midterm report principal of financial markets for finance and banking major topic financial crisis

Definition A financial crisis refers to a disruption or breakdown in the financial system of a country or region that has significant negative impacts on the economy.. It is characterize

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MINISTRY OF EDUCATION AND TRAINING

VIETNAM NATIONAL UNIVERSITY, HO CHI MINH CITY

UNIVERSITY OF ECONOMICS AND LAW

MIDTERM REPORT PRINCIPAL OF FINANCIAL MARKETS FOR FINANCE AND BANKING MAJOR

Topic: FINANCIAL CRISIS Mentor: TS NGUYEN HOANG ANH

Group: IMF

Full name Student ID Level of job completion

Nguyén Thi Ngoc Duyén K224020224 100%

Huynh Thi Ngoc Giang K224020226 100%

Tran Thanh Phuong K224020247 100%

Lé Duc Hau K224030432 100%

Nguyén Yén Linh K224040570 100%

Dang Hoai Minh Thu K224040586 100%

HCM City, 11/2023

4

ACKNOWLEDGEMENT First and foremost, we wish to express our deep and sincere gratitude to the University of Economics and Law for incorporating the Financial Theory and Monetary subject into the curriculum In particular, we extend our gratitude to Ms Nguyen Hoang Anh, the esteemed lecturer of the Financial Theory and Monetary subject, for providing us with the invaluable opportunity to explore and present this report through our group presentation This

opportunity has been instrumental in expanding our knowledge and establishing a strong foundation for mastering this subject However, owing to our limited understanding, there may be some shortcomings in our essay We earnestly hope to receive your valuable feedback and comments, which will undoubtedly aid us in improving and refining our gr oup assignment

In conclusion, we would like to extend our heartfelt wishes to you, hoping you find immense joy, robust health, and resounding success in your esteemed teaching career

DUTY CHART

Definition of a Financial crisis (including differences bw Financia} Ngọc Giang 100% and economic crisis; types)

Causes of financial crisis Ngoc Duyén 100%

The 2007-2008, Key Events

Global Financial Crisis Effects

Thanh Phương 100% FED's responses

2 Slide Design and complete slides Minh Thư 100%

Giang, Duyên,

Conten Linh, Phương °

3 Presentatior Compose Tesponses for viewer’s Hau 100%

questions

Answer the question Linh, Thu, 100%

Phuong Synthesize the content Hau 100%

4 Report Edit according to the correct repon ‘ ; format Minh Thư 100%

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TABLE OF CONTENTS

1 Definition of a financial crisis

1.1 Definition

A financial crisis refers to a disruption or breakdown in the financial system of a country or region that has significant negative impacts on the economy It is characterized by severe disruptions in the functioning of financial markets, institutions, and intermediaries, leading to

a loss of confidence and a sharp decline in economic activity (Scott, n.d)

Figure 1 Definition of a financial crisis 1.2 Differences between Financial and Economic Crisis

A financial crisis specifically refers to a crisis in the financial sector, often caused by speculation in stock markets If investor confidence returns quickly after a financial crisis, it may end without major economic impact However, if panic spreads from financial assets to the broader economy, a financial crisis can lead to an economic crisis, which is broader in scope and impacts many sectors such as banks, retail shops, restaurants, and other business closing down or going bankrupt Interestingly though, an economic crisis does not always have

to start from a financial crisis - the COVID-19 pandemic demonstrated there can be a real- world economic shock first that then exposes fragility in the financial system Both a financial crisis and an economic crisis can potentially cause the other After a financial crisis, solutions tend to focus on central banks and monetary policy In contrast, after an economic crisis, solutions may combine monetary policy responses from central banks and fiscal policy responses from governments (Econimics, 2020)

1.3 Types of Financial Crises

1.3.1 Currency Crises

Currency crises occur when a country's currency rapidly loses its value, leading to economic instability This can be caused by factors such as speculation, loss of investor confidence, or unsustainable economic policies

1.3.2 Sudden Stops

A sudden stop is an abrupt reduction in net capital flows into an economy, especially an emerging economy.

