THE MEXICAN PESO CRISIS OF 1994
1. BRIEF HISTORY OF THE MEXICAN PESO
CRISIS OF 1994
1. The Mexican peso crisis, also known as
the Tequila Crisis, occurred in 1994 and
had a significant impact on Mexico's
economy.
2. The crisis was triggered by a
combination of economic, political, and
financial factors.
3. The Mexican government implemented
economic reforms, including a fixed
exchange rate policy, in an attempt to
stabilize the economy and attract foreign
investment.
4. Warning signs of economic overheating
and growing imbalances were evident in
the years leading up to the crisis.
5. Investor confidence in Mexico's ability to
maintain the fixed exchange rate
decreased, leading to a devaluation of
the peso and a severe financial crisis.
risks of unsustainable borrowing and fixed exchange rate
policies. It also exposed weaknesses in Mexico's financial
system and governance, leading to calls for reforms and
increased transparency.
In the years following the crisis, Mexico
implemented various reforms to strengthen its economy
and financial system. It adopted a flexible exchange rate
regime, implemented fiscal discipline, and pursued
structural reforms to enhance competitiveness and attract
foreign investment. These reforms, along with favorable
global economic conditions, helped Mexico recover from
the crisis and achieve more stable economic growth in the
subsequent years.
II.
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In the late 1980s and early 1990s, Mexico
experienced a period of economic growth known as the
Mexican Miracle. This growth was fueled by foreign
investment, free trade agreements, and financial
liberalization. However, it also led to an increased
dependency on foreign capital and a large current account
deficit.
In the early 1990s, the Mexican government
implemented various economic reforms in an attempt to
stabilize the economy and attract foreign investment. One
of the key reforms was the adoption of a fixed exchange
rate policy, known as the Economic Solidarity Pact.
Under this policy, the exchange rate between the Mexican
peso and the US dollar was fixed at a rate of 3.4 pesos per
dollar. However, in the years leading up to the crisis, there
were warning signs of economic overheating and growing
imbalances. Mexico's current account deficit continued to
widen, and the country's public debt reached
unsustainable levels. Additionally, there was a lack of
transparency and accurate information about the true state
of Mexico's financial situation.
In late 1994, investors began to lose confidence
in Mexico's ability to maintain the fixed exchange rate.
The US Federal Reserve began tightening monetary
policy, leading to a rise in interest rates and a decrease in
liquidity in emerging markets. This made it more
expensive for Mexico to service its foreign debt. To
defend the fixed exchange rate, the Mexican government
spent billions of dollars of its foreign reserves to buy
pesos. However, these efforts were unsustainable, and by
December 1994, Mexico was forced to devalue its
currency. The peso lost more than 50% of its value against
the US dollar. The peso devaluation triggered a severe
financial crisis in Mexico. Many Mexican companies had
borrowed heavily in dollars, and the devaluation made it
difficult for them to service their debt. Numerous banks
and businesses went bankrupt, leading to mass layoffs and
a contraction in economic activity.
In order to stabilize the situation, the Mexican
government requested a bailout from the International
Monetary Fund (IMF) and the US government. The US
Treasury, under the leadership of Treasury Secretary
Robert Rubin, played a crucial role in coordinating
international support for Mexico. The US, along with the
IMF and other international organizations, provided
billions of dollars in loans to help Mexico stabilize its
economy. The Mexican peso crisis of 1994 served as a
wake-up call for many emerging markets, highlighting the
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THE MAJOR
DURING CRISIS
PLAYERS/ACTORS
United States: Mexico and the United States
have a special relationship because it is their
large, influential neighbor and also their greatest
trading partner.The U.S. government, along with
the IMF, helped Mexico when the crisis hit,
giving Mexico a $50 billion bailout package in
January 1995.
US President Bill Clinton was the president of
the United States when the Mexican peso crisis
occurred. He enacted the Mexican Debt
Disclosure Act of 1995 on April 10, 1995, which
provided billions of dollars of financial assistance
for swap facilities and securities guarantees using
American taxpayer dollars and additional
assistance provided by the IMF.
