Homework P 591 1 Financial System 101 Channels funds from borrowers to lenders Maturity transformation Pools risk for those who are risk averse Allows for diversification Equity ID: 557023
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Slide1
Chapter 20. The Financial System
Homework: P. 591 #1Slide2
Financial System 101
Channels
funds from borrowers to lenders.
Maturity transformation.
Pools
risk for those who are risk averse.
Allows for diversification.
Equity
and bonds.
There
are several types of financial intermediaries.
In finance, there is asymmetric information. Also, moral hazard.
Favorably mentions Muhammad
Yunus
and the
Grameen
Bank.Slide3
Anatomy of a Financial Crisis, p. 576 ff.
Speculative bubble
Heavily leveraged financial institutions become insolvent
Falling confidence contaminates otherwise healthy financial
institutions, leading to ‘fire sales’
Credit crunch
Recession as loans to do business are no longer available
Vicious circle feeds on itself
Reference to
Rogoff
and Reinhart “This Time is Different” (2009).
There is a suggestion that recessions due to financial crises are different
from those that arise from ‘normal’ declines in investment, gov’t
spending, etc. Decline is more rapid, recovery is slower.Slide4
Krugman on Financial Crises:
NYT
yesterday
… So
it has been a terrible seven years, and even a string of good job reports won’t undo the damage. Why was it so bad?
You often hear claims, sometimes from pundits who should know better, that nobody predicted a sluggish recovery, and that this proves that mainstream macroeconomics is all wrong. The truth is that many economists, myself included,
predicted a slow recovery
from the very beginning. Why?
The answer, in brief, is that there are recessions and then there are recessions. Some recessions are deliberately engineered to cool off an overheated, inflating economy. For example, the Fed caused the 1981-82 recession with tight-money policies that temporarily
sent interest rates
to almost 20 percent. And ending that recession was easy: Once the Fed decided that we had suffered enough, it relented, interest rates tumbled, and it was morning in America.
But
“postmodern” recession
s, like the downturns of 2001 and 2007-9, reflect bursting bubbles rather than tight money, and they’re hard to end; even if the Fed cuts interest rates all the way to zero, it may find itself pushing on a string, unable to have much of a positive effect. As a result, you don’t expect to see V-shaped recoveries like 1982-84 — and sure enough, we didn’t.
This doesn’t mean that we were fated to experience a seven-year slump. We could have had a much faster recovery if the U.S. government had ramped up public investment and put more money in the hands of families likely to spend it. Slide5
Figure 20-2, p. 580. Anatomy of a Financial CrisisSlide6
Figure 20-1. p. 578. The TED SpreadSlide7
Who should be blamed for the financial crisis of 2008-09? (
pp. 580-81)
Federal Reserve:
(previously kept interest
rates too low, encouraging borrowing and housing investments.
Home buyers: were reckless, gambled, defaulted
Mortgage brokers pushed excess borrowing
Investment banks: bundled mortgages (mortgage backed securities) and sold them, often to sophisticated borrowers
Rating agencies; operated on dubious assumptions
Government regulators: Politicians had encouraged home buying (reduction of interest rates, Fannie Mae and Freddie Mac
)
Policy makers who pushed home ownership, subsidized mortgages through tax deductions, and discouraged effective regulation, including via Fannie Mae and Freddie Mac
Is he avoiding criticizing academic economists?Slide8
Policy
Response in the US: (pp. 581-82)
Countercyclical monetary and fiscal policy
Limited by liquidity trap, size of deficit/debt
Fed as Lender
of
Last
R
esort
“Propped up Financial System” (bailed out commercial and shadow
banks – also, GM and Chrysler)
Reduce excessive risk taking:
Dodd-Frank
Act
More Effective Regulation
.
Note the asymmetry in terms of the crisis starting in the US, then contaminating European markets, where the damage has been larger. Of course, theirs is also a ‘sovereign debt’ crisis, which is structurally different.