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Economics > Recession 2007-09 > Flashcards

Recession 2007-09 Flashcards

1
Q

What was the primary cause for the GFC?

A

Housing Crisis

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2
Q

How did the housing crisis cause the Recession?

A

Expectation was: -House prices keep rising

-Even if borrower defaulted–> Bank would sell house for more than loan value–> NO Money Loss

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3
Q

What 2 Housing booms did rising house prices cause?

A

House Building

Home equity line of credit

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4
Q

How did the 1990s Financial Crises contribute to the GFC?

A

Developing countries started Saving + Lending rather than borrowing + spending
–Lent money to USA–> Increased Savings in Capital Markets–> Increased Demand for Investment (Houses)

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5
Q

How did European Global banks help inflate the US bubble?

A

European banks borrowed from US Money Market–> Used funds to Invest in Securitised Assets–> Helped inflate US bubble- by indirectly providing Credit to US borrowers

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6
Q

What type of operations do C.Bs use to control Inflation?

A

Open-market Operations

-Buying + selling Bonds that Increase/Decrease the Money Supply

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7
Q

Define Interest rate (on Bonds)

A

Price at which people lend/borrow money

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8
Q

How do C.Bs use Open market operations to Increase AD?

A

C.B Buys bonds (debt)–> Increase Money Supply–> Lower Interest rate–> Lowers Borrowing costs for Firms + Households–> Increased Spending + Investment–> Increased AD

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9
Q

Define Reserve Ratio

A

Percentage of each Deposit that a Bank must maintain at the C.B as a reserve

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10
Q

How does the Reserve Ratio (RR) affect the Money Supply?

A

Lower Reserve Ratio–> Less money needed to be stored + more to lend–> Increased M.S
Higher RR–> Lower M.S
Lower RR–> Higher M.S

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11
Q

What is the purpose of the Reserve Ratio?

A

Ensures a level of Liquidity for every Bank to be able to meet Financial Obligations

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12
Q

What is a Bank’s balance Sheet made up of?

A

Assets + Liabilities

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13
Q

What 3 things makes up a Banks Assets?

A

Loans- e.g. Mortgages + Loans to businesses
Investments- e.g. Treasury Bonds + MBS
Cash + Reserves- includes Reserves required to hold on deposits w/ C.B

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14
Q

What 3 things make up a Banks Liabilities?

A

Deposits- made by households + businesses- Funds owed to someone else
Short-term Debt (less than 1 year)- e.g. 30 day Commercial paper
Long-term Debt (more than 1 year)- e.g. 10 year Corporate Bond

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15
Q

Define Equity

A

Value of the Institution to its Shareholders/Owners- value owed to someone else
Net worth/Capital
So, it is a Liability

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16
Q

How do you find the Equity of a Bank?

A

Total Assets - Total Liabilities

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17
Q

What Financial Regulations are Banks subject to?

A

Reserve Requirement- Reserve Ratio (~3%)

Capital Requirement- requires Bank’s Capital to be at least a certain fraction of Bank’s Total Assets

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18
Q

Define Leverage

A

Magnifies any change in Value of Assets and Liabilities in terms of Return to Shareholders

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19
Q

How do you calculate Leverage?

A

Leverage = Total Liabilities / Equity

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20
Q

If Leverage = 9, for every 10£ of Assets, what does it mean?

A

For every £10 of Assets- £9 comes from Borrowing (Debt)

-£1 comes from Shareholders money

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21
Q

What can Negative Equity lead to?

A

Insolvency or Bankruptcy

22
Q

How is the Return on Investment calculated?

A

ROI = Change in Investment / Initial level of Investment

23
Q

How is Return on Equity calculated?

A

ROE = Change in Investment / Equity

24
Q

What were the first signs of the crisis from 2004?

