Introduction to Macroeconomic Theory and Practice

Global Financial Economic Crisis

Submitted by:
Aquino, Mae Angeline
Bacolor, Karla Mae
Bernabe, Shyra Anne A.
Bulanadi, Justine May M.
Lubarbio, Maica Eunice D.
Pagtakhan, Sherubin S.
Pangilinan, Carl Adrian C.
Sta. Ana, Averyl Lei C.
Tarrega, Andrzej
BSA 2-1
To be submitted to:
Mr. Ivan Cantong
09/24/16

Global financial economic crisis

The GFC or global financial crisis began in July 2007 with the credit crunch, when
a loss of confidence by U.S. investors in the value of subprime mortgages caused

a liquidity crisis. It resulted with the U.S. federal bank injecting a large amount of
capital into financial markets.
The collapse of Lehman Brothers on September 2008 marked the beginning of
new phase in in the GFC the fallout from the housing and stock market collapse
worsened.
Around the world stock markets have fallen ,large financial institutions have
collapsed and government in even the wealthiest have had to come up with
rescue plans to bail out their financial systems.
The financial crisis happens because banks were able to create too much money,
too quickly, and used it to push up home prices and speculate on financial
markets.

Asian financial economic crisis

Also known as asian contagion
Series of currency devaluation and other events that spread through many Asian
markets beginning the summer of 1997.
Currency declines spread rapidly throughout South Asia, in turn causing stock
market declines, reduced import revenues and government upheaval.
International stocks also declined as much as 60%. Luckily, the Asian financial
crisis was stemmed somewhat by financial intervention from the International
Monetary Fund and the World Bank. However, the market declines were also felt
in the United States, Europe and Russia as the Asian economies slumped.
Many nations adopted protectionist measures to ensure the stability of their own
currencies. Often, this led to heavy buying of U.S. Treasuries, which are used as
global investments by most of the world's sovereignties.
Indonesia, Malaysia, Korea and Thailand had strong economic performance.
Because of their strong economic performance, they did not deal earnestly with
the surfacing problem. They think that they ar immune to the crisis that had
erupted in Latin America in 1980s.
Current account deficits widened due to massive capital inflows and weakening
exports. A substantial portion of the capital inflow was in the form of short-term
borrowings, leaving the countries vulnerable to external shocks.
Causes:
1. Inefficient allocation of foreign funds because of weak banking system, poor
corporate governance and lack of transparency in the financial sector.
2. Exchange rate regimes gave borrowers false sense of security, encouraging them to
take on dollar-denominated debts.
3. Weak exports
Housing Bubble
Began in 2001 and reached its peak in 2005
A housing bubble is an economic bubble that occurs in local or global real estate
markets. It is defined by rapid increases in the valuations of real property until
unsustainable levels are reached in relation to incomes and other indicators of
affordability. Following the rapid increases are decreases in home prices and
mortgage debt that is higher than the value of the property.
Many economists believe that the U.S. housing bubble was caused in part by
historically low interest rates.
In a 2005 report by the Fed, International Finance Discussion Papers, Number
841, House Prices and Monetary Policy: A Cross-Country Study, the agency said

that house prices, like other asset prices, are influenced by interest rates, and in
some countries the housing market is a key channel of monetary policy
transmission.
Temporary condition caused by unjustified speculation in the housing market that
leads to a rapid increase in real estate prices. As with most economic bubbles, it
eventually bursts, resulting in a quick decline in prices. The end of a housing
bubble is hard to predict given the fact that economic conditions
can change withoutwarning. If a housing bubble swells to an extremely high level,
the aftermath of a burst may set the housing market back years.
Starts with an increase in demand in the face of limited supply which takes a
relatively long period of time to replenish and increase. At some point, demand
decreases or stagnates at the same time supply increases resulting in sharp drop
in prices and the bubble bursts.
Result of rapid innovation
But in this case, the innovation was the process of financial securitization.
This occurs when a financial instrument, such as a simple home mortgage, is
sliced and diced, repackaged, and then sold on securities markets.
Worst example is the subprime mortgages.
Echoing the end of the speculative dot.com stock-market bubble from a decade
earlier.
Many of the new securities lost value.
It turned out they were not top-grade AAA securities but junk bonds.
As banks and other financial institutions suffered large losses, they began to
tighten credit, reduce loans, and cut back sharply on new mortgages. Risk
premiums rose sharply.