Sudden stops refer to a sudden halt in capital inflows to a country or region This can happen when investors quickly withdraw their investments due to concerns about economic or financial conditions Sudden stops can disrupt ec onomic growth, increase borrowing costs, and lead to financial instability

1.3.3 Foreign and Domestic Debt Crises

Foreign debt crises occur when a country is unable to meet its obligations on international debt, leading to aloss of confidence from creditors Domestic debt crises, on the other hand, involve difficulties in repaying debts within the country, such as corporate or household debt These crises can result in financial distress, bankruptcies, and economic downturns

1.3.4 Banking Crises

Banking crises occur when there is a significant disruption in the banking sector, leading to a loss of confidence in the financial system This can happen due to factors like bank failures, inadequate regulation, or systemic issues Banking crises can result in bank runs, liquidity problems, credit crunches, and a contraction in lending, negatively impacting the overall economy

(Mr Stijn Claessens and Mr Ayhan Kose, 2013, January 30)

2 Causes of financial crisis

Financial crises are complex events with multiple causes, and there is no single theory that can fully explain why they occur However, there are a number of factors that have been identified

as contributing to financial crises, including:

2.1 Asset Bubbles

Asset bubbles are periods of rapid and unsustainable increases in asset prices, such as housir prices or stock prices These bubbles can be caused by a variety of factors, including excessive risk-taking, leverage, and speculation When these bubbles burst, they cause sharp declines ir asset prices, leading to substantial losses for investors and financial institutions This can destabilize the financial system and lead to a crisis (Liberto, n.d) The 1929 stock market crash was caused by unsustainable rising of stock prices When the bubble burst, the stock market crashed, leading to a global recession

Figure 2 The Dow Jones Industrial Average has risen just under 6x from its August

closing low of 64, to its September 1929 high of 381

2.2 Excessive Risk-Taking

Financial institutions may take on excessive risk in pursuit of higher profits, especially during periods of economic growth and low interest rates This risk-taking behavior had a significant impact on both the worldwide crisis and the Eurozone crisis (Baldwin, 2012) It is probable that banks will experience a reduction in their ability to take risks, leading them to decrease lending, which will in turn have a negative impact on economic growth (Catalan, M., Natalucci, F., Qureshi, M S., & Tsuruga, T, 2023) The savings and loan crisis of the

1980s in the United States occurred when savings and loan institutions took on too much risk

in their lending practices When these loans became difficult to repay, savings and loan institutions began to fail, leading to a recession in the United States (Boyle M J., 2021)

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1989: 530

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Figure 3 Failures of all Institutions for the United States and Other A

2.3 Regulatory Failures

The failure of regulators to identify and address risks in the financial system or to prevent financial institutions from taking on excessive risk can also lead to a financial crisis (Liou, 2013) Regulatory failures can involve a breakdown in control, or desire on the part of the board to encourage such activity The Asian financial crisis of 1997 occurred when regulators

in a number of Asian countries did not identify and address the risks posed by asset bubbles and excessive risk-taking in the financial sector

Map of Asian Financial Crisis

South Korea

Hong Kong

°

Figure 4 Map of Asian Financial Crisis

2.4 Macroeconomic Shocks

Unexpected economic events, such as recessions or natural disasters, can stress the financik system and trigger a crisis The impact of disruptions to supply chains and commodity markets

on domestic growth and inflation could exacerbate banks’ market and credit losses, further reducing their profitability and capitalization (Kiley, 2018)

2.5 Geopolitical Events

Wars or political instability can disrupt financial markets and lead to a crisis Geopolitical tensions can destabilize financial systems Financial restrictions, heightened uncertainty, and outflows of cross-border credit and investment due to escalating tensions can lead to increased risks and costs for banks in renewing their debt (Lu, Z., Gozgor, G., Huang, M., & Lau, M C