A

Fed started Increasing Federal Funds rate- Tightened Monetary Policy

  • To decrease inflation from rising Oil + commodity prices
  • ->Increased Cost of Borrowing–> Sub-prime borrowers having Financial difficulties–> Negative Equity–> Defaults
25
What happened in February 2007 that showed the 1st Sign of Rising Default rates on Mortgages?
Index based on Price of CDS started FALLING- processionals fell due to lower demand
26
What happened in August 2007?
Financial Institutions became Reluctant to lend to each other French Bank- BNP Paribas unable to value its structured Financial Products- Crisis was going Global
27
Why were Financial Institutions reluctant to lend to each other?
Banks traded Sophisticated Financial Instruments- e.g. MBS - -These products became common--> difficult to asses Institutions exposure to risk 1. First warning signs appear 2. Bank A starts worrying Bank B is backed up by large number of 'bad' mortgages 3. Bank A demands a Premium to lend to money--> institutions use Short-term Debt to fund Asset side of balance sheets 4. Lenders instead invest in US Treasury Bills
28
What happens if the amount of Interbank lending falls?
Liquidity Crisis Financial Institutions may have to fire sale Assets to fund daily operations--> Reduced Capital--> May lead to Insolvency
29
What did the Fed begin doing in September 2007?
Cutting Federal Funds rate
30
When did the Federal Funds Rate become 0?
December 2008
31
What happened to Northern Rock in September 2008?
Bank Run- due to BoE Emergency Liquidity Support
32
Why did Norther Rock experience a Bank Run?
Too much Money Market funding--> Excessive Leverage--> Bank Failed--> Northern Rock was Nationalised
33
What were the Crucial Events in September 2008?
Fannie Mae + Freddie Mac- Bankrupt- gov. took Ownership Lehman Brother Failed- Gov. let it fail Merill Lynch- sold to Bank of America Fed took ownership of AIG $700 Billion- Troubled Asset Relief Program (TARP) setup
34
What did the BoE start doing in October 2008?
Cutting Official Bank rate from 5% March 2009- 0.5% Conventional Monetary Policy
35
Why was Conventional Monetary Policy unsuccessful in the Recession?
Other factors come into play during extreme uncertainty Increased Unemployment Decreased Demand Spending + Investment didn't Increase Liquidity Trap- near-zero IR didn't Stimulate spending
36
How does unemployment + lower demand cause Conventional Monetary Policy to be unsuccessful?
Increased Unemployment--> concern of losing job--> Consumers put off making large purchases Lower Demand--> firms have enough Capital to meet Lower demand--> Investment not stimulated effectively
37
Why did Banks keep a high Reserve Ratio and how did it impact the success of conventional Monetary Policy?
High Reserve Ratio- Banks rather earn moderate IR on Deposits at C.B than loan to Firms + Consumers at low IR High RR--> Less Money being loaned out- Investment Not stimulated
38
What Unconventional Monetary Policy was undertaken?
Quantitative Easing- C.B purchases Long-term Financial Assets to Lower Long-term IR -Aims to directly Stimulate Business Investment + Consumption
39
What was the Success of Unconventional M.P?
During Crisis- Banks need Liquidity--> Banks may not respond to Lower IR Still facilitate Sale of Corporate Bonds Economies eventually picked up due to Low IR for many years
40
What is the Risk of Q.E?
There is so much Money in the System- When economy starts growing again--> Banks + Investors will start loaning aggressively--> Danger of Inflation
41
How can the C.B prevent Inflation?
Sell Bonds + Securitised Assets--> Lower M.S | Increase IR on deposits--> Lower M.S
42
Why does the C.B need to take action at the right pace?
Move too Slowly--> Inflation will Soar | Move too Quickly--> Recovery will Stop
43
How was Fiscal Policy used to combat the Recession?
Non-Discretionary- Increased G + Decreased Taxes (Progressive) Discretionary- Tax Cuts + Increased Aid + Spending programs
44
What did the size of a country's Fiscal Policy depend on?
Economy's Public Finances Extent of bailout Ability to use its own Currency
45
What was the impact of Fiscal Policy on Public Finances?
Public Finances were Deteriorated
46
What type of Fiscal Policy did many advanced economies engage in due to deteriorated public finances?
Discretionary Contractionary Fiscal policy | -Lower Debt/GDP
47
How is the Global Financial System 10 years later?
Much more Robust Big Banks now hold 3x-5x more Capital Banks in Europe + America- Increased Deposits--> Stable funding option
48
Why are there fears of a New Crisis?
High DEBT | Developed economies- Debt burden shifted to Public sectors
49
What was China's Debt in 2016?
250% of GDP
50
Why may Economic Growth be Debt-driven?
Rising Inequality may have caused greater use of Credit

Economics (20 decks)

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