Teaching Financial Crises

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Teaching Financial Crises

Jean WalkerWest Texas Center for Economic Education

College of BusinessWest Texas A&M University

Canyon, Texas

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Teaching Financial Crises:

. . . presents an organizing framework for putting into context the media attention that has been paid to the 2008 financial crisis . . .

This publication, in it’s entirety, is included on the Virtual Economics CD, version 4.

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Workshop and Materials Funded and/or Sponsored by:

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Teaching Financial Crises lessons: Common elements of financial crises worldwide throughout history

Lesson 1 – compares 1907 & 2007 crises

Lesson 2 – compares 2007 crisis with: (emphasis on reading eco. Data)▪ Recession of 2001 (Dot-Com bubble burst, Enron, Worldcom, et.)▪ Recession of 1990-1991 (oil price shock due to Gulf War)▪ Recession of 1981-82 (tight money to control inflation)▪ Recession of 1973-75 (stagflation; OPEC oil embargo spiked oil prices)▪ Great Depression 1929-38 (stock market crash; falling demand)

Lesson 3 – a historical look at five bubbles & panics:▪ Tulipmania in the Dutch Republic – 1630’s▪ The South Sea Bubble – Great Britain 1711-1721▪ The Roaring 20’s Stock Bubble – 1920’s▪ Japan’s Bubble Economy – 1985-90▪ The Dot-Com Bubble – 1990’s

Lesson 4 – comparison to Lost Decade in Japan

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Teaching Financial Crises lessons: Specific focus on the recent financial crisis

Lesson 5 – focuses on monetary policy▪ Students role play as Federal Reserve Board governors

Lesson 6 – examines the housing bubble▪ Heavy use of supply/demand graphs▪ Securitization simulation for students

Lesson 7 – helps students learn terminology about modern financial markets▪ Quiz bowl game on terminology

Lesson 8 – interaction between modern financial markets and monetary and fiscal policies▪ Students take part in mock trial

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Financial Crisis:

What happened?

Why?

In 5 years, how far have we come?

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The Last 5 Years: GDP

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The Last 10 Years: Unemployment

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The Last 5 Years: Stock Markets

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The Last 25 Years: Housing Prices

The Case-Schiller Price Index represents the real price of housing throughout the country, so it is inflation-adjusted.

The index equals 100 for the price of housing in 1890.

Prices peaked in 2006.

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Fall, 2007 – Trouble on the Horizon In the fall of 2007, the “subprime crisis” was a

concern, and we began to realize the real estate bubble had burst. (Home prices peaked in 2006.)

However, the stock market peaked, and GDP in the 2nd & 3rd quarters of 2007 was especially strong.

Generally, people deeply involved in finance began to talk about problems in the credit markets and a lack of liquidity.

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From BusinessWeek, 9-3-07

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From BusinessWeek, 9-24-07

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2008: The Year It All Fell Apart December, 2007

Dec. 11 – Fed begins lending to banks for longer than overnight. (By October 2008, many banks are on Fed life support.)

January Jan. 12 – Bank of America agrees to buy Countrywide

Financial, the largest mortgage lender, and casualty of the mortgage-default crisis.

February Feb. 8 – Congress approves a $168 billion economic

stimulus plan. Feb. 29 – Dollar hits record low against euro.

March March 17 – Bear Stearns, which traded at a share price of

nearly $90 per share in January, sells itself to J.P. Morgan Chase for $2 per share, with the Fed providing special financing. Mortgage-backed securities took them down.

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2008, The Year It All Fell Apart April

April 18, 19 – Merrill Lynch posts a $1.96 billion loss; Citigroup posts a $5.1 billion quarterly loss.

April 30 – Countrywide Financial posts a $893 million loss. May

May 9 – AIG posts $7.8 billion quarterly loss. June

June 9 – Average price of gasoline in U.S. first hits $4 a gallon.

