Y376 International Political Economy

1. Y376 International Political Economy January 23, 2012

2. Financial Crises • Often begin with a structural deficit problem accentuated by a severe downturn in the domestic economy • Country may default on its international obligations (loans, other foreign investments) • All this occurs in a general atmosphere of panic, currency value may fall rapidly

3. The Peso Crisis of 1994 • Mexico admitted to OECD in May 1994 • Huge balance of payments deficit financed by Tesobonos (bonds denominated in dollars) • Zedillo replaces Salinas as President • Sudden devaluation of the peso in December 1994 • GDP contracted by 7 percent in 1995

4. The Asia Crisis of 1997-98 • Starts with collapse of Thai currency, the baht • Crisis spreads to Indonesia, South Korea, and other East Asian countries • IMF criticized for bad advice/pressure during the crisis

5. Depreciation of Asia Currencies

6. Russian Crisis of 1998 • Delayed impact of Asia Crisis • Oil prices on the decline, government unable to collect taxes • Use of dollar-denominated GKO bonds to finance budget deficits • Ruble suddenly devalued in August 1998 • Economy recovered quickly several years later when oil prices increased

7. Argentine Crisis, 1999-2002 • New currency created in 1983, the austral • Inflation problems led to the restoration of the peso in 1990, and the peso was pegged to the dollar • Balance of payments problems led to debt increases that resulted in speculation about the value of the peso • When Brazil devalued the real, Argentine trade suffered further, and GDP declined by 4% in 1999 • 3 years of recession followed, combined with capital flight to produce a major economic collapse • In 2002, the peso was allowed to float (and devalue)

8. Global Financial Crisis 2007-8 Led by bursting of the housing bubble in the US in 2007 Made worse by near collapse of US financial markets connected with mortgage-backed securities, synthetic collateralized debt obligations (CDOs), and credit default swaps Response to the crisis revived the debate over regulation of financial markets and Keynesian approaches to preventing deep recessions

9. Global Financial Crisis 2007-8 • Led by bursting of housing bubble in the US • Made worse by near collapse of US financial markets connected with mortgage-backed securities and credit default swaps • Response revives debate over Keynesian approach to preventing deep recessions

10. US Home Price Index 1963-2010 1963-2010 The Bubble Bursts

11. Contributing Factors • Subprime mortgages • Unethical mortgage brokers • Low interest rates set by the Federal Reserve • Credit Rating Agencies (conflicts of interest) • Insufficient regulation of financial markets • Mortgages and related markets • Derivatives, including credit default swaps

12. Subprime Mortgages • Definition: a type of mortgage granted to individuals with low credit ratings (FICO less than 600) • Subprime mortgages feature higher interest rates than conventional mortgages because of the higher risk of default • Subprime borrowers were offered adjustable rate mortgages (ARMs) • US policy from the 1990s on was to encourage the growth of this market to make home ownership available to a wider spectrum of the population

13. Expansion of Subprime Market

14. Unethical Mortgage Brokers • Exaggerated expected earnings of borrowers • Sold more expensive loans when less expensive loans were available • Conspired with real estate brokers to raise the sale price of properties above market value • As a result, subprime delinquency rates began to increase rapidly after 2007 Angelo Mozilo

15. The Role of Low Interest Rates • Investors were looking for ways to obtain higher rates of return for low-risk investments • Treasury Bonds became less attractive for this purpose • Mortgage Backed Securities (MBSs) and Collaterized Debt Obligations (CDOs) expanded rapidly to fill the void

16. Credit Rating Agencies • These firms (e.g. Fitch Group, Moody’s, Standard and Poor’s) establish credit ratings for issuers of certain types of debt obligations. • The highest rating is AAA which denotes low risk and high liquidity. • They sometimes compete for business by offering better ratings (a clear conflict of interest).

17. Insufficient Regulation • Securities and Exchange Commission (SEC) was supposed to regulate the mortgage market and apparently failed to do so • The Federal Reserve (especially when headed by Alan Greenspan) chose not to regulate derivatives markets • Government financial regulators relied too much on the private credit rating agencies and business journalist to expose malfeasance and overly risky investments

18. Short-Term US Government Responses • “Rescue” of Bear Stearns • Decision not to rescue Lehman Brothers • Takeover of Fannie Mae and Freddie Mac • Troubled Asset Relief Program (TARP) • Bailouts of AIG and GM • $245 billion invested in US banks • Obama’s economic stimulus package

19. Bear Stearns stock price

20. Medium and Long-Term Measures • Capital Adequacy Requirements and Deleveraging • Regulation of previously unregulated markets (derivatives, but especially credit default swaps) • Improved protection for consumers • Mortgage renegotiation incentives

21. The Group of Eight (G8) • Began in 1975 as a way for the largest industrialized economies to deal with the problems of interdependence • Heads of state of the G7 countries met annually until 1997 when Russia joined • The European Union is represented separately in all G7/G8 meetings

22. Who are the G8? • US • UK • Germany • France • Italy • Japan • Canada • Russia

23. G7/G8 Meetings, 1975-2011 • 1975 Rambouillet • 1976 Puerto Rico • 1977 London • 1978 Bonn • 1979 Tokyo • 1980 Venice • 1981 Ottawa • 1982 Versailles • 1983 Williamsburg • 1984 London • 1985 Bonn • 1986 Tokyo • 1987 Venice • 1988 Toronto • 1989 Paris • 1990 Houston • 1991 London • 1992 Munich • 1993 Tokyo • 1994 Naples • 1995 Halifax • 1996 Moscow • 1997 Denver • 1998 Birmingham • 1999 Cologne • 2000 Okinawa • 2001 Genoa • 2002 Kananaskis • 2003 Evian • 2004 Sea Island • 2005 Gleneagles • 2006 St. Petersburg • 2007 Heilegendam • 2008 Hokkaido • 2009 L’Aquila • 2010 Muskoka • 2011 Deauville

24. Heilegendam Summit in 2007 L to R: Tony Blair, Romano Prodi, Vladimir Putin, Nicolas Sarkozy, Angela Merkel, George Bush, Stephen Harper, Shinzo Abe and Manuel Jose Barroso

25. 2009 L’Aquila G8 “Family Photo” L to R: Taro Aso, Stephen Harper, Barack Obama, Nicolas Sarkozy, Silvio Berlusconi, Dmitry Medvedev, Angela Merkel, Gordon Brown, Fredrik Reinfeldt, Jose Manuel Barroso

26. Who are the G20? • G8 countries • Argentina • Australia • Brazil • India • Indonesia • Mexico • Saudi Arabia • South Africa • South Korea • Turkey • China • European Union Pittsburgh Summit 2009

27. What are the G8 and the G20 Doing about the Current Crisis? • Stimulus packages • Improved regulation of financial markets • Capital adequacy reforms (credit default swaps, especially) • Improve credit rating agencies • Continued meetings