The Great Recession Of 2008 Causes – 2 Overview This chapter uses agency theory, an economic analysis of the effects of irregular information (adverse selection and moral hazard) on financial markets, to understand why financial crises occur and why they have such devastating effects on the economy. It applies our analysis to explain the course of events that led to several past financial crises, including the global financial crisis.
Identify the main characteristics of the three stages of financial crisis Explain the causes and consequences of the global financial crisis Summarize the changes in financial regulation that have developed in response to the global financial crisis Identify the gaps in current financial regulation and how they can be addressed with future regulatory changes.
The Great Recession Of 2008 Causes
A financial crisis occurs when there is a significant disruption in the flow of information in financial markets, resulting in a sharp increase in financial volatility and disruption of financial market operations.
Global Recession 2023 What Is Its Impact On India?
Stage 1: Financial Crisis Credit Booms and Busts: Financial Liberalization/Innovation Management Leads to Asset Price Booms and Busts and Asset Price Busts and Increasing Uncertainty Stage 2: Bank Crises Stage 3: Debt Relief
How did the financial crisis occur during the Great Depression and lead to the worst economic downturn in American history? This event occurred: stock market crash bank panic sustained decline in stock prices debt reduction.
Causes of the financial crisis: Financial innovation appears in the mortgage market Subprime mortgages Mortgage-backed securities obligations (CDO) Housing price bubble formation Increased liquidity from cash flows in the US fuel the growth of the subprime mortgage market. Demand for housing and housing prices
Reasons (cont.): There is a problem in agency The product for delivery models under the principal (investor) agent (mortgage broker) problem, commercial and investment banks (and rating agencies) have little incentive to disclose information about the borrower’s ability to pay and weak incentives to assess the quality of securities. Background information The housing price bubble has burst
What Really Spurred The Great Recession?
A mortgage loan obligation structure consists of a corporate entity called a special purpose vehicle (SPV) that purchases a pool of assets such as corporate bonds and loans, commercial real estate bonds and mortgage-backed securities. The SPV separates the payment stream (cash flow) from these assets into buckets called trans.
The highest rate tranches, known as super senior tranches, are issued first and therefore carry less risk. The minimum portion of a CDO is the equity tranche, and it is the first cash flow that occurs if the underlying asset defaults and stops paying. This trans has high risk and is rarely traded
House prices began to rise in 2006 after a long period of growth following the effects of the financial crisis. The fall in housing prices has led to an increase in mortgage defaults and a deterioration in the balance sheets of financial institutions. This development subsequently put pressure on the shadow banking system
The TED spread (the 3-month interest rate on the Eurodollar over the 3-month interest rate on the Treasury bill) widened from 40 basis points in August 2007 to around 240 in August 2007, a sign of the globalization of financial markets.
The Global Financial Crisis Of 2007 2008. Causes Explanation & Overview
Balance Sheet Decline of Financial Institutions: Asset Sales and Debt Constraints High-Profile Institutions Bankruptcy Bear Steers (March 2008) Fannie Mae and Freddie Mac (July 2008) Lehman Brothers, Merrill Lynch, AG, Reserve Primary Fund) and Washington 800800 )
Bailout Debate House representatives rejected a $700 billion bailout on September 29, 2008. It was adopted on October 3, 2008. On February 13, 2009, Congress approved a $787 billion fiscal stimulus package.
Some economists argue that the Federal Reserve’s low interest rate policy of 2003–2006 led to the housing bubble. Taylor argued that the low federal funds rate translated into low mortgage rates, which stimulated housing demand and subprime mortgage issuance, leading to housing price inflation and the bubble.
Federal Reserve Chairman Ben Berne backed that argument, saying the culprits were the proliferation of new mortgage products that lowered mortgage payments, the easing of lending standards that brought more homebuyers into the housing market, and capital inflows from emerging market countries. The debate over whether monetary policy caused the housing bubble continues to this day.
Pdf) What Really Caused The Great Recession?
Widening budget deficits since the 2014 recession have raised the risk of government defaults and raised interest rates. Sovereign debt that started in Greece moved to Ireland, Portugal, Spain and Italy. The resulting tensions and related events continue to threaten the viability of the euro
The height of the financial crisis led to the stock market crash of 2008, and the week of October 6, 2008 posted the worst weekly decline in US history. Increased interest rates from borrowers led to a sharp decline in consumer spending and investment, and the unemployment rate rose sharply in late 2009, making it the worst economic contraction in the United States since World War II.
Government Intervention and Recovery The Great Recession was shorter than the Great Depression because of government and central bank intervention. In October 2008, a key provision of the Bush administration’s Emergency Economic Stabilization Act, the Troubled Asset Relief Program (TARP), authorized the Treasury Department to spend $700 billion to buy or inject capital into subprime mortgage assets from financial institutions. In these institutions
Macroprudential vs. Microprudential Supervision Dodd-Frank Wall Street Reform and the 2010 Volcker Rule Regulation of Systemic Risk in Derivatives’ Consumer Protection Resolution Authority
Great Recession Vs Great Depression
Three approaches have been proposed to solve the too-big-to-fail problem: Break up large financial institutions High capital requirements Leave it to Dodd-Frank.
Overview This analysis is applied to the events surrounding the recent financial crises in South Korea and Argentina and examines why these events caused such severe contractions in economic activity.
Stage 1: Inception Stage A: Credit Boom and Bust Weak supervision and lack of expertise lead to credit booms. Local banks borrow from foreign banks A stable exchange rate means less risk Banks play a more important role in emerging market economies as securities markets are not yet well developed.
Stage 1: Early Stage Path B: Severe Fiscal Imbalances Governments in need of financing sometimes force banks to buy government debt. When government debt loses value, banks lose money and their net worth falls Additional factors: rising interest rates (from abroad) falling asset prices Uncertainty related to an unstable political system.
Housing Market Crash 2008 Explained: Causes & Effects
Stage 2: Currency Crisis The depletion of bank balance sheets creates a currency crisis: the government cannot raise interest rates (which would bankrupt the banks)… and prices are expected to fall. Severe financial imbalances lead to currency crises: foreign and domestic investors sell the local currency
Stage 3: Full financial crisis Debt burden increases (net worth decreases) in local currency terms. An increase in expected and actual inflation reduces firms’ cash flow Banks are more likely to fail: people are unable to repay their loans (property values fall). Increase in foreign currency debt (increase in liability value).
Financial liberalization and globalization mismanaged Distortions of financial liberalization and globalization: Chaebols and South Korea’s crisis Stock market crashes and corporate bankruptcies increase uncertainty Adverse selection and moral hazard problem worsens and economy collapses
Severe financial imbalances Adverse selection and moral hazard problems initiate more vicious bank panics Currency crisis occurs Currency crisis causes full financial crisis Recovery begins
Causes Of The 2008 Financial Crisis
Global: When an advanced economy is like an emerging market economy: Iceland’s financial crisis of 2008 Iceland’s financial crisis and the financial crisis that started in 2008 followed a similar situation to a financial crisis in an emerging market economy, although Iceland is richer. Ethnic economic liberalization led to a rise in stock market prices and currency imbalances as foreign capital left the country due to the growth of recession.
Strengthening prudential regulation and supervision of banks to promote transparency and market discipline
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Learning The Right Lessons From The Financial Crisis
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