The economics of the financial crisis
24/09
PART 1 – WHY BUBBLES OCCUR EXPLAINED USING BEHAVIOURAL ECONOMICS
Setting the scene
Why is it important to learn about the financial crisis?
People tend to say it is the second worse financial crisis, after the great depression of 1929.
Although that is not true, the global financial crisis of 2008 – GFC is the worst crisis ever
including the Great Depression
We are talking about a crisis never seen before due to its magnitude. A global loss of at least
759 billion dollars. For the US and UK it was roughly the same fiscal costs of a World War.
In the UK
In the UK research from the Institute for Fiscal Studies showed that the economy is £300bn
(16%) smaller than it would have been if the financial crisis hadn’t happened.
A recent BBC sponsored study has shown the impact of the financial crisis on UK wages.
At the time of the financial crisis in 2008, the average wage was £24,100, accounting for
interest rates. In 2017, it was £23,300.
IBS was the biggest bank in the world and was starting to haemorrhage, the bank was going
to run out of money. If the biggest bank in the world can collapse, every other bank can too.
In the US
In particular the crisis has hit at the heart of the community.
Unlike other crises (internet stocks, tulips, equities) this involved the building blocks of
community and social life, the family home. Houses were being repossessed. More than 9
million Americans would lose their home, millions more suffered from stress and anxiety of
not being able to make their mortgage payments. At the worst point nearly 25% of all US
homes had negative equity (meaning that the value of the house was lower than the
mortgage on the house). In the UK that figure was 10%.
The US banking sector, like the UK, came very close to total shutdown.
Rep. Paul Kanjorski, senator in US, so much money was being drawn from the accounts that
the whole banking system was collapsing. Withdrawals had to be limited to avoid further
panic.
“What would happen if there was no money in the ATMs and no pay checks were being paid
out?“ Blyth p. 48 There are over 70 million guns in the US. ANARCHY.
Globalisation
The GFC was truly global. Of the 104 countries for which the WTO collects data, every single
one experienced a fall in BOTH imports and exports between the second half of 2008 and
the first half of 2009. Every country experienced a decline.
Human cost
35.7 million people lost their jobs, 19 million of which were in developing countries.
The incomes of 84 million people were pushed below $1.25 per day.
,As a result the United Nation Food Programme cut its food operations as a result of a
deduction from donor countries by 20-25%.
Countries are really reliant on each other, mainly the less wealthy countries on the richer
ones.
A World Bank study estimated that 1.4 to 2.8 million infants died over the 6 years following
the crisis as a result of the financial crises, due to lack of donations.
Joseph Stiglitz … Nobel Laurette
If we can understand what bought about the crisis of 2008 .. We can make future crisis less
likely, shorter and with fewer innocent victims.
What started out as an economic crisis has MORPHED into a social and ideological crisis with
far reaching consequences.
Capitalism
The crisis has caused many to question the form of capitalism which dominated before the
crisis occurred and ask if there is another way?
Capitalism has dominated western economies, nationalisation of the banking system in the
UK, US, France, Belgium, Switzerland. People started to question if there was another way
to do things. Is the efficient market economies with really low levels of regulation always
going to end up crashing.
Ideological
The GFC has had implications about how
society views banks, and finance.
They used to be worshipped, now it
changed the whole way people think about
bankers and finance.
Wall street, our street. In Iceland, US,
France, Greece… riots, kidnappings,
demonstrations
Political implications
The GFC was core for Trump to gain the elections. He leaned heavily on the concept of
making America great again.
Or the trade war between America and China has his roots on the GFC as there has been a
fundamental ship between economic powers.
It was also said the left had predicted the financial crisis.
Genesis Bitcoin Block chain
It was created post GFC. There is a little message encrypted on the side, Chancellor on the
brink of second bailout of our banks.
Bitcoin has its roots on taking money power away from governments and back to the
people.
,Economic Crisis or Crisis of Economics?
