Financial Crisis . ppt - Royal Holloway, University of Londonpersonal.rhul.ac.uk/pntm/366/Financial...

Globalization and the Financial Crisis in Southeast Asia

Nov. 15, 2005

The Global Financial Crisis and Developing Countries

Valpy FitzGerald

Oxford Department of International Development

UNDP HDR Course, St Catherines College, Oxford

22 September 2008

Three FAQs

What is happening on global financial markets?

What does it mean for developing countries?

What can be done from a human development perspective?

FAQ 1

What is happening on global financial markets?

Origins of current financial crisis

Since 1990s deregulation of financial markets: risk pricing replaces prudential supervision. Rise of derivative assets with opaque markets and few players. Bank loans replaced by bonds etc.Huge US fiscal deficit, monetary expansion (Greenspan put), low savings led to a US mortgage boom/bust (non traded sector) and a huge current account deficit (traded sector).Mortgage bubbles (e.g. 1992 in UK) are familiar with obvious political costs; join recurrent bubbles in past decade (dotcoms, LTCM, Tequila etc);But this is by far the most serious systemically because it threatens the global banking system itself as creditor, and whole US electorate as debtor.

the elephant in the room

Sub-prime lending

Sub-prime lending had spread from inner-city areas right across the US by 2005. By then, one in five mortgages were sub-prime, and they were particularly popular among recent immigrants trying to buy a home for the first time, and the poor.House prices were high, and it was difficult to become an owner-occupier. But these mortgages had a much higher rate of repossession than conventional mortgages (and thus much riskier) because they were adjustable rate mortgages (ARMs). Payments were fixed for two years, and then became higher and linked to Fed interest rates, which also rose substantially.

Subprime 2

A wave of repossessions is sweeping America as many of these mortgages reset to higher rates. By late 2007, one in ten homes in Cleveland had been repossessed and Deutsche Bank Trust, acting for of bondholders, was the largest property owner in the city. As many as two million families will be evicted from their homes as their cases make their way through the courts. The Bush administration is pushing the industry to renegotiate, but mortgage companies are being overwhelmed by a tidal wave of cases.

Scale and Spread

Collapse of the government backed mortgage system in the USA (Fannie and Freddie) followed by meltdown of major investment banks (Lehman, Bear, Merrill) exposed to mortgage marketMark-to-market asset pricing effects on balance sheets and cumulative liquidity retraction due to rising risk aversion;Now affecting Insurance (AIG) ; and pensions funds next?

Global mortgage boom and bust

The end of the stock market boom

Financial Times, 20 Sept 2008

bank boards and bank executives have failed to understand complex mortgage-backed banking products, as have central bankers, regulators and credit rating agencies.a reward system that has granted huge bonuses to those who peddled toxic mortgage-related products. Almost as absurd has been the degree of leverage racked up by investment banks.

Policy reactions

There are no atheists in foxholes and no ideologues in financial crises, Mr. Bernanke told colleagues(NYT 21.09.08)Freddie Mae and Freddie Mac (re)nationalised; Merrill sold to BankAmerica; Lehman to Barclays; Goldman and Morgan become banks again; US govt $700bn purchase of bad debt; G3 central banks support world banking. Expansionary monetary policy (to avoid recession like 1930s) and scale of US Govt (and G3) bailouts will have large repercussions, yet to be evaluated [lessons of Mexico etc?]

Scale of the potential bailout (already up to $850bn)

FAQ 2

What does it mean for developing countries?

Growth and trade

World GDP growth already projected by IMF to slow down by 2 % points (from 5 to 3 for 2008 and 09); probably more. So with 2% world growth; global GDP per capita fallsAsia probably most resilient (though exports to US will fall); LA will slow down, Africa recession?Commodity prices declining already; volumes too. Natural resource exporters will be hit; food and oil importers to benefit.

World growth will slow, reducing trade expansion etc.

An end to the commodity boom?

Investment and aid

International investment (bonds, FDI) will slow down; as will emerging market stocks; as global confidence declinesSovereign spreads will rise due to rising risk premium (default probability x risk aversion): already up to 4%. Aid flows already under pressure; will be hurt by fiscal overload in G3.

S&P 500 vs Emerging Markets Index

Unsurprisingly, G3 market expectations are bad

US now HIRC?

Recent ODA rise will be difficult to sustain

Poverty and human development

MDG goals even less likely to be met (growth and aid are main drivers)Limitations of family support (Asia), few universal benefits (LA) and narrow safety nets (Africa): effect on poor Previous crises increased inequality, which remains even when growth recoversCommodity price reverse will change lottery of winners and losers

FAQ 3

What can be done from a human development perspective?

Proactive macroeconomic policy

Countercyclical monetary policy and real exchange rate management (inc. capital controls) necessary: MICs with forex reserves already do this;but LICs constrained by IMF.Support domestic banks (esp for agriculture and SMEs), underwrite longterm investment lending; keep real interest rates low.Raise tax pressure (not rates) to maintain fiscal balance and reduce public borrowing.

