Upload
mariah-mathews
View
214
Download
0
Embed Size (px)
Citation preview
Financial Crisis- 2
Great Depression & Financial Regulation
$ Stock Market Crash of 1929¢ October 29, 1929 “Black Tuesday”¢ Financial collapse contributed to collapse of economy more
generally¢ Despite Federal Reserve Act of 1913
$ New financial regulations in 1930s:¢ Farm Credit Administration, ¢ Federal Securities Act, Glass-Steagall Act (creates FDIC,
lets Fed set max interest rates on S&L, splits commercial and investment banking),
¢ Export-Import Bank created, ¢ Exchange Stabilization Fund created, Federal Farm
Mortgage Corporation, SEC created, etc.
Keynesian Era & financial Crises$ Comprehensive financial regulation at home
meant virtually no domestic financial crises$ Bretton Woods agreement on fixed exchange
rates with IMF as overseer and lender of last resort
$ UNTIL: accelerating inflation and growing gov. debt, trade deficits and speculative attacks on the dollar lead to abandonment of Bretton Woods, volitile flexible exchange rates and negative interest rates.
Deregulation$ Formal Deregulation = removing rules that
reduced or eliminated various activities¢ Some can be done by executive fiat¢ Some requires changes in the laws
E.g., Carter Airline Deregulation Act of 1978 E.g., Clinton: Gramm-Leach-Bliley Act of 1999
$ Defacto Deregulation = failure to enforce existing rules.¢ Can be the result of top-down executive policy changes
E.g., Nixon ending gold-dollar linkage and Bretton Woods E.g., Reagan appointing James Watts head of Dept of Interior
¢ Can involve reduced oversight¢ Can be engineered by defunding oversight institutions
Refusal to Regulate$ Refusal to enforce existing law and/or rules
¢ Presidential “Signing Statements”¢ James Watt, Reagan appointed Sec of Interior, failed to
enforce environmental laws seen as burdensome /costly to business
$ Refusal to create new laws/rules to cover new situations.¢ Financial regulations had led to creative exploitation of
loopholes in laws¢ Financial deregulation opened the door to all kinds of
new speculative innovations E.g., Collaterialized Debt Obligations (CDO’s) created in 1987 E.g., Asset-backed Securities (ABS’s)
CDO = Collateralized debt obligationsABS = Asset-Backed SecuritiesCMBS = Commercial Mortgage-Backed SecuritiesRMBS = Residential Mortgage-Backed Securities
History of Financial Deregulation - 1$ Bought by financial lobbying over decades$ Deregulation in Carter Administration
¢ Financial Institutions Deregulation Bill of 1979¢ Depository Institutions Deregulation and Monetary Control
Bill of 1980 Removed upper limits on interest rates in response to accelerating
inflation (W > productivity ), negative real interest rates
$ Deregulation in the Reagan Administrations¢ Garn-St.Germain Depository Institutions Act of 1982
Eliminated deposit interest rate ceilings Permitted Savings & Loan Institutions to diversify their investments into
commercial mortgages
¢ In Aug. 1987 Reagan appoints Alan Greenspan head of FED Ayn Rand disciple and pro-deregulation advocate
History of Financial Deregulation - 2
$ Deregulation in the Reagan Administrations cont’d
$ Deregulation in general was attack on cost of labor¢ E.g., removal of OSHA protections¢ E.g., refusal to enforce protections (EPA)¢ E.g., union busting (PATCO, United Airlines, etc.)
$ Financial deregulation¢ Provided business an alternative to real investment¢ Reduced wages led to recourse to credit¢ Credit cards & mortgages: way to harness, profit from
that recourse
History of Financial Deregulation - 3
$ Deregulation in the Bush Sr. Administrations¢ 1990 J.P. Morgan given permission to underwrite securities¢ 1991 Fed approves expansion of Glass-Steagall loophole¢ 1996 Fed allows bank holding companies to own investment
bank affiliates¢ 1998 Citicorp merges with Travelers that owned Smith-
Barney (securities and insurance underwriting)
$ Deregulation in Clinton Administrations¢ Gramm-Leach-Bliley Act or Financial Services
Modernization Act of 1999 repealed part of Glass-Steagall Act of 1933 that separated investment banking, deposit banking and insurance activities.
History of Financial Deregulation - 4$ Regulation in Bush Jr. Administration
¢ Enron bankruptcy fiasco reveals accounting fraud in deregulated energy market
¢ Sarbanes-Oxley Act of 2002: created Public Company Accounting Oversight Board to avoid Enron-style disasters
$ Failure to Regulate in Bush Jr. Administration¢ Mostly failure to regulate new methods of financial
speculation, e.g., derivatives, keeps anti-regulation Alan Simpson at Fed.
