Topic 12: Financial Crisis

Question 1

What is a financial crisis?

Answer 1

“Sharp, brief, ultracyclical deterioration of all or most of a group of financial indicators”

Question 2

Why do financial crisis occur?

Answer 2

• Not really too sure.
• Large and growing mismatch between bank long-term assets and short-term liabilities.
• Herd behavior.
• Poor risk management.

Question 3

What are the consequences of financial crisis?

Answer 3

• Uncertainty.
• Lack of liquidity.
• Recession / Depression.

Question 4

What is a depression?

Answer 4

Substantial output decline, some say a cummulative contraction of 10%.

Question 5

What were the external causes of the 1890’s crash?

Answer 5

• Fall in wool prices in london.
• Fall in overseas capital inflow. (Collapse of house of baring.)

Question 6

What were the internal causes of the 1890’s crash in Australia?

Answer 6

• Overinvestment in pastoral development.
• Overspending by colonies on infrastructure (mostly railways).
• Property bubble in the 1890’s.
• Ten victorian banks (Associated Banks) oversaw but couldn’t manage free banking.

Question 7

What were the chain of events in the 1890’s Au crash?

Answer 7

1. Land boom, emergence of NBFIs, increased foreign depositors.
2. Melbourne land prices turn down in 88-89 and banks increase interest rates.
3. Reduction in domestic bank activity offset by external inflow.
4. 1890 Bearing Bank Collapse
5. 91 Land prices collapse and land investors forced to liquidate.
6. 92-93, there is a run on the banking system and banks collapse.

Question 8

Contrast the 1890 crash in Australia with the effects of the great depression in the 1930’s.

Answer 8

1890:

• Free banking, no central bank -> financial crisis.
• Colonies dependent on foriegners for debt

1930:

• Fixed exchange.
• Commonwealth bank (but no reserve bank)
• No financial crisis.
• States in financial distress in the 1920’s.
• Lots of public debt
• Premiers planned an intial fiscal expansion followed by a moderate contraction.

Question 9

How does the stock market fair as a predictor of crashs?

Answer 9

Out of war, a stock market crash means a 30% chance of minor depression, 11% of major depression.

But a depression means a 69% chance of a stock market crash, and a major depression means a 91% chance.