1. The Subprime Crisis The Economist, 20 Sept 2008
“Ten short days saw the nationalisation, failure or rescue of what was once the world’s biggest insurer, two of the world’s biggest investment banks, and two giants of America’s mortgage markets”
“Regulation is necessary and much must now be done to improve the laws of finance: better oversight, more transparency, supervision of giants, accounting that values risk better, safer financial transactions (derivatives)”.
Source: The Economist, 20 Sept

2. But first things first...

3. THE BUSINESS CYCLE

4. Good news or bad news for the GDP?
recession peak expansion upturn depression downturn contraction trough downswing recovery slump boom

5. The economy ...
... grows ...peaks ...contracts ...bottoms out ...recovers ...expands ...booms ..works at full capacity/at below its potential

6. MK, pp
The Business Cycle Pg.1: general information (def. + stages) Pg.2: internal causes of the cycle Pg.3 external causes of the cycle

7. Notes on text (more detailed, pgs.2-3)
CAUSES a) internal e.g. interest rates up→more expensive loan repayment→less money available→lower consumption→lower output →lower employment→even lower spending → … b) external (e.g. elections, natural disasters, “creative destruction”, …)

8. OPTIONAL EX. Keynesianism & Monetarism Make full sentences:
lead / market system / full employment
durable equilibrium/produce/high unemployment / market forces /reduced income and investment
counteract the business cycle/ manage the demand/ governments/
excess savings / interest rates / cause / in the long run / investment / fall / increase
dead / in the long run
neutral / money supply / constant / non-inflationary / government / money /output & employment /no effect
governments / too late / fiscal & monetary measures / recession / foresee / take effect.
MK, pp

9. OPTIONAL EX. Keynesianism & Monetarism Make full sentences:
lead / the market system / full employment (M)
durable equilibrium/produce/high unemployment / market forces /reduced income and investment (K)
counteract the business cycle/ managing the demand/ governments/ (K)
excess savings / interest rates / cause / in the long run / investment / fall / increase (M)
dead / in the long run (K)
neutral / money supply / constant / non-inflationary / government /money /output & employment /no effect (M)
governments / too late / fiscal & monetary measures / recession / foresee / take effect. (M)
MK, pp

10. The Crisis

11. The Subprime Crisis The Economist, 20 Sept 2008
“Ten short days saw the nationalisation, failure or rescue of what was once the world’s biggest insurer, two of the world’s biggest investment banks, and two giants of America’s mortgage markets”
“Regulation is necessary and much must now be done to improve the laws of finance: better oversight, more transparency, supervision of giants, accounting that values risk better, safer financial transactions (derivatives)”.
Source: The Economist, 20 Sept

12. What is the chronology of the events below?
Poor borrowers go bankrupt, so houses are returned to lenders.
Central banks help to prevent system collapse.
Poor borrowers can no longer repay their loans.
Some lenders go bust as they cannot sell the property, and some lenders sell loan obligations to investors.
Poor borrowers buy houses with loans.
Because of low interest rates, it is easy to borrow.
But after some time, interest rates go up.
(RB:p.80)

13. The Financial Crisis Mortgage lenders Subprime borrowers Hedge funds
Default (n.), to default on mortgage (v.)
To release liquidity
RB: p. 80

14. What is the chronology of the events below?
Replace the red parts with the words from before:
Poor borrowers go bankrupt, so houses are returned to lenders.
Central banks help to prevent system collapse.
Poor borrowers can no longer repay their loans.
Some financial institutions go bust as they cannot sell the property, and some lenders sell loan obligations to investors.
Poor borrowers buy houses with loans.
Because of low interest rates, it is easy to borrow.
But after some time, interest rates go up.
(RB:p.80)

17. OPTIONAL READING

18. Northern Rock: A case study of a troubled bank
RB: p.59
optional reading

19. Do you know the meaning of the words below?
Shake-out
Credit squeeze
Run on a bank (bank run)
Solvency (being solvent)
Mortgage loan
Deposits
Emergency funding

20. Which of the previous words are defined here?
Government measures designed to limit the supply of credit in the economy (e.g. by restricting bank lending)…………..
A loan to finance the purchase of real estate………………
The ability of a corporation to meet its long-term fixed expenses ……………..
the decline in the number of commercial banks (bigger banks acquire weaker competitors who verge with bankruptcy)………..

21. Government measures designed to limit the supply of credit in the economy (e.g. by restricting bank lending) CREDIT SQUEEZE
Loan to finance the purchase of real estate MORTGAGE
The ability of a corporation to meet its long-term fixed expenses SOLVENCY
The decline in the number of commercial banks (bigger banks acquire weaker competitors who verge with bankruptcy) SHAKE-OUT

22. Northern Rock - Basics What happened to Northern Rock?
What exactly did the bank’s customers do and why?
Who helped and how?

23. Text 2 Go bust Securities (e.g. bonds, …) Bank run The Treasury
The Chancellor (of the Exchequer)
Subordinated debt
Piece of legislation
Bailout
In a transparent manner
Banking regulator

24. A banking crisis: the worst-case scenario
Put the following statements in the chronological order:
The regulators do not spot the trouble in time.
The bank goes bankrupt.
The government (the Treasury) steps in and guarantees 100 per cent of the deposits, but repays only investors who made unsecured loans to the bank, and not those who bought the bonds issued by the bank.
The bank management borrows over their heads.

25. So, why did all this happen to Northern Rock (and many other players)?

26. More about the financial crisis
The subprime crisis and the credit crunch (MK, p.75)
(optional material)

27. The outcome
In 2007, Northern Rock received liquidity from the Bank of England following problems in the credit markets caused by the US subprime mortgage financial crisis.
The bank was nationalised in February 2008 as a result of two unsuccessful bids to take over the bank, neither being able to fully commit to repayment of taxpayers' money.
As of 1 January 2012 Northern Rock has become part of Virgin Money.

28. The subprime crisis and the credit crunch MK, p.75, 76
Find definitions for the following:
subprime borrowers, securitization, MBS and CDO, toxic debt, credit crunch
Answer the questions:
Why did banks buy MBS and CDOs?
What happened in the end?
What were the consequences of all this?

29. Joseph Stiglitz Nobel Prize in Economic Sciences 2001
Columbia University

30. Optional reading (RB: pp.81-84)
What did Stiglitz say in his text Capitalist Fools (Vanity Fair, Jan, 2009)?
Give a brief explanation of the five mistakes covered by the text in RB, pp:82-83, (1-2 sentences for each)