bertrand candelon financial crises analysis 1studium general - 06/10/2011

Studium general - 06/10/2011

Sequence of the Sub-Prime crisis:

1. US Housing Market Collapse.

2. Bank distress: US-Europe-ROW.

3. Stock Market Crash.

4. Economic Recession.

5. Sovereign Debt Crisis .…..

2

The strongest crisis since 1929?

The same causes, the same errors ?

Where do we go?

Studium general - 06/10/2011 3

1 - What is a financial crisis?

2 - The origins of the crises.

3 - Crisis Mutation

4 - The Current crisis.

5 - A European Crisis

4Studium general - 06/10/2011

1- What is a financial crisis?

1. Wikipedia: ” Situation, when money demand exceeds money supply”

. Temporary event

. Liquidity problem.

2. Frederic Mishkin: ”Nonlinear disruption,..., so that financial markets are unable to channel funds to those with the most productive investment opportunities.”

. Several markets involved

. Role of the banking sector

. Jumps ! Speculative attacks



• Stock markets crisis

• Currency crisis

• Banking crisis

• Sovereign debt crisis

… Food crisis, Political crisis

Financial Crisis: a growing and more severe problem for the world economies ?

No,….

- Globalization leads to a better risk

diversification.

- Better economic education.

- More efficient prudential rules (Basle).

- Information better widespread.


Yeah,….

- Capital highly mobile.

- Financial products (hedge,..) have widespread the risk but not removed it.


2- The origins of the financial crises

. Fundamental based crises

Macro- and Micro fundamentals.


. Non-fundamental-based crises

- Self-fulfilling propheties.

- Contagion

- Moral hazard.


3- Crisis mutation

. Flood and Garber (1984) – Currency Crisis

- Economic relationships (UIP, PPP,..) on flows - But also accounting relationship extracted from

the central bank balance sheet.

R + DC = Ms

A crisis occurs when R=0 .


. Balance sheet Approach (Rosemberg at al. 2005)


. The subprime crisis explained via the BSA.

Real estate bubble – non-financial BS

Then financial sector BS --- Banking crisis

Then Government BS --- Sovereign debt crisis

Then…. Resurgence banking, currency,..


. Empirical analyses.

- From currency to banking crisis: Glick-Hutchinson (1995), Bordo et al. (2001),..

- From banking to sovereign debt: Reinhart-Rogoff (2009) Candelon-Palm (2010)


4- The Current crisis

History 1/

- Business cycle turning point in early 2007.

- Real estate bubble explodes.

- Financial institutions faced liquidity problem (Northern Rock, Bear Stearn, Freddy Mac, Fanny Mae,…)

- Bankruptcy of Lehman brothers.

Sept 15th, 2008 - Systemic Banking crisis18Studium general - 06/10/2011

- Irrational reaction of stock markets, which crashed.

- Several financial institutions in Europe faced liquidity problems (fortis, dexia,..). Nobody believe anymore in the IFS.

- Uncoordinated reaction of governments (Paulson’s plan, recapitalization, nationalization)

- G20 meeting to restore credibility.


History 2/

- Real economy collapse since 2009.

- Public finance, austerity measures.

- Greek default.

- Distress of the €, banking sector weakness,..


The origins of the crisis 1-

. Business cycle turnpike.

. Bad banking management and governance: Scandals ( SoG, CL,..), not enough diversification, too complex financial products.


The crisis becomes irrational with the bankruptcy of Lehman brothers.

Why?

Incoherent political reaction

(Paulson’s plan by the US congress, or the absence of coordinated EU reaction)


The origins of the crisis 2-

. Bad macroeconomic fundamentals

(important debt, global disequilibrium)

. Political incompetences leading to a status quo (on financial regulation –CRA-, on decisions,..) -

. Procyclical fiscal policies (banking safety plans,..)


Political Crisis (in particular Europe )

The markets and investors do not believe anymore politicians

Studium general - 06/10/2011 24

What is the situation in October 2011?

. Financial markets: quiet until July 2011, loose more than 25% last 3 months…

. Sovereign bonds markets: extremely huge spreads for Greece, Italy -- unsustainable


. Real Markets - Disastrous

GDP growth at 0%.

Unemployment increases.

Debt level and budget deficit will still deteriorate with austerity –

Deflation is around the corner


5- the European crisis

. From a Banking crisis to a sovereign debt crisis.

. From a sovereign debt to a currency crisis

(to the end of € ?).

. From a sovereign debt to a political crisis


. 2009. Loss of Credibility in the European Area.

Sovereign Debt crisis

. 2010. Threat on the euro (will it still exist in this form?) and depreciation with respect to the US$

Currency crisis ?

banking crisis (Dexia) ? ---- vicious circle ?


Sovereign debt crisis ?


. French and German banks highly involved

In PIIGS

BIS (2009)

Greece Spain Ireland Italy Portugal

Total. Capital & reserve

French b. 75.2 219.6 60.3 511.4 44.7 579.3

German b. 45.0 237.9 183.8 189.7 47.4 565.2


Depreciation of the Euro vis a vis of other currencies is the next step,

if Euro still exist…


Policy recommendations:

- Fiscal Policy (SGP and its implementation, the ESF and fiscal federalism). Avoid deflation..

- Monetary Policy: Role of the ECB (not quasi fiscal operations).

- Exchange rate stabilization: A Future for Euro?

- Debt restructuration (Greece) – exit option.34Studium general - 06/10/2011

Political Decisions have to be quickly taken

. Within Europe: Eurobonds, restructuration of the Greek debt, fiscal policy coordination,..

. In the world: Intervention of the BIRC, IMF,...

For a new world order.35Studium general - 06/10/2011

Conclusions

My vision of the future: Pessimistic

-2012: election year – expect no courageous political decision.

-On the edge of deflation (brain drain,..)

-Crisis almost out of control.Studium general - 06/10/2011 36

bertrand candelon financial crises analysis 1studium general - 06/10/2011

Documents

financial crisis

crisis mutation

strongest crisis

european crisis

subprime crisis

subprime crisis

financial markets

financial institutions