June 21 – Bond insurers MBIA and Ambac lose AAA ratings from Moody’s.

July July 12 – Regulators seize IndyMac bank. July 14 – Treasury and Fed place Fannie Mae and Freddie

Mac under govt. control. July 31 – Pres. Bush signs a housing-rescue bill.

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September 2008: The Month Wall Street Died August

August 7 – Freddie Mac posts an $821 million loss; AIG reports a $5.4 billion loss.

September – Wall Street Journal calls Sept. 14 – 21, “The Week That Wall Street Died” Sept. 7 – Govt. seizes Fannie and Freddie; Treasury replaces CEOs

and buys $1 billion of preferred shares in each. Sept. 14 – Merrill Lynch sells itself to Bank of America . Sept. 15 – Lehman Brothers files for bankruptcy. Fed and

Treasury choose to let Lehman fail. (In hindsight, probably a disastrous decision.)

Sept. 16 – Banks stop lending to each other. Sept. 17 - Govt. seizes control of AIG, makes $85 billion loan and

receives warrants in exchange. Sept 21 – Fed converts the last two major investment banks, Morgan

Stanley and Goldman Sachs into traditional bank-holding companies.

Sept. 24 – Goldman Sachs gets $5 billion investment from Warren Buffett.

Sept. 26 – Feds seize Washington Mutual and sell it to J.P. Morgan Chase—largest bank failure in U.S. history.

Sept. 30 – Citigroup agrees to acquire Wachovia, and Wells Fargo makes higher bid. Congress passes the bailout bill.

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2008, The Year It All Fell Apart

October Oct. 4 - President Bush signs $700 billion bailout bill. Oct. 8 – Fed says it will lend directly to U.S. corporations for the first time

since the Great Depression. Oct. 9 – World Central Banks coordinate lowering of short-term rates. Dow down 14% in October, worst month in % terms in 10 years.

November Nov. 10 – Govt. scraps $123 billion deal with AIG and replaces it with a $150

billion package on better terms. Govt. injects $20 billion into Citigroup and guarantees $300 billion of its

troubled assets.

December Dec. 9 – On this date, only McDonald’s and Walmart in the Dow have higher

stock prices that this date last year. Dec. 12 – Fund advisor Bernie Madoff is arrested by federal agents in a $50

billion Ponzi scheme. Dec. 17 – Fed funds rate cut to 0 - .25%. Dec. 17 – Goldman Sachs posts $2.12 billion loss, first since going public in

1999. Dec. 20 – White House agrees to lend GM and Chrysler $17.4 billion.

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2008 – Winners & LosersSample of Bankruptcy filings in 2008:

Sharper Image Lillian Vernon Aloha Airgroup, ATA Airlines, Skybus

Airlines, Frontier Airlines Linens ‘N Things Tropicana Entertainment (casino

operator) Circuit City Pilgrim’s Pride (chicken processor) Tribune (newspaper publisher)

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How did major players survive 2008?

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One of the very few beneficiaries of the Recession

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Fed’s Effort to Stimulate the Economy

Unintended consequence of low rates since 2009: when interest rates are low, corresponding investment yields are low and investors move to riskier assets trying to find yield.

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Lesson 1, Activity 3, page 11 Introduce the 2007 Financial Crisis with

Activity 3 – Characters in the Financial Crisis Announcer Joe, who needs money for his kid’s college tuition Bruce, the mortgage banker/mortgage broker Mortimer, the old-time banker Uncle Sam Wall Street banker Investment salesman Village treasurer of Narvik, Norway Bruce’s boss The World – (all together)

(Nine characters plus “the world”)

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Lesson 1, Activity 1, page 15

Have students complete Activity 1 as you progress through the slides of visual 1. If you have not taught about the recent financial crisis, you will find information in other lessons to assist with explanations.

