Financial Crises

The term financial crisis broadly alludes to a range of situations where financial institutions or assets suddenly lose a large part of their value.

Typically these involve • Banking panics• Stock market crashes• Currency crises • Sovereign defaults• Or the bursting of asset bubbles

FC: Impact

Financial Crises are often followed by economic downturns and recession.

• Financial Crises not new

• Inherent in capitalism

• Charles Mackay

Memoirs of Extraordinary Popular Delusions and the Madness of Crowds

• Reinhart and Rogoff,

• "Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one!“

• Technology has changed, the height of humans has changed, and fashions have changed. Yet the ability of governments and investors to delude themselves, giving rise to periodic bouts of euphoria that usually end in tears, seems to have remained a constant.

• Carmen Reinhart

• Tulip Mania, 1630s

• South Sea Bubble, 1720s

• Closer home

• Bombay Cotton boom and share mania –

•failure of the Bank of Bombay 1866

Asset Class   Period Low High % Gain  

             

Housing & Real Estate Schillers 2000-06 100 206 106% ##

Equities S&P 2002-07 768 1565 104% ##

  SSEC 2005-07 1015 6039 495%  

  Nifty 2004-08 1250 6320 406%  

Commodities - Precious Gold 2001-08 254 1030 306%  

  Silver 2001-08 4 21 425%  

Commodities- Industrial Copper 2001-08 1338 8730 552%  

  Aluminium 2001-08 1250 3380 170%  

Commodities- Energy WTI Crude 2001-08 17 147 765%  

Commodities- Agricultural AGI index 2007-08 52 102 96% @

Currencies - Emerging mkt KRW 2001-07 1360 900 34% **

  INR 2002-08 49 39 20% **

  TWD 2002-07 35 30 14% ##

Currencies - Commodities AUD 2000-07 0.48 0.98 104%  

  CAD 2002-07 1.61 0.93 42% **

Currencies - Reserve Ccy Euro 2001-07 0.8 1.6 100%  

  Stg 2001-07 1.37 2.11 54%  

Currencies - Funding JPY 2001-07 115 120 -4% ## **

  USD Index 2001-07 120 71 -41% ##

• Impact: Trends in Capital Flows

US Current A/cMonthly QaUSCURAC [Line]

8/8/1978 - 2/19/2009 (GMT)[Professional]

Source: S1=REUTERS S2=US Department of Commerce Source: S1=REUTERS S2=US Department of Commerce

79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 2000 01 02 03 04 05 06 07 08 09

PriceUSDBilln

-230

-220

-210

-190

-180

-170

-160

-150

-140

-130

-120

-110

-90

-80

-70

-60

-50

-40

-30

-20

-10

-200

-100

0

QaUSCURAC, Cvalue, Line, (S1)6/30/2008 -185.0090 (Billn)

US Budget

Failure of market fundamentalism – the auto-corrective

nature of the financial markets

• Periods of high international capital mobility have repeatedly produced international banking crises, not only famously as they did in the 1990s, but historically

• Carmen M. Reinhart and Kenneth S. Rogoff

Financial liberalization, capital inflows and financial crises

• The historical record, however, suggests that a high ratio of domestic to external debt in overall public debt is cold comfort to external debt holders. Default probabilities depend much more on the overall level of debt.

• Carmen M. Reinhart and Kenneth S. Rogoff

Overall Debt & Defaults