HD strategy for difficult times

Evidence (UNICEF) that for children employment stability more important than wages; implications for e.g. inflation policyEssential to ringfence budgets (in real terms) for education and health; extend schemes for (simple) universal benefits.Focus on inequality (especially horizontal) rather than just poverty; to reduce conflict and increase social cohesion.

International action and the duty to protect

Essential to moderate G8 policy shifts (e.g. bank regulation, interest rates, exchange rates) from viewpoint of impact on world poor.Need for UN to speak in a clear, timely and credible fashion on these issues (TDR08 good, UN/DESA etc silent)Regional arrangements for mutual currency support etc are vital (Asia progressing; LA talking; Africa nothing). Role for sovereign wealth funds?

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Study Questions

What are the new challenges for SE Asia in the world of global finance?* Are they more structural or more relevant to some actors?What were the internal and external causes of the Financial Crisis?*What are the roles of intl institutions in SE Asia after the crisis, esp. the IMF?*Do you think it is fair to criticize ASEAN as not doing enough in the crisis?* If so, what do you expect ASEAN to do? Is it feasible in reality or not?*What are the constraints preventing ASEAN from doing more during and after the crisis?*What are domestic consequences of the crisis in the hard hit countries?*What are the consequences of the crisis to IR b/w SE Asia and Japan, China, and the U.S.?

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What are the new challenges for SE Asia in the world of global finance?

Globalization: massive increase of trade and capital flows with the rise of information and communication technologyGlobal capital: availability and willing to take risk in fast-growing economies, but volatile and unstable.Neo-liberal Agenda Washington Consensus (1989): liberalization of trade/finance/(foreign) investment, privatization, deregulation, etc.

Structural challenges and opportunities for emerging economies

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Backgrounds for Growth

From ISI (Import Substitute Industrialization) to EOI (Export-Oriented Industrialization)The Four Dragons NICs (Newly Industrialized Countries): Korea, Hong Kong, Taiwan, SingaporeThe New Tigers: Malaysia, Thailand, Indonesia, the PhilippinesFDI from Japan after 1985 Plaza AccordResults: around 10% of growth (1986-95)

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What were the causes of the Financial Crisis?

4 views

Macroeconomic mismanagement (esp. exchange rates)Regulatory and structural problems (esp. in the financial sector)Volatility of intl financial markets* Political uncertainty (esp. on govt. policy and regime change)

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Intl Contexts before the Crisis

Chinese devaluation in 1994 the full rise of Chinese export compete w/ SE AsiaProlonged economic recession in Japan lower capacity to absorb SE Asian exportCollapse of semiconductor prices hurt Korea and Malaysia

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Towards the Financial Crisis

East Asian economic model: debt-financing (bank loan) > equity (stock market)Availability of global capital = cheap money for Asian businesses capital liberalization (esp. offshore banking)

rapid increase of private short-term loans

Pegged exchange rates to US$ = guarantee for unhedged loans and reassurance against currency for investors

*

Why Thailand?

Weak financial supervision after liberalization too many unproductive/speculative loans, esp. in real estate and stock market Also unhealthy corporate governance and indecisive govt.Worsening macroeconomic situations: deficit in Balance of Payment, Trade Balance investors began to call back loans Unlikely to keep pegged exchange rate hedge funds speculative currency attackDevaluation (July 2, 1997) skyrocketing import bills/debt-servicing costs scarce capitals heightened interest rates liquidity problem bankruptcies chain reaction

*

The Effects

Contagion to other countries, esp. Korea, Malaysia, and IndonesiaEconomies with high foreign reserves (HK) and also with open exchange-rate regime (Singapore) were able to largely escape the crisis. Social effects: hundreds of thousands of workers lost jobs, even millions in IndonesiaPolitical unrest and regime changes in Indonesia and Thailand

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What are the roles of intl institutions (IMF, ADB) after the crisis?

IMF bailout package of $120 billion to Thailand, Indonesia, Korea and the PhilippinesRestrictive conditions keep interest rates high, restrictive bank loans severe liquidity problem more bankruptcies And even more neo-liberal agenda privatization, deregulation, liberalization of foreign investment massive asset sell-off to foreign companies

*

Criticism against IMF

Wrong prescriptions

- too restrictive

- same prescriptions to all countries

- gave priority to investor protection

the Wall St-Treasury-IMF Complex

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ASEAN and the Crisis

ASEAN financial ministers started to talk in early 1997, but too optimistic.Later on emphasize macroeconomic coordination and financial supervisory mechanisms also through peer review, but ASEAN lacks capability and the norm of non-interferenceNeed to get help from Japan and ChinaASEAN+3The Chiang Mai Initiative (for swap arrangement)Asia Bonds

*

Japan, China, the U.S. and the Crisis

Japan proposed AMF (Asian Monetary Fund), but was shot down by the U.S.Then substituted with a moderate Miyazawa FundChina loaned some money to SE Asia during the crisis, but more importantly not to devalue its currency.The U.S. offered only moral support and urged for reforms.

