Financial Crisis

12 Key excerpts on "Financial Crisis"

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  The Financial Crisis and Federal Reserve Policy

  • L. Thomas(Author)
  • 2011(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  The effects of the crisis in the United States spilled over to infect countries from Iceland to Spain to the Philippines. A Financial Crisis occurs when a speculation-driven economic boom is followed by an inevitable bust. A Financial Crisis may be defined as a major disruption in financial markets, institutions, and economic 2 The Financial Crisis and Federal Reserve Policy activity, typically preceded by a rapid expansion of private and public sector debt or money growth, and characterized by sharp declines in prices of real estate, shares of stock and, in many cases, the value of domestic currencies relative to foreign currencies. Ironically, the same aspects of capitalism that provide the vitality that makes it superior to other economic systems in fostering high and rising living standards— the propensity to innovate and willingness to take risk—also make it vulnerable to bubbles that eventually burst with devastating results. The 2007–2009 worldwide Financial Crisis, hereafter dubbed the “Great Crisis,” was just one of hundreds of financial crises that have occurred around the world over the past few hundred years. Financial crises date back many centuries to the earliest formation of financial markets. In fact, these crises can be traced back thousands of years to the introduction of money in the form of metallic coins in ancient civili- zations. In those times, monarchs often clipped the metallic coins of the realm to forge additional money with which to finance military adven- tures and other expenditures. Such a debasement of currency often led to severe inflation. Financial crises come in several varieties; the characteristics, causes, and consequences of each type are sketched in this chapter. Chapter 2 focuses on the particular type—the banking crisis—that characterizes the recent Great Crisis and provides a theoretical framework that enables us to understand the forces triggering banking crises and why such crises occur with considerable regularity.

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  Feminist Political Economy

  A Global Perspective

  • Sara Cantillon, Odile Mackett, Sara Stevano(Authors)
  • 2023(Publication Date)
  • Agenda Publishing

    (Publisher)

  The last section focuses on the Covid-19 pandemic and the economic crisis that emerged from the health crisis. 10.2 Definitions of an economic crisis The term “crisis” implies a deviation from some degree of normality. Crises range from wars, financial market crashes and health crises to natural disasters. Often crises have important economic impacts on the communities that are affected by them. Consequently, they tend to result in some form of reorganization in the way resources are obtained, distributed and accumulated. A historical analysis of resource distribution and accumulation often provides important clues as to how communities, individuals and countries fare during and in the aftermath of a crisis, and some even result in a change (even if small) in prevailing gender norms. A crisis need not be widespread, and, when a crisis does hit, some groups may be better prepared for it than others. Nevertheless, it becomes useful to define a crisis, for whom the crisis exists and the scale thereof. A debtor, whether it be a household, firm, or country, “experiences a Financial Crisis when it cannot meet current debt obligations and its creditors demand repayment” (Floro & Dymski 2000 : 1271). A Financial Crisis implies that some degree of scarcity in relation to monetary resources arises, and a country faces a Financial Crisis when it is unable to meet its debt obligations. Financial crises are closely linked to the concept of financialization, which is defined by Isaacs (2016 : 8) as “the predominance of the influence of financial markets over more and more spheres of economic, political and social life and the subjugation of these to the logic, dictates and imperatives of financial markets”. However, monetary resources are not the only necessary resources in an economy, and the economics discipline has an interest in exploring the distribution of a broader range of resources, such as natural resources, human and environmental well-being and time

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  Understanding Financial Stability

  • Indranarain Ramlall(Author)
  • 2018(Publication Date)
  • Emerald Publishing Limited

    (Publisher)

