Bertrand Candelon Financial Crises Analysis 1Studium general - 06/10/2011

Sequence of the Sub-Prime crisis: 1. US Housing Market Collapse. 2. Bank distress: US-Europe-ROW. 3. Stock Market Crash. 4. Economic Recession. 5. Sovereign Debt Crisis.….. 2

The strongest crisis since 1929? The same causes, the same errors ? Where do we go? Studium general - 06/10/20113

1 - What is a financial crisis? 2 - The origins of the crises. 3 - Crisis Mutation 4 - The Current crisis. 5 - A European Crisis 4Studium general - 06/10/2011

1- What is a financial crisis? 1. Wikipedia: ” Situation, when money demand exceeds money supply”. Temporary event. Liquidity problem. 2.Frederic Mishkin: ”Nonlinear disruption,..., so that financial markets are unable to channel funds to those with the most productive investment opportunities.”. Several markets involved. Role of the banking sector. Jumps ! Speculative attacks 5Studium general - 06/10/2011

6 Stock markets crisis Currency crisis Banking crisis Sovereign debt crisis … Food crisis, Political crisis

Financial Crisis: a growing and more severe problem for the world economies ? No,…. - Globalization leads to a better risk diversification. - Better economic education. - More efficient prudential rules (Basle). - Information better widespread. 7Studium general - 06/10/2011

Yeah,…. - Capital highly mobile. - Financial products (hedge,..) have widespread the risk but not removed it. 8Studium general - 06/10/2011

9

2- The origins of the financial crises. Fundamental based crises Macro- and Micro fundamentals. 10Studium general - 06/10/2011

. Non-fundamental-based crises - Self-fulfilling propheties. - Contagion - Moral hazard. 11Studium general - 06/10/2011

3- Crisis mutation. Flood and Garber (1984) – Currency Crisis - Economic relationships (UIP, PPP,..) on flows - But also accounting relationship extracted from the central bank balance sheet. R + DC = Ms A crisis occurs when R=0. 12Studium general - 06/10/2011

. Balance sheet Approach (Rosemberg at al ) 13Studium general - 06/10/2011

. The subprime crisis explained via the BSA. Real estate bubble – non-financial BS Then financial sector BS --- Banking crisis Then Government BS --- Sovereign debt crisis Then…. Resurgence banking, currency,.. 14Studium general - 06/10/2011

. Empirical analyses. - From currency to banking crisis: Glick-Hutchinson (1995), Bordo et al. (2001),.. - From banking to sovereign debt: Reinhart-Rogoff (2009) Candelon-Palm (2010) 15Studium general - 06/10/2011

16Studium general - 06/10/2011

17Studium general - 06/10/2011

4- The Current crisis History 1/ - Business cycle turning point in early Real estate bubble explodes. - Financial institutions faced liquidity problem (Northern Rock, Bear Stearn, Freddy Mac, Fanny Mae,…) - Bankruptcy of Lehman brothers. Sept 15 th, Systemic Banking crisis 18Studium general - 06/10/2011

- Irrational reaction of stock markets, which crashed. - Several financial institutions in Europe faced liquidity problems (fortis, dexia,..). Nobody believe anymore in the IFS. - Uncoordinated reaction of governments (Paulson’s plan, recapitalization, nationalization) - G20 meeting to restore credibility. 19Studium general - 06/10/2011

History 2/ - Real economy collapse since Public finance, austerity measures. - Greek default. - Distress of the €, banking sector weakness,.. 20Studium general - 06/10/2011

The origins of the crisis 1-. Business cycle turnpike.. Bad banking management and governance: Scandals ( SoG, CL,..), not enough diversification, too complex financial products. 21Studium general - 06/10/2011

The crisis becomes irrational with the bankruptcy of Lehman brothers. Why? Incoherent political reaction (Paulson’s plan by the US congress, or the absence of coordinated EU reaction) 22Studium general - 06/10/2011

The origins of the crisis 2-. Bad macroeconomic fundamentals (important debt, global disequilibrium). Political incompetences leading to a status quo (on financial regulation –CRA-, on decisions,..) -. Procyclical fiscal policies (banking safety plans,..) 23Studium general - 06/10/2011

Political Crisis (in particular Europe ) The markets and investors do not believe anymore politicians Studium general - 06/10/201124

What is the situation in October 2011?. Financial markets: quiet until July 2011, loose more than 25% last 3 months…. Sovereign bonds markets: extremely huge spreads for Greece, Italy -- unsustainable 25Studium general - 06/10/2011

. Real Markets - Disastrous GDP growth at 0%. Unemployment increases. Debt level and budget deficit will still deteriorate with austerity – Deflation is around the corner 26Studium general - 06/10/2011

5- the European crisis. From a Banking crisis to a sovereign debt crisis.. From a sovereign debt to a currency crisis (to the end of € ?).. From a sovereign debt to a political crisis 27Studium general - 06/10/2011

Loss of Credibility in the European Area. Sovereign Debt crisis Threat on the euro (will it still exist in this form?) and depreciation with respect to the US$ Currency crisis ? banking crisis (Dexia) ? ---- vicious circle ? 28Studium general - 06/10/2011

Sovereign debt crisis ? 29Studium general - 06/10/2011

30Studium general - 06/10/2011

31Studium general - 06/10/2011

. French and German banks highly involved In PIIGS BIS (2009) Greece SpainIrelandItalyPortuga l Total. Capital & reserve French b German b Studium general - 06/10/2011

Depreciation of the Euro vis a vis of other currencies is the next step, if Euro still exist… 33Studium general - 06/10/2011

Policy recommendations: - Fiscal Policy (SGP and its implementation, the ESF and fiscal federalism). Avoid deflation.. - Monetary Policy: Role of the ECB (not quasi fiscal operations). - Exchange rate stabilization: A Future for Euro? - Debt restructuration (Greece) – exit option. 34Studium general - 06/10/2011

Political Decisions have to be quickly taken. Within Europe: Eurobonds, restructuration of the Greek debt, fiscal policy coordination,... In the world: Intervention of the BIRC, IMF,... For a new world order. 35Studium general - 06/10/2011

Conclusions My vision of the future: Pessimistic -2012: election year – expect no courageous political decision. -On the edge of deflation (brain drain,..) -Crisis almost out of control. Studium general - 06/10/201136