FIM Tutorial

Compare and contrast the causes and evolution of the US Banking Panic of
1933 to the sub-prime mortgage crisis of 2008
* A lot of the answers are in the document uploaded.
NB What is the financial system: Designed in order to facilitate the transfer of
funds between surplus budget units and deficit budget units.
Balance budget unit: In the absence of financial system, you have BBU.
Expenditure = income + wealth.
Tutor said watch video ‘1929 great depression’. Says what is taking place at the
time. 58 minutes long.
What was the cause of the US Banking Panic of 1933?
In terms of ‘evolution’, what led up to the US Banking Panic of 1933?
3 main things:
1. Introduction of credit: Introduced in 1920. 1920s introduced concept of
credit. People would buy tvs, irons, washing machine etc using credit. Note
well that in 1933 there was a stock market crash. In the 1920s, persons
were also buying STOCKS on credit. As a result, stock market appeared to
go up, individuals were coming into the stock market.
Now lets contrast this with 2008. What happened here? In 2008 people
were investing in housing. There was the creation of a bubble.

Comparison: In 1920, there was inflated stock prices on credit. There was a
stock market bubble that burst in 1929 and continued until 1933. In 2008,
this was similar, except not stocks, but houses. There was an increased
housing bubble. There was an investment in housing and the related
mortgage market. Bubble also burst.
Comparison is also that banks were giving out credit and loans to people
that had no idea of stocks and housing.

2. Persons buying on margin: 1920s – Borrow money to buy stock. Essentially,

bank owns the security.
Persons borrowing 100% of house – So, who owns the house? The bank. If
housing price drops, bank will suffer. If house was valued at $100,000 and it
 is now $90,000, banks will face that loss since they own it basically. So now,
the bank is selling houses at low prices. So here, what we see is bank runs,
meaning loan value is decreasing. When bank sells mortgage, they can’t
regain the initial value. Thus, this affects their profitability.

In terms of stock in 1920s, banks ask individuals to put in some money and
bank puts in the rest (credit). If stock prices drop, banks will have a
problem, just like in 2008, because in their books, they bought the price for
$80, but not it is valued at $60 (for e.g).

So regulations were put in place in 1934: Glass Steagall etc.

3. Introduction of legislation to deal with financial crisis. In 1934, there was

significant legislation to address problems in 1920.

In 2008, there was also legislation. E.g Dodd Frank Act.

In paper uploaded, in 1933, it is argued that regulation did not have the
power to stop the financial crisis that existed at the time. But, in 1913,
Federal Reserve Act of 1913, gave the Federal Reserve the power to step in
if there was a crisis. But in 1929, they did not consider this a crisis. So, there
was a legislation that they could have used, but they didn’t. They could
have stopped it, but didn’t.

In 2008, similar argument, say there wasn’t regulation to stop the crisis. But
THERE WAS. There was shadow banking. There were entities that were
doing what banks were supposed to do: mortgage brokers. They were not
regulated by any entities. They had no authority to deal with banking??
There was legislation saying that these entities need to be regulated, BUT IT
WAS NEVER ENFORCED. If legislation was enforced against these
institutions, they should not have been allowed to do what they are doing
(mortgage brokers).

Now DIFFERENCES:
1. Involvement of government early in the 2008 crisis vs. 1933 great
depression.
 In 1933, government says they weren’t going to get involved in the
concept of credit.

In 2008, government got involved early to help stop bankruptcy of Fannie Mae
and Freddie Mac. Fannie and Fred were very important because both were US
institutions, as opposed to Lehman which was a private entity. So diff in 2008
and 1933, government didn’t get involved early in 1920s when it was
happening, but did VERY LATE in 1933. They should have stepped in earlier. In
2008, GOVERNMENT GOT INVOLVED VERY EARLY cause they realized there
was a significant crisis to incur and saw they had to stop this crisis. Their
decision not to bail out Lehman brothers however was bad.

In both cases, crisis already started. 1933 government stepped in late, in 2008
stepped in early. But, didn’t bail out Lehman Brothers. They said it’s a private
institution, so not dealing with that. This raised the discussion of “What is too
big to fail?” Because it was assumed government would bail them out cause
they are too big to fail, but they didn’t. Government said no institution is too
big to fail (is this true?). So they had no choice but to fail. Today, this discussion
of what is too big to fail is still happening.

Tutor said watch video: 1929 The Great Depression. About an hour long. Talks
about issues that happened in 1929. Biggest issue was introduction of credit.
First bought tvs, which escalated to stocks to become multi millionaires. But
these people didn’t realize stocks go up and down. But at that time, stocks only
went up and so this is what people assumed.

Inside job: Talks about legislation put in place after crisis (towards end of
documentary).

READ DOC US BANKING PANIC 1933.