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Consequences in IR

The U.S. reputation was tarnished by predatory practices of takeover and the Wall St-Treasury-IMF Complex.Compared to friendly supports from Japanese companies.The growth of nationalism and Islamic activism in SE AsiaMore regionalism in East Asia (i.e. ASEAN+3) with Japan and China playing key roles (stemmed from anger + anxiety)China and Japan compete for leadership in East Asia.

The Current Financial Crisis and its Impact on Emerging Markets

LILIANA ROJAS-SUREZ

Interamerican Development Bank

Washington DC, May 2008

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Hypotheses about the Origin of the Current Financial Turmoil

Highly expansive monetary policy in industrial countries.The persistence of global macroeconomic imbalances.Technological developments in financial markets, which led to the creation of complex instruments.Insufficient transparency of non-bank entities operations and off-balance sheet bank operations.Inadequate regulation for the current sophisticated financial and equity markets.

*

Hypotheses about the Origin of the Current Financial Turmoil

ALL the advanced hypotheses are part of the problem.

But there is one more:

A not-yet learned lesson: capital markets complement, not substitute the banking system.

All financial crisis are characterized by the presence of incentives for excessive risk taking.

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The Crisis: Policies and Incentives

Excepting the period 2005-2006, monetary policy has remained expansive in industrial countries (with periods of negative real interest rates).

*


The main reasons that prevented a restrictive monetary policy in the US:

The vulnerability of the economic recovery after the 2001 recession, especially in the context of geopolitical risks.

Low inflation expectations.

*


Despite the stock markets crash in 2001, monetary policy stabilized real consumption growth in the period 2000-2006, through its effects on the consumers wealth. This was possible because of the large increase in housing prices associated with low interest rates.

Over the last decade, consumption has offset declines in investments. This responds to the consumers perception of greater wealth, through the value of stocks at first and then through the value of real state.

*


The large global liquidity (low interest rates) created incentives for:

The aggressive expansion of financial non-bank intermediaries (mortgage lenders, hedge funds) with increasing demand for high-yield assets.The use of financial products that saved capital for banks through securitization. (Under Basel I, mortgages held on banks balance sheets are subject to a 50% capital charge. There is no capital charge when mortgages are sold to a SIV.)The use of housing equity to get individual funding (home equity loans).

In contrast to the 2001 crisis, in 2008 the American consumer is highly indebted.

*


The Mortgage Loans Expansion in the Industrial World

Before:

Traditional Relationship between Borrower and Creditor

Bank

Borrower

- Pays interest and

principal

- Lends money

- Manages delinquencies

*


The Mortgage Loans Expansion in the Industrial World

Now:

Mortgage Broker

Creditors:

Banks and others

Borrower

Loan

Servicer

Monthly payments

Issuer of Structured

Products -securities- (SIV)

Monthly payments

Loan

Cash

Investors (investment banks,

hedge funds, pension funds,

mutual funds, etc.)

Cash

Securities

Monthly payments

Fuente: Shila Bair, FDIC

Trustee

Underwriter

Rating Agencies

Insurers (monolines)

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The system, though complex, can work if risks are correctly assessed.The problem is that under conditions of large liquidity, the quest for returns encourages excessive risk taking and exposes the systems vulnerabilities:Market participants that work for fees (mortgage brokers, payments receivers) dont have incentives to monitor the quality of loans, only to increase the quantity of loans.The same thing happens with the credit rating agencies which supply ratings for the structured products and do not face any financial responsibility to cover losses from their mistakes.Regulatory Arbitrage: different financial institutions undertaking similar activities face different regulations (especially capital requirements).Principal-Agent Problem: huge disparity in traders maximum loss (zero bonus) vs. investors losses (the full capital invested).

*


But the largest problem is that, if an adverse shock to the system occurs (in this case, the generalized fall of housing prices), all the involved financial institutions lose capital.Because banks provide liquidity to capital markets and hold structured products as assets, a complex system in crisis might collapse to the simple system: bank-borrower.This trend is already happening:Banks have absorbed many SIVs into their books.Banks faced pressures from authorities to finance insurers (monolines).Many mortgage brokers have declared bankruptcy.

*

Would Basel II Helped Prevent the Crisis?

Most likely not!

Under the Standardized Approach Basel II emphasizes the reliance on external credit ratings. The current crisis has seriously questioned the credibility of these agencies for the adequate assessment of risks.For large and sophisticated banks, Basel II relies on the banks internal risk models for assessing credit risk. During the current crisis, large banks were heavily affected using their own internal models!Because of the large demand from investors for mortgage-backed structured products, a reduction in capital charges (from 50 to 35 percent in Basel II for mortgage held on banks balance sheets) would not have prevented excessive securitization.Basel II does not properly take into account liquidity risk. Funding for SIVs collapsed when doubts about the quality of their assets emerged. Under huge liquidity constraints, many SIVs were forced to sell their assets at very low prices.

*

And Moving Forward?

Under current circumstances, when the value of the fundamentals is adjusting (the decrease in housing prices)

*

And Moving Forward?

The systems equilibrium involves a lower size of the banking system (according to the available capital)

And thats already happening.

*

And Moving Forward?

