2008 CRISIS : COLD OR CANCER? MARTIAL FOUCAULT Université de Montréal 28 juin

Plan of the talk Crisis: what does it mean? The American financial crisis followed by a worldwide economic crisis Market and State Lessons for capitalism 2

Plan of the talk Crisis: what does it mean? The American financial crisis followed by a worldwide economic crisis Market and State Lessons for capitalism 3

Financial crisis Banking Crises – Bankruptcy Inability to pay debts. OR Run on the Bank, Credit Crunch

Financial crisis Economic Crises – An economic crisis can take the form of a recession or a depression. – Economic Crisis will most likely experience a falling GDP, a drying up of liquidity and rising/falling prices due to inflation / deflation

Financial crisisS Capital Market Bubbles/Crashes – Market Price of stocks are higher than present value of future Cash flows. – A dramatic decline of stock prices in a market. Crashes are driven by panic as much as by underlying economic factors

Financial crisis Currency Crisis – A currency crisis occurs when the value of a currency changes quickly, undermining its ability to serve as a Medium of exchange or a Store of value.

Financial crisis A Short History Stock Market CrisisBank Crisis 1910: Shanghai rubber stock market crisis 1929: Wall Street Crash 1980: Japanese property bubble 1980: Latin American debt crisis; beginning in Mexico : United State Saving & Loan Crisis Economic CrisisCurrency Crisis : Argentine economic crisis [breakdown of banking system] Economic Crisis in Mexico, speculative attack and default on Mexico Debts : Speculative attacks on currencies in the European Exchange Rate Mechanism

A short crisis ? 9

hits for "recession is over“ Jul 25, 2009 The Recession Is Over Slate The Recession Is Over! What America's best economic forecaster is saying. By Daniel GrossPosted Tuesday, July 14, 2009 Sept. 15, 2009 Bernanke declares 'recession is very likely over' Unfortunately, unemployment will come down slowly

The roots of the crisis Easy access to cheap borrowing combined with: – low interest rates (since the collapse of the internet bubble) – null regulation (Glass-Steagall Act in 1999) Fundamentals of the US economy – Low level of savings rate – Unbalanced international trade – Excessive private consumption Financial sector oriented economy – Last transformation of the “American dream” capitalism – Risk value: new sources of profit 11

Water in the dam… Asset price bubbles are not rare in history (tulip speculation in Netherlands, share prices in the 1920s, « dotcom » bubble…) Low US interest rates Low Japanese interest rates Impact of China and sovereign wealth funds (state-owned investment fund composed of financial assets such as stocks, bonds, property, precious metals or other) 12

Why low interest rates? Economic boost? Laxist monetary policy? Stop increasing Wages ? 13 -European responses different from the US policy: - Competition race? - More cautious Euro zone?

Easy mortgage: subprimes A myriad of actors Subprime borrowing – Credit score (good borrower vs. bad borrower) – Adjustable-rate mortgages – Expectations that house prices would rise faster than loan rates… Subprime crisis once mortgages securitized – RMBS (Residential Mortgage Backed Security) – SPV (Special Purpose Vehicle) – Things can go wrong… 14

Explosion in mortgage assets, USA : beginning of the end

Housing market 16

The crisis goes on… 17

Why did banks create these securities? How banks work? Is there a risk for not getting back my money? – Basel capital rules (Basel I in 1998 and Basel II in 2004) In the 1990s, they changed their core business – Trading income – Increasing fees from mortgage securitization A new financial capitalism is born 18

Explosion in mortgage assets, USA : beginning of the end

Financial (De)regulation New US policies to encourage home ownership Changes to Fannie Mae and Freddie Mac rules Changes to rules on investment banks Publication of Basel II proposals 20

Consequences A US CREDIT CRUNCH followed by an ECONOMIC CRISIS 21

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Bad times for the economy Macroeconomic consequences Microeconomic consequences Financial consequences Political consequences 24

Macroeconomic consequences GDP growth Public Debt Unemployment Income inequalities 25

GDP impact

More recently… 27

GDP decrease in developped countries Table 1.1 The global outlook in summary (percentage change from previous year, except interest rates and oil price) e2010f2011f2012f Real GDP growth 5 World 1,7-2,13,3 3,5 Memo item: World (PPP weights) 6 1,3-0,44,24,04,3 High income 0,4-3,32,32,42,7 OECD Countries0,3-3,42,22,32,6 Euro Area0,4-4,10,71,31,8 Japan -1,2-5,22,52,12,2 United States0,4-2,43,32,93,0 Non-OECD countries 3,0-1,74,2 4,5 Developing countries 5,71,76,26,0 East Asia and Pacific 8,57,18,77,87,7 China9,68,79,58,58,2 Indonesia6,04,55,96,26,3 Thailand2,5-2,36,24,05,0 Europe and Central Asia 4,2-5,34,14,24,5 Russia5,6-7,94,54,84,7 Turkey0,7-4,76,34,24,7 Poland4,81,73,03,74,0 Latin America and Caribbean 4,1-2,34,54,14,2 Brazil5,1-0,26,44,54,1 Mexico1,8-6,54,34,04,2 Argentina7,0-1,24,83,44,4 28

Public debt levels 29

Confidence erroded 30

Bank lending growth 31

Labor still prime affected 32

Crisis and unemployment 33

Crisis and income inequalities in the US 34

How the crisis affected global trade? 35 Growth in World merchandise exports trade by region (Year to year % change in dollar values) Volume of world merchandise exports, (Annual % change)

Microeconomic consequences I 36 Bank Failures

Microeconomic consequences II 37

Time-lags: Schematic comparison of stock markets, employment, public revenues and public debt OctNovDecJanFebMarAprMayJuneJulAugSepOctNovDecJanFebMar Stock markets ? ? ? Public revenues ? Public debt ? G20 uncertainties ? ? ? ? Employment

To sum up… Basic story of the crisis: – Causes of mortgage bubble Role of the financial sector – Manage risks – Allocate capital – Run payment mechanisms Regulators – Insufficient regulations – Special interests – Economics as a not so credible science 39

Lessons for Capitalism Permanent sources of crisis: – Information – Confidence – Corporate governance Market and States Capitalism and self-regulation Governments are strongly exposed 40

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