THEORY OF FINANCIAL CRISES Elective M1, FINANCIAL ECONOMICS TRACK ACADEMIC YEAR 2012 / 2013

1. THEORY OF FINANCIAL CRISES Elective M1, FINANCIAL ECONOMICS TRACK ACADEMIC YEAR 2012 / 2013 Professor: Nikolay NENOVSKY

2. Theory and History of Financial crises Pr Nikolay NENOVSKY University of Picardie Jules Verne Former Member of Bulgarian Central Bank Governing Council EDHEC, Nice, May 2013 EDHEC May 2013

3. IVCrisis: Policy responses and prevention EDHEC May 2013

4. Policy reactions Macroeconomic policy (fiscal/monetary) Regulation policy (banking supervision…) International policy European dimension How government reacts? EDHEC May 2013

5. First reaction: Fiscal stimulus … Fiscal multipliers (à la Keynes) …. Huge stimulus (China)/not so huge government spending (Europe…) Different fiscal packages… Banks and systemic firms nationalization (ex: Dexia…)/General Motors/FED Explosion of Public debts Second reaction: Fiscal austerity (cut of public expenditures…)…. Fiscal policy (stimulus) …. EDHEC May 2013

6. Monetary policy (stimulus)…. • Restoring confidence at the money markets • (government guarantees/collateral …) • Providing abundant liquidity… EDHEC May 2013

7. Monetary policy (stimulus)…. • Restoring the monetary transmissionmechanism • Lowinterest rates… • New monetary policy tools… EDHEC May 2013

8. Monetary policy (stimulus)…. • Quantitative easing (… non conventional measures)/QE1/QE2/QE3… • Baying debt on secondary (ECB) and …primary markets (FED)… • Emergency liquidity assistance (ELA)/ECB • Collateral easing … • Long-term maturity/ECB (LTRO 3 y)… EDHEC May 2013

11. EDHEC May 2013

12. EDHEC May 2013

13. EDHEC May 2013

14. EDHEC May 2013

16. Collateral … • http://www.ecb.int/pub/pdf/other/gendoc201109fr.pdf?bd3a046b48684b180acd567265771f93 • http://www.ecb.int/paym/pdf/collateral/collateral_data.pdf?d45435a4d56a30d81d6753e2840f15ee • http://www.ecb.int/paym/coll/assets/html/list.en.html

20. ECB

28. Financial/banking system New regulation/Banks separation (UK/?) Stress testing … Safety net (Europe) New mandate for ECB/Supervision… Bankers responsibility… Regulation policy EDHEC May 2013

29. Voluntary regulatory standard on bank capital adequacy… stress testing and … market liquidity risk…. Basel III (BIS)/2010 – 2013/2019… EDHEC May 2013

30. In addition, Basel III introduced a minimum "leverage ratio" and two required liquidity ratios… The leverage ratio was calculated by dividing Tier 1 capital by the bank's average total consolidated assets; the banks were expected to maintain the leverage ratio in excess of 3%... The "Liquidity Coverage Ratio" was supposed to require a bank to hold sufficient high-quality liquid assets to cover its total net cash outflows over 30 days… Basel III (BIS)/2010 – 2013/2019… EDHEC May 2013

31. Requires banks to hold 4.5% of common equity (up from 2% in Basel II) and 6% of Tier I capital (up from 4% in Basel II) of "risk-weighted assets“… Introduced "additional capital buffers", (i) a "mandatory capital conservation buffer" of 2.5% and (ii) a "discretionary counter-cyclical buffer", which would allow national regulators to require up to another 2.5% of capital during periods of high credit growth… Basel III (BIS)/2010 – 2013/2019… EDHEC May 2013

32. Global crisis – global response Regional (EU) crisis – regional (EU) response International policy coordination G20: eliminating global imbalances (causes/remedies.) BoP sustainability/Exchange rate parities BRIGS/BRIGS bank/Swap exchanges … Regional integrations... (Asia, Latin America/…/Equator…sucre…./ International policy/international coordination…. EDHEC May 2013

33. International monetary system/new monetary order Global monetary/financial architecture Global safety net … IMF/ symmetry between debtors and creditors/new and old leaders ….(who should adjust ?) Avoiding Currency wars … Place of the USD/Triffin dilemma (world growth/financial stability…) International policy/international coordination…. EDHEC May 2013

34. Robert Triffindilemma: issuing countries of reserves currencies cannot maintain the value of the reserve currencies while providing liquidity to the world (to preserve world growth that need more base money … ) … International policy/international coordination…. EDHEC May 2013

35. Solutions/choices Cooperative policy actions Market driven developments …………………………. Four technical options Currency competitions/multi-polar world … Basket currency (SDR enlargement/other basket …) Global, supranational fiat currency (bancor…) Clearing unions at different levels … International policy/coordination…. EDHEC May 2013

36. Euro as Gold standard/golden fetters …. Who should adjust (debtors or creditors/or both… ? Systemic dimension Germany + : need inflation and fiscal expansion South/peripheral countries: need deflation and some austerity Redistribution and fiscal transfers are they possible? European dimension EDHEC May 2013

37. European Financial Stability Facility (EFSF/SPV) May 2010 (up to 440 bn), in Luxembourg, Klaus Reding Money is borrowed by the EU Commission (AAA/AA) Jan 2011, EUR 5 bn of 2.5% five years notes Lend to Ireland at 5.51%/to Portugal/to Cyprus… Buying Bonds on primary market (not secondary as demanded by Greece, or ECB..) European Stability Mechanism (ESM), permanent facilities/max lending 500 bn/27 countries ratifications/2013 Recapitalisation of Spanish banks … EU Safety net … EDHEC May 2013

38. Future of the euro ?…. Different scenarios Back to national currencies Hard core North euro/South euro Two levels, dual monetary system (EPU/clearing/1950…) Euro as common currency National currency ……………………… Regional/community currencies European dimension EDHEC May 2013

39. Civil society solutions/EU federalism … EDHEC May 2013

40. Emergency, complementary currencies Regional, local, social money Barter organization/Clearing unions (WIR…)/Time bank …/ Bristol Pound… Money as confidence, as network, as social capital/ 0 interest rate (against of political, bank money …) International Journal of Community Currency Research http://www.ijccr.net/IJCCR/IJCCR_Home.html EDHEC May 2013

41. SilvioGessel (1862 – 1930) EDHEC May 2013

42. Dominant: forward to the state and government intervention (policy led stabilization/exit form the crisis) Similar to Great Depression Need of new Keynes.. Paul Krugman /Inflation Back to the free market economy (market driven stabilization and crisis resolution) Need of new Hayek… Combination of both … Too ideological trends, two visions … EDHEC May 2013

43. Vision 1(Market is guilty, state is the savior) Market failure/preferences of economic agents are unstable Lack of consumption, investment instability Financial market instability Lack of regulations, lack of activism Monetary regime is restrictive Global imbalances State is the solution Monetary stimulus Fiscal stimulus Nationalization Regulation Vision 2(State is guilty, market is the savior) State failure/state capture, special interests Monetary and fiscals policies, debt accumulation Deformation of C,S, I preferences Lack of saving, money is not capital (wrong signals) Moral hazard/implicit and explicit guarantee – more risk ex: EU funds Back to the real market Two visions, then (1929) and now (2009) EDHEC May 2013

44. Conclusions/Discussions EDHEC May 2013

45. Two keys themes Self similar structures Fractal: name applied to irregular mathematical shapes similar to those in nature, with structure that are self-similar over many scales, the same pattern being repeated over and over. Part of fractal geometry/fractal mathematics/mathematical physics Benoit Mandelbrot EDHEC May 2013