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Origins and Lessons from the Financial Crisis

ByLester Henry

Department of EconomicsUWI St Augustine

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Outline• The Extent of the Current Crisis• Origins of the Crisis:

– How Did We Get here?: The Causes of the Crisis – The Minsky Hypothesis

• Attempts to Solve the Crisis and Why they have all failed• Consequences of the Crisis for:

• The Global Economy• The Caribbean

• Lessons and the way forward• What should we be talking about

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The Financial Crisis• The largest financial Meltdown since the Great

Depression• Over US$6 trillion lost on Stock Exchange• 4 to 6 Million US residents losing their homes• The Collapse of major financial firms: Merrill Lynch,

Bear Stearns, Lehman Brothers etc.• International Contagion- Europe and Asia• Impact on Commodity prices• US Recession that is dragging down the rest of the

world

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From a Financial to a “Real” Crisis

• No longer limited to financial sector• The impact on emerging economies has been

somewhat severe• Even worse least developed economies• A Crisis through not fault of their own• Exposes the rest of the world’s dependence on US

mass consumption• Real wage stagnation in the US catches up the of rest

of “us”

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What Caused this Mess?

• The US Housing Bubble: Sub-Prime • Speculative activities in the FIRE economy• 5 to 6 years of fun!! • Greenspan’s easy low interest rate policy comment about “wealth

creation”

• Deregulation• Repeal of Glass-Steagal Act 1933 (Clinton/Rubin 1999)• Exemption of Investment Banks from holding reserves(2004)• Revolving Door (etc. Henry Paulson)• The removal of Interest rate ceilings (regulation Q)• Amartya Sen “disaster waiting to happen”

• The Credit Rating Agencies• Irresponsible “AAA” ratings on all sort of junk• Helped to Internationalize the “pyramid” scheme

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The “Minsky Hypothesis”• Hyman Minsky: Post-Keynesian economist• Warned of the inherent instability of financial markets• He argued that during good times agents get careless and take

on excessive risk eventually becoming “Ponzi borrowers”(aka, Pyramid Scheme)

• Ponzi borrowers can repay neither the interest or the original debt, and rely entirely on rising assetprices to allow them continually to refinance their debt. The longer a period of economic stability lasts…., the more society moves towards being full of Ponzi borrowers, until the entire economy is a house of cards, built on excessively easy credit and speculation. (Wilson, 2007)

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The “Minsky Moment” 2

• The “Minsky Moment” arrives when “over-indebted investors are forced to sell even their solid investments to make good on their loans, sparking sharp declines in financial markets”(Lahart, 2007)

• This is triggered by a sudden or unexpected event

• Many believe the initial “Minsky Moment” came since early in 2007

• So what is happening now is one “huge Minsky Meltdown”

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Attempts to Solve the Crisis and Why they have all failed

• Trying to Solve the Crisis• Adding Liquidity thru lower interest rates• Bailing out of troubled Investment banks• The US$700 billion bailout of “the system• More stimulus packages

• Why they have all failed• Not aimed at the real problem of foreclosures• Aimed at re-inflating asset prices• Really been “Welfare for Wall Street”• In fact it has been Class warfare with a vengeance

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Consequences of the Crisis : Global

• Contagion and “neighborhood” effects• Global recession (BIS warned of this in 2007)• Fall in commodity prices • May force China and other emerging markets to

decease their dependency on the US market• Potential US$ decline (reduced role as a reserve

currency)• At what point will the US lose its “AAA” rating?• Could lead to a new “race to the bottom” among

emerging economies

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Consequences of the Crisis :The Caribbean

• Continued fall in Oil and Gas prices due to the worldwide recession

• Contagion in the Financial Sector (the CLICO demise)• Decline in tourist arrivals• Pension funds at risk (e.g. UWI)• Intra-CARICOM exports may also suffer• Negative effect on remittances• Lay-offs could lead to mortgage foreclosures regionally

• Houses can become “upside down”• Banks may receive “jingle mail”

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Lessons and the way forward

• Unregulated financial markets are a disaster waiting to happen (Leads to Sophisticated Pyramid schemes)

• Must guard against the “revolving door”• we should perhaps not be to too hasty to get highly

sophisticated in our financial system (IFCs)• Must also take decisive action against excessive debt

accumulation and speculative increases in asset prices • Impose taxes on financial speculation (Stiglitz)

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The Way forward: What Should We be Talking About?

• Where are we going? “to hell” perhaps• Current policies can be worsening the crisis• Further skewing income inequality and environmental

degradation• Must look beyond the US consumers for salvation• US, given its problems, cannot be the “engine” of world

economic growth”• Must look toward new and sustainable patterns of

consumption• Can only come with honest dialogue inclusive of the South

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The Way forward: What Should We be Talking About?

• “Since the suffering of the most deprived people in each economy—and in the world—demands the most urgent attention, the role of supportive cooperation between business and government cannot stop only with mutually coordinated expansion of an economy. There is a critical need for paying special attention to the underdogs of society in planning a response to the current crisis, and in going beyond measures to produce general economic expansion”

Amarta Sen (March 31st 2009)

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Selected References

• Sen, Amartya (2009). “Capitalism Beyond the Crisis”, New York Times Review of Books, March 31.

• Lahart, Justin (2007) “In Time of Tumult, Obscure Economist Gains Currency Mr. Minsky Long Argued Markets Were Crisis Prone; His 'Moment' Has Arrived”, Wall Street Journal, August 18th.

• Minsky, Hyman (1992)”The Financial Instability Hypothesis”, The Jerome Levy Institute, Bard College, May.

• Wilson, Simon (2007) “Hyman Minsky: Why Is The Economist Suddenly Popular?”, The Daily Reckoning (UK Edition), April 13.

• Wolfson, Martin (2002) Minsky’s Theory of Financial Crises in a Global Context”, Journal of Economic Ideas, Vol. XXXVI, No. 2, June, pp.394-400.

• Ghosh, Jayati (2008) “The Economic Crisis: Why more of the Same Will not work”, Countercurrents, March 26. (www.countercurrents.org)

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Thank You!!!!!