With a lower lending capacity to corporations (affecting investment) and with a poorer consumer (decrease in wealth), the chances of a prolonged US slowdown or recession are very high.

Consumer confidence is at levels of past recessions.

*

Effects of the Current Financial Turmoil on Emerging Markets

Up to now, the effects of the financial turmoil in industrial countries on emerging markets have been:

Mild and mostly limited to financial variables

Different between regions and between countries

HAVE NOT BEEN AN OBSTACLE TO THE CONDUCT OF FISCAL AND MONETARY POLICY

*


A most important current feature of many emerging markets is their ability to tighten monetary policy -increase interest rates- in the presence of inflationary pressures.

Source: Central Banks and IFS-IMF

*

This contrasts with monetary policy in industrialized countries where fears of a significant slowdown in economic growth are keeping interest rates low and decreasing

in spite of expectations of higher inflation.


*

What Factors might weaken the Performance of Emerging Markets?

Severe and protracted recession in the US / Banking crisis (a mild recession is already priced in).High inflation leading to increases in industrial countries interest rates (more relevant in 2009).The China factor and the sustainability of high commodity prices.

*

The External Risks affecting Emerging Markets

US Recession / Banking Crisis

Without doubt the worst case scenario for global growth and emerging markets performance is a systemic banking crisis in the US.This worst case scenario can only materialize if the US enters in a vicious circle where:

severe decline in the value of banks assets loss of bank capital

credit crunch financing problems in corporations and non-bank

financial institutions recession increase in severity of bad

banks assets banking crisis prolonged recession

This is still a relatively low probability scenario, however, because the Fed and the Treasury are currently aligned to prevent its occurrence.

*



While a mild US recession would find emerging markets in good standing, a severe and prolonged recession would increase risk aversion, hurting investment inflows to emerging markets.

Foreign direct investment tend to decline sharply in the face of global slowdowns.

*



Trade flows would also be affected, especially if the US financial troubles expand to other industrial countries, particularly Europe (some markets estimations calculate that UK residential properties are 30% overvalued).

Export growth has suffered the most in periods of global slowdowns.

Re-emerging calls for trade protectionism in the US exports are also a potential threat for emerging markets exports.

*


The Costs of Preventing a US Financial Meltdown: Inflation

Concerns about inflation are keeping long-term interest rates high.

A medium-term risk (2009 onwards) is a sudden increase in interest rates in industrial countries to contain inflation.This risk, which will affect emerging markets financing costs, has a low probability under current circumstances, when fears of a prolonged recession in the US is the main driver of monetary policy.

*


A Decline in Commodity Prices?

Although, as stated before, global exports are at risk in the face of a US-led global slowdown, the sustainability of high commodity prices is less risky in the short and medium-term due to two factors:

Cyclical

There is an inverse correlation between the value of the dollar and the price of commodities.This is because commodities (especially oil and gold and food, more recently) are perceived as a hedge against dollar weakness and the risk of inflation.

*



Cyclical

and the dollar is expected to depreciate further, especially with respect to Asian currencies. Recent policy signals by the Chinese authorities to control inflation point towards further increases in interest rates in China and further appreciation of the RMB against the US dollar.

*



Structural Factors

China, a major importer of many commodities -second importer of oil-, will continue a strong path of growth in the coming years.Supply problems in the precious and industrial metals are a long-term issue, especially given South Africas power crisis (SA produces 69% of platinum, 30% of palladium and 18% of worlds supply of gold). Supply problems of aluminum are also large.Land and water constraints supporting high prices for agricultural commodities.

*



Structural Factors

And the markets are forecasting a continuation in the upward trend of major commodities prices.

*



Also oil prices will remain high, supported by: (a) Chinas strong demand, (b) ageing infrastructure leading to unplanned outages and (c) climate change leading to extreme weather conditions.

Future prices anticipate a modest decline, but these prices have not been effective predictors of oil returns in the past.

*

In Conclusion

Prospects in the industrial economies (especially in the US) arent encouraging in the short-term.The good news is that, at least in the short-term, investors are increasing their investments in commodities and emerging markets.The bad news is that if the financial problems remain severe and prolonged, there will be adverse effects on the sustainability of growth in emerging markets.

*

The Financial Crisis and its learning's:
Theoretical and Policy-oriented

Jacques SAPIR, PhD.

Professor of Economics,

EHESS-Paris

Director CEMI-EHESS -Paris

[email protected]

I. The creeping financial world crisis

The US Subprime crisis.The banking crisis.The Currency crisis

I.I. The Subprime crisis

I. Subprime and Subprime-ARM:Mortgages where the debt to income ratio is over 55% (highly indebted households) or mortgages where the loan to good value is over 85% (high leverage loans).ARM: Adjustable Rates Mortgage.II. Alt A:Debt to income ratio or loan to value ratio are under Subprime thresholds but documentation incomplete (so-called fast track loans).III. Jumbos:Loans of over 417,000 USD.