FYI: The slides for Activity 1 are available in powerpoint on www.councilforeconed.org/financialcrises

THE PANIC OF 1907 THE FINANCIAL CRISIS OF 2007

PANDEMONIUM IN THE MARKETS

DEVASTATION SAN FRANCISCO EARTHQUAKE

Shortly after 5 a.m. on April 18, a 7.8-magnitude quake, unleashed offshore, shook the city for just less than a minute.

EVENTS IN 1906

UNCONTROLLABLE BLAZE

80% OF THE CITY DESTROYED

Though the damage from the quake was severe, the subsequent fires from broken gas lines caused the vast majority of the destruction.

SAN FRANCISCO EARTHQUAKE 1906

3,000 PEOPLE DIED THE FIRES RAGED FOR FOUR DAYS

REMEMBERING THE SAN FRANCISCO EARTHQUAKE OF 1906

TOUGH BALANCING ACT INFLEXIBLE CURRENCY

Between 1870 and 1914, many countries adhered to a gold standard.

This strictly tied national money supplies to gold stocks.

Currency was redeemed for gold at a fixed exchange rate.

THE GOLD STANDARD

THE WORLD’S FINANCIAL SYSTEM HAD BECOME COMPLEX & INTERRELATED

At the end of 1905, nearly 50% of the fire insurance in San Francisco was underwritten by British firms.

The earthquake gave rise to a massive outflow of funds—of gold—from London.

The magnitude of the resulting capital outflows in late summer and early autumn 1906 forced the Bank of England to undertake defensive measures to maintain its desired level of reserves.

The central bank responded by raising its discount rate 2.5% in 1906.

Actions by the Bank of England attracted gold imports and sharply reduced the flow of gold to the United States.

Interest rates rose and by May 1907, the United States had fallen into one of the shortest, but most severe, recessions in American history.

GREAT ECONOMIC PROMISE At the beginning

of the century, the nation was brimming with a great amount of optimism.

Here is a list of familiar companies founded between 1900 and 1905.

Eastman Kodak Firestone Tire Ford Motors Harley-Davidson Hershey U.S. Steel J.C. Penney Pepsi-Cola Texaco Sylvania Electric

EVENTS IN 1907 In October 1907 two

brothers, Otto and F. Augustus Heinze, attempted to manipulate the stock of a copper company.

They planned to corner

the market in the copper company's shares by buying aggressively in hopes they could later force short sellers to buy them at high prices.

The plan did not have sufficient backing and failed.

PANIC IN THE STREETS News a number of

prominent New York bankers were involved in the failed scheme began a crisis of confidence among depositors.

As additional institutions were implicated, queues formed outside numerous banks as people desperately sought their savings.

FURTHER COMPLICATING MATTERS

Trust companies were a financial innovation of the 1890s. They had many functions similar to state and national banks but were much less regulated. KNICKERBOCKER TRUST

COMPANY

GREATER RISKS WERE TAKEN They were able to hold

a wide array of assets and were not required to hold reserves against deposits.

They earned a higher rate of return on investments and paid out higher rates, but, to do this, they had to be highly leveraged.

They took more risks than traditional banks. Illustration from Harper's Weekly December 20, 1913 by

Walter J. Enright

A NEW YORK CITY BANK RUN IN NOVEMBER 1907

The runs on deposits that sparked the Panic of 1907 were at two of the largest New York City trust companies: Knickerbocker Trust and Trust Company of America.

THE IMPACT The crash and panic of 1907 had a dramatic effect on the

health of the American and worldwide economies. In the United States:

Commodity prices fell 21 %. Industrial production fell more than in any other crisis in

American history to that point. The dollar volume of bankruptcies declared in November

was up 47 % from the previous year. The value of all listed stocks in the U.S. fell 37 %. In October and November 1907, 25 banks and 17 trust

companies failed. Thousands of depositors lost their life savings.

Gross earnings by railroads fell by 6 % in December and production fell 11%.

Wholesale prices fell 5 %. Imports shrank 26 %. In a few short months, unemployment rose from 2.8 % to

8%. Immigration reached a peak of 1.2 million in 1907 but fell to

around 750,000 by 1909.