I.T. Bubble
The dot-com boom refers to the speculative investment bubble that formed
around Internet companies between 1995 and 2000. The soaring prices of Internet
start-ups encouraged investors to pour more money into any company with a
.com or an e-something in its business plan. This excess capital encouraged
Internet companies to form, often with very little planning, in order to get in on
some of the easy money that was available at the time.
The dot-com boom is also known as the dot-com bubble, Internet bubble, IT
bubble or Internet boom.
The period was marked by the founding (and, in many cases, spectacular failure)
of several new Internet-based companies commonly referred to as dot-coms.
Companies could cause their stock prices to increase by simply adding an e-
prefix to their name or a .com suffix, which one author called prefix investing.
A combination of rapidly increasing stock prices, market confidence that the
companies would turn future profits, individual speculation in stocks, and widely
available venture capital created an environment in which many investors were
willing to overlook traditional metrics, such as P/E ratio, in favor of basing
confidence on technological advancements.
The collapse of the bubble took place during 19992001. Some companies, such
as pets.com and Webvan, failed completely. Others such as Cisco, whose stock
declined by 86% lost a large portion of their market capitalization but remained
stable and profitable. Some, such as eBay.com, later recovered and even
surpassed their dot-com-bubble peaks. The stock of Amazon.com came to exceed
$700 per share, for example, after having gone from $107 to $7 in the crash.

Monetary Policy
The means by which the federal reserve manipulate the U.S. money supply in
order to influence the U.S. economy's overall direction particularly in areas of
employment, production and prices.
Changes in the interest rates and money supply to expand or contract aggregate
demand. In a recession the Fed will lower interest rates and increase money
supply. In an overheated expansion, the Fed will raise interest rates and decrease
the money supply.
The goals of monetary policy are to promote maximum employment,stable price
and moderate long term interest rates.
The crisis has demonstrated that a monetary policy aimed at fine tuning short
term objectives causes serious risks.
Money and credit matter for successful monetary policy making.
Initially the crisis started in the sub-prime mortgage market during the summer of
2007, and became very intense in September 2008 with the default of Lehman
Brothers. Subsequently, financial woes spilled over into the real economy,
resulting in recessions in almost all industrialised countries. Monetary and fiscal
policy countered this with unprecendented vigour. Monetary policy responded with
very low interest rates and a wide range of non-standard measures. Fiscal policy
allowed public deficits to widen and set up rescue packages for troubled financial
institutions. To a large extent thanks to these measures, economic activity
rebounded in 2010. But at the same time, countries that had entered the financial
crisis with large public and private debt burdens started to have serious problems
accessing sovereign debt markets.
Subprime mortgages
Type of loan granted to individuals with poor credit history.
It charges interest rates higher than the prime leading rate because of the higher
risk of return.
Adjustable rate mortgage - a kind of subprime mortgage where in the borrower
initially pay at a lower interest rate. When mortgages went to higher interest rate
mortgage payments increase significantly. This is one of the factors that lead to
the sharp increase in the number of subprime mortgage foreclosures in August of
2006 and the subprime mortgage meltdown that ensued.
Subprime mortgage crisis
Started in 2007-2010 due to earlier expansion of mortgage credit, including to
borrowers who previously would have had difficulty getting mortgages, which both
contributed to and was facilitated by rapidly rising home prices.
Before, potential homebuyers found it difficult to obtain mortgages if they have
below average credit histories.
The housing crisis provided a major impetus for the recession of 2007-09 by
hurting the overall economy in four major ways. It lowered construction, reduced
wealth and thereby consumer spending, decreased the ability of financial firms to
lend, and reduced the ability of firms to raise funds from securities markets (Duca
and Muellbauer 2013).
Collateral debt obligation

Financial tool that bundles individual loans (e.g., mortgages, auto loans, credit
card debt, corporate debt) into a product that can be sold on the secondary
market.
Selling CDOs is a way for companies to increase their liquidity. For example, a
bank might sell debt (i.e., a group of mortgages) to obtain capital to invest (e.g.,
make more loans). An investor buying the CDO does not necessarily know what
assets are included in the instrument.
There are numerous CDO types, each based on the underlying asset (e.g., loans,
fixed income securities, real estate, reinsurance contracts).
Each one is its own little corporation.
Constructed from the bottom, or riskiest, tranches of a hundred different
mortgage bonds. Hundreds of sections of different mortgage bonds get bundled
together into a new instrument, or re-securitized.
On average their size was about $800 million, and a CDO had an average of about
7 tranches. Typically three of these tranches would be rated AAA, and at least one
would be BBB. The average tranche size is about $100 million.
Issued mostly by big banks, the most active of which were J.P. Morgan, which
issued $128 billion of them, and Citigroup, which issued $110 billion.
The banks would create a subprime-backed CDO filled with the tranches of BBBrated bonds, then take it to rating agency which would declare it to be rated AAA
or something else that indicated safety.

