ACC1018_W7_S13_FinancialCrisis

Financial Crisis Overview

  • Definition: A financial crisis occurs when the value of financial institutions or assets drops rapidly.

  • Characteristics:

    • Panic or runs on banks, leading investors to withdraw or sell off assets.

    • If unchecked, can lead to recession or depression.

Impact of Financial System Crisis

  • Consequences:

    • Reduced lending by banks.

    • Increased company bankruptcies and rising unemployment.

  • Case Study: 2008-2009 financial crisis.

Financial Crisis of 2008-2009: Key Facts

  • Economic Impact:

    • Losses exceeding $4.1 trillion.

    • Unemployment rate surpassing 10% in the US.

    • Global stock market crashes, with significant drops in various markets.

    • Increased poverty levels and reduced consumer spending.

  • Global Implications:

    • Shift in economic power, notably between the US and China.

    • Countries adopting protective measures and focusing on internal issues.

Causes of the 2008 Global Financial Crisis

  • Precursor Events:

    • The Asian Financial Crisis of 1997 set the stage for 2008.

    • Excessive deregulation and financial liberalisation.

  • Key Factors:

    • Low interest rates and subprime mortgage issuance.

    • Speculative behaviours in financial markets.

    • Rapid advancements in financial technologies.

Subprime Crisis and Housing Bubble

  • Definition: Subprime mortgages aimed at low/modest-income households, often adjustable- rates.

  • Execution:

    • Securitisation of these loans into mortgage-backed securities.

    • Rising house prices during 1996-2005 led to defaults once prices started falling in 2006.

Credit Default Swaps and Financial Innovations

  • Concept: A financial instrument to hedge against risks of borrower default, leading to a lack of transparency and excessive risk-taking.

  • Market Events: The system for trading was overwhelmed during defaults, and entities faced difficulties in understanding their own exposure.

Executive Compensation and Regulatory Failures

  • Executive Practices:

    • Incentives focused on short-term gains contributed to flawed decision-making.

    • Corporate fraud cases emerged, leading to significant punishments for executives.

Financial Regulations Post-Crisis

  • Basel Agreements: Established new international rules for banking regulations aimed at reducing systemic risk.

  • Challenges: Individually, nations struggled to effectively regulate their financial sectors, highlighting the need for better domestic oversight of financial practices.