Global Financial Crisis (2013) - This Mini Lecture addresses causes and possible solutions of the global financial crisis.

The idea that money is a destructive monster is more than a mere phrase. It became reality in 2007 to 2008, as the world faced its worst financial crisis since the Great Depression. The sheer magnitude of the global financial crisis became fully evident in 2007. It had, however, started years earlier with a boom on the U.S. subprime housing market: Since interest rates on subprime mortgages were low, medium and low income groups could easily get credit to buy a house. To both attract moderate income groups and distribute credit risks, banks created complex off-balance sheet instruments, commonly referred to as CDOs. In simple terms, collateralized debt obligations are asset-backed securities – such as mortgage-backed debts or other fixed-income securities – bunched into tranches and mainly sold to non-depository financial institutions, many of them shadow banks. Since returns on these credit instruments appeared highly profitable and ratings signalled they were safe, international investors such as hedge funds, investment banks and insurance companies bought them in huge amounts. Simultaneously, derivatives activities on the markets as well as foreign exchange trading had heavily grown since 2000. A more and more complex, high-risk system based on shadow banking and virtual instruments developed all around the globe, buttressed by inaccurate, profit driven agency ratings. A bubble grew, which seemed to be a win-win-situation for everybody at first sight until all broke down in 2007. The bubble turned into a monster, when house prices in the U.S. declined, rates were raised and failures in the repayment of subprime mortgage loans as well as in the repayment of subprime mortgage-backed debts and other securities increased greatly. A crisis of liquidity and trust among banks occurred, which engulfed private investors, hedge funds, insurers and big companies such as General Motors and banks themselves in the abyss: Lehman Brothers in the U.S. collapsed first in 2008, followed for example by Northern Rock in England, Glitnir Bank in Iceland or WestLB and IKB in Germany. As in a cascade, one bank after another finally fell. By 2009, 21 banks and 62 hedge funds had been forced to declare bankruptcy in the U.S. alone. The crisis highlighted the international linkages between the financial markets of the U.S. and European economy as well as the fatal interdependencies of banks and governments; the monster, created by the financial sector took its prey in almost every part of the world with an ensuing global recession ahead. It also hit the Eurozone: Since 2009 Portugal, Ireland, Italy, Greece and Spain have been facing severe financial challenges which led each country close to bankruptcy. This could only be prevented with the help of several multi-billion Euro bailout-packages funded by other countries in the Eurozone and the International Monetary Fund as well as severe austerity measures and debt erasure. Reasons for the Eurozone debt crisis go beyond the consequences of the U.S. subprime mortgage crisis however. Mismanagement and excessive government spending are among the reasons, especially in Greece. By 2010 more than half the Eurozone member states had violated the stipulated 60 percent for public sector debt which had been set as stability criteria in the Maastricht Treaty of 1993. But in their analysis of the crisis other economists refer to fatal methodological failures. They question the efficiency of standard macroeconomic models which failed to predict the macroeconomic effects of local market imperfections. The test of any science is prediction and if you can’t predict something that’s important as a global financial crisis at the magnitude of the one we’re going through, obviously something’s wrong with your models. In fact, as I mentioned, in some quarters there’s a complacency that macroeconomics is in its golden age. I think, if it is in its golden age, it’s a very tarnished gold. Some experts hold huge swings of the U.S. dollar-euro exchange rate liable for financial problems of every country in the world as almost all countries relate their currencies to the U.S. dollar and euro. To prevent constant revaluations of the major world currencies, having destabilizing effects on national economies and markets, they argue for a multiple-currency monetary union linked to the U.S. dollar, the euro and the yen as fixed entity. This anchor unit is supposed to generate more stability on the markets and to prevent a future currency war. What I believe needs to be done is to have… the dollar-euro exchange rate has to be the pillar by which you fix the thing. Fix the dollar-euro exchange rate and then add China to it and have the I.M.F. create… Ask the three big countries, the E.U., U.S. and China to fix… to be the anchor for a global currency which I would call the INTOR and then go on with it. The European Union is undergoing a challenging period. Nevertheless, the community of 27 member states is also a success story: Since its foundation in the 1950s it has turned Europe from a continent of war to a continent of peace. For this achievement the European Union was awarded the Nobel Peace Prize in 2012. Some see the award as a symbol of encouragement and affirmation. But the European community as well as governments around the world have to deal with the question of how a crisis such as the current one can be prevented in the future. We ought to make ourselves aware here in Europe of the ruptures and the discrepancies of the past 100 years and of what happened on our continent Europe over these past 100 years between 1911 and 2011. The first half of these 100 years saw two world wars, the Shoah, the Great Depression and the division of Europe and of the world into two parts by means of the Iron Curtain and of the Wall. At the same time, we ought to remind ourselves of what happened over the last 50 of these 100 years, of all the positive things that were created – in the West of Europe at first, and then in all of Europe – peace, after thousands of years of war, the Single Market, prosperity, a space of freedom, of democracy and of justice. What a list of accomplishments! In order to enhance fiscal stability, the Eurozone adopted the European Fiscal Treaty in the early 2013: All member states, apart from the UK and the Czech Republic, signed the Treaty and submitted to a more disciplined budgetary policy under one single controlling institution. Furthermore, a permanent rescue fund, called the European Stability Mechanism, was established in 2012. And the U.S. passed the so called Dodd-Frank Act in 2010, which is seen as the largest reform on the American banking sector since World War II. It also aims for stricter financial supervision as well as better consumer protection. The future will show whether these actions can prevent the financial markets from turning into yet another monster, again born of greed and money.

Global Financial Crisis (2013)

This Mini Lecture addresses causes and possible solutions of the global financial crisis.

Global Financial Crisis (2013)

This Mini Lecture addresses causes and possible solutions of the global financial crisis.

Abstract

The Mini Lecture "Global Financial Crisis" addresses causes and possible solutions of the global financial crisis that hit the world in 2007 with lecture snippets of Robert Mundell, Christian Wulff and Joseph Stiglitz.

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