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The Global Financial Crisis of 2008

The Global Financial Crisis of 2008. “The global pool of money”. Subprime crisis  housing bust  credit crunch  global financial crisis  Great Recession ¼ of residential mortgages “underwater” (w/negative equity)

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The Global Financial Crisis of 2008

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  1. The Global Financial Crisis of 2008

  2. “The global pool of money” • Subprime crisis  housing bust  credit crunch  global financial crisis  Great Recession • ¼ of residential mortgages “underwater” (w/negative equity) • “real” unemployment is about 17% (counting discouraged and underemployed workers) • cuts to public spending (social services) at all levels • And now: “foreclosure crisis”

  3. Role reversal? • In the lead-up to the 2008 global financial crisis, the “hot money” is pouring into the US, fueling a “speculative real estate boom” like the ones seen in East Asia in the late 90s

  4. History of US financial regulation • 1940s-1970s: Regulatory Expansion • 1980s-present: Deregulation • circa 2011? • uncertainty • crisis

  5. Key events in US financial regulation • 1940s-1970s - Regulatory Expansion: highly regulated financial institutions, high capital requirements, capital controls, etc., took us out of historical boom-bust cycles • Glass-Steagall Act (1933)mandated a separation between commercial banking (handling deposits and lending) and investment banking (buying/selling securities, underwriting, etc.) • 1980s-present - Deregulation: placing faith in free markets, regulation was loosened, regulatory agencies downsized, increasingly leveraged banks, growth of derivatives, high-frequency trading – highly volatile • Sparked by the Reagan revolution, deregulation continued under Democratic and Republican administrations alike • Gramm-Leach-Bilely Financial Services Modernization Act (1999):tore down Glass-Steagall's wall separating commercial and investment banking • Commodity Futures Modernization Act (2000): banned the regulation of derivatives • 2010:Dodd-Frank Wall Street Reform & Consumer Protection Act • Critics charge the bill is weak, and many provisions won’t take effect for years • Bill does not fundamentally address incentive structures that promote risk taking or Too Big To Fail (TBTF) -- systemic risk • TARP (aka the bank bail-out) made big banks bigger

  6. Arguments for separating commercial & investment banking • Conflicts of interest characterize the granting of credit (lending) and the use of credit (investing) by the same entity • Depository institutions possess enormous financial power, by virtue of their control of other people’s money (O-P-M), must be limited to ensure soundness and competition in the market for funds (loans or investments) • Securities activities can be risky, leading to enormous losses, which could threaten the integrity of deposits • In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses • Depository institutions are supposed to be managed to limit risk, so managers may not be conditioned to operate prudently in more speculative securities businesses (http://digital.library.unt.edu/govdocs/crs/permalink/meta-crs-9065:1)

  7. “Why We Have to Change Capitalism” Joseph Stiglitz, Excerpted from Freefall: Free Markets and the Sinking of the Global Economy, 2010

  8. The Great Recession that began in America in 2008 soon turned global • Millions of Americans lost their homes & jobs • Many more saw their retirement and education investments dwindle in value • Soon tens of millions lost their jobs worldwide • 20m in China alone

  9. Economic bubbles • economic bubble: buying and selling in high volumes in assets with inflated values (i.e., at prices far in excess of intrinsic values). Sometimes called speculative bubbles, they are typically the result of a "bandwagon effect," where investors, seeing an upward trend in prices, quickly enter the market; typically, bubbles are followed by even faster sell-offs once prices decline.

  10. Boom-bust cycle • Boom-bust cycle: a pattern of performance over time in an economy or an industry that alternates between extremes of rapid growth (booms) and extremes of slow growth or decline (busts), as opposed to sustained steady growth, extreme form of business cycle • Examples of "Booms & Busts": • Holland's Tulip mania in the 1630s • California Gold Rush of the late 1840s • Roaring Twenties that led to Wall Street Crash of 1929 • Dot-com bubble in the late 1990s • Subprime lending boom in the 1990s and early 2000s, followed by the Subprime Mortgage Crisis of 2006 and beyond

  11. Housing bubbles • In late stages, characterized by: • rapid increases in valuations of real property until unsustainable levels are reached (relative to incomes, price-to-rent ratios, and other indicators of affordability) • reduction in price levels • falling home prices put many owners "underwater," in a position of negative equity (a mortgage debt higher than the value of the property) • US Housing Bubble: • At national level in the US, housing prices peaked in early 2005, and started to decline in 2006 • Underlying causes are complex; factors include historically low interest rates, lax lending standards (including predatory lending), and a speculative fever

  12. Current crisis has uncovered deep flaws in capitalist system, esp. American-style capitalism • Even incomes in the middle have stagnated for at least a decade • Increasing income/wealth inequality • Declining social mobility • statistical chances of a poor American making it to the top are lower than in “Old Europe”

  13. Rugged individualism & market fundamentalism have undermined community and trust • Even in a market economy, trust is the grease that makes society function • Big lesson of the crisis is that our complex financial system still depends on trust – when trust broke down, financial system froze

  14. Excessive risk-taking in the financial sector caused the crisis. Solution? • Reinstitute regulations & change incentive structures that reward excessive risk-taking • reinstitute Glass-Steagall (some version of it) • Increase transparency • Increase capital requirements for banks • Overall: reduce leverage & place restrictions on risky products

  15. But US response–NSA bail-outs–was shaped by same political forces that caused crisis • revolving door: movement of personnel between roles as legislators and regulators (of industries personnel had previously legislated on) • can lead to “regulatory capture” • moral hazard, or the adverse incentives provided by bail-outs & expectations of bail-outs, has only increased

  16. Too Big To Jail?America’sTheft Inflection Point? (www.Firedoglake.com)

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