Economic Crisis 2007

7/30/2019 Economic Crisis 2007

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Economic Crisis 2007 .


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When Did the Crisis Begin?


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When?2007?2001?1999?1981?1973?

1971?1944?1936?


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1936 and KeynesThe year Keynesian Theory was published.Keynes in a letter to G B Shaw boasted economicswould never be same again. It was not.Keynes taught spending as salvation, government assavior, deficit finance as the weapon.He asserted unemployment and inflation aremutually exclusive

In decades thereafter, the western world took Keynesian advice right.

And very wrong.


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1944 and Bretton WoodsIMF was establishedDollar was accorded the status of the King of Currencies. It wasmade currency of reserve.Fixed exchange rates establish with currency tied to dollar anddollar to gold.Undervalued currencies distorted trade.US acquired enviable capacity to write cheque on it self.

And US used the prerogative abundantly And irresponsibly with excesses in spending and debt.

US deficits in budget, in trade, US expanding money supply andUS debt wrote the script of crisis.


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1971 and NixonNixon closed the gold window endingtwenty five years of fixed prices givingway to more excesses and loss of faithin dollar.Smithsonian realignment of currencywas short lived.


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1973 and Oil Shock OPEC oil shock changed the macroeconomic of worldOil producing countries acquired upper hand andlicense to amass wealthUS developed vested interest in high oil prices asproducer and as beneficiary and keeper of oil wealth.Keynes exclusivity of unemployment and inflationwent for a toss creating dilemma and inefficacy of

monetary and fiscal policy which aggravates crisis.G7 decided to maintain value of Dollar byintervention


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1981 Regan and Deng

XiaopingBacklash of capitalism and free market notonly in the west but in Communist China

Deregulation and encouragement to amasswealth Moral Hazard entered the macroeconomicscene with government bailout.

401 (k) and other measures to create equityculturePlaza meeting 0f G7 in 1987 and triggeringdepreciation of dollar wealth acquired bycountries could and did lose its value.


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1999 IT bubble, Y2K and

Repeal of Glass Steagall ActIT bubble is born and grows

Y2K facilitates outsourcing

Power shiftRise of China as Worlds factory and of Indiaas its back office.

Accelerates globalization enabled by IT

Glass Steagall repealed wiping outdemarcating line between commercial banksand investment banks. Invitation to takemore risk.


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2001, Bush, IT bubble burst

and WTCBush paints a rosy picture of making America anOwnership SocietyRefunds $ 168 bn. to no availReduces taxes. Rich get $ 450 bn + benefit out of total $ 650 bn cutCapital gains tax rate (15 %) at half the income taxrate (30 %)

IT bubble bursts creating mini crisis of confidence Further setback with 9/11 and WTC collapseInitiates Greenspan Put and Housing Bubble.


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2007 Crisis Begins withBursting of Housing Bubble

Followed by Finance Sector Crisis

on the Wall Street


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Housing Bubble Blew 2004-07Surge in housing with cheap money, easymortgage availability and belief that houseprices would always riseSub-prime and NINJA loans

ARM and zero and negative equity loansHELOC and Refi loans making existing houses

ATM Alt-A loans minimum or no documentationSecuritization and the finance bubble


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Bubble Grows; Economy

GrowsHousing triggers economic growthWith cheap money, failure rates fall;falling failure rates trigger moreirresponsible lending

We have no way to know a bubble till

it bursts Alan Greenspan While the music plays, you have todance Charles Price, CEO Citi Group


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Housing Bubble65 % home ownership in 2001, 69% in2006

Sub-prime $ 145 billion in 2001 $ 625billion in 2005In 1998 Real Estate Agents 718,000; in

2006 1.37 millionIn 2000 mortgage brokers 240,000; in2006 418,700


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Housing Bubble (Continued)

By 2005, 40 % home purchases forinvestment or second homes

HELOC (Refi) increased from $ 59.1Billion in 4th qtr 2001 to $ 206.7 billionin 3rd qtr 2004

In fall 2005, Mark Zilbert Miami Realtorlaunched www.condoflip.com withmotto bubbles are for washtubs.


