Lecture 3 - Financial Crises: History Flashcards
What are economic crises often preceded by?
Economic crises are often preceded by a period of high growth that has been supported by ample liquidity provided by both domestic and foreign sources
Explain the Liquidity Crisis of 33 AD
- In 33 AD during the reign of the Emperor Tiberius, a number of regulatory measures on the market of real estate loans and a significant decline in public spending led to a sudden shortage of money and a contraction of credit that threatened to bankrupt Rome’s financial system
- At those times credit was provided by banks owned by very rich individuals
- As borrowers attempted to comply with the regulations by selling land, the prices of real estate collapsed. In the meantime runs on banks exaggerated the economy’s liquidity problems
During the Liquidity Crisis of 33 AD how was a complete collapse of the economy avoided?
An injection of free interest rate loans in the economy averted the complete collapse of the economy
Explain what is meant by debasement
- Debasement occurs when a government reduces the gold or silver content of their coins allowing them to produce more out of a given quantity of the metal
- This allowed governments to pay back their debts and it also reduced significantly the purchasing power of the currency
Explain how the Great Debasement (1544-1551) occurred?
The Great Debasement (1544-1551) occurred as there was a succession of debasements in the period 1544-1551 during the reigns of Henry VIII and Edward VI
Explain how the Tulip Mania (1637) financial crisis occurred?
- Originally the demand for the flower picked up as a result of scientific interest in the bulbs. However, from around 1630 bulbs became attractive financially. In 1636 and early 1637 there was a frantic trade in tulips
- Countless people with no prior interest in the flower invested in tulips, some of them even putting up their homes as collateral so that they can get funds to finance their investment
- In February 1637 the market crashed with adverse consequences for many investors
Explain the events that led up to the financial crises of the South Sea and Mississippi Bubbles
- Both of these crises were preceded by a new type of financial innovation which was the exchange of government debt for private equity
- The deal was that in exchange of monopoly rights with respect to some trading activity, a private company would assume the country’s government debt
- In Britain the South-sea Company was granted exclusive rights in any trade in the South Seas with the Spanish colonies
- In France the Scotchman John Law founded a bank to support government finance and was able to purchase Mississippi Company that held royal patents to colonise the territory of Louisiana
Explain how the two financial crises of the South Sea and Mississippi Bubbles occurred
- Both the South-Sea Company and the Mississippi Company issued shares to cover the corresponding government debts
- The shares of the former rose dramatically during the first half of 1720 and remained flat till September and then crashed
- The shares of the latter rose fast in 1719 and early the following year, the bubble burst in the spring of 1720
What is the relationship between the 1929 stock market crash and the Great Depression?
The 1929 stock market crash caused the Great Depression
Explain the stock market situation before it crashed in 1929
- The 1920s was a period of speculative boom initially fuelled by fast economic growth with all sectors of the economy growing very rapidly
- During the first half of 1929 the combined profits of 536 manufacturing and trading companies increased by 36%
- These numbers convinced many Americans to invest heavily in the stock exchange leading to investors borrowing $8.5 billion so that they can invest in stocks
- The rise in share prices resulted in speculation of further rises creating a bubble
- The stock market peaked on the 3rd September 1929 and by that time economic indices were falling affecting the confidence of investors
Explain the events of the stock market crash of 1929/Great Depression
- There was a collapse in aggregate demand driven by a lack of confidence by consumers and investors and by a drop in aggregate liquidity
- The labour market severely crashed
What was Black Monday?
- On Monday the 19th October 1987 Black Monday occurred
- There was a decline of more than 20% in various US stock market indices
- The causes of the decline have been attributed to problems with the microstructure (organisation and operations of these markets and not with economic fundamentals
What were the three main problems caused by Black Monday?
1- Margin Calls: Investors can borrow finds to buy shares by posting the shares as collateral. When there is a drop in the price of shares the value of collateral decreases. Lenders will then ask borrowers to repay part of the loan. During a crisis, margin calls can exaggerate any already in place liquidity problems
2- Program trading: A great bulk of trading is automatically done by computers that have been programmed
3- Information acquisition problems: Markets work efficiently when trades reflect new information. However, during a panic traders follow the actions of other traders thus reinforcing the decline of prices which cease to reflect economic fundamentals
Explain the situation in South East Asia before the twin crisis in 1997
- For several decades before the crisis, economies in the Southeast Asian region experienced high economic growth rates and moderate inflation rates
- From the second half of 1980s there were also increases in stock prices and land values
- Furthermore, many banks and corporations in the region relied on short-term foreign loans for financing their operations
What led to the Southeast Asian Twin Crisis of 1997 to happen?
The crisis in Thailand:
- The crisis occurred as a result of a series of external shocks such as the devaluation of the Japanese yen, the sharp decline in semiconductor prices and the severe decline in asset prices
- In Thailand, these developments put downward pressure on the foreign exchange market ending with the collapse of the Thai baht in July 1997
Explain the events of the Southeast Asian Twin Crisis of 1997
- There was a wave of currency depreciations and stock market declines
- In 1998 the value of the most affected East Asian currencies fell by 35-83% against the US dollar and the most serious stock declines were as great as 40-60%
- There was a sharp decline of credit flows and as a result economic activity in the region collapsed
Explain the events of the Dotcom bubble 2000
- The dotcom bubble was a rapid rise in U.S. technology stock equity valuations fuelled by investments in Internet-based companies during the bull market in the late 1990s. The value of equity markets grew exponentially during this period, with the technology-dominated Nasdaq index rising from under 1,000 to more than 5,000 between the years 1995 and 2000. The bubble burst between 2001 and 2002 with equities entering a bear market
- By the end of 2001, most dotcom stocks went bust with the share prices of blue-chip technology stocks like Cisco, Intel and Oracle losing more than 80% of their value
What is a bear market?
A bear market is a financial market experiencing prolonged price declines, generally of 20% or more