J.P. MORGANNEITHER ELECTED NOR

APPOINTED, HE FELT IT WAS HIS TIME TO ACT

In the absence of a strong federal regulatory structure or any safety nets, the response to this crisis had to be delivered by a private citizen, J.P. Morgan, the world’s most powerful banker.

He used all of his influence to convince fellow titans of industry to pool their resources and salvage the nation.

The Panic subsided after six weeks.

WHAT WAS DONE?

SPECULATION IN OFF-STREET MARKETS

A BUCKET SHOP IN 1907

LESSONS FROM THE PANIC OF 1907

Bucket shops were blamed for fueling the speculation in 1907. They enabled people to speculate on the value of a stock without having to purchase the stock itself. The actual order to purchase went in the “bucket.” Beginning in 1909, New York banned bucket shops and other states followed.

THE WORLD MADE HUGE INVESTMENTS IN THE U.S. HOUSING MARKET ……….AND LOST!!

By ignoring risk, remaining irrationally optimistic, and forgoing transparency through an array of fantastically complicated investment vehicles, the world’s financial markets were extremely dependent on housing prices.

The underlying assumptions were (1) that housing prices never fall and (2) homeowners almost always pay their mortgages.

THE FINANCIAL CRISIS OF 2007

DURING AND AFTER THE MILD RECESSION OF 2001, THE FED

LOWERS INTEREST RATES

FORMER FED CHAIRMAN ALAN GREENSPAN

THE ORIGINS OF THE CRISIS

FORMER PRESIDENT GEORGE BUSH

STRONGLY PROMOTED HOMEOWNERSHIP

“We can put light where there’s darkness, and hope where there’s despondency in this country. And part of it is working together as a nation to encourage folks to own their own home” –President Bush, October 15, 2002.

THE ORIGINS OF THE CRISIS

HIGHLY COMPLEX FORMS OF FINANCING

THIS WAS TOO TEMPTING FOR THE

FINANCIAL INSTUTIONS The momentum behind the

expansion of homeownership led the government to reduce regulations and capital requirements for making loans.

This led to a dizzying number of innovative ways to get less-qualified borrowers a mortgage and seemed to reduce risk for the lender.

Mortgages could be bundled and sold around the world as securities.

CAUSES OF THE CRISIS

TRUSTED AGENCIES FAILED TO WARN INVESTORS

RISK-RATING AGENCIES

Mortgage-backed securities were constructed of mortgages of differing quality levels.

The obligations of solid

and sub-prime borrowers were mixed in a manner that made it very difficult for experts to calculate risk.

The assumption that U.S. housing prices would continue to rise and incentives to provide good ratings led agencies to rate these securities as AAA, lowering investors’ concerns.

CAUSES OF THE CRISIS

WHAT WERE WE THINKING? THE PERFECT STORM

Homeownership peaks in early 2005 at 70% of households.

The Fed raises interest rates. Home prices fall. Higher adjustable interest

rates increase payments for borrowers.

Borrowers default in waves. Dozens of subprime lenders

file for bankruptcy. Mortgage-backed securities

lose value as investors question their contents.

Financial institutions struggle to find buyers for the MBSs.

EFFECTS OF THE CRISIS

“FINANCIAL WEAPONS OF

MASS DESTRUCTION”

Financial institutions could purchase credit default swaps.

A CDS is a private insurance contract that paid off if the investment failed.

One did not actually have to own the investment to collect on the insurance.

These promises were unregulated, and the sellers did not have to set aside money to pay for losses.

