Financial Crises History Part 3

Lecture 3
Financial Crises: History
Part 3
The 2008 Global Financial Crisis

Content
 In this lecture we are reviewing some major financial crises over the past
2000 years
o In the first part after a brief introduction we focused on crises that took
place before 1900
o In the second part we examined more recent episodes
o The this third part we will cover the 2008 Global Financial Crisis
The Credit Crunch of 2007-2008
References
Books
Simon Johnson and James Kwak, 2010, 13 Bankers: The Wall Street takeover and the next financial
meltdown
William Cohan, 2009, House of cards: How Wall Street’s gamblers broke Capitalism
David Einhorn, 2008, Fooling some of the people all of the time
John Lanchester, 2010, Whoops: Why everyone owes everyone and no one can pay
Charles Morris, 2008, The Trillion dollar meltdown: Easy money, high rollers and the great credit crash
Frank Partnoy, 2009, F.I.A.S.C.O.: Blood in the water on Wall Street
Richard Posner, 2009, A failure of Capitalism
Gilliam Tett, 2009, Fool’s gold: How the bold dream of a small tribe at J. P. Morgan was corrupted by
Wall Street greed and unleashed a catastrophe
Michael Lewis, 2010, The big short: Inside the Doomsday machine
Articles
Paul Krugman, 2009, How did economists get it so wrong? The New York Times, September 6
John Lanchester, 2008, Cityphilia, London Review of Books, January 3
John Lanchester, 2008, Cityphobia, London Review of Books, October 23
John Lanchester, 2009, It’s finished, London Review of Books, May 28
Paul Mizen, 2008, The credit crunch of 2007-2008: A discussion of the background, market reactions, and
policy responses, Federal Reserve Bank of St Louis Review, September/October
Related Readings
George Akerlof and Robert Shiller, 2009, Animal spirits: How human psychology drives the economy, and
why it matters for global Capitalism
Nassim Nicholas Taleb, 2004, Fooled by randomness: The hidden role of chance in life and the markets
Liaquat Ahamed, 2009, Lords of finance: The bankers who broke the World
Michael Lewis, 2006, Liar’s poker

(Mis-)Management of Risk
Getting There … The ‘Great Moderation’
 A decade of low inflation, low interest rates, steady growth; BUT
 Savings Glut (accumulation of reserves by China, Japan and oil-exporting countries)
 Foreign Capital Inflows financing the U.S. Trade Deficit
 Credit Boom (excessive lending supported by a loose monetary policy)
 U.S. Saving Rate fell from 6% to 1% of Disposable Income
 U.S. Debt-to-Disposable Income Ratio rose from 75% to 120%
 Housing Bubble
Iceland, Northern Rock and ‘Too Big to Fail’
‘Too Big to Fail?’
A very concise history of financial (de)regulation
 (1933) Glass-Steagall Act

o Separation of Commercial Banking from Investment Banking
o Rationale: Commercial banks allocate funds collected from depositors to
households and firms in the form of loans. The viability of the intermediation
process crucially depends on the beliefs of depositors about the soundness of the
banking system. Investment Banking would expose commercial banks to great
levels of risk. The separation allowed the government to offer protection to
depositors.
 (1986) ‘Bing Bang’: Complete deregulation of the U.K. financial system.
 (1999) Abolition of the Glass-Steagall Act
Luca Pacioli, Summa de arithmetica and the Birth of Modern Accounting
A snapshot of a firm
o Balance Sheet
o Income Statement
o Cash Flow Statement
o Retained Earnings Statement
A typical balance sheet
Assets Liabilities
Cash & Investments Loans
Fixed Assets Bonds
Inventories Equity
Accounts Receivable Accounts Payable
The Bank Balance Sheet
Assets Liabilities
Reserves Deposits
Loans Equity
An example (2008)
Assets £m Liabilities £m
Cash 17,866 Deposits by Banks 312,663
Treasury Bills 18,229 Customer Accounts 682,365
Loans 1,048,710 Other 814,065
Derivatives 337,410 Total 1,809,093
Other 478,304 Equity 91,426
Total 1,900,519 Total 1,900,519
 Insolvency: Total Assets < Liabilities-Equity; Negative Equity

Guess who?
 Total Assets: £1,900,519,000,000; 1.9 trillion pounds

 U.K. GDP: 1.7 trillion pounds
 The biggest company in the world
 Royal Bank of Scotland
What makes banks different?
Apple Computers (2008) RBS (2008)

Assets $39.5 billion £1,900 billion
Liabilities $18.5 billion £1,109 billion
Equity $21 billion £91 billion
A measure of risk
 Leverage ratio: Liabilities/Equity

o Apple Computers: <1
o RBS: 18.8
o Barclay’s 61.3
o US Banks: 35
o UK Banks: 41
 What it takes to become insolvent?
o On average, in the U.S. it takes 1/35 of a bank’s assets go bad, for the bank to
go bust.
o On average, in the U.K. it takes 1/41 of a bank’s assets go bad, for the bank to
go bust.
Incentives and bail-outs
 Depositors vs Shareholders
 Upside risk vs Downside risk and moral hazard
 Management compensation (bonuses)
 Political risks – TBTF
Bill please!
 U.S. bail-out cost (Bloomberg News Service): $7.76 trillion

o Marshall Plan
o Louisiana Purchase
o 1980s Savings and Loan Crisis
o Korean War
o New Deal
o Invasion of Iraq
o Vietnam War
o Total Cost of NASA

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Lecture 3

Financial Crises: History

The 2008 Global Financial Crisis

Frank Partnoy, 2009, F.I.A.S.C.O.: Blood in the water on Wall Street

Richard Posner, 2009, A failure of Capitalism

John Lanchester, 2008, Cityphilia, London Review of Books, January 3

John Lanchester, 2008, Cityphobia, London Review of Books, October 23

John Lanchester, 2009, It’s finished, London Review of Books, May 28

Michael Lewis, 2006, Liar’s poker

 (1933) Glass-Steagall Act

 Insolvency: Total Assets < Liabilities-Equity; Negative Equity

 Total Assets: £1,900,519,000,000; 1.9 trillion pounds

What makes banks different?

Apple Computers (2008) RBS (2008)

 Leverage ratio: Liabilities/Equity

 U.S. bail-out cost (Bloomberg News Service): $7.76 trillion

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