BBK 9 Intro to Financial Crises

8/6/2019 BBK 9 Intro to Financial Crises

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Financial or Economic Crises?

From National to International

See Doug Nolan's Credit Bubble Bulletin at

http://www.financialsense.com/Experts/2007/Noland.html

http://www.prudentbear.com/index.php/commentary/creditbubblebulletin


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In this session we will look at

1) National financial crises and global crises2) The problem of the relation between stock, bank, financial

and economic crises3) The common features of early and later crises

4) Stock prices and crisis5) State debt6) Bank losses and assets7) Cases8) Derivatives

9) Mergers and acquisitions10)Gold


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From mid 2007 to end 2008 the USA experienced a major financial

panic, which apparently then became economic.

This is not a unique occurrence.

In the USA there has been a financial crisis roughly every 14 to 20

years : in 1819, 1836, 1857, 1873 (& the so-called 'Long Depression' of

1873-1896 ),1893, 1907, (1918 post war was an industrial collapse,

1919 boom and 1920 crisis) the 1929 great crisis to 1933, then .....

1973, 1987, 1997 and now 2007-8. Many of these marked thebeginning of a period of economic depression, not simply a recession.

http://online.wsj.com/article/SB122360636585322023.html

According to the US Bureau of Economic Analysis, during the post war

boom, real gross domestic product fell throughout the 1945-7 period

(war production reduced) and in 18 of the 104 quarters between 1948and 1973. In 1949, 1953-4, 1957-8 and 1969-70 it declined for at least

two quarters in a row, but these output recessions were not financial

crises, and the distinction must be retained.


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US financial crises do not always tie in with the 23 slumpsin the world market. The coincidence is indicated in red.

World slumps broke out successively in 1825

(undercapitalised banks collapse), 1836, 1847, 1866(Overend-Gurney crash), 1873, 1882, 1891, 1900, 1907, 1913, 1921, 1929,1937, 1949, 1953, 1957, 1960, 1970, 1974, 1981, 1990, 2001 and

2007.

Nor do UKnational problems always link clearly with widerinternational phenomena, thus the Stock exchanges

Spanish panic of 1835, or the British railway share bust of1837, the 1933 Kaffir (tea shares) boom, the Western

Australian boom, the 1890 Barings Crisis, the MarconiScandal 1912 are international events not much affectingnational.


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Many economists attempt to establish a regularity orexplain the periodicity of crises.

I think that the momentum of this stumbling giant is notregular, nor can it be constantly re-explained as ever

new contingencies.

Rather such movements arise from a recurring generalproblem ofhow to avoid decreasing profitability. Many

factors promote profitability, that vary in type, weightand consequence, and we encounter a conflicts between

inbuilt characteristics of capital growth.

Growth certainly takes place, but at increasing cost toentire societies and their natural basis. Stagnation and

crisis seem ever present and grow ever more persistent.


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US Financial crises have all been managed differently but with agreater degree of centralised management every time. There was

no US central bank from 1828 to 1913.

As a result, the panics of the 19th century were far worse in the USA thanin Europe and precipitated longer and deeper depressions. In fact in 1907,

J.P. Morgan, probably the most powerful private banker who ever lived,acted as the central bank to end the panic that year. Resentment at his

power provoked a new Fed Reserve in 1913.

A stock market crisis is NOT in itself a financial crisis (except forindividuals!). Financial crises are those which seem to arise from

financial activity itself, borrowing, lending, and so interest rate issues,and the purchase of paper claims on other assets, including the use offoreign exchange, and NOT from the production or commercial spheres

where money is used to purchase inputs, or to sell non financial outputs.Since a crises can only express itself generally (ie on a large scale) in

monetary terms, because of the way value measured, the focus on thefirst news (financial indices) of a crisis can create the illusion that it is

only a financial issue, or is then the cause of an economic crisis rather

than its expression or result.


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President Andrew Jackson attacking the Bank ofthe United States. Lithograph,1828. The 1st Bank ofthe United States was established in 1791, closed 1811 after southern states against it. A 2nd bank was established 1816

until opposed by Jackson, its charter expired in 1836. The Federal Reserve was created in 1913 as 12 separate banks,thenfinally centralised in 1934.


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Dot .com bust

2007 crashBlack Monday 10/87

The movement of profits does not necessarily coincide with stock price changes. TheBlack Monday (19 Oct 1987) decline was, until then, the largest one-day percentage

decline in stock market history.The most popular explanation for the 1987 crash was selling by program traders


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Writing at the time of (probably the worlds first) the1825 banking crisis,

Jeremiah Harman, Director of the Bank, described it thus:

We lent [money] by every possible means and in modes wehave never adopted before; we took in stock on security, we

purchased Exchequer bills, we made advances on Exchequer

bills, we not only discounted outright, but we made advanceson the deposit of bills of exchange to an immense amount, inshort, by every possible means consistent with the safety of

the BankSeeing the dreadful state in which the public were,

we rendered every assistance in our power.