Nearly all economists had no idea it was going to occur. Orthodox, mainstream economics
failed to predict the GFC.
“After the crash, we need a revolution in the way we teach economics”
“What makes economics so unique is the fact that it is the only academic discipline in which
a significant and increasing number of students are in an open revolt against the content of
their degree courses.”
The discontent has been brewing since the outbreak of the 2008 financial crisis, when
students found out that their professors have little to offer in terms of explanation of the
biggest financial crisis”
Kate Raworth – Doughnut Economics
“Students today are still being taught economics that came out of the textbooks of 1950…
Given the challenges of the 21 st century, from climate change to extreme inequality to
repeated financial crises, this is shaping up to be a disaster”
Is economics providing enough explanation for today’s issues.
Brexit
No –one trusted what economists thought of Brexit, coming out of the crisis, economists
have no trust from the communities.
25/09
Narratives
There are loads of narratives for the cause of the financial crisis:
• Greenspan’s interest rate policy: mainly used by bankers, not bankers fault, interest
rates very high which encouraged spending.
• Inequality: mainly used by the left wing
• Complex financial derivatives: used by academics, CDO, CLO, interconnectivity
• FNMA/FDMC: mainly used by the right wing, fault of the US government for
intervening
• Leverage: mainly used by regulators, everyone was borrowing too much money
• Banker Greed: mainly a populist view, too simple
• Failure of economics (academics) and the rise of behavioural economics to
understand the GFC.
It is important to differentiate between the true causes that caused the GFC and the factors
which perhaps turbo charged events but did not cause the crisis itself.
Sovereign Debt Crisis versus a Private Sector debt crisis
The crisis was at first a private sector crisis it emanated there through financial institutions,
apart from in Greece, where the government overspent money. It became a sovereign debt
crisis when the governments took on the debts of these banks – rescue the banks – and
nationalised them.
, What does the Burj Khalifa, the Empire States Tower and the Petronas Tower have in
common?
The tallest skyscraper have been built during the financial crisis as they were planned right
before then. They embody huge levels of confidence in societies
“Skyscrapers are rarely built by their anticipated tenants with cash, they are inherently
speculative ventures. In many ways, the tallest skyscrapers under construction are an
indicator of where money is easiest, speculative juices are flowing most briskly, and
confidence is high.”
Banks
What is a bank?
Banking crisis are the most devastating crisis. A bank is at the heart of any society, they can’t
function. For example, the tech boom in 2000 was a big crisis but easily recoverable as
banks didn’t go bust.
Trust and confidence
The word credit comes from the Latin word “belief”. Even the architecture of banks is
intended to project an aura of trust, stability and permanence.
Banks provide 2 basic functions
1. They provide a place for people to put their money that will earn them more than “under
the mattress”, through interest rates.
2. They provide loans to people to enable them to buy houses, cars and businesses.
Banks take in deposits normally on a short term basis but lend money on a long term basis
creating a maturity mismatch.
Maturity mismatch
Banks take in deposits normally on an short term basis but lend money on a long term basis
creating a maturity mismatch. The risk occurs when people want to take their money out
but their money is not available. In other words a BANK RUN.
To reduce the risk of bank runs
1. Banks are regulated and required to hold bank capital to absorb losses
2. They are required to keep a certain amount of funds in liquid form
3. They are required to take out deposit insurance, to assure people can get their money
back if there is a bank run from a third party.
With these measures they intend for people to have some level of trust in banks’ ability to
survive.
Banks are required to hold capital to absorb losses
What is bank capital?
These are really complicated calculations but they’re RISK ADJUSTED based on the perceived
riskiness of each asset that the bank holds. Recognising that holding a security from (say)
Sudan is risker than holding a US$ bond. Banks were required by the regulator to hold
roughly 8% of “Tier 1” capital.
The lower the risk the lower the capital the bank has to hold against the asset.
Risk was a function (in the case of debt) of the rating.
