Student Name Student ID Financial Crisis 2007-2010 Student Name Student ID Fong Kwok Ki 09009388 Cheng Tsz Hong 09020055

Financial Crisis2007-2010 1.Background 2.Causes why the financial crisis would occur 3.Consequences of the financial crisis 4.How the government reacts

Background The global financial crisis of 2008 is the worst of its kind since the Great Depression Began with failures of large financial institutions in the United States Rapidly evolved into a global crisis resulting in a number of bank failures

What is financial Crisis? The term financial crisis is applied broadly to a variety of situations 1 Banking panics and recessions 2 Speculative bubbles and crashes 3 Currency crisis 4 Sovereign defaults

Causes 1. Easy credit conditions Lower interest rates encourage borrowing Banks borrowing to finance investments potential returns from investments↑ overleveraged  creates a higher risk of bankruptcy created demand for various types of financial assets raising the prices of those assets bubbles burst  financial crisis

Sub-prime lending refers to the credit quality of particular borrowers weakened credit histories and a greater risk of loan default than prime borrowers Higher demand and price of house  real estate pricing bubbles financial crisis Subprime mortgage payment delinquency rates increased rapidly to 25% by early 2008 losses of banks are so much greater than the loans

2.Asset-liability mismatch A situation in which the risks associated with an institution's debts and assets are not appropriately aligned The mismatch between the banks' short-term liabilities and its long-term assets one of the reasons bank runs occur or go bankrupt. E.g. Bear Stearns failed in 2008 unable to renew the short-term debt it used to finance long-term investments in mortgage securities.

3. Deregulation Insufficient regulation to guard against excessive risk-taking in the financial system E.g. the deregulation of credit default swaps Regulators allowed depository banks such as Citigroup to move significant amounts of assets and liabilities off-balance sheet into complex legal entities (structured investment vehicles) For masking the weakness of the capital base of the firm or degree of leverage or risk taken  weakened in parts of the financial system.

4. Fraud Companies have attracted depositors with misleading claims about their investment strategies Embezzled the resulting income Caused large losses at financial institutions Contributing to the financial crisis

Consequences of financial crisis(2007)

1. Investors have suffered losses Stock price ↓ Wealth ↓ Consumption, investment ↓ Contractionary effect on economy Wealth will further decrease

2. Reducing export of developing countries GDP of developed countries ↓(e.g. US) Purchasing power ↓ Import ↓ Exporting countries will suffer (e.g. China) GDP of exporting countries drop further Economic situation worsen

3. Global Contagion Global Economic shock European bank failure Investors lost confidence Various stock indexes ↓ Market value of equities and commodities ↓ Badly affect the stability of the financial system

Dow Jones Industrial Average

4. Company shutting down Company is hard to borrow money Turnover is likely to drop Drop in allowance ,wages or even dismissed Unemployment ↑ Income of people ↓ Investment , consumption ↓ Business volume dropped further

How the government react ?

1. Reduce the interest rate Interest rate = opportunity cost of investing and consuming Interest rate ↓ More people are willing to borrow money opportunity cost of investing and consuming ↓ Consumption , investment ↑ Expansionary effect on economy

2. Reduce the discount rate Commercial banks borrow money ↑ Reserve of banks ↑ Source of capital for company ↑ Investment tends to increase

3. Increase the government expenditure on infrastructure Provide job opportunities Unemployment ↓ Income ↑ Consumption ↑ Improving the economic environment

4. Reducing tax rate & Increasing Transfer payment Disposable income ↑ Stimulate consumption & investment Improve the economic environment

5.Establish fund for the company to borrow money Stable source of capital Borrow money easily The underfinanced problem can be resolved Not needed to close down Reduce the pressure on unemployment

THE END