Last resort lending from the start!


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The 1866 UK failure of Overend, Gurney and Company Ltd,followed the acceptance of bills of less and less satisfactory

quality after 1856-7, and lending to companies withunsatisfactory collateral. It was floated (note the same withUS investment banks at the turn of the 21st century!) in 1856

as a limited company. Bad debts increased as companieslinked to OGC failed, its stock fell, it was refused aid by the

bank of England in May. It collapsed bringing down countrybanks and firms, then other London banks then a run on theBank of England. The Bank Charter Act was suspended, andthe fiduciary issue expanded to save the day! So whats new

today??


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Tuesday 29 October1929 crisis: was preceded by speculation using

margin payments. Thus 1925 to 1929 saw turnover in securities

doubling.

The Smoot-Hawley Tariff Act of 1930 was considered by many to be

the factor that transformed the U.S. recession into a global depression.

It was enacted on 17 June 1930, about 8 months after the collapse of

the U.S. stock market. It quadrupled import tariffs on 20,000 goods,

particularly agricultural products. Retaliation, brought internationaltrade to a halt and depressed global demand. Ironically, the U.S.

economy was showing signs of recovery by the spring of 1930.

Unemployment stood at 7.8%, but the decline in global trade doubled

the rate by 1931 to 7m. and wages fell 39% from 1929-31.

Britain went off the gold standard in 1931.The unemployment rate in

the U.S. continued to climb, peaking at 32% in 1933. 19 April gold

standard abandoned and $35 an ounce of gold by Jan 1934. Only

France adhered to the gold standard.


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In 1933 the US Banking Act orGlass-Steagall Act was passed,following the collapse of nearly 5000 banks, forcing

commercial and investment banks to separate. Commercialbanks could not underwrite stocks and bonds sales.

Investments banks could not take deposits.

It was repealed in 1999 The Financial Services

Modernisation Act (by the Republicans Gramm, Leach andBliley). Now these banks could combine and join with

Insurance companies. This allowed eg Citigroup to emergeafter Citibank merged with Travellers and then expanded

through takeovers.


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Ignoring emerging markets (which have to be explained within the

whole picture), from 1975 to 2007, there were 5 BIG wealthy nation

crises, Spain 1977, Norway 1987, Finland 1991, Sweden 1991 and

Japan 1992 (all starting dates) plus the EU /EMU/ crisis of 1992.These are associated with major declines in economic performance for

a time, the Japanese for a lost decade.*

Other non emerging market banking and financial crises were in

Australia 1989, Canada 1983, Denmark 1987, France 1994 (CreditLyonnaise), Germany 1977, Greece 1991, Iceland 1985, Italy 1990, New

Zealand 1987, UK 1974 (Secondary banking crisis) and 1991 (BCCI and

91-93 Small banks crisis and 1992 abandonment of EMS), 1995

(Barings fraud) and 1984 USA started its Savings and Loans crisis (cost

3.2% GDP), 1997 (NYSE stopped trading, with Asian Financial crisis),

1998 (LTCM/Russian)

An estimated 42 systemic banking crises between 1970 and2007

Kaminsky GL and Reinhart CM AER Vol 89 1999: Caprio G Klingebeil D Laeven L Noguera G 2005 Banking Crisis Database in Honohan P & Laeven L Sustemic Financial

Crises CUP. See http://ssrn.com/abstract=1282250


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It is difficult to separate out and prioritise all these crises,and they need to be examined and linked to the (unmentioned

here) developing economy crises : Thus 2000-3 there was amajor fall in stock prices globally, as dot.com boom ended,

and 2001 Argentine default occurred.

Now we haveU

S/Global 2007-2009 crisis!

These financial crises are continuous and yet have notproperly been assessed as linked within a global process.

They are usually presented as separate and different, with

multiple causes. They need to be connected to generaleconomic crises.


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Financial markets are risky /unstable because participants expect

future yields. The future is uncertain. Financial instability itself canintensify to financial crises. The liberalisation of the global financial

markets since the late 1970s, several speculation waves have affected

different world regions leading to serious debt and financial crises:

eg the third world was hit by the debt crisis of the 1980s. The result

was a lost decade, but actually the problem is continuous!!!

