The Financial System in CrisisThe Financial System in CrisisLecture 9: International Political EconomyLecture 9: International Political Economy

Financial crises

- Debt crisis (1980s)

- Asian crisis (1997-98)

- Subprime crisis (current)

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Economist: World on the edge

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Subprime crisis

- Lenders have spread risk over many investors

- Too much lending, too much risk

- Mortgage takers fail to repay

- Unexpected insolvencies: banks short of funds

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- Banks have higher outstanding loans to collateral ratio than previously estimated

- Banks need more funds

- Everyone needs more funds; no one trusts any bank with one’s money anymore

- Funds are withdrawn and credit dries up: - no new loans

Real economy dragged down- no new mortgages

- falling share prices More money evaporates in

financial sector- Bankruptcies

Credit crisis

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The political-economic impact of the bailout

- Bailout would reduce pressure on financial institutions, get credit flowing again

- Credit is necessary to avoid recession

- Bailout creates Moral Hazard problem- Should renumeration of ‘financial talent’ be capped?

- Bailout is transfer from poor to rich- Counterargument: government invests rather than spends

- Bailout amounts to socialism

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Is crisis the problem?

Structuralist perspective:

- Capitalism is inherently unstable- Profit-seeking causes overproduction, booms and busts- Speculation

- Question is: why did we believe the system was stable?- Central Banks have delayed big crisis (Niall Ferguson)

- Capitalism needs peaceful labour and willing consumers

- Tendency to think “this boom is different”

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Political-economic impact: Historical parallels

- Long waves?

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Historical Pattern: Crises followed by change in ‘economic regime’- 1870-1932: Neoclassical economics, Liberalism

- Free markets- Centred on entrepreneur- Focus on individual, micro-level

- 1936-1973: Keynesian economics, Welfare states/Development

Economics - Government steering- Centred on consumers and labourers- Focus on aggregate, macro level

- 1980-2008: Supply side economics, Neoliberalism- Created markets - Centred on entrepreneurs- Focus on individual, micro-level

- 2008- : ?- Government regulation

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Debt crisis (early 1980s)1970s: - Oil crisis: increasing costs of production & consumption- Stagflation in developed world- Cheap Credit-fuelled expansion in developing world

1980s: - Thatcherism & Reagonomics- Rising interest rates

Consequence: - Inflation tamed- Unemployment in developed world- Defaults in developing world (Mexico 1982): credit withdrawn

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Asian crisis (1997-1998): Causes- No Fundamental macro-economic problems

- Enough foreign reserves- Exports surpassed imports- Fiscal policies sound

- Institutional, regulatory problems- Fixed exchange rates had seemingly reduced risks of foreign borrowing- Short-term foreign borrowing, long-term domestic investment- Property market bubbles- ‘Streets of Asia are paved with gold’: Lack of detailed information- Lax oversight, close connections between investors and politicians

- Self-fulfilling speculation- Contagion

- ‘Consensus’: financial liberalisation without proper regulation

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Asian crisis (1997-1998): Development- What happened:

- Investors massively withdraw funds from Asia- Currencies devalue sharply- Domestic businesses see (dollar-denominated) loans increase- Credit crunch

- IMF response: - Let insolvent banks and financial institutions fail

- Avoid moral hazard- Avoid political interference in markets- Break up links politics & business

- Raise interest rates - Shore up currency- Penalize insolvent companies

- Allow foreign take-overs- Break up links politics & business: worldmarket efficiency instead

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Asian crisis (1997-1998): Consequences

- Political upheaval - Malaysia: DPM Anwar Ibrahim jailed for corruption and ‘sodomy’

- Indonesia: fall of Suharto

- Major recession- Took about 8 years to reach pre-1997 income levels again,

Indonesia even longer

- Alternative reactions?- Malaysia did not turn to IMF

- Imposed capital controls

- Came off relatively easy

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Questions

1. What way now for capitalism?

2. Financial systems and Capital flows: should they be regulated and limited?

3. Who was gaining from previous situation? How were they making sure situation persisted?

4. Has crisis caused a shift in power, making a change of regime likely?

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