International Monetary Fund (IMF): it is an
organization aims to promote global monetary
cooperation, financial stability, international
trade, employment, sustainable economic
growth, and poverty reduction in the world. The
IMF's role in the crisis was that they provided a
$7.8 billion bailout package that would aid
Mexico in overcoming the crisis. They provided
assistance to Mexico to help them stabilize their
economy and restore investors' confidence.
The Treasury Department of the US- is the
department that manages federal finances by
collecting taxes, paying bills, managing currency,
government accounts, and public debt. During the
Mexican crisis, they were the ones who organized
the bailout package with a total of $50 billion in
bailout packages that comprised assistance from
other financial institutions in the financial
community.
Bank for International Settlements: Their
mission is to support or provide central banks
pursuit of monetary and financial stability
through international cooperation and to act as a
bank for central banks. During the crisis, they
were also one of those international financial
institutions that contributed $10 billion in
assistance to help Mexico.
Carlos Salinas de Gortari is the former
president and a Mexican economist who served
as the 60th president of Mexico from 1988–1994.
He was a major actor in the Mexican peso crisis
of 1994, as his administration's stubborn
adherence to a "strong" currency was one of the
main causes of the crisis.
Luis Donaldo Colosio was a presidential
candidate for the ruling party, Party of
Institutional Revolution (PRI), in Mexico in
1994.After his assassination in March of that year
had make an impact on the Mexican peso,
because of the Mexican government's sudden
devaluation of the peso against the US dollar in
December 1994.The investors further question
the political uncertainties and stability after the
assassination of presidential candidate Colosio.
III.
CAUSES OF MEXICAN PESO CRISIS
OF 1994
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Currency Mismatch: The Mexican
government faced a major currency
mismatch on their balance sheet. This
meant that even though the Mexican
government earned all their revenues in
peso, they had issued a major portion of
their debt which could be converted into
United States dollars. Thus, the Mexican
government owed money in US dollars
whereas its receipts were in pesos.
Ideally, a government can swap the pesos
for dollars on the market and pay off their
debt. However, the Mexican government
was maintaining a currency rate peg with
the United States. This meant that the
Mexican Central Bank would conduct
foreign market operations to keep the
value of their debt stable as compared to
the United States. Hence, they needed
dollar reserves to conduct these
operations and therefore did not have the
dollars to pay up on their loans.
Overvalued Peso: The Mexican
government had maintained a currency
peg with the United States. As a result,
the value of the peso would float in
tandem with the United States dollar.
Hence, if the value of the dollar went
down by 5%, the Mexican government
would conduct Forex operations to
ensure that the value of the peso also
went down by exactly 5%. A currency
peg can be dangerous if there is runaway
inflation in any country. This was the
case with Mexico where the government
was creating credit in huge quantities
driving inflation through the roof. If the
peso were a freely floating currency, it
would have undergone a serious
devaluation. However, since the peso
was pegged, its value remained stable to
the dollar. Hence it was extremely
overvalued which could have been
observed by the rising imports and the
dwindling exports.
Current Account Deficit: The Mexican
government was also facing a major
current account deficit because of the
overvalued peso. This deficit was largely
being financed by portfolio investments
in the Mexican stock market. In the short
run it appeared to be harmless. However,
portfolio investment can leave countries
within a matter of minutes. Therefore, it
is an unstable foundation to finance
something as important as current
account
deficits.
The
Mexican
government paid the price of this mistake
later as it witnessed a massive flight of
capital and had no avenues to finance its
deficits.
Maturity Mismatch: Along with
currency mismatch, the Mexican
government also had a major maturity
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mismatch on its debt. This meant that a
large amount of debt was to come due
almost immediately in 1994. This was
dangerous given the fact that there were
no reserves to pay off the debt. Hence, in
1994, the government owed $35 billion
in interest and principal payments
whereas it only had $6 billion in reserves
bringing shivers up the spine of Mexican
officials. Also, the Mexican government
was so far up in debt that it could hardly
finance any more deficits by borrowing
more money.
Political situation: The political
situation in Mexico also began to scare
investors. There were a lot of highprofile kidnappings during that time
which suggested to investors that the
law-and-order situation within the
country had broken down. Also, there
was the assassination of a Presidential
candidate which sparked further fears
amongst investors. Also, the Mexican
president started seeking counsel from
his foreign minister, eminent economists
and labor unions in a very public manner.