Whats the Subprime relevance

Subprime and Alt A have a relatively low share in the US Mortgage market (around 15% each). The traditionally subsidised mortgage brokers Fanny Mae and Freddie Mac where making more than 55% of mortgages.But Subprime and other specials developed fast since 1998. Subprime loans were over 1300 billions USD by March 2007. They were at 150 Billions in 2001 and 600 Billions in 2005..And they were backed by a powerful string of financial derivatives. It is the collateralization process which gave Subprime mortgages their relevance.

The development of Mortgage Based Securities

Credit Default Swaps (CDS).Collateralized Debt Obligations (CDO).Collateralized Loan Obligations (CLO).

Selling risk on financial markets: MBS are actually a kind of insurance system for the emitter and they are attractive bonds for buyers till the default rate is low (usually 0.5%).But MBS have spread the risk throughout the financial system and everybody can become an insurance company if it buy a CDS or a CDO.

MBS: an industry which grew too fast...

MBS have developed extremely fast in 8 years.Risk has been spread-out among Banks and Hedge-Funds through obligations baskets sold by SPV working from off-shore zones.Weak collateralization could induce a major liquidity crunch.

US Household indebtedness in GDP %

The current crisis compared to 40 years of indebtedness cycles

Mortgaged loans have been made so easy that they had been used as a proxy for an income policy.

The US economy paradox: Fast growth but an impoverished middle-class.From 2000 to 2006 if the average income increased by 3% a year, the median income has been stable.Lower income households have lost ground. From 1997 to 2004 the 2nd lowest decile lost 12% when the 2nd best decile gained 10%.Poverty is gaining ground: in the USA 20% of children are under the poverty line against 16% in GB and 7% in France and Germany.The 0.1% wealthiest part of the population is accumulating 7% of the national income against 2% in France and Germany.As a result indebtedness has been used to maintain consumption. The average household debt ratio is 120% of the yearly income and households saving ratio was 1.5% of GDP in 2006.

I.II. The Banking crisis

Banks have been the main user of MBS (40% of cumulative total).Strong competition in a deregulated market has made Subprime-ARM based CDS attractive to boost Banks profit rates.The use of SPV and SPV-based Securities-baskets by banks has decreased transparency.New accounting rules (Mark to Market) have increased Banks and Insurance companies vulnerability to financial market fluctuations.

The Body Count(early December 2007).

Total losses in real-estate properties is 107 Billions USD.Total financial losses is around 400 Billions USD.Banks are accounting for at least 50% of losses.Butnobody knows precisely how much has been lost. Confidence has been broken and the inter-bank monetary market has collapsed.

Requiescat in Pace.New Century Financial (Subprime lender)American Home Mortgage (Subprime lender).Ameriquest (Subprime lender)Netbank (Internet Bank)NorthernRock (Bank)

Whos next?

Known losses.Citigroup, investment Bank, USD 11.0 Bln.Merry Lynch, investment bank, USD 12.5 Bln (and may be 15.0)Morgan Stanley, investment bank, USD 3.7 Bln.HSBC, bank, USD 3.4 Bln.Freddie Mac, Mortgage Lender, USD 3.7 Bln.UBS-AG Investment bank, USD 3.6 Bln.Propagation into Europe.The German Banking System is highly vulnerable. Deutsche Bank acknowledge a loss of Euro 2.2 Bln.The Spanish Banking System: dead on Arrival?Insurance Companies: Swiss-Re acknowledge for more than USD 1,1 Bln of losses.

I.III. The Currency Crisis

The banking crisis raises the ghost of a generalized Credit Crunch.Central Banks are reacting by injecting liquidity.But the US Economy is so much indebted that the value of the USD is in doubt.Currency change rates are now extremely volatile.A major crisis is possible in 2008 when we will reach the peak of the Subprime crisis (March-April 2008).

The US Debt is increasing fast.

Is the US Dollar to spin down?

NOThe US Treasury needs to keep the USD attractive to sell T-Bonds.East-Asian countries want to defend their competitiveness and would try to prop-up the USD.The ECB is pouring as much money as it can to prevent a bank crisis.A brutal fall of the USD could have widespread political implications.

YesThe US Government cant afford a recession in an electoral year and any increase of interest rates would have devastating effects.The FED is to bail-out US Banks.Commodity exporters are beginning to use other currencies.The wealth risk on USD denominated Funds is too high. A flight from the USD is to happen.

II. Theoretical and Political lessons

II.I. The current crisis validates some important theoretical findings.

(A): Moral Hazard and Adverse Selection have been proeminent in the Subprime crisis.(B) The Herd Mentality validates Herbert Simons theory of Bounded Rationality. (C) Markets are not spontaneously information-efficient (Stiglitz).(D) Uncertainty and Surprise are shaping decision-makers preferences.(E) Rationality is context-dependent.(F) Institution matters.(G) Market-value is not the value.

II.II. Keynes is back..
(and so are Minsky and Shackle)

(A) When uncertainty is prevalent credit is crunching: this is the preference for liquidity.(B) Agents are reacting not to what happens but to how they understand other agents reaction to the new situation: this is the Beauty Pageant metaphor.(C) When a surprise comes from the Unexpected it can have disastrous consequences.(D) Money-managers are not stabilizing but de-stabilizing the economy.(E) A market does not generate institutions it needs.