THE FINANCIAL CRISIS OF 2007-2009

Bank failures: 183 (2%) 12/07-2/10 (No deposits lost)

Unemployment rate: 10.1% (10/09)

Economic decline: -4.1% (4Q 2007-2Q 2009)

Biggest drop in DJIA: -53.8% (12/07-3/09)

Emergency spending and tax reduction programs: 2.5% of GDP in 2008 and in 2009

Aggressive increase in monetary stimulus by the Fed

THE FINANCIAL CRISIS OF 2007-2009

6.7 million jobs lost in 2008 and 2009

Capital investment levels lowest in 50 years

Domestic demand declines 11 consecutive quarters

Industrial production down worldwide: Japan 31%, South Korea 26% , Russia 16% , Brazil 15% , Italy 14%, Germany 12%

The federal government unleashed a series of remedies in an attempt to limit the contagion.

Massive sums of bank reserves were created to ease fears.

In the process, the taxpayers took over or funded several familiar financial and nonfinancial companies.

This time the government bails out the economy and business leaders and bankers are criticized.

1907 2007 Highly complex and linked

financial system Strong growth in the

economy starting in 1900 Many people and institutions

highly leveraged Innovative form of finance:

trust companies Stock market setting all-time

highs A limited role for government Markets swing from great

optimism to great pessimism

Global interdependent financial system

Vibrant economic recovery after recession in 2001

Lenders willing to take more risk in making loans

Unregulated financial institutions: hedge funds

Companies reporting record earnings

Absence of many safety buffers

Dow 14,164 to 6,500 in 16 months

SIMILARITIES

1907 2007 J.P. Morgan, a private citizen,

orchestrated the bailout The Panic lasted for six weeks,

though the economy didn’t return to pre-Panic levels until 1909

Many banks were closed and many depositors lost their savings

The nation was on the gold standard and the supply of money was fixed

The San Francisco earthquake was a catalyst for the Panic

The climate toward business was hostile prior to crisis

The Federal Reserve and Treasury Department organize the reaction

The event has been unfurling for more than five years

Many banks closed and folded into healthier banks, but depositors did not lose any of their savings

The nation uses Federal Reserve notes, creating a flexible money supply

Hurricane Katrina was generally benign as a catalyst

The climate toward business was friendly prior to crisis

DIFFERENCES

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FYI: Community Reinvestment Act – signed in 1977 by

Jimmy Carter Induced lenders to enter underserved or “red-lined”

areas. 1993 -1995, President Clinton asked regulators to

reform the CRA to "deal with the problems of the inner city and distressed rural communities”--availability of credit should not depend on where a person lives.

The Interstate Banking and Branching Efficiency Act of 1994, which repealed restrictions on interstate banking, used CRA ratings as a consideration when determining whether to allow interstate branches

George Bush, as early as 2002, pushed home ownership—”an ownership nation.”

In 2007 Ben Bernanke suggested further increasing the presence of Fannie Mae and Freddie Mac in the affordable housing market to help banks fulfill their CRA obligations by providing them with more opportunities to securitize CRA-related loans.

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What do all of the explanations show? The rise in housing prices represented a bubble.

A price bubble is a situation where increases in price are not justified by fundamental factors affecting supply or demand, and therefore not sustainable.

A price bubble is often caused by contagion, which is prices increasing because people observe them going up and think they will continue to go up. At one point, people who couldn’t pay their mortgages were taking out home

equity lines of credit and using the cash to pay the mortgages! They could do this because equity in homes rose as home prices rose, and “personal bankers” were pushing home equity lines of credit.

This causes people to purchase houses with the expectation that they will be able to sell them for a higher price in a relatively short time.

It was a speculative bubble.

When the bubble burst in 2006, house prices tumbled.

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A Look at Historical Homeownership - USA

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How does home ownership in the US compare to the world?

U.S. Homeownership rate:

2000 67.4%2004 69.0%2010 66.9%

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Mortgage-backed securities: Positives:

Spreads risk. Not all eggs in one basket. Diversified. Made a liquid investment from an illiquid investment. Allowed smaller investors to invest in housing. Meant more money flowed into mortgage markets.