The media started speculating about the
gravity of the situation and investors in
the Forex market started exiting the peso
as fast as they could.
US Interest Rate Increase: The last nail
in the coffin for the Mexican government
was the fact that interest rates in the
United States rose at the same time.
Investors were getting a better return
without having to face the risks that the
Mexican economy brought along. Hence,
investors started dumping dollar
denominated Mexican debt and buying
United States treasuries. Mexican debt
had no buyers and given the rapid
devaluation of the peso; Mexico was
headed towards troubled times.
FINANCIAL
PROBLEMS
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CHALLENGES
AND
Decrease in foreign reserves and an
increase in debt: Leading up to the
crisis, Mexico experienced a substantial
decline in its foreign exchange reserves.
Foreign exchange reserves are assets
held by a country's central bank, often in
the form of foreign currencies and shortterm securities. These reserves are
crucial for maintaining stability in the
foreign exchange market and ensuring
that the country can meet its international
financial obligations. To defend its fixed
exchange rate and prevent the peso from
depreciating
further,
Mexico's
government
and
central
bank
implemented a series of measures,
including significant borrowing. They
borrowed both domestically and
internationally to obtain the necessary
funds to support the peso and replenish
foreign exchange reserves. However, this
increase in debt raised concerns about
Mexico's ability to service its
obligations. The government also issued
short-term debt instruments called
Tesobonos, which were denominated in
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U.S. dollars and carried high interest
rates. This exacerbated Mexico's debt
burden as the peso depreciated, making it
more costly to repay these dollardenominated debts in pesos.
Increased interest rates: A pivotal
measure taken by the Mexican
government to combat the severe
economic turmoil was the significant
increase in interest rates. This move was
undertaken in an effort to stabilize the
rapidly depreciating peso and restore
investor confidence. By raising interest
rates, authorities aimed to make it more
appealing for foreign investors to hold
onto pesos and invest in Mexican assets,
thereby halting the rapid capital flight.
However, the sharp rise in interest rates
led to higher borrowing costs for
businesses and consumers, which, in
turn, triggered a severe economic
contraction and strained the country's
financial sector.
Inflation. The Mexican economy
experienced inflation of around 52% and
mutual funds began liquidating Mexican
assets as well as emerging market assets
in general. The Mexican economy
experienced inflation of around 52% and
mutual funds began liquidating Mexican
assets as well as emerging market assets
in general. The Mexican peso crisis
initially led to inflationary pressures due
to the sharp devaluation of the peso and
the increase in interest rates. However,
the subsequent economic recession had
deflationary effects. The government's
policy responses and economic reforms
ultimately played a role in achieving
greater stability in inflation over the
longer term.
Mexico faced a default.: Mexico came
very close to defaulting on its
international debt obligations. The crisis
had severely strained Mexico's financial
system and foreign exchange reserves,
making it increasingly difficult for the
country to meet its debt repayment
obligations. The assistance provided by
the IMF and the United States, along with
Mexico's commitment to implementing
necessary economic reforms, helped
avert a full-scale default. However, it's
important to note that the crisis still had
severe economic consequences for
Mexico, including a deep recession and a
significant depreciation of the peso.
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IMPACT/EFFECT OF THE CRISIS
The 1994 Mexican currency crisis was a sudden
devaluation of the Mexican peso, which caused
other currencies in Latin America (such as in the
Southern Cone and Brazil) to decline as well. The
effect of the crisis was informally known as the
"Tequila Effect" or the "Tequila Shock." Tequila
Effect (also known as "Tequila Shock" or the
"Tequilla Crisis") is a slang term for financial or
economic fallout resulting from the Mexican
economy.
Mexico's economy experienced a severe
recession as a result of the peso's devaluation and
the flight to safer investments. The country's GDP
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declined by 6.2% over the course of 1995.
Mexico's financial sector bore the brunt of the
crisis as banks collapsed, revealing low-quality
assets and fraudulent lending practices.