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Housing Bubble (Continued)Mortgages $ 304 billion in 2001, $ 985 billionin 2004, $ 2.9 trillion in 2005.

ARM share 12 % of mortgage in 2001 to 19% in 2004 to 31% in 2005Foreclosure fell from 1.49 % in third quarter2002 to less than 1 % in second quarter of

2005952 days without a bank failure since June2004


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Housing Bubble: InnovativeFinance

MBS securities $ 482.4 billion in 2000increased to $ 2.14 trillion in 2003

Daily trading MBS rose from $ 69.5billion in 2000 to $ 211.5 billion in 2004Synthetic CDOs outstripped cash-flow

CDOs in 2006 and early 07CDS $ 1 trillion in 2001 to $ 62 trillion in2008


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I sincerely believe that banking

establishments are moredangerous than standing armies.

Thomas Jefferson - 1816


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Finance Sector on SteroidsPhenomenal growth of the Wall Street. Dow at alltime high of 14,400 +Investment banks reap it rich. Billions of dollars of profits, billions of dollars of bonusesHeavy interdependenceHigh leverageGlobalization of finance. Hunger for US assets.

Assets-liabilities mismatch. Borrow short in moneymarket, lend / invest long in capital market. Bubblefeeds on bubble.


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Humpty Dumpty had a GreatFall

House of Cards

Collapses September 2008


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Tsunami 2008 A Black Swan?

Bear Stearns folds up in March with highexposure to sub-prime losses

Dollar collapses in July 2008. Euro=$ 1.59Oil at $ 147 a barrelNero fiddles I am an optimist Bush in July

2008 Avalanche moves. In September, Fannie Maeand Freddie Mac are effectively taken over


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Tsunami A Black Swan?Continued

Money market dries. Difference in LIBOR and US 90days TBs rises to 345 basis pointsCrisis of confidence in markets. Dow slidesLehman in trouble. Paulson decides to let it fall. On15 th September, Lehman files for BankruptcyPanic ensues

AIG is effectively nationalized with Govt. pumping $

85 bn in bail out against 80% stock of AIG. Total AIGfunding $ 210 bn and counting


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Tsunami A Black Swan?Continued

House passes TARP on second attempt Bailout Package of $ 700 billion

Meltdown is global Systemic risk implodesDow at less than 6,500On October 13 th , government recapitalizes

banks total support over time $ 350 billionIn November Obama wins Presidency.


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Asian Development BanksReport on The Cost of theFinancial Crisis

A hole of US $ 50 trillion


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. and Counting

$1.2 trillion wiped off in losses and write-downs by banks and other financial

institutions.$28.7 trillion lost in global derivaties.$6.6 trillion has been wiped from the valueof world equities$9.6 trillion wiped off from Asian countries,excluding Japan.$2.1 trillion drop in financial assets of Latin

American region


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Who Done It

Complexity of multiple causes

A character of global world


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It is class warfare and my class iswinning, but that shouldnt be

Warren Buffet - 2007


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Factors that Propelled Bubbles

Capitalist Expansion and Ownership SocietyCultural and Political Changes Favoring

Business SuccessNew Information TechnologySupportive Monetary Policy and Greenspan

Put. Cheap money. An Expansion in Media Reporting of BusinessNews


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Factors that Propelled Bubbles(Continued)

Analysts Optimistic Forecast. Role of ratingagencies.The Expansion of Defined ContributionPension Plans (401 (k))The Growth of Mutual FundsExpansion of the Volume of Trade: Discount

Brokers, Day Traders and Twenty-Four-HourTradingThe Rise of Gambling Opportunity.Refinancing and flipping.


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Financial innovation. Securitization, packing,repacking, slicing, debt. Alphabet soup of

ARM, MBS, ABS, CLO, CDO, CDO squared,cubed, Synthetic CDO, CDS, Alt-A, SIVs,conduits.Global liquidity and global market for debtpaper.Enhanced risk taking due to low failure rate.Sub-prime lending


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Baseless optimism on continued rise in pricesMoral Hazard

Global savings glut (Chinese fund AmericanExcesses)Iraq and Afghanistan Wars (Chinese pay forit)

Absence of regulationDomino effect


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Rising Inequality of Income Middle ClassSqueeze. Let them eat credit.Increasing gap between rising productivityand constant remuneration.