Negatives: Reduced the incentive for investors to be concerned about

the creditworthiness of borrowers. Reduced the incentive for banks and mortgage brokers to be

concerned with creditworthiness. Exported the risk around the world because the MBS

securities were stamped AAA by the ratings agencies and sold worldwide.

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Lesson 2 – Comparative Economic Performance

Before teaching this lesson, make sure students understand the concept of business cycles: Expansion Recession Peaks Troughs

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Lesson 2 – Comparative Economic Performance Growth of real GDP measures health of economy

Generally, we say two quarters of declining GDP is a recession, but economists at the National Bureau of Economic Research actually make the determination

GDP = C + I + G + Net Exports▪ Consumer spending is 60-70% of U.S. GDP▪ Investment spending, government spending, and net exports make up the rest

Contributing factors to growth: Level and rate of change of technology Investment in tools, machines, computers, infrastructure, and building Skill and experience levels of the economy’s labor

The main activity in this lesson asks students to work in groups to analyze 6 of the 14 recessions between 1929 and 2007. Before working, they should understand business cycles and how GDP and Unemployment affect or are affected by recessions.

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Lesson 2: How Economic Performance from 2007-09 Compares to Other Period in U.S. History

The Great Depression (1929-1938) Duration: 1929-1933 (43 months)

& 1937-1938 (13 months) Began with falling demand for

durables and investment goods Stock market crashed in Oct.

1929 By March 1933, 25% of the

workforce was out of work. More than 9,000 bank failures

between 1929 and 1933 Fed did not act as the lender of

last resort, even raising interest rates in late 1931

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The Recession of 1973-1975 Duration – Nov. 1973 to

March 1975 (16 months) Peak unemployment - 9.0%

(May, 1975) Inflation rate - 11% Economic stagflation Causes

▪ 1973 Oil Crisis – OPEC’s oil embargo caused “oil price shock”, which slowed production of goods and services

▪ Vietnam War

Remember Gerald Ford and the WIN buttons – Whip Inflation Now!

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The Recession of 1981-1982 Duration – July 1981 to Nov. 1982

(16 months) Peak unemployment - 10.8%

(Nov., 1982) Inflation rate – 8.9% Business bankruptcies up 50% Farmers especially hard hit

▪ Ag exports declined▪ Crop prices fell▪ Interest rates rose

Causes▪ Iranian Revolution increased oil prices

and new Iranian regime exported oil inconsistently

▪ FED adopted tight money policy (high interest rates) to break the back of inflationPresident Reagan was in office and

is often credit with “breaking the back of inflation.”

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The Recession of 1990-1991 Duration – July 1990 to March

1991 (8 months) Peak unemployment - 7.8%

(June, 1992) Although brief, the recession

caused George H.W. Bush to be defeated by Bill Clinton

Causes▪ 1990 oil price shock because of the

Gulf War▪ Ongoing concerns of savings and

loan crisis▪ After a long expansion, inflation

began to increase so the FED increased interest rates

▪ Debt accumulated in the 1980’s was a concern

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The Recession of 2001 Duration – March 2001 to

November 2001 (8 months)

Peak unemployment - 6.3% (June, 2003)

NASDAQ returns▪ 2000 (40%)▪ 2001 (21%)

Causes▪ Collapse of speculative

dot.com bubble▪ Uncertainty after attacks of 9-

11-2001▪ Accounting scandals and

fraud at Enron, Worldcom, etc.

Since most dot.com stocks were traded on the NASDAQ, the stock graph tells the story of the bubble collapse that was a cause of the recession.

