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Recession 2007 2010 Global Implications

Recession 2007 2010 Global Implications. Dr Maurice Mullard Lecture 10. Explaining the Crisis. Financial crisis that started in America with sub prime mortgages Savings glut thesis on global imbalances China Germany Japan high export surpluses US UK France deficit countries

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Recession 2007 2010 Global Implications

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  1. Recession 2007 2010 Global Implications Dr Maurice Mullard Lecture 10

  2. Explaining the Crisis • Financial crisis that started in America with sub prime mortgages • Savings glut thesis on global imbalances China Germany Japan high export surpluses US UK France deficit countries • Alan Greenspan low interest rates after 9/11 • Compare with Depression of 1929 – 1931 • Consumer debt

  3. Overspill finance to real sector • Differences trigger events from structural flaws • Financial Sector Banks assets liabilities capital and liquidity • Intermiedary role deposits short term and long term exposure • Leverage • Thin capital and liquidity • Run on Banks • Gorton on repo markets and investment banks

  4. Sketch of Financial Crisis • Credit crunch 20 07 limited to sub prime mortgages total1 trillion dollars not sufficient to create global crisis • Finance Securities Derivatives and Credit Default Swaps • 640 trillion dollars 10 times global GDP • Bear Stearns March 2008 and JP Morgan • Lehman bankruptcy September 2008 • AIG

  5. Banking Crisis • Innovation and New Instruments • Derivatives Market now worth 600 trillion dollars keep in mind world GDP is 65 trillion dollars • CDS Collatarised default swaps insurance for a fee insured pays insurer against default of loans worth 47 trillion dollars • Argument of distributing risks financial modelling started at JB Morgan

  6. Shadow Banking • CDS Collaterised Debt Obligation contained tranches of loans mortgage backed securities on home loans and also commercial properties • CDS sliced and diced into tranches according to risk and default • Senior seen as safest Mazzini and high risk • Mainly held at Lehmann and Bear Stearns

  7. Early Signals • History of House Prices house prices slowing down in 2007 first time in history CMS started to lose value worry about defaults • Bear Stearns take over by JB Morgan share value fell from 170 dollars to 2 dollars • Lehmann Brothers allowed to go into bankruptcy watershed • AIG rescue • Financials system described as falling off a cliff Buffet derivatives weapons of mass destruction

  8. Implications • Idea of Household Net worth • Estimate US household net worth about 103 trillion dollars net debt 50 trillion dollars • US households debt 15 per cent of income

  9. Economic History • Lessons from History Financial Panics • Bank runs and insurance • Loss of confidence • 30 year flood syndrome or a repeat of history • Unable to forecast the bubble • Reluctance to increase interest rates • The Savings Glut

  10. Regulation UK • Bank of England monetary policy target inflation FSA responsible for Banks stress tests • De regulation Thatcher Revolution continued Labour Government light touch on regulation • Finance important to UK GDP expansion of hedge funds and Special Investment Vehicles SIV beyond supervision not defined as Banks

  11. UK proposals on Banking Reforms • More Powers to Bank of England deal with system failure Banks too big to fail competition authority • Future role of FSA • Bank of England MPC and New Finance Committee • Beishoff Report Adair Turner Report • HC Reports on Banking Crisis

  12. Unresolved Problems • Difference between Commercial and Investment Banks how to protect individual savings account • Banks that are too large to fail a moral hazard • Shadow Banking bring into the formal system of regulation • Hedge Funds • Transparency and risk

  13. EU Proposals • More restrictions on Shadow Banking Sector • Hedge Funds • Special Investment Vehicles • German criticisms of US and UK Model • Resistance from City of London

  14. US Legislation Frank Dodd Bill June 2010 • Oversight and Regulatory authority • Tighter controls of regulators stop regulatory arbitrage • OTC to be standardised through central clearing system more transparency • Consumer protection

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