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Wall Street Crisis moves toMain Street

Great Recession and

Unemployment


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Slowdown

The US and World economies slow downUnemployment mounts to 10 % in US

European Debt Crisis further compound woes.Iceland is BankruptGreece, Portugal, Spain and Ireland struggle

Economic growth in China and Indiaslowdown


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Unemployment Story2008 Continuing


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Long Term (> 6 Months)Unemployment


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America Imbalance andUnemployment


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What Happens Now

Some thing Done

A lot more to do and will not bedone


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Some thing DoneFEDs QE1 (quantitative easing) and QE2.Ballooning FEDs balance sheet. Floodingliquidity. Continued Cheap Money. Total QE $2.3 trillionObamas Stimulus $ 1.9 trillion deficit in 2009,$ 1.4 trillion deficit in 2010Passes Health-Care BillPasses Finance and Wall Street RegulatoryBill


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Stimulus

Freefall - Stiglitz


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A well designed stimulusshould

Be fastBe effective

Address long term problemFocus on investmentBe fair

Deal with short term exigencies createdby the crisisBe targeted at areas of job loss


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Shortcomings of Obama Stimulus Inadequate

$ 800 billion for two years 2009-10 fora $ 14 trillion a year economy was

merely 3 %$ 200 billion in 2009 failed to have anyimpact.The cut back in state budgets inaggregate was almost similar and hencenet stimulus was zero.Failed to create jobs. Joblessnessremained high.


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Shortcomings of Obama Stimulus(Continued)

Too little to meet demand of jobs lost anddemand of jobs for new entrants.Economy will be no where close to fullemployment till may be 2015State finances in disarray. With job losses andfalling property prices, revenue base hasshrunk.States are cutting back expenditure off-setting the effect of stimulus

h f b


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Shortcomings of ObamaStimulus (Continued)

Tax cut has not increased spending aspeople uses tax cut to repay borrowing

or to save with anxiety on jobsTax cut on cars increased purchases butit only be proponed purchase decision.

Cars then bought meant no purchasenow.


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Finance ReformCreated new agencies to overseeperformance, particularly for ConsumerProtection.

Limited risk taking by defining limits onderivatives (3 % of Capital)Brought Rating Agencies within purview of Consumer Protection and made accountable

Brought Insurance within regulatory control.No institution to be too big to fail More transparency and accountability


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Finance Reform

Too elaborateToo bureaucratic

Already implementation is being watereddown.Banks are making profits due to low FED rateand are back to high bonuses and old tricks.Regulators, including Bernanke and Geithner,too close to the Wall Street


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The issue is Deficit .

And Debt


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A Lot More to Do

But Would not Be Done


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Albert Einstein

Problems that are created by ourcurrent level of thinking cant be solved

by that same level of thinking

T D I E lit


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To Do Income Equalitythrough Fiscal Reform

Make tax structure progressive andequitable according to ability to pay

principleInsist on banks raising more capital andhave lesser leverage through taxincentivesCapital gains needs to be taxed at samerate as income
http://visualizingeconomics.com/2011/04/14/top-marginal-tax-rates-1916-2010/


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http://visualizingeconomics.com/2011/04/14/top-marginal-tax-rates-1916-2010/


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To Do Income Equality throughFiscal Reform (Continued)

Increase marginal tax rate from 30 % to55 %Negative tax to ensure family income of atleast $ 35,000 per yearReemployment incentives not unemploymentcompensation.

More spend on skill building and retrainingMedicare for allSelect reduction in defense expenditure


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To Do Income Equality throughFiscal Reform (Continued)

School vouchers of value inverse of income

Carbon tax on fossil fuelStudent loan repayment as proportionof income and not on amount of loan

Strict limit on political funding


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The Alternative is

Conservative Backlash and Chaos

Global InflationRepeated bubbles and crisis

Economic Crisis 2007

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