  Chapter 6

  Financial Crises

  6.1. Key Features of A Crisis

  • Economic and financial crises tend to be recurrent in nature. This implies that the same phenomena are at work to constitute the genesis of a crisis.
  • Nearly, all crises exhibit three common elements. First, there is distrust in the financial system or lack of confidence in the financial system. Second, there are spillover or contagion effects such as in the case of Allen and Gale (2009) who base themselves on the contagious transmission of bank difficulties. Third, there are network effects based on endogenous interactions among different financial institutions.
  • A crisis is usually financial in first stage to then entangle the real economy in the second stage. This can be corroborated by the evolution of the global Financial Crisis in 2007 into an economic crisis and thereafter into a debt crisis.
  • Crisis often occurs because market players assume that EMH (all relevant information is automatically reflected in the price) holds while in practice it is hard to see that assets are properly priced – a clear instance of this appears during the US subprime crisis.
  • Humans have a strong tendency to herd so that deleveraging of assets often witnesses a highly painful adjustment in the financial system, all geared towards an unending downward spiral in asset prices.
  • Crises are often caused by two events, a euphoria phase and a de-illusion stage. Under the euphoria stage, there are strong incentives to push forward asset prices while in the de-illusion stage, investors began to realise of over-valued assets which then lead to massive sell-offs and drastic asset price declines. The leverage cycle (Geneakopolous, 2009) contributes to higher asset prices. When the de-illusion stage manifested in the case of the US subprime crisis, it led to negative equity holdings by borrowers who had no choice but to deliberately default on their home loans.
  • Political forces can also contribute to crises. For instance, in the case of the US subprime crisis, there were strong political incentives to make each household own his home.

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  Financial Assets, Debt and Liquidity Crises

  A Keynesian Approach

  • Matthieu Charpe, Carl Chiarella, Peter Flaschel, Willi Semmler(Authors)
  • 2011(Publication Date)
  • Cambridge University Press

    (Publisher)

  6 Financial crises and the macroeconomy arising from the stock market (as in the 1990s) or from the credit market, for example as now triggered by the subprime crisis. The evolution of the subprime crisis and its effect on the financial sector in the USA is described by the following trends: 3 • the current financial market crisis is likely to have originated in low interest rates, rapidly rising household debt and a bubble in the housing market (high housing prices compared with fundamentals); • the bubble phase has undergone an acceleration due to the outsourcing of risk because of the securitisation of mortgages (that were packaged and sliced into risky securities of different types, in particular CDOs); • expectation of returns from investment in real estate and CDOs were rising, due to low interest rates, low default rates and high recovery rates; • liquidity in the housing sector (and financial market) was pumped up by capital inflows, partly from abroad; • the burst of the bubble was triggered by the failure of hedge funds (for example by the hedge funds of Bear Stearns), triggering a credit crunch in the banking sector; • default risk and risk premia suddenly shooting up and a credit crunch occurring (as at the beginning of all downturns); • the feedback to the real sector causing the growth rate of GDP to fall, with further feedback effects expected from the real to the financial side, that is, insolvency of financial institutions. Indeed, as we have recently experienced, besides the open economy and currency crisis mechanism, an important financial market instability is likely to arise from the interplay of the real estate boom and the financial market boom. In the USA the financial market crisis of 2007/8 originated in the interaction of the housing market and the banking sector. Often one can also observe other scenarios; see Kindleberger (2000). For instance a stock market crash, together with the instability of credit, can trigger a downturn.

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  The Bank Credit Analysis Handbook

  A Guide for Analysts, Bankers and Investors

  • Jonathan Golin, Philippe Delhaise(Authors)
  • 2013(Publication Date)
  • Wiley

    (Publisher)

  There are archetypal scenarios but no uniform pattern. The three scenarios enumerated below are among the most common.

  1. Early and sharp decline. The shift to the crisis may occur quickly in a dramatic fashion, as some event presents an enormous shock to the market—the failure of a major bank, for example.

  2. After a period of uncertainty that prevails for several weeks or months, a panic arises, and prices fall precipitously.

  3. The contraction phase sets in gradually without a period of panic and an accompanying plunge in prices; problems in the banking industry surface gradually as the recession grows deeper.

  As scenario three illustrates, a banking crisis need not coincide with a precipitous fall in asset prices, such as a stock market crash. It is, however, not unusual for a banking crisis to begin with such a period of panic (as scenarios one and two illustrate) that may last for days or weeks, during which key financial markets are characterized by either a steep plunge in prices or an equally sharp widening of spreads. When markets experience such sharp corrections, the onset of the crisis is clearly marked.

  Nevertheless, such an event is not a mandatory prelude to a serious banking crisis. When the banking system reaches a threshold level of vulnerability—and the crisis of 2007–2012 demonstrated that banks are vulnerable to many more factors than the traditional bubbles, for example to liquidity issues—a crisis could conceivably surface at any time during the phase of economic contraction. In the same manner, absent such vulnerability, a banking crisis is not inevitable as the business cycle turns after a prolonged expansionary phase. This said, banking is a cyclical industry, and member institutions face much tougher times when the economy is contracting than they do during a period of rising prosperity.