Thousands of mortgages went into default as
Mexican citizens struggled to keep pace with
rising interest rates, resulting in widespread
repossession of houses.
In addition to declining GDP growth, Mexico
experienced severe inflation and extreme
poverty skyrocketed as real wages plummeted
and unemployment nearly doubled. Prices
increased by 35% in 1995. Nominal wages were
sustained, but real wages fell by 25-35% over the
same year.
Unemployment climbed to 7.4% in 1995 from
its pre-crisis level of 3.9% in 1994.In the formal
sector alone, over one million people lost their
jobs and average real wages decreased by 13.5%
throughout 1995. Overall household incomes
plummeted by 30% in the same year. Mexico's
extreme poverty grew to 37% in 1996 from 21%
in 1994, undoing the previous ten years of
successful poverty reduction initiatives. The
nation's poverty levels would not begin returning
to normal until 2001.
Mexico's growing poverty affected urban
areas more intensely than rural areas, in part
due to the urban population's sensitivity to labor
market volatility and macroeconomic conditions.
Urban citizens relied on a healthy labor market,
access to credit, and consumer goods. Consumer
price inflation and a tightening credit market
during the crisis proved challenging for urban
workers, while rural households shifted to
subsistence agriculture.
Mexico's gross income per capita decreased by
only 17% in agriculture, contrasted with 48% in
the financial sector and 35% in the construction
and commerce industries. Average household
consumption declined by 15% from 1995 to 1996
with a shift in composition toward essential
goods. Households saved less and spent less on
healthcare. Expatriates living abroad increased
remittances to Mexico, evidenced by average net
unilateral transfers doubling between 1994 and
1996.
Households' lower demand for primary
healthcare led to a 7% hike in mortality rates
among infants and children in 1996 (from 5% in
1995). Infant mortality increased until 1997,
most dramatically in regions where women had
to work as a result of economic need.
Critical scholars contend that the 1994 Mexican
peso crisis exposed the problems of Mexico’s
neoliberal turn to the Washington consensus
approach to development. Notably, the crisis
revealed the problems of a privatized banking
sector within a liberalized yet internationally
subordinate economy that is dependent on foreign
flows of finance capital.
Immediately after the Mexican peso was
devalued in the early days of the Presidency of
Ernesto Zedillo, South American countries also
suffered rapid currency depreciation and a
loss of reserves. Foreign capital not only fled
Mexico but the crisis led to financial contagion in
emerging markets as well.
WHAT ARE THE SOLUTIONS TO
RESOLVE THIS FINANCIAL CRISIS?
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TIN response to the crisis, the US. Congress
passed the Mexican Debt Disclosure Act of
1995, which was enacted by President Clinton on
April 10, 1995. The law provided billions in
financial assistance for swap facilities and
securities guarantees using American
taxpayer dollars, and additional assistance
provided by the IMF.
The Mexican government—as a condition of the
sizable bailout—was required to implement
certain fiscal and monetary policies controls.
They were also careful to maintain their existing
commitments to policies of the North American
Free Trade Agreement (NAFTA). Mexico
suffered through a severe recession and bouts of
hyperinflation in the years following the crisis, as
the country maintained excessive levels of
poverty for the remainder of the nineties.
The United States organized a $50 billion
bailout for Mexico in January 1995,
administered by the International Monetary
Fund (IMF) with the support of the G7 and Bank
for International Settlements. In the aftermath of
the crisis, several of Mexico's banks collapsed
amidst widespread mortgage defaults
Structural Reforms: Mexico implemented a
series of economic reforms, including fiscal
discipline and banking sector restructuring, to
address the root causes of the crisis. The
combination of financial assistance, structural
reforms, and increased economic integration
helped Mexico recover from the peso crisis, but
the event underscored the risks associated with
unsustainable economic policies and the
importance of international cooperation during
financial crises.
Lesson:
The Mexican peso crisis of 1994, often referred to as
the "Tequila Crisis," offers several important lessons:
1. Exchange Rate Policies Matter: The crisis
highlighted the importance of maintaining
realistic and sustainable exchange rate policies.
An overvalued currency can lead to trade
imbalances and vulnerability to speculative
attacks.