Student loan
A student loan is a type of loan designed to help students pay for post-secondary
education and the associated fees, such as tuition, books and supplies, and living
expenses. It may differ from other types of loans in that the interest rate may be
substantially lower and the repayment schedule may be deferred while the
student is still in school. It also differs in many countries in the strict laws
regulating renegotiating and bankruptcy.
Australia, Canada, South Korea, USA, United Kingdom, Germany
In general, students are not required topay back these loans until the end of
a grace period, which usually begins after they have completed their education.
Credit ratings
An assessment of the creditworthiness of a borrower in general terms or with
respect to a particular debt or financial obligation. A credit rating can be assigned
to any entity that seeks to borrow money an individual, corporation, state or
provincial authority, or sovereign government. Credit assessment and evaluation
for companies and governments is generally done by a credit rating agency such
as Standard & Poors, Moodys orFitch. These rating agencies are paid by the
entity that is seeking a credit rating for itself or for one of its debt issues.
Quantitative easing

QE is aimed at stimulating economic activity, such as increasing consumer

spending
One of the main tools they have to control growth is raising or lowering interest
rates. Lower interest rates encourage people or companies to spend money,
rather than save. But when interest rates are at almost zero, central banks need
to adopt different tactics - such as pumping money directly into the financial
system. This process is known as quantitative easing, or QE.
The central bank buys assets, usually government bonds, with money it has
"printed" - or, more accurately, created electronically.
It then uses this money to buy bonds from investors such as banks or pension
funds. This increases the overall amount of useable funds in the financial system.
Making more money available is supposed to encourage financial institutions to
lend more to businesses and individuals.
It can also push interest rates lower across the economy, even when the central
bank's own rates are just about as low as they can go. This in turn should allow
businesses to invest and consumers to spend more, giving a knock-on boost to
the economy.
Pumping more money into the economy could lead into inflation
Its effect is still contested because in US, over the last few years, the economy
was stabilized and unemployment has fallen steadily. Some credit the QE for this.

Washington consensus
Set of broadly free market economic ideas, supported by prominent economists
and international organizations such as IMF, the world bank, etc.
Advocates free trade, floating exchange rated, free market and macroeconomic
stability.
The ten principles originally stated by John Williamson in 1989, includes ten sets of
relatively specific policy recommendations.
1. Low government borrowing.

2.

3.

4.

5.
6.

Avoidance of large fiscal deficits

relative to GDP;
Redirection of public spending
from subsidies (especially
indiscriminate subsidies) toward
broad-based provision of key progrowth, pro-poor services like
primary education, primary health
care and infrastructure
investment;
Tax reform, broadening the tax
base and adopting moderate
marginal tax rates;
Interest rates that are market
determined and positive (but
moderate) in real terms;
Competitive exchange rates;
Trade liberalization: liberalization of imports, with particular emphasis on
elimination of quantitative restrictions (licensing, etc.); any trade protection to
be provided by low and relatively uniform tariffs;

7. Liberalization of inward foreign direct investment;

8. Privatization of state enterprises;
9. Deregulation: abolition of regulations that impede market entry or restrict

competition, except for those justified on safety, environmental and consumer

protection grounds, and prudential oversight of financial institutions;
10. Legal security for property rights.

Sources:
positivemoney.org
www.canstar.com.au
ecb.com
www.federalreserveeducation.org
faculty.etsu.edu
www.economicshelp.org
www.investopedia.org
www.imf.org
www.investorwords.com
wikipedia.org/wiki/1997_Asian_financial_crisis
www.investopedia.com/terms/a/asian-financial-crisis.asp#ixzz4Jcpe9YH3
danwang.co/collateralized-debt-obligations-and-credit-default-swaps/
Economics by Paul A. Samuelson and William D. Nordhaus
www.cga.ct.gov/2008/rpt/2008-R-0668.html
m.economictimes.com
http://www.federalreservehistory.org/Events/DetailView/55
https://business.cch.com/images/banner/subprime.pdf
https://en.wikipedia.org/wiki/Student_loan
http://www.bbc.com/news/business-15198789