¢ First Treasury Secretary Paul O’Neill appalled at Bush lack of interest in ANYTHING he had to say about financial situation (see his book: The Price of Loyalty)
¢ 2005 Chairman of SEC quits over White House resistance to regulating mutual and hedge funds
Shadow Banking System - 1$ Banking regulations since 1930s aimed at
depository banks, e.g., commerical banks, S&L’s, credit unions.
$ “Shadow banking” has included¢ Investment banks¢ Hedge funds (hedge against downturns, speculate on upturns)¢ Money market funds (invests in short-term debt securities)
$ Shadow banks borrow short term credit markets and invest in longer term speculation
$ New Shadow banking methods, e.g., derivatives ¢ remained unregulated even as financial deregulation
allowed merger of depository and investment operations
Shadow Banking System - 2$ Shadow banking exploded with deregulation
¢ Deregulation: regular banks diverted funds from usual regulated investments to unregulated ones
¢ Shadow banking out grew regular banking
$ Shadow banking subject to panics ¢ Like other banks, shadow banks can be subject to sudden
loss of confidence in investors¢ When “asset bubble” speculation bursts – investors panic
Asset bubble = price of asset far exceeds real value inevitable collapse, bursting of the bubble
¢ When participation in bubbles are widespread panic spreads, i.e., “financial contagion” (failure here = fear of failure there)
¢ Sales of assets here = fall in value of assets there, or “vicious cycle of deleveraging”.
Recent Banking Crises
$ S&L Crisis of 1987¢ Followed deregulation and bursting of commercial
mortgage bubble$ Swedish Banking Crisis of 1991
¢ Followed credit market deregulation and bursting of housing price bubble
$ Irish Banking Crisis of 2007¢ Housing price bubble led to new regulatory efforts
that discovered hidden financial deals $ US Banking Crisis of 2007-2011
¢ Followed deregulation and bursting of housing price bubble in 2006.
US Financial Crisis - 1
$ Deregulation facilitated widespread speculation, especially in housing bubble¢ Lax oversight of loan operations permitted widespread fraud¢ Rapid growth of sub-prime & adjustable rate mortgages¢ Bundling and securitization of mortgage bundles obscured
risks ¢ So money poured into housing boom inflating an asset
bubble, housing prices jumped 60%
$ Housing price bubble burst in 2006¢ Value of mortgage-based securities plummeted¢ Dramatically reducing value of assets of investors
US Financial Crisis – 2Timeline - 1
$ Summer of 2007¢ Jump in TED spread indicates jump in uncertainties
TED Spread = diff inter-bank interest rates from rates charged to the government
¢ Fed reduces discount rate
$ Fall 2007 – Winter 2008¢ Fed cuts Federal Funds Rate (down from 5.25% to 2.0%)¢ Bear Sterns investment bank nears bankruptcy as value of
its MBS’s fall¢ Fed takes over Bear Sterns, loan to JP Morgan to take over¢ Citigroup & Morgan Stanly fire CEO’s after losses on MBS
US Financial Crisis – 3Timeline - 2
$ September of 2008 (SHTF)¢ Lehman Brothers investment bank goes under, no Fed
takeover or bailout¢ Fed loans AIG $85 billion (insurance conglomerate)¢ Massive flight from money market funds, Dow Jones
plummets¢ Fed announces temporary insurance for money market
funds¢ Fed establishes asset-backed loan facility
$ October of 2008¢ Bush signs TARP legislation¢ Fed begins purchasing MBS’s, buys stock in banks¢ Federal Funds Rate near zero
US Financial Crisis – 4Timeline - 3
$ November 2008¢ Obama Elected, keeps same Fed Chairman
$ February 2009¢ Obama signs fiscal stimulus package
$ October 2009¢ Unemployment peaks at 10.1%
$ July 2010¢ Obama signs Wall Street Reform and consumer Protection
Act
US Financial Crisis – 5
$ Obama signs Wall Street Reform and consumer Protection Act¢ New Financial Services Oversight Council to coordinate¢ New Consumer Protection Agency to force honest lending¢ New Office of Credit Ratings to examine rating agencies’
performance¢ Some derivatives to be bought and sold in open markets¢ Creates panel that can decide to regulate some shadow
banks¢ FDIC gets new authority to seize some shadow banks¢ Issuers of MBS must retain min 5% of default risk¢ Financial holding companies prohibited from hedge funds
US Financial Crisis – 5
$ New Regulations?¢ It remains to be seen whether these regulations will be
enforced¢ Conservative opposition threatens to withhold funding
needed for regulations to be enforced
--END--