2. Debt Management: Accumulating a large
amount of short-term foreign debt can be risky.
It's crucial for countries to manage their debt
prudently and ensure they have the means to
repay it.
3. Political Stability: Political instability can have
severe
economic
consequences.
The
assassination of a presidential candidate and
political uncertainties added to the crisis. Stable
political environments are conducive to
economic stability.
4. International Cooperation: The crisis
demonstrated the significance of international
cooperation. The involvement of institutions like
the IMF and support from the U.S. government
helped stabilize the situation in Mexico and
prevent a more widespread financial meltdown.
5. Structural Reforms: Implementing necessary
structural reforms, such as fiscal discipline and
banking sector restructuring, is essential to
address the root causes of a crisis and lay the
foundation for long-term economic stability.
6. Economic Integration: The role of economic
integration, as seen with the implementation of
NAFTA, can be crucial in promoting economic
recovery and growth. Trade agreements can help
open up markets and create opportunities for
economic development.
In summary, the Mexican peso crisis underscores
the importance of sound economic policies,
responsible debt management, political stability,
international cooperation, and structural reforms in
preventing and recovering from financial crises. It
serves as a valuable case study for policymakers and
economists on how to address and learn from such
challenging situations.
WHAT IS THE CURRENT SITUATION IN
MEXICO?
It has a Gross Domestic Product (GDP) in Mexico is
expected to reach $1447 Billion by the end of 2023. The
15th largest economy in the world. Mexico has a Foreign
Direct Investment of $29.3 billion placing 19th in the
World Export Ranking and the leading exporter in the
Latin America.
Today’ s exchange rate in Mexico - 1 USD = 17.60 MXN
The Asian currency of 1997
The Asian Currency crisis also known as the Asian
Contagion. A financial crisis started in Thailand in July
1997 and spread across East Asia, wreaking havoc on
economies in the region and leading to spillover effects in
Latin America and Eastern Europe in 1998
MAJOR PLAYER OR ACTORS INVOLVED
Thailand- The Thai government's decision to float the
baht initiated the crisis due to unsustainable economic
policies.
Indonesia- Indonesia faced political turmoil, corruption,
and poor banking practices, which made it vulnerable to
the crisis.
South Korea- Corporate conglomerates, called chaebols,
had amassed high levels of debt and engaged in risky
financial practices, exacerbating South Korea's
vulnerabilities.
Malaysia- Malaysia's Prime Minister, Mahathir
Mohamad, imposed capital controls and pegged the
ringgit to the U.S. dollar to stabilize the currency.
International Monetary Fund (IMF)- The IMF provided
financial aid packages to several countries to stabilize
their economies. However, the conditions attached to the
assistance were criticized for exacerbating social and
economic hardships.
FINANCIAL CHALLENGES AND PROBLEMS
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Currency Devaluation
High External Debt
Weak Financial Systems
Lack of Transparency
Fixed Exchange Rates
IMF Interventions
Contagion Effect
Impact on Real Economy
Banking Crisis
Corporate Debt
IMPACT OR EFFECT OF CRISIS
Social Unrest - Widespread job losses and economic
hardship led to social and political unrest in several
countries.
Global Contagion - The crisis sent shockwaves through
global financial markets, affecting investor confidence
and leading to financial turbulence beyond Asia.
Economic Contraction- The crisis triggered severe
recessions across affected countries, causing GDP to
contract and unemployment to surge.
43.2% Indonesia
21% Thailand
19% Malaysia
18.5% South Korea
SOLUTIONS TO RESOLVE THE FINANCIAL
CRISIS
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International Monetary Fund (IMF) Assistance
Exchange Rate Stabilization
Fiscal and Monetary Policy Adjustments
Banking Sector Reforms
Corporate Sector Reforms
Structural Reforms
International Cooperation
Transparency and Information Sharing
The Argentine peso crisis
The Argentine Peso Crisis of 2002 had its roots in a
decade of economic instability:
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In 1989, hyperinflation hit Argentina due to
economic troubles.
The Convertibility Plan in 1991 pegged the Peso
to the US Dollar, leading to low inflation but a
deep recession by 1998.