Emerging markets faced a financial crisis, beginning with Mexico in

1974, and then reaching the Asian tigers in 1997, Brazil suffered a

setback in 1999, and Argentina in 2001. The USA also went through

some financial crises: the Savings and Loan crisis (1987) and the

crisis following the wave of unfriendly takeovers (1986 and 1989),


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Following the financial crises in Asia, Russia, Turkey and Latin America,capital surpluses flowed into the new techno-economy and pumped up a

speculative bubble there.

This burst in 2000. The rescued capital was invested in the real estatesector - until the subprime crisis erupted in 2007 which caused massive

losses in almost all countries of the world.

The crisis on the financial markets is still primarily being fought withtrillions of dollars and euros. No one wants to think of the losses, and

they have not yet been finally distributed between classes and nations.The plagues of climate collapse, peak oil and hunger are neglected in thediscussion. The conflict to determine who the devil will take has only just

started.


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DJIA (30 stocks) broke 12000 (12,049.5) for first time in 110 years 18.10.2006.12,000. FTSE also 5 year high of 6172 earlier in that week. Prices are actuals.

It will fall to 7000 by start 2009 (below 1997level)

19801929 1945 1970 2000

2000-3 Stock crash

These 30 stocks are of the biggest US monopolies dramatically expanding after 1980

1987Crash22.61% fall

12 stocksin 1896

20 stocksin1916

30 stocksin 1928


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The TWO FT examples here

ignore the sharp falls in stock

prices (capitalisation) e.g.

1903, 1914 (world war starts),

1920, 1937. Why?

!!

!

!


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NB: from 66-83, the periodofthe great rethink, there isa stagnation around 1000 pts.

Y axis is log scale


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UK


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UK Statistics 1988 to 2006


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2008 estimate


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The bigger crises have interesting similarities: financial liberalisation

precedes the majority of crises; there is a rise in housing prices, (best

leading indicator of countries with large capital inflows) that level out

or dip about 1 year before ; the rate of growth in equity prices alsoslows then falls up to 3 years before the crisis; the momentum ofreal

growth slows for three years going into crisis and remains low for 2

years. Rising public debt near universal precursor of other post war

crises (accelerating thereafter).

The consequences are an average drop in real per capita output

growth is 2%, with two years to return to trend. In the 5 big cases

drop in growth pa is over 5%, with 3+ years required for recovery.


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In 2011 Jean Claude Trichet will retire as head of ECBMuch of his career has been spent battling economic

disaster, he said,from Latin America to Africa, Russia,Mexico and Asia WSJ 27 Jan 2010.


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The role of Banks in the national economy


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In the UK 1970 to 2007, the contribution of thefinancial sector to the GDP rose from 5.1% to 8.3%.

We can compare this to Real estate which wentfrom 10.8% to 23.6%,

or manufacturing which fell from 31.7% to 12.4%,or mining (including oil and gas) which rose from

1.6% to 2.6%.

But such figures need to be investigated to see howmuch of the actual profit element in society came

from different sectors, and especially theretained/reinvestable profits.

Furthermore we need to see which sectors werecritical to paying for imports or capital exports.


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To Sept2008 only


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CASES


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BCCI was a major international bank founded in London in 1972 by

Agha Hasan Abedi, a leading Pakistani financier. Registered inLuxembourg, at its peak it operated in 78 countries, had over 400

branches and had assets in excess of US $20bn. making it the 7th

largest bank in the world by assets.

It became the focus in 1991 of the world's worst financial scandal -

what was called a "$20-bn + heist". Regulators in the US and UK found

it to be involved in money laundering, bribery, support of terrorism,

arms trafficking, the sale of nuclear technologies, the commission and

facilitation of tax evasion, smuggling, illegal immigration, and the

illicit purchases of banks and real estate. The bank had at least $13 bnunaccounted for. The bank was dubbed the "Bank of Crooks and

Criminals International. A Bank of England report was drawn up on

the collapse and regulatory issues. The Bank of England was not

blamed.

Bank of Credit and Commerce International (BCCI) scandal 1991


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An attempt was made to tighten cross border coordination after thisBCCI collapse, but US insolvency law dictates that most of liquidity and

capital inU

S must stay there. Each state prefers to protect its owntaxpayers. So will cross border regulators oblige banks with US presenceto store extra cash elsewhere? Still in 2010 not the case.


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UK small bank failures & liquidity problems,

1991-93 crisis : I

Started pre-BCCI, but exacerbated by it.

Regulators contained a liquidity problem.

Bank of England kept the problem secret until afterresolution.

Asset quality deteriorated as property prices fell

(banks focused on property lending). Wholesale funding withdrawn as US and Japanese

banks reduced deposits due to long recession.


