money and banking

Robert E. Wright Vincenzo Quadrini Chapter 12 The Financial Crisis of 2007-8  •   •  •   • !" •    •   • #$  %&&'  •   () *+ •   • , #+ •  * !+ - -+ • ! !+ ./ 1. Financial Crises -0-+ 1'2% 131312 134'42 135' 13'4 1336 132425 12&' 12%244 %&&3 #0-+ 1277 * 12'4'6 -** 123' -** 1223 8  %&&& .* %&&1 9211 %&&' :* # #  ; ; ;+  • <  = • *,* [...]...Chapter Objectives • Define financial crisis and differentiate between systemic and non-systemic crises Key Takeaways  Throughout history, systemic (widespread) and non-systemic (contained within a few industries); financial crises have damaged the real economy by disrupting the normal flow of credit and insurance  Understanding their causes and consequences is therefore important Chapter Objectives... credit, and the de-leveraging of the financial system  The most highly leveraged investors suffer most Chapter Objectives • Define and explain the importance of lender of last resort What is a lender of last resort and what does it do? Purpose: Stop panics and de-leveraging by: • adding liquidity to the financial system and/ or • attempting to restore investor confidence Methods: • • • Increase money. .. Exuberance” Robert J Schiller (2000, revised 2005) Economic factors • • • • • • • • • • • • The capitalist explosion and the ownership society Cultural and political changes favoring business success New information technology Supportive monetary policy and the Greenspan Put The baby boom and bust and their perceived effects on the markets An expansion of media reporting of business news Analysts’ optimistic... the Stock Price Bubble 1970s, bank loans to developing countries 1985-89, real estate and stocks (Japan) 1992-1997, real estate and stocks (Asia) 1990-1993, foreign investment (Mexico) • 1995-2000, OTC stocks (U.S.) 2003-2007, Real estate and credit (U.S.)? from Charles P Kindleberger and Robert Aliber, Manias, Panics, and Crashes New York: John Wiley & Sons, Inc (2005) Causes: • low interest rates PV... decline of inflation and the effects of money illusion Expansion of the volume of trade: discount brokers, day traders, and 24-hour trading The rise of gambling opportunities “Irrational Exuberance” Robert J Schiller (2000, revised 2005) Cultural factors • • The news media New era economic thinking Psychological Factors • • • Psychological anchors for the markets Herd behavior and epidemics Rationalizing... epidemics Rationalizing exuberance: efficient markets and random walks Chapter Objectives • Describe a generic asset bubble Key Takeaways  Asset bubbles occur when the prices of some asset, like stocks or real estate, increase rapidly due to some combination of low interest rates, high leverage, new technology, and large, often self-fulfilling, shifts in demand  The expectation of higher prices in the future,... asset bubble Define leverage and explain its role in asset bubble formation What are asset bubbles and what role does leverage play in their creation? Asset bubbles are rapid increases in the value of some asset, like bonds, commodities (cotton, gold, oil, tulips), equities, or real estate Causes: • • • • low interest rates, new technology, unprecedented increases in demand, and leverage The big ten financial... increase g (constant growth rate)  Price increases Causes: • unprecedented increases in demand Demand can be increased merely by investors’ expectations of higher prices in the future: In the One Period Valuation Model: P = E/(1+k) + P1/(1+k) As P1 increases, P increases Causes: • unprecedented increases in demand Some scholars verify the existence of an asset bubble when news about the price of an... prices to detach from their underlying economic fundamentals Chapter Objectives • Explain why bubbles burst, causing financial panics What are financial panics and what cause them? 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