By the late 2000s, Argentina faced limited access
to financial markets and rising bond spreads.
The IMF provided financial aid, but poor fiscal
management and global issues caused a loss of
market access in 2001.
Deposits were partially frozen in December 2001,
leading to default and a fixed exchange rate
collapse.
In January 2002, Argentina formally abandoned
the peg, causing the Peso to plummet and a severe
banking crisis, resulting in a 20% economic
contraction and social turmoil by the end of 2002.
MAJOR PLAYERS
The Argentine peso crisis of 2002 involved various key
players and actors, both domestically and internationally.
Some of the major players include:
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GOVERNMENT OF ARGENTINA
INTERNATIONAL MONETARY FUND (IMF)
FINANCIAL INSTITUTIONS
BUSINESS COMMUNITY
CIVIL SOCIETY
INTERNATIONAL INVESTORS
RATING AGENCIES
MEDIA AND PUBLIC OPINION
Financial challenges
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Fiscal Policy
Convertability Regime (Exchange Rate)
Decline of Capital Flows
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Structural Reform
External Shocks
Debt Dynamics
Banking System
In Statistics
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Real Gross domestic product
Argentina Currency
Inflation
Unemployment
Poverty Rate
Argentina was plunged into a devastating economic crisis
in December 2001/January 2002, when a partial deposit
freeze, a partial default on public debt, and an
abandonment of the fixed exchange rate led to a collapse
in output, high levels of unemployment, and political and
social turmoil.
IMPACT OR EFFECT
The Argentine Peso Crisis of 2002 had profound effects
and impacts on Argentina's economy and society. It
includes the following:
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Economic contraction
HYPERINFLATION
HIGH UNEMPLOYMENT
POVERTY UNREST
BANKING CRISIS
DEFAULT ON SOVEREIGN DEBT
POLITICAL INSTABILITY
CURRENCY REDOMINATION
DEBT RESTRUCTURING
LONG-TERM IMPACT
SOLUTIONS
In order to address the financial challenges of the
argentine peso crisis of 2002, these actions must be
considered:
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Reduce wasteful spending of government and
prioritize investment in education, health, and
infrastructure.
Enhance the business environment of the country
to attract foreign investors.
Reduce the dependency on foreign capital.
Improve the skills of the workforce through
investing in education and vocational trainings
Diversify the economy to reduce dependence on
single export.
The financial crisis of 2007
The subprime mortgage crisis was one of the main
contributors to the 2007- 2008 global financial crisis. Also
known as "The Great Recession, " it was the worst
economic downturn since The Great Depression of the
1930s. For many Americans, it took years to recover from
the financial crisis.
The subprime mortgage crisis occurred from 2007 to
2010 after the collapse of the U.S. housing market.
When the housing bubble burst, many borrowers were
unable to pay back their loans. The dramatic increase in
foreclosures caused many financial institutions to
collapse. The crisis spread around the world and was the
main trigger of the global financial crisis.
What are subprime mortgages?
The subprime mortgage crisis led to a drastic impact on
the U.S. housing market and overall economy. It lowered
construction, reduced wealth and consumer spending,
and decreased the ability for financial markets to lend or
raise money. The subprime crisis ultimately extended
globally and led to the 2007-2009 global financial crisis.
The cause of the crisis was years in the making and didn't
happen overnight
2000-2003, 2004-2006, 2007-2008.
MAJOR PLAYERS/ ACTORS
BANKS AND FINANCIAL INSTITUTIONS:
These institutions were at the heart of the crisis. Their
heavy investments in mortgage-backed securities and
risky lending practices led to massive losses and a
breakdown in trust within the financial system. The
failures of Lehman Brothers and Bear Stearns, in
particular, had a domino effect, causing panic and a loss
of confidence in the markets.
LEHMAN BROTHERS- The bankruptcy of Lehman
Brothers in September 2008 is often considered a trigger
for the crisis. Its failure sent shockwaves through the
financial system
BEAR STEARNS- It faced severe liquidity problems and
was acquired by JPMorgan Chase in March 2008
Mortgage Lenders and Originators:
Mortgage lenders and originators, like Countrywide
Financial, were responsible for issuing subprime
mortgages to borrowers who often couldn’t 't afford
them. This reckless lending contributed to the housing
bubble and the subsequent collapse of the mortgage
market.