II.III. Policy implications.

Central Banks need to be reactive and not bounded by a single target. They have to interact with governments. Full independence is not workable.Financial markets need regulations and supervision. Regulation cant be fully market based. Wealth redistribution is to be consistent with the accumulation process.There cant be good finance where the real sector is not working well.Change rates in a fully liberalised financial environment doesnt reflect actual economic performances.

The New Financial Order and the Current Financial Crisis

Robert J. Shiller

Professor of Economics, Yale University

Co-Founder and Chief Economist, MacroMarkets LLC

New Economic School, Moscow

March 14, 2008

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New Financial Order

Advances in mathematical financeAdvances in behavioral financeAdvances in information technologyDemocratization of finance

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Books

Discussing the need and history of financial innovation in risk management

Macro Markets, 1993

The New Financial Order, 2003

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New Markets in Progress

Home price marketsOil price marketsNatural gas marketsComponents of consumer price indexMedical costsEducation costsPersonal income risksGDP Longevity

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Current Financial Crisis

International Stock market boom 1990s, collapse 2000-2003International housing market boom Late 1990s-2000sCollapse of housing boom in US since 2006, following in other countriesUS Subprime crisis leads to freeze up of financial markets, systemic effects

*

Spread of Crisis to Europe

IKB Deutsche Industriebank AG, and SachsenLB Bank in GermanyFunds sponsored by BNP Paribas in France Northern Rock Building Society in the United Kingdom

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The Crisis as Opportunity

Example of stock market crash of 1929US Reaction in 1930s: financial progress: creation of Securities and Exchange Commission, Federal Deposit Insurance Corporation, Fannie Mae, Homeowners Loan Corporation, Federal Home Loan Bank System, Federal Housing Administration European reaction: not so congenial to marketsThe current crisis should be dealt with with financial progress again

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Real S&P500 Price and Earnings
January 1871 to February 2008

