Global Financial Crisis Flashcards
When are banking systems susceptible to collapse?
- When banks expose themselves to high risk loans
- When banks have inadequate capital to absorb losses
What’s a fact we can say about the distribution of banking crises?
That they are non random events. (They are predictable using stock prices)
How do we know banking crises aren’t random?
If they were random, all countries would experience them with equal frequency.
US has had way more than Canada since 1830s
What did Laeven and Valencia study and what did they find?
They looked at the frequency of banking crises in 117 nations.
Very few counties have plentiful bank credit and stable banking systems.
Trade off between being ‘underbanked’ and having fewer crises but slower economic growth.
What is a fact we have about the causes of baking crises?
We have panic-based and fundamental-based theories of banking crises
Banking crises entail what?
WHAT DO THEY NOY INVOLVE?
Banking crises entail a a systemic liquidity disruption
THEY DON’T involve in solvency and cosy bailouts
What is a self-fulfilling bank crisis?
Depositors panic and anticipate that the bank will be insolvent so they run. This causes bank to actually become insolvent.
How can self-fulfilling banking crises be prevented?
Suspension of convertibility
Deposit insurance
What is a fundamental based bank crisis?
When depositors observe fundamentals and have reason to believe they will be poor in the future.
What’s the difference between a fundamental and panic based bank run?
With panic, depositors predict insolvency when it’s only a liquidity crisis. This leads to insolvency if acted upon
With fundamentals, depositors see that insolvency is coming in the future.
What approach do we take to look at the GFC?
We look at information asymmetry.
Give a brief overview of the mechanism that creates information asymmetry with the housing market.
-Risky borrowers get sub-prime mortgages from banks
-Banks sell these mortgages instantly to govt. agencies promoting home ownership
-Agencies securities mortgages to create MBS and these are resold to the market
Through securitisation, we lose touch of the risk
What was the first sign of the crisis?
Freddie Mac stopped buying risky securities
Big mortgage lender went bankrupt
Volume of sub prime mortgages was 1.2 trillion, 80% securitised
Yes it was
How did the crisis get realised?
When house prices started to collapse, people handed back their keys and the value of banks assets plummeted
