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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
Q

What happened in February 2007 that showed the 1st Sign of Rising Default rates on Mortgages?

A

Index based on Price of CDS started FALLING- processionals fell due to lower demand

26
Q

What happened in August 2007?

A

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
Q

Why were Financial Institutions reluctant to lend to each other?

A

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
Q

What happens if the amount of Interbank lending falls?

A

Liquidity Crisis
Financial Institutions may have to fire sale Assets to fund daily operations–> Reduced Capital–> May lead to Insolvency

29
Q

What did the Fed begin doing in September 2007?

A

Cutting Federal Funds rate

30
Q

When did the Federal Funds Rate become 0?

A

December 2008

31
Q

What happened to Northern Rock in September 2008?

A

Bank Run- due to BoE Emergency Liquidity Support

32
Q

Why did Norther Rock experience a Bank Run?

A

Too much Money Market funding–> Excessive Leverage–> Bank Failed–> Northern Rock was Nationalised

33
Q

What were the Crucial Events in September 2008?

A

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
Q

What did the BoE start doing in October 2008?

A

Cutting Official Bank rate from 5%
March 2009- 0.5%
Conventional Monetary Policy

35
Q

Why was Conventional Monetary Policy unsuccessful in the Recession?

A

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
Q

How does unemployment + lower demand cause Conventional Monetary Policy to be unsuccessful?

A

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
Q

Why did Banks keep a high Reserve Ratio and how did it impact the success of conventional Monetary Policy?

A

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
Q

What Unconventional Monetary Policy was undertaken?

A

Quantitative Easing- C.B purchases Long-term Financial Assets to Lower Long-term IR
-Aims to directly Stimulate Business Investment + Consumption

39
Q

What was the Success of Unconventional M.P?

A

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
Q

What is the Risk of Q.E?

A

There is so much Money in the System- When economy starts growing again–> Banks + Investors will start loaning aggressively–> Danger of Inflation

41
Q

How can the C.B prevent Inflation?

A

Sell Bonds + Securitised Assets–> Lower M.S

Increase IR on deposits–> Lower M.S

42
Q

Why does the C.B need to take action at the right pace?

A

Move too Slowly–> Inflation will Soar

Move too Quickly–> Recovery will Stop

43
Q

How was Fiscal Policy used to combat the Recession?

A

Non-Discretionary- Increased G + Decreased Taxes (Progressive)
Discretionary- Tax Cuts + Increased Aid + Spending programs

44
Q

What did the size of a country’s Fiscal Policy depend on?

A

Economy’s Public Finances
Extent of bailout
Ability to use its own Currency

45
Q

What was the impact of Fiscal Policy on Public Finances?

A

Public Finances were Deteriorated

46
Q

What type of Fiscal Policy did many advanced economies engage in due to deteriorated public finances?

A

Discretionary Contractionary Fiscal policy

-Lower Debt/GDP

47
Q

How is the Global Financial System 10 years later?

A

Much more Robust
Big Banks now hold 3x-5x more Capital
Banks in Europe + America- Increased Deposits–> Stable funding option

48
Q

Why are there fears of a New Crisis?

A

High DEBT

Developed economies- Debt burden shifted to Public sectors

49
Q

What was China’s Debt in 2016?

A

250% of GDP

50
Q

Why may Economic Growth be Debt-driven?

A

Rising Inequality may have caused greater use of Credit

Economics (20 decks)

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