Figure 1.1

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337.278487712732.9900321739

356.674060150432.1573928195

363.049253731331.2756716418

359.379963099630.670392952

332.422209944830.3553720442

326.584285714329.9314285714

339.760327868930.0236193443

343.015226039830.0603128029

336.580540540530.204972973

366.88338129531.0344478058

379.683870967731.8038835484

380.88837209332.6260465116

382.533689839633.2480339037

377.216283185833.7456866903

377.448591549334.2966549296

384.317338003534.4852889667

379.006620209134.6719512195

385.73437534.9171875

370.641450777235.172746114

367.460689655235.5478275862

378.862886597935.8598969072

373.6835.880012

359.908629441635.7175461929

356.073277310935.6781176471

347.665535.778483

344.922985074635.9965343284

344.488863261936.1524217463

345.936393442636.3084757377

336.37536.5222382353

330.065765472336.7349511401

320.481233766236.8208116883

320.765234248836.8464943457

318.17217391336.9313043478

304.106436.72864

297.92031796536.5285532591

295.039305993736.2736908517

305.551267605636.3303126761

318.054976744236.3299693023

315.44779141136.2735889571

311.540547945236.3607150685

331.535454545536.5572881818

329.042706766936.6412330827

315.743070044737.1085988077

295.93362017837.7352080119

298.977341211238.3559527326

307.451332357239.0158855051

299.381157742439.5498266281

302.020916905440.1286532951

304.564589235140.3501844193

293.750181818240.50972

296.238174273940.7218257261

295.877154582840.9004790698

306.482926829341.1306365854

306.583914209141.3013136729

292.655585106441.1865827128

287.736758893341.0192750988

295.99322033940.8020338983

300.199742930640.6130460154

307.758935361240.4295946768

275.278651685440.2006741573

267.839.45058

277.281418092938.7645601467

291.835066505438.0455139057

305.07714631237.7908585248

312.234093637537.2658343337

317.153571428636.7045714286

323.350471698136.5073113208

334.250526315836.3562105263

325.783314020936.165608343

321.951724137935.6809655172

307.634129692835.1239590444

316.970847457634.6954576271

317.672727272734.8005272727

308.864365256134.8655570156

307.531788079534.890794702

296.817248908334.7092251092

295.707042253534.6435859155

267.317381974234.5049570815

270.127194860834.4987152034

276.229882604134.4556883671

277.364680851134.4129361702

261.965853658533.8940935313

254.901691331933.3783190275

246.925714285733.0051428571

258.090410958932.3926767123

255.885594989631.6192377871

238.173402061930.7649690722

236.30430.168072

236.466939611129.6678708291

263.303779366729.1699284985

284.588798370728.4230649695

296.774081632727.8221940816

300.795491803327.2744262295

310.731901840527.0608079755

315.792441266626.8752704801

326.763432073526.7175893769

336.831845841826.64901643

348.381653225826.60799375

352.199396984926.6477788945

352.054054054127.0400702703

341.331736526927.456397006

349.675471698127.8150943396

349.679405940628.2397918812

343.78577075128.6905041502

341.783218163929.1679960513

343.904219823429.8436113837

323.509570312530.5411132812

323.084210526331.3231578947

321.925897187231.8112219205

318.955125725332.3572439072

310.924397299932.899903568

305.68357348733.0162536023

331.317129186633.1317129187

333.149142857133.2146285714

329.633.1734

332.633.2266

32933.28

342.549383886333.050625782

359.41075471732.7290281132

355.090601503832.4411090226

355.793826005631.7771562208

362.907176141731.148387698

369.724349442430.5526579926

376.071428571430.2484506494

367.18529.945565

358.000554016629.616232687

360.751793928229.1067799448

381.591743119328.6274955963

399.427081427328.1506495883

400.063138686128.0159489051

422.741445562728.0350411711

449.654227941228.1058088235

461.535911602228.2803220994

461.231404958728.3250231405

471.782465753428.2915616438

461.973698630128.3813791781

470.346399270728.4190973564

455.408166969128.3794010889

453.27688123328.118250408

467.554891304327.8573820652

473.802352941227.5971764706

500.932553956827.8149192446

530.08548387128.1050983871

549.513826940228.3680642284

540.608518189927.7934070985

538.32413793127.2731655172

559.2496916326.7564052863

573.875746924427.5741652021

606.395454545528.3131818182

583.636695652229.0444869565

511.796357328729.9674849957

447.114384748730.9390379549

439.814558058931.9367417678

455.966292134832.5152202247

468.58533.0908881034

480.312618025833.6056137339

472.276345004335.279906234

459.018382978736.9998211064

483.130677966138.675440678

478.248607594939.1401432911

466.682521008439.6011178151

471.125208681139.9577462437

486.026955074940.4262643927

474.418952618540.9938239401

483.243983402541.5257759336

496.327332782842.0156564822

509.180921052642.5356578947

504.027964022942.980997547

517.176116978142.8500001625

533.984975767442.7550321486

549.324899274842.7988074134

561.882154340841.8322025723

585.826324237640.9030497592

585.1310439.912912

582.503503184739.2807565287

569.07164416238.7465526608

582.197938144338.2453608247

561.991224489837.1773469388

543.69351562536.3285

553.843636363635.46

552.526826997735.1816367727

570.918343653334.8772834365

584.281247113234.4677136259

581.45949386534.5939570552

529.300531914934.5345592705

500.567792012134.5022155237

484.490426966334.0851761798

496.26363228733.7987816143

517.449551569533.5889686099

509.273358098133.1441528975

565.964065281932.8503191395

580.756832.5572

591.424615384631.7197557692

587.055265486730.8393880531

585.793191176529.9640441176

587.932731277529.1314537445

600.348755490528.2598682284

594.346355685127.3534402332

592.990742358126.3683768559

589.802264150925.3494849057

593.329992748424.3892820885

634.51446777724.4709270094

626.876883116924.4990402597

615.865154343124.4918880115

615.057677419424.8844658065

625.332755905525.2760702935

613.278616262525.6114835949

622.13188612126.0514448399

624.670390347826.4707310149

623.721783439526.8876433121

612.641043723627.312651622

627.113408450727.7932676056

646.552389006328.3323044397

642.773057503528.5624403927

650.049056603828.8305660377

660.192869080829.0968245125

648.004528.767375

650.274965325928.4791955617

653.472548476528.1918144044

652.349542936328.7168559557

660.495704419929.1611187845

666.546822880829.6233356306

