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Financial Crisis (addendum) 1 1989-91 Savings and Loan Crisis (the S&L Crisis) • • • • • • Deposit insurance creates moral hazard Relaxed regulation permitted riskier investments S&L in the U.S. speculated on real-estate loans Liabilities were savings deposits Property value bust led 1,043 financial institutions to fail Total cost of S&L crisis was $153 billion (cost to tax payer $124 billion); 2.7 percent of GDP 2 1992 British Currency Crisis (Black Wednesday) • Great Britain joined the European Exchange Rate Mechanism (ERM), which pegged its currency to the DeutschMark • Objective was to maintain credibility relative to the DeutschMark • Germany raised interest rates out of fear of inflation due to German reunification (1-1 conversion) • Great Britain was in a recession • Speculative attack led to large loss of reserves • Great Britain withdrew from ERM • Estimated cost of £3.3 billion • George Soros made over $1 billion by selling Sterling short 3 1994 Economic Crisis in Mexico (Mexican Peso Crisis) • Low credibility due to hyperinflation from 1985-1993 • Fixed exchange rate to the U.S. Dollar • Too much stimulation of the economy during 1994 election leading to high spending and deficits • Speculative attack led to loss of reserves, which were insufficient to maintain the value of the peso 4 1997 Asian Financial Crisis • Crony capitalism unsound banking led to investments whose rate of return began to fall • Fixed exchange rate to the U.S. Dollar • Banks borrowed in dollars but lent in local currency, making them susceptible to a currency crisis • Speculative attack and “bank run” led to loss of reserves • Dramatic rise in problem loans • Governments became burdened with bailout expenses • IMF engineered bailouts tied to a Structural Adjustment Package requiring reduced govt spending and deficits, allowing banks to fail, and higher interest rates 5 1998 Russian Financial Crisis (the Ruble Crisis) • • • • Fixed exchange rate Chronic fiscal deficit Declining GDP/productivity; low oil prices “Bank Run” to dump Ruble led to large loss of international reserves • Russia – Devalued Ruble – Defaulted on domestic debt – Moratorium on payments on foreign debt • Quick recovery due to surge in oil prices 6 Value of Russian Rubble 7 2001 Argentine Financial Crisis • Fixed exchange rate to maintain credibility and low inflation following a period of hyperinflation • Growing government debt • GDP began to decline in 1999 (by 4%) • Loss of confidence and capital flight led to a rise in interest payments that worsened the fiscal situation • Domestic run on banks to convert pesos to dollars, leading eventually to conversion of all dollar accounts to peso accounts • IMF provided loans to allow an injection of dollars • Fixed exchange rate abandoned in Jan 2002 • Led to very severe recession 8 2007-08 Global Financial Crisis • Excessive leverage by financial institutions • Maturity mismatch and excessive dependence of real estate • Credit rating mistakes permitted risky mortgage-related investments • Collapse of real estate led to classic “bank run” that dried up funding by non-bank financial institutions • Shortage of liquidity 9 2010-? European Sovereign Debt Crisis • Low interest rates due to membership in EU • Large fiscal deficits and consequent large debt/gdp levels worldwide, but especially in Portugal, Italy, Greece, and Spain • Stagnant GDP growth and weak government response • Rising interest payments on sovereign debt to reflect default risk • Lack of independent monetary policy to stimulate the economy or devalue the debt • Reluctance by EU to bailout without significant reforms 10