is not sustainable(fear of default). This fear led to an increase in the interest rates wich worsen the situation by creating a self fueling cycle.
What happened with Greece?
from 07-09 there was an increase of fear in the government defaults and a surge in interest rates. Given the EA design, governments who got in truouble had no LOLR. Thus the second wave of turbulence started in early 2010 with the Greek solvency crisis which led to the solvency agreements. The markets expected a Greece default which caused the secondary market for government bonds to dried up.Greece had to be bailed out and the first package was approved in May 2010. In the same month the Europe securities Market program was introduced. But this faild. Markets understood that Greece was not on a clear path to debt sustainability. This caused Greece’s borrowing cost to increased, the same happened in other countries. The discussions for the second bailout in Greece started in 2011.The private sector should take parte of the cost, which lead to a increase in spread. Also during this year there were discussions about the Greece leaving EA.In March 2012 to second package was aproved. I t was destined to Private Sector Investment.
What happened to Ireland?
Asked for help in Nov 2010. The government went down trying to save the banking system. The baylour was signed in November 2010. And a doom lop started.
What is a Doom Lop?
It is a sovereign-bank vicious feedback cycle. There as a large but thiny capitalized banking system. As the fear of the solvency of the markets increased so did the fear of the gov solvency. This happened because the banks hold a large amount of domestic public debt. So when the crisis deepened, the banks needed were supported support by national government. This caused a weakening in the fiscal position of the government, which caused the refinancing costs to rise, higher debt yields. This made the balance sheet of banks weaker , thus deepning the crisis ect.
How was the ECB role? How did we got to the crisis?
From 08-09 the ECB cut rates and massively expanded its refinancing operations, introducing FRFA and launched CBPR.
Due to the EA design , governments who got in trouble had no LOLR and the second waver of problems began in early 2010. There had been a accumulation of inbalances in several euro area countries in the period preceding the financial crisis. There as and increase in P.debt / Deficit, a credit boom and a housing boom in countries like Spain. However due to the crisis there was a reduction of cross border capital flow and investor repatriated to home markets, thus reassed the internacional exposure of banks. The asset prices hou housing were reassessed just like the growth prospects in countries with macroeconomic inbalances. The euro banks exposed to us mortage market hit hard and the government came to the rescue , however it had high costs. This countributed directly to the solvebcy crisis. The ECB introduced the Securities Market Program in May 2010. The December 2011 the ECB took new measure decreasing the reserve requirements. However the distrust in the banking systems leads to massive accumulation of liquidity at the ECB in 2012 the ECB launch the banking union project. In Auguts 2012 the OMT is announced. The financial Fragmentation starts to decrease . hOWEVER INnflation and economics news worsened in 2014 the asset purchase program was extend in 2015. This crissis had different phases implied different respondes by the autorities. Not only central banks and governments financial help but this let also the changes in the institutional framework and regulatory agreement.