COUNTRYWIDE FINANCIAL- This mortgage lender was
heavily involved in subprime lending, which contributed
to the crisis.
Rating Agencies:
Credit rating agencies assigned high ratings to complex
financial products like mortgage-backed securities and
CDOs, which misled investors into believing these assets
were safe. When these securities began to default, it
became evident that the ratings had been overly
optimistic, causing a loss of confidence in financial
markets.
STANDARD & POOR'S (S&P), MOODY'S, AND FITCH
RATINGS- These credit rating agencies assigned high
ratings to complex financial products like mortgagebacked securities and collateralized debt obligations
(CDOs), which later turned out to be far riskier than
initially believed.
GOVERNMENT ENTITIES:
The actions of government entities like the Federal
Reserve and the U.S. Department of the Treasury were
critical in stabilizing the financial system. The Federal
Reserve implemented emergency measures to inject
liquidity into the markets, while the Treasury introduced
the TARP program to recapitalize troubled banks
FEDERAL RESERVE- The U.S. central bank played a
crucial role in responding to the crisis, implementing
various measures to stabilize the financial system.
U.S. DEPARTMENT OF THE TREASURY- Under Secretary
Henry Paulson, it played a key role in crafting the
government's response, including the Troubled Asset
Relief Program (TARP).
CONGRESS- Legislation was passed to authorize the
TARP program and provide regulatory reforms through
the Dodd-Frank Wall Street Reform and Consumer
Protection Act.
Regulators:
Regulators like the SEC and OFHEO were responsible for
overseeing financial markets and institutions. Their
oversight and regulatory actions, or lack thereof, had a
significant impact on the crisis. In some cases,
regulatory failures allowed risky practices to go
unchecked.
SECURITIES AND EXCHANGE COMMISSION (SEC)- The
SEC regulates financial markets and plays a role in
investigating misconduct related to the crisis.
OFFICE OF FEDERAL HOUSING ENTERPRISE OVERSIGHT
(OFHEO)- Regulated Fannie Mae and Freddie Mac,
which were involved in the mortgage market and faced
significant problems during the crisis.
Investors and Speculators:
Investors and hedge funds played a role in inflating the
housing bubble by speculating on mortgage-backed
securities and CDOs. When the bubble burst, these
investors suffered massive losses, exacerbating the crisis
Many investors and hedge funds were involved in the
speculation of mortgage-backed securities and CDOs,
contributing to the bubble and subsequent crash.
Global Financial Institutions:
The interconnectedness of the global financial system
meant that problems in one part of the world could
quickly spread to others. The involvement of global
financial institutions amplified the reach and impact of
the crisis beyond the United States. The crisis had a
global impact, affecting banks and financial institutions
worldwide. Institutions in Europe and other regions also
faced significant losses and liquidity problems.
Economists and Analysts:
Economists and financial analysts who warned about
the risks of the housing bubble and excessive risk-taking
were important because their insights could have
prompted earlier intervention and risk mitigation
measures. Some economists and financial analysts had
warned about the housing bubble and the potential
risks to the financial system, but their warnings were
often ignored or downplayed.
Credit Default Swap (CDS) Market Participants:
The CDS market was instrumental in spreading the
contagion of the crisis. When financial institutions faced
massive losses on their CDS contracts, it created a spiral
of financial distress. The CDS market, which provided
insurance against defaults on various financial products,
played a significant role in the crisis. Some institutions
faced massive losses due to their exposure to CDS
contracts.
CHALLENGES AND PROBLEMS
MORTGAGE FORECLOSURE CRISIS- The housing market
was ground zero of the crisis. The market crashed as
homeowners with subprime and other troublesome
loans defaulted at record levels. Home prices dropped,
and millions lost their homes to foreclosure.
UNPARALLELED UNEMPLOYMENT- A sharp rise in
joblessness, which began in early 2008 and lasted to late
2009. Approximately 7.5 million jobs were lost between
2007 and 2009, representing a doubling of the
unemployment rate.