  The strong returns of the peak boom period weaken during the transition period.88 Less vigorous price rises dampen expectations resulting in flattening or declining loan growth. This is accompanied by higher NPLs and NPL ratios as the expanding denominator no longer can mask growth in the percentage of duff loans. At the same time, rising NPLs will compel the bank to set aside higher levels of loan-loss provisioning to compensate for the decline in asset quality arising from growth in delinquencies. That is, as the bank’s credit costs outpace growth in its operating income, such costs will consume an increasing chunk of pretax income.89

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  Governance of Global Financial Markets

  The Law, the Economics, the Politics

  • Emilios Avgouleas(Author)
  • 2012(Publication Date)
  • Cambridge University Press

    (Publisher)

  1 See Ross Cranston, Principles of Banking Law (Oxford University Press, 2nd edn, 2002), Chapters 12 and 13. Financial markets and financial crises 22 The evolution, development and characteristics of the global finan- cial system have been described in numerous works. 2 As a result, in this chapter I shall only offer a cursory picture of the parts of the global finan- cial system that contributed the most to the Global Financial Crisis (GFC), especially global derivatives markets and the shadow banking sector. The relevant analysis would have been incomplete without a discussion of the prevailing theories relating to the price formation mechanism in finan- cial markets and the behaviour of market participants. This discussion also aids reader understanding of some of the causes of financial mar- ket fragility, such as asset bubbles, inextricably linked to boom and bust cycles in the real economy. In the same context, liberalization and policies centred on the Washington Consensus are also examined. These were as central to the explosive growth of modern financial markets as techno- logical advancements and financial innovation. Financial markets have historically shown strong signs of instability, especially when countries’, corporations’ and households’ indebtedness becomes unsustainable. Thus, this chapter will examine the link between financial markets and financial crises, trying to explain the causes of the latter. It will critically consider theories relating to the perceived inherent instability of financial markets and to other market failures associated with their operation. In this context, the chapter advances the view that in the past three decades the world experienced a financial revolution of unprecedented proportions, which was much misunderstood by policy- makers and regulators.

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  Road to Recovery

  Singapore's Journey through the Global Crisis

  • Sanchita Basu Das(Author)
  • 2010(Publication Date)
  • ISEAS Publishing

    (Publisher)

  2 Global Financial and Economic Crisis: Causes, Impact, and Policy Response The global financial turmoil surfaced in the middle of 2007 as a result of defaults of sub-prime mortgage loans in the United States. It was blown into an unprecedented financial crisis in 2008 when a series of major financial institutions in the United States and Europe started to fail. Around the world stock markets fell, financial institutions were bought out, and massive coordinated actions by the authorities were taken to inject liquidity into money markets and restore confidence in the financial systems. Strong calls were made at the Group of Twenty (G-20) 1 level for a new financial system to prevent future financial crises and to maintain global financial stability. As the U.S. sub-prime mortgage crisis spread to the rest of the U.S. financial system and other industrialized-country financial markets, a significant slowdown was observed in economic growth of the U.S., Europe, and Japan. The financial sector crisis subsequently moved to the real economy. Although Asian financial institutionsʼ exposure to sub-prime-related products was limited, the impact was felt through capital flow and trade channels. Global Financial and Economic Crisis 17 Accordingly, the IMF in its World Economic Outlook (WEO) Update publication (January 2010) placed global growth at 3.0 per cent in 2008 and a contraction of –0.8 per cent in 2009. This represented a significant slide from an economic growth of 5.0 per cent observed in 2006–7. The advanced economies were in or close to recession in the second half of 2008 and early 2009, and showed some signs of recovery later in 2009. Growth in most emerging and developing economies was below trend, although key emerging economies in Asia, like China and India, showed higher resiliency. Genesis of the Global Financial Crisis The global financial crisis was triggered in August 2007 when the U.S. sub-prime loan defaults began to rise and foreclosures increased.