670.537680164730.2096087852

668.618888888930.8966666667

673.038888888931.6044444444

681.338536251731.9165596443

676.992147239332.2048601227

663.575991847832.4913451087

638.986689280933.6331343284

643.793491525434.7954033898

647.210797297335.8589189189

640.598652291136.769851752

656.16740939637.6253154362

658.244819277138.5254216867

653.367130434840.0351304348

648.555150300641.5150701403

640.3674949943.048496994

651.907185628743.7874251497

672.580198807244.5204771372

685.980118890445.2776089828

704.185951283745.9974524029

724.798856767446.7738172142

744.833508196747.5472655738

769.718832786947.8925114754

770.101805101448.1115631131

795.619856396948.3610182768

798.717970071647.6464344828

816.527460937547.1199675781

843.182032573346.5926775244

838.062512953446.3575066062

883.106029696646.2440347321

875.227630057846.0425433526

872.00257197746.2565451056

889.240344827646.5579310345

898.443522654846.9179706445

863.956318471347.3156495541

887.224462809947.7119454545

900.695361216748.0456273764

933.212103600849.1045230575

976.873278688550.22

986.938524590251.4283606557

1014.242187303651.9329539912

1053.514624060252.4345176692

1042.680652.9659

1004.267528089953.0355741573

1095.869793878853.2047159275

1151.258103555853.2740486588

1214.118841121553.2470280374

1214.407611940353.1869776119

1224.171290322653.0941935484

1239.568663366352.5630753713

1224.374934984552.1958081734

1256.510365778151.8600867948

1255.467920792151.6856188119

1331.684027177351.5117974058

1398.152885326851.3386189889

1441.411250.9976

1433.865184275250.6578378378

1432.067079754650.350196319

1492.498455882449.91000625

1385.036548347649.4707648715

1313.855647921849.0327261614

1325.842573170748.7504328049

1469.61559756148.587859878

1529.130750457648.4547040879

1600.675362142448.6230066908

1595.925519756848.8498115544

1635.864218181848.9868363636

1691.338483754549.7482310469

1687.929855595750.8633212996

1675.866606498251.9784115523

1744.67002999453.0605878824

1673.066391382454.1686894075

1653.404419297255.1398213222

1627.717633769356.7985612366

1740.609625668558.520855615

1787.7660.2768983957

1778.609324644661.2503317536

1722.591413427662.0348056537

1774.12047897262.6633411215

1796.628231173463.0283712785

1741.876897959263.3560116618

1785.897772621863.4243155452

1795.2187564.000625

1810.40437564.72375

1779.915544041465.1077720207

1682.548758620763.5027586207

1666.945571510661.9743825388

1610.884241379360.5172413793

1606.417350085758.3088977727

1564.22610921556.2558361775

1417.366685584654.3113734393

1416.50821933350.6638439796

1505.570748452547.0185931345

1465.574865168543.5279438202

1429.054478873240.2967774648

1398.265352112736.9429971831

1233.882131239533.4385081324

1275.913640967932.121339336

1341.097001127430.743167982

1364.585500848929.4267911715

1355.890604178429.3642913608

1303.718233970729.252632171

1358.99426174529.0929530201

1302.405216907729.7276307008

1264.127085650730.5241156841

1187.062879377431.3031906615

1056.613292615232.6716490838

1063.547482014433.9617266187

1009.728099447535.301679558

992.747258687334.1784555985

1056.984324324333.1136458908

1046.806567164232.1197014925

1038.326384149733.033021464

962.744500273133.8271217914

967.971107491934.6655374593

1019.805865070736.3565723613

1074.186245231638.0342452316

1132.677191072439.6093086554

1136.64450244741.1046003263

1128.900422535242.4812676056

1159.255205183643.8712095032

1182.46777297347.7739459459

1198.422439024451.7691707317

1234.849614758555.6953011394

1287.844017278656.6603455724

1293.188055853957.585112782

1263.128004268958.4375667022

1269.604340425559.8006914894

1228.162178741460.993442623

1257.560653663762.3362677912

1229.630464625163.0354487856

1210.188728232263.6023113456

1239.490236966864.0672037915

1232.500921948764.0184284966

1288.89405235664.271591623

1327.134135575464.7957435628

1304.692952281165.3114001049

1317.216256517265.5846611053

1301.841386445965.7185307812

1260.169362795566.3761562179

1276.4767.5422222222

1301.767866323968.6047095116

1317.31701125969.4419549642

1312.786466395170.2357433809

1298.685875251570.5213380282

1260.174578313371.5638253012

1318.775921052673.3369736842

1350.568810975674.8336280488

1358.046081694475.2375491679

1353.107649723276.0541217916

1363.671891891976.5981081081

1360.977677419476.5859354839

1341.610476.8386666667

1300.727461803877.316875308

1304.209061425178.4963636364

1329.444776851479.7470622854

1367.747875800981.5517102021

1422.833637264683.0189791873

1451.352774193584.1668387097

1478.18658077385.0644499504

1481.741048138585.3743478776

1495.215603025185.4857370306

1442.90618060785.2749912346

1491.356860164785.3257792013

1530.404493409485.4050656651

1530.527251958285.836238673

1537.508706234883.7281407976

1473.39068955481.7481206443

1512.27143747979.3954626121

1551.92210054752007.7916666665

1466.33520318592007.8749999999

1483.19208135752007.9583333332

1379.522008.0416666665

Price

Earnings

Real Price

Real Earnings

Year

Real S&P Composite Stock Price Index

Real S&P Composite Earnings

Figure 1.3

18.47395230143.7

18.1472581653.6933333333

18.27011914023.6866666667

17.95010827823.68

18.86971869323.6733333333

19.02871073113.6666666667

18.11636718743.66

17.2862435543.6533333333

16.72483664883.6466666667

16.26198941123.64

16.47864231663.6333333333

15.95875420613.6266666667

15.678764163.62

15.15386152843.6208333333

15.09167029953.6216666667

14.91699716843.6225

14.56710320223.6233333333

14.32740489013.6241666667

15.24055976123.625

15.52542933153.6258333333

16.08110662453.6266666667

15.75558103053.6275

15.19267031323.6283333333

15.38212833213.6291666667

15.27025911913.63

14.75759014623.6291666667

15.05125412143.6283333333

15.4820672223.6275

15.33549763733.6266666667

15.90338838863.6258333333

15.9487831273.625

15.19681087663.6241666667

15.49469242583.6233333333

15.04805627023.6225

15.40821814243.6216666667

14.89640394193.6208333333

14.4328217223.62

14.80596022883.6116666667

14.7360234543.6033333333

14.353

Financial Crisis . ppt - Royal Holloway, University of Londonpersonal.rhul.ac.uk/pntm/366/Financial...

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