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UK small bank failures & liquidity problems,

1991-93: II

Bank of England actions:

- 25 banks failed or closed due to problemsduring the period.

- BoE monitored 40 small banks very closely;

- told many banks to reduce assets and/or

increase their liquidity;

- supply of liquidity in form of loans to afew small banks.

Contagion was feared. A realistic fear?


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Barings, 1995: I

Rogue trader in Singapore (bet on Tokyo shareindex holding 19,000 against downward pressure)

without supervision. (2010 its at 10,000)

Losses of 800mn on derivative contracts, onBanks capital base of 540mn.

Insolvency highly likely.

Was contagion likely? Bank of England decided no:

- small merchant bank;

- problems due to fraud.


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Barings, 1995: II

Reputational risk to other merchant banks or toLondon as a financial centre?

Bank of England tried to put together a lifeboatbut failed.

Bank of England said it would provide liquidity tomarkets if necessary but refused to use publicfunds to bail out Barings.

Barings acquired by ING, Dutch bank/insurance co.


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Long term Capital management crisis 1998

In 1994, John Meriwether, (famed Salomon Brothers trader), founded ahedge fund called Long-Term Capital Management, with academics models

and traders' market skills. Sophisticated investors, including many large

investment banks initially invested $1.3 bn. By end September 1998, the fund

had lost substantial amounts of investors' equity capital and at brink of

default.The proximate cause for LTCM's debacle was Russia's default on its

government obligations (GKOs). The banks guaranteeing the rouble hedge

shut down when the Russian rouble collapsed. The Russian government

prevented further trading in its currency. LTCM was than caught in a "flight to

liquidity" across the global fixed income markets. To avoid the threat of asystemic crisis in the world financial system, the Federal Reserve

orchestrated a $3.5 bn rescue package from leading U.S. investment and

commercial banks. In exchange the participants received 90% of LTCM's

equity. Small change compared to 2008.

http://www.erisk.com/Learning/CaseStudies.asp


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US consumer debt sharply increased from < US$740bn in1975 to almost US$11,500bn in 2005, (from 62.0% to 127.2%

of disposable income). Ratio of total debt to GDP rose fromapprox. 160% at the beginning of the 1970s to 340% in 2005.The debt of consumers corresponds to an increase in

monetary wealth of suppliers. Demand for investmentopportunities leads to the supply of new vehicles

promising high returns. A large part of this monetary wealthis hoarded as foreign currency reserves by China, Japan,

Russia and some other countries with a positive balance ofpayments, such as Germany.


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From 1990, Finance capital turned to derivatives, wherever

it looked a possible haven, and so implicitly to loan packages

of various kinds, as well. Over the counter derivatives rose 5

times from 2001 to 2008, while credit default swaps rose 62times, from almost $1 trillion to $62 trillion. The Dow Jones

index of shares rose 7 times from 1987. The house price rise

in the USA and the UK was just one aspect of this a huge

asset inflation during this period. The rewards to financecapital soared: its share of the American stock market

climbed from 5.2% pa in 1980 to 23.5% pa 2007.

The fall of commodity prices, including oil in particular,

preceded the threat of meltdown. Oil had dropped byalmost half from $147 US in July2008 to $70 in October

2008 and $47 in December. Commentators talk of the

socialisation of risk and the privatisation of profit, but that

has always been the case.


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* On Aug 2010 Corus and SSI Thailands largest steel producer sign MoU for the potential sale ofTeesside Cast Products.

*


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Lower production of gold in 2008 than 2000. Jewellery 70% end use.


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Reinhart, C. M and Rogoff, K (2009), This Time is Different: Eight Centuries ofFinancial Folly, Princeton University Press.

Sheppard, D. K (1971), The Growth and Role of U.K. Financial Institutions 1880-

1962, Methuen.

Laeven, L. and Valencia, F. V (2009), Systemic Banking Crises: A New Database,IMF Working Paper No. 08/224.

Logan, A (2000), The Early 1990s Small Banks Crisis: Leading Indicators, Bankof

England Financial Stability ReviewIssue 09.

Ahamed, Liaquat. Lords of Finance: a history of the economics of World WarIandthe Depression Penguin 2009

David Kynastons The City of London: A World ofIts Own, 1815-90 (Vol. 1)The City of London: Golden Years, 1890-1914 (Vol. 2), The City of London:Illusions of

Gold, 1914 - 1945 (Vol. 3), The City of London: Club No More, 1945-2000 (Vol. 4)

Bloomsbury 2010

Documents

BBK 9 Intro to Financial Crises