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The Financial Crisis of 2007-09 Duration – December 2007 to

June 2009 (18 months) Peak unemployment - 10.1%

(October, 2009) GDP Decline peak to trough:

(4.1%) Bank failures (2007 – 2009): 168 Causes

▪ Subprime mortgage crisis led to housing market collapse

▪ Collapse of MBS brought down Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers, and AIG

▪ Investment banks used too much leverage

▪ All remaining investment banks turned into commercial banks

▪ Government bailout of financial services and auto industries

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Lesson 3 – Manias, Bubbles, and Panics in World History

▪ Tulipmania in the Dutch Republic – 1630’s▪ The South Sea Bubble – Great Britain

1711-1721▪ The Roaring 20’s Stock Bubble – 1920’s▪ Japan’s Bubble Economy – 1985-90▪ The Dot-Com Bubble – 1990’s

http://www.library.hbs.edu/hc/historicalreturns/fb/movie.html

http://www.library.hbs.edu/hc/historicalreturns/fb/movie.html

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What is a bubble? Hyman Minsky’s phases of a bubble:

Displacement▪ Crisis begins with an outside shock to the system—war, new invention, political event, etc.

Boom▪ Rapid rise in prices of a financial or physical asset as investors and speculators earn profits

Euphoria▪ People take more risk as more credit is offered. High profits repeat the cycle, and at some point rational decision-

making succumbs to manic behavior.

Profit-taking▪ A few insiders begin to take profits and get out, and price increases begin to level out.

Panic▪ The failure of a large institution, the realization of a swindle, or an increase in the supply of the asset bring everyone

back to their senses. People scramble to sell as the price falls.

Bailout (not a part of Minsky’s description)▪ A central bank may expand the money supply to salvage essential financial institutions.▪ Rationale: don’t make the whole economy pay for the actions of a few.▪ Negative externality: the anticipation of a bailout may indirectly add to the problem because people may take

greater risks if they know there is a safety net—this is known as a moral hazard.▪ John Kenneth Galbraith suggests investors have a short financial memory and investors have a tendency to attribute

greater intelligence to individuals who have higher income or control more wealth.

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What is a bubble?

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Bubble Quotes

“The four most expensive words in the English language are, this time it’s different.”

attributed to Sir John Templeton

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Japan’s Lost Decade: 1991-2000

LESSON

4

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Japan: Late 1980’s Strong demand for Japanese exports

Large amounts of foreign currency flowed to Japan as a result Low interest rates Speculative surge in Japanese stock market Speculative surge in Japanese real estate Boom in stocks and real estate were supported by debt Japanese govt. feared an asset bubble and decided to

“pop the bubble” by increasing interest rates It had been easy for the Japanese to borrow money to invest in

stocks or real estate because rates had been low Collapse in prices led to a credit crisis—banks suffered massive

losses as defaults on loans rose

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Attempt to Recover: 1990’s Govt. injected massive amount of money

into banks—was controversial Government said banks were “too big to fail” This led to “zombie banks”

The problems in real estate and stock spilled over into the rest of the economy Housing prices peaked in 1991

The whole economy fell into recession A series of graphs in Activity 2 compares

the 2007 recession in the U.S. to Japan’s lost decade

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Japan’s recovery By 1995, the Japanese had spent nearly $2.1

trillion on public projects to stimulate the economy.

In 1994-95 the economy began to rebound, but it was a false recovery. The stimulus plans had created huge budget deficits. Some argued the govt. stopped spending too soon;

others argued reducing taxes would have been better. The govt. increased taxes to reduce the deficits, and

by 1997, growth was again at zero. Between 1994 and 2009, prices declined (deflation) in

all but one year. Growth recovered in 2003-04.

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Should we be worried? Through opinion pieces in the Financial

Times and Washington Post, Larry Summers, former economic adviser to Barack Obama and Treasury secretary under Bill Clinton’s presidency, expressed concern that the United States is heading for a “lost decade” similar to Japan’s lost decade in the 1990s.

This country has already experienced five years of economic growth under 1% annually, and that’s half way to a decade.

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The Next Bubble?????

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Jean WalkerDirector, West Texas Center for

Economic EducationCollege of Business

West Texas A&M UniversityCanyon, Texas 79016

[email protected]

mailto:[email protected]

Documents

Teaching Financial Crises