Financial Crisis- I

Pre-Capitalist Finance “Money lenders” loaned their own money From ancient times Money was loaned to: Individuals for consumption The state, governments, for roads, wars, exploration Merchants for trade Rise of Banking Loans from deposited monies Renaissance Italy in 14 th Century See: Shakespeare’s Merchant of Venice

Capitalist Finance $ Commercial credit: finances trade ¢Just as before, money borrowed to buy cheap and sell dear $ Industrial credit: finances real investment ¢Money borrowed to build plants, buy machinery and raw materials and hire workers $ Consumer credit: finances personal consumption ¢From pawnbrokers through installment plans to credit cards ¢Mortgages to buy homes $ State credit: Governments borrow and lend ¢Borrows to finance expendiures > tax revenues ¢Lends at home and abroad, e.g., foreign aid

Financial Institutions - 1 $ Banks ¢Private banks uLend to consumers, business & governments uObjective: profit ¢National banks uCentral Banks: regulate money supply, oversee private banking sector uDevelopment Banks: fund investment, consumption, buy political support ¢Supranational Banks uInternational private banks uWorld Bank

Financial Institutions - 2 $ Stock markets ¢Buy & sell stocks ¢Stocks are ownership shares, of various sorts u e.g., some pay dividends, some don’t $ Commodity Markets ¢Buy & sell commodies, e.g., metals, soy beans, pork bellies, spot sales & futures contracts (that can be bought and sold $ Foreign exchange markets ¢Buy & sell currencies $ Bond Markets ¢Buy & sell bonds

Crises & Financial Crises $ Many kinds of crises: ¢Commercial crises ¢Industrial crises ¢Financial crises $ All are Interrelated ¢Remember discussion of growth & what has to happen: ¢M-C(MP,L)... P... C’-M’ ¢Or, to be more complete:

Interrelationships L - M - C( MS )...P(2)...L *. L - M - C( MS ) M - L... P(1)... C’ - M’.... P... M - MP A rupture at one point circulates to others, e.g., if money (M) can’t be had for investment, then M-L and M-MP can’t take place, then no P(1), etc.

Circulation of Crisis in Industrial Circuit - 1 $ Crisis of Industrial credit means no M $ No M (no bank credit, no stock sales, etc.), then no M-L, M-MP, …P…, C’, M’ $ No L (refusal of labor market), or no MP (trade disruption), then no …P…C’, M’ $ No …P…, then no C’, M’ $ No C’-M’, then no revenue, no profit, no beginning again in new period

Circulation of Crisis in Industrial Circuit - 2 $ Crisis of Commerical Credit means breakdown in C’-M’ $ Expand C’-M’…. $ C’ sold to wholesalers (who need credit) $ C’ sold by wholesalers to retailers (who need credit) $ Breakdown in C’-M’ circulates

Circulation of Crisis in Reproduction of Labor - 1 $ No L-M (refusal to enter labor market), then no wage), more …P(2) …, Life but no L. (assuming ability to produce consumer goods) ¢E.g., frontier, unsubordinated colonials $ No L-M (no jobs), then no wage, less C(MS), more …P(2) …, less L. (assuming some MS purchased with savings) ¢E.g., downturn, rising unemployment $ In other words: a breakdown in the subordination of life to labor, or in the reproduction of labor.

Circulation of Crisis in Reproduction of Labor - 2 $ Crisis of Consumer Credit ¢E.g., default on consumer debt  repo’s ¢E.g., defaults on mortgages  foreclosures $ Surge in Consumer defaults ¢  collapse in consumer demand for durables and housing $ Collapse in consumer demand ¢  drop in aggregate demand, drop in both C’-M’ and in M – C(MS) which provokes fall in investment, employment etc. $ Collapse in market for consumer debt ¢E.g., mortgages and mortgage-based securities

Finance & Keynesian Models - 1 $ All the major components of aggregate demand: C, I, G, X and M depend on finance $ C = consumer demand, depends on consumer credit $ I = investment demand, depends on capital markets (loans, stocks, bonds, etc.) $ G = government expenditures, depend upon borrowing, e.g., in US Treasury Bills $ X = exports, depend upon commercial credit $ M = imports, depend upon commercial credit

Finance & Keynesian Models - 2 $ Two-way relationship: ¢Healthy credit  growth in C,I,G,X,M. ¢Healthy growth  confident credit markets, but…. ¢Breakdown in credit  breakdown in C,I,G,X,M ¢Breakdown in C,I,G,X,M  breakdown in credit markets. $ Monetary Policy ¢Central bank affects finance through interest rates and handling of government debt uVia reserve requirements, discount rate, open market operations ¢Regulation of finance part of monetary policy

Financial Crises & Regulation - 1 $ Regulations were created because: ¢the “free market” was subject to manipulation and abuse and regularly produced crises that undermined part or all of the economy. $ Examples: ¢Tulip Mania ( ) ¢Bank Panics and Crises of: 1792, ,1819,1825,1837,1847,1857,1866, 1873, 1884, 1893, 1896, 1907 ¢Wall Street Crash of 1929.

Financial Crises & Regulation - 2 $ Primary purposes of regulation: ¢To create and maintain confidence in various financial institutions and their operations ¢In order to create and maintain useful flows of money to finance consumption, investment, trade and government expenditures ¢To protect those who depend upon credit from misconduct and exploitation

Financial Crises & Regulation - 3 $ Financial regulation includes: ¢Specification of what actions are legal and which ones are illegal and… ¢Specification of what institutions can do what uBroadly this involves laws passed by congress ¢Supervision to enforce laws, prosecute violations of laws ¢Institutions to supervise, to check to see if regulations are being adhered to, investigate violations and prosecute them.

Financial Crises & Regulation - 4 $ Regulatory institutions in the US include: ¢Federal Reserve System (Fed) uRegulates member banks reserves, etc. ¢Federal Deposit Insurance Corporation (FDIC) uInsures deposits, regulates bank deposit behavior ¢US Securities and Exchange Commission (SEC) uRegulates securities markets (stock, bonds, etc.) ¢National Credit Union Administration (NCUA) uLicences, supervises and regulates credit federal credit unions ¢Commodity Futures Trading Commission (CFTC) uOversee and regulate commodities markets, futures & options

Great Depression & Financial Regulation $ Stock Market Crash of 1929 ¢October 29, 1929 “Black Tuesday” ¢Financial collapse contributed to collapse of economy more generally ¢Despite Federal Reserve Act of 1913 $ New financial regulations in 1930s: ¢Farm Credit Administration, ¢Federal Securities Act, Glass-Steagall Act (creates FDIC, lets Fed set max interest rates on S&L, splits commercial and investment banking), ¢Export-Import Bank created, ¢Exchange Stabilization Fund created, Federal Farm Mortgage Corporation, SEC created, etc.

Keynesian Era & financial Crises $ Comprehensive financial regulation at home meant virtually no domestic financial crises $ Bretton Woods agreement on fixed exchange rates with IMF as overseer and lender of last resort $ UNTIL: accelerating inflation and growing gov. debt, trade deficits and speculative attacks on the dollar lead to abandonment of Bretton Woods, volitile flexible exchange rates and negative interest rates.

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