Week 5 Flashcards
What is a banking crisis
Banks cannot pay back liabilities. This is because banks take short term liabilities and turn them into long term assets. Banks loan the money you deposit. Banks can also loan money from other banks within what is known as the wholesale market, although this can be risky.
when does lending money go wrong?
- Bank run (creditors demand funds all at once)
- non-performing assets (e.g mortgage loan) people not paying back
- arrears (when you don’t pay your morgage)
What is a sovereign debt crisis
This is when a government cannot pay back its liabilities.
- it thus cannot borrow from markets
- however most governments in the world work in a deficit, meaning they borrow more than they lend.
- deficit does not mean you are in debt
If GDP gets bigger then debt can get bigger (60%)
If the government is unreliable, then people may stop lending their money to governments, which causes issues such as the Greece.
- Gov. can’t pay liabilities + can’t borrow from markets
What is a currency crisis
- Sudden plus unexpected currency depreciation
- sudden fact of depreciation can be quite destabilizing for a country
● also create debt crisis and baking crisis
What is a bank run?
if individuals decide that they are worried about their money, they can all go to the bank and ask for their deposits → bank will not have money as they gave it out loan. large group asking at the same time which is the issue. This is quite unlikely. This can however happen in wholesale markets when other banks want their money back.
what are non-performing assets:
This is usually with mortgage loans, and it is when someone goes into arrears (cannot pay back mortgage) and it causes a cashflow issue for the bank as they are not receiving back money that they expected.
if a lot of people stop paying their mortgage, the bank runs the risk of going bankrupt and more non-performing assets happen. This happened in the crisis 2007/2008 in the US.
what are non-performing assets:
This is usually with mortgage loans, and it is when someone goes into arrears (cannot pay back mortgage) and it causes a cashflow issue for the bank as they are not receiving back money that they expected.
if a lot of people stop paying their mortgage, the bank runs the risk of going bankrupt and more non-performing assets happen. This happened in the crisis 2007/2008 in the US.
What is a bond auction
gov’t says they want to borrow certain amount, others say i will lend it at certain percentage, then next bank says lower until no bank wants to lend at low interest rate → if unreliable, no one wants to lend at low interest rate but high interest rate
Bond auctions are the primary method through which governments sell their bonds to investors. In a bond auction, the government announces the issuance of new bonds and invites investors, such as banks, institutional investors, and individuals, to bid on them.
How are currency, bank, and sovereign debt crisis interconnected?
Through THE DOOM LOOP:
- This describes the mutual dependency of banks and their national government.
A national banking crisis can cause a sovereign debt crisis and the other way around.
First way: National banking crisis to sovereign debt crisis
happened in Ireland in 2008
● banks had extensive borrowing → so much that Irish banking system became larger than Irish economy
- had 10x Irish GDP in banking assets
● problem: Irish banks were banking for entire Eurozone, but were regulated by small Irish government → if banking system were to collapse, Irish government would be responsible to bail them out, even though their economy was too small to do that.
● main issue: bail-out being impossible → leads to huge costs for government which then causes sovereign debt crisis
● Maastricht policy says 60% GDP debt is max, Ireland reached 40% in one year because of one policy which was bail-out
● banks were transnational in life but national in death → changed a bit nowadays
- sovereign debt crisis → national banking crisis
most governments borrow from their banks
● if crisis of sovereign happens, question is who they owe?
● if they borrow from their domestic banks, but cannot pay the sovereign debt that they owe, then banks go bust which gets worse because banks cannot receive bail-out from governments
● doom loop: country pretty much needs to receive bailout from outside/another country
→ very dangerous
● needs to be broken: country should be able to borrow from much wider sector, by e.g., creating single european bond
Third way –> Currency crisis
Currency crisis leading to sovereign debt and banking crisis
How? Making currency risk worse
● e.g., Hungary: mortages were denomated in Euros or Swiss Francs →
● Hungarian banks loan in foreign currency
● ordinary homeowners: if hungarian currency loses value, it doubles the value of what
you owe to the bank in relation to your home currency
● banks & gov’t also have currency risk: e.g., in USA: loans in USD → no currency risk
o in most countries it is not possible to borrow money in own currency, which puts them at currency risk if their own currency crashes
o → Latin American debt crisis: classical example where sovereign governments found themselves with foreign denominated debts and currency of that debt was getting much stronger relative to their home currency which made debts effectively bigger until they couldn’t pay
o in theory can also happen to banks, but in practice transactions are in swaps to minimize currency risk
Explain the latin American debt crisis
classical example where sovereign governments found themselves with foreign denominated debts and currency of that debt was getting much stronger relative to their home currency which made debts effectively bigger until they couldn’t pay
Explain the eurozone crisis
Eurozone Crisis
The core of eurozone (Rich eurozone countries with current account surplus) aka lots of forex to lend
They need FA+
K flows into periphery
The periphery are:
Greece
Spain
Ireland
Portugal
These countries have lots of capital inflows = FA -
Represents borrowing capital from the core
But also CA - because you are spending it
Greece spending deficit was 15% of GDP instead of max 3
Triggered the selling of greek government bonds, capital flying away, foreigners pulling investments
Ireland didn’t have much public debt at all (anti Greece)
Went into commercial real estate sector
Let their entire national banking system collapse or bail out banks
They bailed out the banks and payed 40% of GDP in one year. Now private debt turned into government debt
Spain: local government and Cajas (= regional banks) → private & public sector focused
on local
Not affording import spending.