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  How Latin America Weathered the Global Financial Crisis

  • José De Gregorio(Author)
  • 2013(Publication Date)
  • Peterson Institute for International Economics

    (Publisher)

  71 4 Financial Stability Financial systems are essential to development, but they can also be a source of disaster and therefore a source of policy confusion and ambivalence. A well-functioning financial system is key to prosperity. It promotes eco-nomic growth by channeling investment funds from savers to borrowers (Levine 2006), and it is central to promoting entrepreneurship and facilitating invest-ment, including human capital accumulation. Meanwhile, it provides house-holds with financing in order to smooth consumption, with insurance, and with safe and cheap means of payment. The difficulties faced by households and firms in many emerging-market economies because of underdeveloped fi-nancial institutions and markets should be a clear reminder of this positive role. But financial deepness may also be a source of big problems. As in many situations, more is not always better, especially when more comes at the cost of excessive risk. When a recession or a currency crisis comes together with a finan-cial crisis, its output costs increase significantly (Reinhart and Rogoff 2009). In the past in Latin America and Asia, currency crises had output costs of 7 percent of GDP over a five-year period, and when crises come with a banking crisis the costs double (De Gregorio and Lee 2004). Therefore, a strong financial system and a flexible exchange rate regime can be very effective in mitigating the cost of a crisis. Finally, unfettered financial markets are prone to deep crises, but regulation has its limitations and may even be a source of problems because of negligence, political capture, and other agency problems. Crises are not always avoidable, so it is also key to have appropriate resolution mechanisms to con-tain the costs of financial instability and quickly restore normalcy. This chapter focuses on the policies that could prevent these problems and on the evidence of financial market resilience in Latin America.

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  Britain at the Polls 2010

  • Nicholas Allen, John Bartle, Nicholas Allen, John Bartle(Authors)
  • 2010(Publication Date)
  • SAGE Publications Ltd

    (Publisher)

  4 THE Financial Crisis AND ITS CONSEQUENCES Michael Moran, Sukhdev Johal and Karel Williams 1 The ‘credit crunch’ and the ‘Financial Crisis’ conventionally define a searing experience in the life of the Brown government, but they actually only catch a part of that experience. The ‘crunch’ specifically refers to the vir-tual cessation of the banking system’s provision of credit for the wider economy in the great banking crisis of October–November 2008. Indeed, it was the most difficult economic event confronting any government since Britain was evicted from the European Exchange Rate Mechanism on ‘Black Wednesday’ in September 1992. Yet, the great banking crisis was just one part of a bigger story involving the discrediting of New Labour’s economic and regulatory policies and the end of fifteen years of sustained economic growth, low unemployment and low inflation. The crash which ended all that also raised fundamental questions about the success of a thirty-year experiment in economic management that can be traced back to Margaret Thatcher’s first administration in 1979. This chapter is therefore about the crisis, but it is also about much more. It is about how New Labour’s policy response of bailing out the banks and markets terminated New Labour and opened the way for the new coalition government’s subsequent attack on the public sector. This chapter traces the origins of the thirty-year economic experiment, shows how it ended, and concludes by arguing that it has left economic policy makers without a convincing solution to the problem that the experiment was supposed to solve – how to create an economy capable of generating sustainable employment, especially in the private sector. The symbolic beginning of the Brown government’s financial woes occurred on 14 September 2007 when depositors queued to withdraw funds from Northern Rock, a bank founded and still based in Labour’s North East heartland.

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  Introducing a New Economics

  Pluralist, Sustainable and Progressive

  • Jack Reardon, Maria Alejandra Caporale Madi, Molly Scott Cato(Authors)
  • 2017(Publication Date)
  • Pluto Press

    (Publisher)

  14

  Recessions and Financial Crises

  All economies go through cycles of boom and bust, otherwise known as ‘the business cycle’. This chapter will investigate whether the business cycle is inevitable or is a consequence of how the economy is structured. Are there institutional adjustments that can prevent or ameliorate it? We will first define the business cycle, then discuss how recessions are defined and measured. We then ask about the causes and origins of financial crises – a specific type of recession that most of us are now familiar with. We will then look to the global picture and ask: What is the proper role of global financial architecture? And what are alternative economic policies for sustainable economic growth?

  14.1 SETTING THE SCENE: WHAT IS A BUSINESS CYCLE?

  A business cycle refers to the ups (expansions) and downs (recessions) of the economy. Perhaps the term ‘business cycle’ is misleading, since it affects everyone rather than just businesses; and the word ‘cycle’ implies circularity; that what goes around comes around. But no two business cycles are alike: they differ in terms of severity, causation and length. Likewise, no two recessions are alike, for they differ in length and severity; and no two expansions are alike, also differing in length and vigour.