STRESSES IN THE FINANCIAL SYSTEM- Some lenders and
investors began to incur large losses because many of the
houses they repossessed after the borrowers missed
repayments could only be sold at prices below the loan
balance.
MASSIVE DECLINES IN GROSS DOMESTIC PRODUCT
(GDP)- This was caused by a number of factors, including
the collapse of the housing market, the decline in
consumer spending, and the drying up of credit.
THE STOCK MARKET DECLINED- The stock market
declined during the financial crisis of 2007 primarily due
to widespread panic and a loss of confidence among
investors.
THE CONSUMER SPENDING DROPPED- The housing
market collapsed during financial crisis, leading to job
losses and a decline in income.
IMPACT / EFFECT
1. The economic global recession brought forth by
the crisis was defined by a sharp decline in
economic activity, dropping output and rising
unemployment.
2. Several sizable financial institutions failed as a
result of the banking crisis, which necessitated
government intervention in the form of bailouts
and recapitalizations
3. HOUSING PRICE DECLINE- The U.S. housing price
slump that caused a large drop in household
wealth and a wave of widespread foreclosures
served as the crisis's catalyst.
4. RISE IN PUBLIC DEBT- Public debt increased as a
result of numerous government interventions to
maintain their financial and economic systems.
5. Political consequences: The crisis led to a decline
in confidence in the government and financial
institutions and fueled the emergence of
populist and anti-globalization views.
6. Financial sector reforms: The crisis led to
significant changes in the financial industry, such
as more rules and oversight, which are intended
to lower the likelihood of future financial crises.
SOLUTIONS TO THE PROBLEMS
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BUSINESS FINANCING DRIED UP- Banks were hesitant to
lend money to businesses during the financial crisis, even
to businesses that were considered to be creditworthy.
This made it difficult for businesses to expand and create
jobs.
REVENUE DECLINES BOTH STATE AND LOCAL
GOVERNMENT- The financial crisis led to a decline in tax
revenue for state and local governments. This forced
them to cut spending or raise taxes, which further hurt
the economy.
INCREASED GOVERNMENT SPENDING- Governments
increased their spending to stimulate demand and
support employment throughout the economy;
guaranteed deposits and bank bonds to shore up
confidence in financial firms; and purchased ownership
stakes in some banks and other financial firms.
LOWER INTEREST RATE- Central banks lowered interest
rates rapidly to very low levels (often near zero); lent
large amounts of money to banks and other institutions
with good assets that could not borrow in financial
markets.
FAILURE OF FINANCIAL FIRMS, PANIC IN FINANCIAL
MARKETS- Investors began pulling their money out of
banks and investment funds around the world as they did
not know who might be next to fail and how exposed
each institution was to subprime and other distressed
loans.
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American Recovery and Reinvestment Act (ARRA),
also called the Stimulus, legislation, enacted by the
U.S. Congress and signed into law by Pres. Barack
Obama in 2009, that was designed to stimulate the
U.S. economy by saving jobs jeopardized by the Great
Recession of 2008–09 and creating new jobs.
Emergency Economic Stabilization Act of 2008
(EESA), legislation passed by the U.S. Congress and
signed into law by Pres. George W. Bush on Oct. 3,
2008. It was designed to prevent the collapse of the
U.S. financial system during the subprime mortgage
crisis, a severe contraction of liquidity in credit
markets worldwide brought about by widespread
losses in the subprime mortgage sector.
Between 2008 and 2014, the Federal Reserve slashed
interest rates to nearly 0 percent.
Began a series of quantitative easing measures which
added more than $4 trillion to the financial system
and thus encouraged banks to loan again—to each
other as well as to consumers.
In 2011 President Barack Obama approved a program
that would allow borrowers to refinance their loans
even though they were “underwater, ” which meant
that the value of their homes was less than the
amount that they had to repay of their remaining
mortgage
In 2010, Congress passed the Dodd-Frank Wall Street
Reform and Consumer Protection Act. Dodd-Frank
limited future speculative trading by banks. In
addition, it created the Consumer Financial Protection
Bureau to safeguard consumers against further
predatory lending practices.