BoP needed to be balanced again, so international help was needed through IMF bailouts and partner countries.
In addition:
birth of € important because it meant that in between the countries that adopted the €,
there was no currency risk anymore, because there was only one currency, the €
● lending to a country such as Greece is now more attractive as there were higher interest rates for the core, while Greece found a cheap way to increase money supply. cost of borrowing became lower, GDP up interest rates lower.
Prices rising in periphery as increased money supply»_space; risk of inflation
2009 —> MONEY FLOW STOPS. PEOPLE STOP INVESTING. WHY?
Greece lied about BoP and gov spending. Larger deficit than expected. Sudden stop in cash inflows. opposite happens thus reversed causal chain. NO CREDIBILITY
bailout phase: led to agreement that greece could have missing outflows replaced (bailout) but came with restrictions (on employment, healthcare, etc.) Greece cut off from private market
spain: bailout for banks and not countries
italy: followed instructions from Brussels
What were the policy responses in response to the crisis
. European Banking Union: attempt to transnationalize European banking system & avoid “doom loop” → half constructed & half stuck for now
- Six-Pack: about strengthening governmental fiscal restrains → limit government pending* Macroeconomic Imbalances Procedure (MIP): prevent large deficits or surpluses from happening in BoP
- Two-Pack: allowed for more European surveillance for Eurozone countries (especially for
countries receiving bailouts) → Commission has veto power of national budget
- loose policy autonomy - Fiscal Compact (outside EU)
these were about reducing government spending because main narrative was that that was the issue (MIP)
NOW:
Problem with Six pack: Macroeconomic Imbalances Procedure (MIP): prevent large deficits or
surpluses from happening in BoP
has only been applied to countries with deficits and not to those with surpluses → linked to narrative that surpluses are a sign of good economy, and deficits of bad economy
▪ linkage between surplus in country A and therefore deficit in country B mostly being ignored
→ policy response inadequate
● covid will demand fiscal stimulus from countries which cannot create fiscal stimulus
Explain the structural adjustment programs (SAP)
things that are agreed with an international lender, whereby in order tor receive funds (bailout) they have to sign up to making changes in their policies → conditionality
● alternative is to get not bailout at all, so that’s why this is interesting
● negotiated between government (that is in fiscal trouble or BoP trouble → fixed
exchange rate) and foreign creditor
● have to sign a Memorandum of Understanding → lays out what country needs to do in
order to receive bailout
● usually signed with IMF (apart from Eurozone), sometimes with WorldBank but not to
bailout
● types of policies that go into SAPs (in order to liberalize, privatize, deregulate)
→ reduce spending
→ increase taxes (or improve tax collection)
→ encourage exports
→ reduce government payroll
→ privatize state assets
→ liberalizing economy & interest rate (government should not interfere)
→ labor market reforms
→ pensions reduced
→ more flexibility (easier to fire employees)
→ legal reforms (if there is corruption, or judicial system doesn’t work well) → financial reforms (if banks are not safe, e.g., they are taking too many risks)
● not all SAPs include this, list also not exhaustive
purpose:
has always been seen as a best practice policy
- IMF has been criticized because they used policies as “one size fits all”, even though in
the wrong context some of these policies can be very damaging
—
goal: improve economic governance & reduce likelihood of future crises by imposing
“good behavior”
● problem: not at all democratic → imposed from the outside to countries that usually
reject the implementation of the actual policies
o e.g., Greece in 2015 → January: new elected officials said they were not going to
do it, because it’s not what the people want, July: referendum to the people if they want to sign SAP or not, result: clear no vote, few months later it still got signed
● in extreme cases, the democratically-problematic nature of the SAPs is very dangerous, inconsistent with what the people want → IMF is hated in many developing countries, because government is in dead-end situation if IMF is there
What is the hyperglobalisation thesis
hyperglobalization = structural need for firms to move their capital to where it earns the highest return, e.g., lower taxes
● central idea: globalization threatens the ability of countries to govern themselves effectively
Key mechanism: Capital flows
aka threat of exit: when a person/company says to government that if gov’t doesn’t give policies needed to run business, they will just take capital elsewhere → puts pressure on government
hard to grow economically with capital if everyone decides to take out capital of country
national institutions & policies will agree on one or more capitalistic economic models in order to not have a large difference to fall into those situations, that are amenable to global financial interest
→ forces countries to follow economic model/policies that is in global financial interest and in interest for financial markets
● problem: similar to SAPs → situations in which, in order to gain access to capital, governments can’t do what they want nor what the voters want, they can only do what is in interest for creditors/financial markets, because worse thing that could happen is to be cut-off from financial markets
● raises problems, if it is true → no large empirical evidence on it, even if narrative is appealing
undermines democracy as it is going against what voters want just to stay alive as a country in the financial market
practical problem: Karl Polanyi → if the market determines societal outcomes (who’s
rich, who’s poor, how poor is poor, what are the taxes), people will get fed up with it and it will lead to the Double Movement (= society fights back), which might lead to a resort to non-system options
o e.g., rise to fascism → societal reactions to a complete failure of the policy-making elite making economic decisions during golden era of globalization at end of the 19th century