K, 2020)

In addition to these factors, financial crises can also be caused by human error, fraud, and other unforeseen events

Each of these factors can independently lead to a financial crisis, but they often interact in complex ways that can exacerbate the severity of the crisis

Financial crises can have a devastating impact on the economy and on individuals They can lead to recessions, job losses, and foreclosures Financial crises can also damage public trus

in the financial system

3 The 2007-2008 Global Financial Crisis

3.1 Main Causes

3.1.1 Housing bubble

In the early 2000s, the US economy was on the verge of recession and inflation To revive that economy, FED reduced the interest rates from 6.5 percent (%) in 2000 to 1 percent (%) in

2003 At that time, alot of people went to the banks borrowing money to buy houses so that the real estate was extremely hot There was a boom in U.S housing prices fueled by low interest rates and lax lending standards This created a bubble that eventually burst, leading housing prices to plummet Many mortgage borrowers defaulted as their home values declined below what they owed (Nguyen, 2019)

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Figure 5 FED Fund Rates Chart

3.1.2 Subprime mortgages

Due to changes in banking laws in the 1980s, many banks and financial institutions offered subprime mortgages to borrowers with poor credit histories (Britannica, 2019) Many of these mortgages had adjustable rates that later reset to much higher interest rates, leading to defaults During the period from the late 1990s to 2004-2006, the ratio of subprime mortgages to total home loan accounts increased from about 2.5 percent to Approximately 15 percent per year (Britannica, 2019)

U.S Subprime Lending Expanded Significantly 2004-2006

Subprime Mome

Share of Mortgage Ownership

Originations (%) Rate (%)

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or 8 1 00 2001 aa z0) ot 7% % or

EE Subprime Share % El Home Ownersiup %

Figure 6 U.S Subprime lending expanded dramatically 2004-

3.1.3 Securitization

Many subprime mortgages were bundled together to create mortgage-backed securities (MBS) and collateralized debt obligations (CDOs) that were then sold to investors These securities were often given high credit ratings, but they contained risky underlying assets This spread risk throughout the financial system When borrowers defaulted, these securities plummeted

in value (Boyle M J., 2019)

Chart 1

Gaining popularity

Issuance of European and U.S structured credits has soared

(billion dollars)

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3,000

2,500

2,000

1,500

1,000

500

0 2000 O1 02 03 04 05 O6 07

Sources: Inside MBS & ABS; JPMorgan Chase & Co.; and European Securitization Forum

Note: CDOs = collateralized debt obligations; ABSs = asset-backed securities, including

auto, credit card, etc., and excluding MBSs; and MBSs ~ mortgage-backed securities,

excluding U.S agency MBSs

Figure 7 Securitization chart from 2000 to 2007

3.1.4 Credit default swaps

Financial firms often bought derivatives called credit default swaps (CDS) as insurance against MBS defaults Many CDS were sold without having enough capital to pay claims when defaults happen (example: AIG) The CDS market grew rapidly to over $60 trillion by 2007 (Britannica, 2019)

Credit Default Swaps Outstanding at Year End*

(notional amount in trillions of dollars)

$62.2

$0.91

2001 2002-2003 2004 200X 2006 2007 2003 2009 2010

“Note: the 2010 figure utilizes mid-year data

Source: Intemational Swaps and Derivatives Association

Figure 8 10 years growth of Credit Default Swap (CDS)

3.1.5 Lack of Transparency

The complex interconnectedness between firms through securitization and derivatives made it difficult to assess firms’ real risks and exposures Many investors, including other financial institutions, were unaware of the risks they were taking This uncertainty fueled panic during the crisis

3.2 Key events

3.2.1 Housing market downturn (2006-2007)

The crisis initiated following the collapse of the housing bubble in the United States Housing prices started declining, particularly in the subprime market, which led to a wave of foreclosures (Turner, 2023)

Figure 9 In October 2007, Burbank, California home sellers had to decrease their a

prices due to the housing market's downturn