  A business cycle is a short-term phenomenon, to be distinguished from long-term economic swings. Throughout the business cycle there are alternating increases and decreases in the level of economic activity, of varying amplitude and length. A conventional business cycle contains the following phases:

  •   a beginning or recovery •   an expansion phase, in which the economy grows •   a peak, at which the expansion reaches a relative maximum •   a contraction (recession), in which the level of economic activity declines •   a trough, in which the economy reaches a relative low point. After the trough, the economy recovers, and we begin the next cycle.

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  Macroeconomics and Development

  • Mario Damill, Martín Rapetti, Guillermo Rozenwurcel(Authors)
  • 2016(Publication Date)
  • Columbia University Press

    (Publisher)

  A key motivation for the analysis is the question of “perverse” interactions among financial disequilibria, macroeconomic imbalances, and the stabil-ity of economic institutions, all of which are typical during crises. These interactions delay the return to normality and, under certain conditions, may even induce irreversible changes. On the financial side, we frequently observe permanent reversions in the process of financial development, whereas on the real side, the probability that the economy is mired in a low-growth trap or long-lasting period of recession increases, as was the case of the “lost decade” in Latin America in the 1980s and Japan in the 1990s. The analysis basically refers to emerging economies, but some aspects are also relevant to advanced countries. Traditionally, financial analyses tended to focus on the study of effi-ciency and equilibrium. As a consequence, too little effort was invested in the specification and description of the economic institutions that support market transactions. This made it difficult to analyze systemic instability and conflicts over property rights—phenomena that usually accompany financial crises. The lack of specification of the institutional framework creates a gap between microeconomics and macroeconomics and, in the case of the analysis of crises, makes it necessary to establish sounder macrofoundations for microeconomics (Fanelli and Frenkel 1995; Fanelli 2011). The approach to these issues has changed substantially in the last two decades thanks to the contributions of institutional analysis and the political economy literature. Institutional economics allows us to define C H A P T E R 1 4 Financial Crises, Institutions, and the Macroeconomy José María Fanelli 288 FINANCE AND CRISES the notion of economic systems more precisely, facilitating the study of disequilibria that originate from systemic failures.

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  The Financial and Economic Crisis of 2008-2009 and Developing Countries

  • (Author)
  • 2011(Publication Date)
  • United Nations Conference on Trade and Development (UNCTAD)

    (Publisher)

  Yet others, like Borio and Drehmann (2009) and Reinhart and Rogoff (2009), hold that most financial crises in history evolved from previous excessive credit lending and asset price bubbles. The patterns of emergence and unwinding of the major financial crises in emerging and industrialized economies in WHAT WENT WRONG? ALTERNATIVE INTERPRETATIONS OF THE GLOBAL Financial Crisis 19 the past few decades (e.g. Japan in 1992, the Asian crisis in 1997–1998 and Argentina in 2001) are similar to those of the subprime crisis. In phases of boom, the confidence that “this time is different” prevails until the crash disabuses all. Those who cite a lack of macroprudential surveillance by banks have emphasized that the risks of the bubble were not recognised in time (Brunnermeier et al., 2009; Goodhart, 2009). Here, in the lack of macroprudential surveillance lies the predominant answer, as expressed by the G-20 meeting in Pittsburgh in 2009 and by the Financial Stability Forum (2009). Although interesting, it falls short of explaining the full scope of what happened. Most observers exclude the role of global imbalances in trade and capital flows as a major cause of the crisis. Some cite a “global saving glut” as one of the causes, but fail to explain what this really means. Furthermore, most observers fail to consider that the roots of the Financial Crisis lie in a pattern of macroeconomic and structural development that has been described as finance-driven capitalism. This pattern has led to seemingly ever-increasing income inequality in most OECD countries. Here, some deeper underlying causes are addressed, which emerged in the past decades with the concomitant financial vulnerability of developed economies. It can demonstrate only that a Financial Crisis of this type could happen, but not that it did happen and in the specific manner of the latest crisis. This paper distinguishes between proximate and more structural or ultimate causes of the Financial Crisis (see box 1).

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