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T2-Lec 1 Global Capitalism -Fin crisis -DW
Onaran (2010) argues:
Neoliberalism is an initial attempt to deal with the 1970s stagflation crisis
• After leaving the policies based on the “Keynesian consensus” and turning away from the
capitalism’s “golden age” (higher spending on social welfare, strengthening the unions,
cooperation between labour and management) neoliberalist policies were introduced.
• Profits increased but a greater risk of crisis arose as a result : investment and wages
declined
• To control the crisis, US boosted the economy with quick financialization- this stimulated
debt-credit and other yields of wealth
Capitalism is facing a major realization crisis:
• An inability to sell the output produced, i.e., to realize, in the form of profits, the surplus
value extracted from workers’ labor.
Why did unemployment grew and labour’s purchasing power decline?
• Economic growth rates have been low and well below the mark leading to unemployment
• Labour’s purchasing power declined as a result of unemployment and lower wages –
decline in consumers for goods produced – capitalists as profit-makers do not spend as
much as workers who earn wages (“a dollar transferred from a worker to a capitalist
reduces total consumption spending”).
The result was
Capitalists played the financial markets for high-profits through financial speculation
This led to unmanageable debt leading to capitalist crisis: The Financial crisis of 2008
Immanuel Wallerstein (2011) argues:
• Capitalist system requires endless accumulation of capital
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Appropriation of surplus value
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Monopoly of global production with global linkages
Support of various states
AICs rules that shaped global neoliberalism (text below in green
for yourself to review)
What are the Neoliberal policies? DOPE LD
Liberalize trade
Deregulate finance/currency
Open up for foreign investment,
Privatize economy
Deregulate commercial activity
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Ensure property protection
WASHINGTON CONSENSUS (1989)
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LAPDog
Liberalization
Austerity
Privatization
De-regulation
Global Capitalism, Financial Crisis and its impact on the Developed & Developing
Countries
1. Origins of the Crisis: USA
2. Impact of the Crisis: Global
What caused the US/EU financial system to fail in 2007-9 that led to a shock to global
production and trade?
What has been the impact of this crisis on the DW?
Why has the impact on the Developing World been less than on the AICs?
Why has the recovery been quicker in the Developing countries?
What caused the crisis?
• Market failure?
• Policy failure?
Market failures
• Information: markets do not know how to price systemic risk (hidden by derivatives) and
investors “herd” (risk aversion)
• Principle-agent: incentives to traders to take risks; securitization of loans by banks removes
monitoring
• Moral hazard/market distortion: banks “too big to fail” and government underwriting
assumed
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Security
• An instrument representing ownership (stocks), a debt agreement (bonds) or the rights to
ownership (derivatives).
• A security is a negotiable instrument representing financial value. The company or other
entity issuing the security is called the issuer
• A country's regulatory structure determines what qualifies as a security.
For example, private investment pools may have some features of securities, but they may not be
registered or regulated as such if they meet various restrictions.
Derivatives http://www.youtube.com/watch?v=X3nS5kSce_M Derek Banas 8min
• A derivative is an agreement between two parties that is contingent on a future outcome.
• It is a financial contract with a value linked to the expected future price movements of the
asset it is linked to - such as a share, currency, commodity or even the weather.
• Derivatives allow risk related to the price of the underlying asset to be transferred from
one party to another. Options, futures and swaps, including credit default swaps, are types
of derivatives.
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A common misconception is to refer to derivatives as assets. This is erroneous, since a
derivative is incapable of having value of its own as its value is derived from another
asset.
https://www.youtube.com/watch?v=NPfwUTm1isU
understanding the fin crisis 11 min Mostafa Mourad 2009
CDO CDS, SUBPRIME, INTEREST RATE, EQUITY etc
SayItVisually--US Financial Crisis
http://www.youtube.com/watch?v=h4Ns4ltUvfw
Derek Banas fin instruments - deregulation
http://www.youtube.com/watch?v=S3AXHQcXYMk
http://www.youtube.com/watch?v=bYZdKNjTIzY sovereign bonds/debt 10116 min ( watch at home) 201
Equity http://www.youtube.com/watch?v=tcpW0mM4OD4 equity 7.5min (watch at home)
A stock or any other security representing an ownership interest.
In finance, equity is ownership in any asset after all debts associated with that asset are paid off,
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e.g., a car or house with no outstanding debt is the owner's equity because he or she can readily
sell the item for cash. Stocks are equity because they represent ownership in a company.
Interest Rate Swap financing involves two parties (MNCs) who agree to exchange loan
payments (cash flows), results in benefits for both parties.
Currency Swap - One party swaps the interest payments of debt (bonds) denominated in one
currency (USD) for the interest payment of debt (bonds) denominated in another currency
(BP), Currency swap is used for cost savings on debt, or for hedging long term currency risk.
CDS: The buyer of a Credit Default Swap receives credit protection, whereas the seller of the
swap guarantees the credit worthiness of the product. By doing this, the risk of default is
transferred from the holder of the fixed income security to the seller of the swap.
For example, the buyer of a credit swap will be entitled to the par value of the bond by the seller
of the swap, should the bond default in its coupon payments.
Subprime
Subprime is a classification of borrowers with a tarnished or limited credit history.
Lenders will use a credit scoring system to determine which loans a borrower may qualify for.
Subprime loans are usually classified as those where the borrower has a credit score below 640.
Subprime loans carry more credit risk, and as such, will carry higher interest rates as well.
Approximately 25% of mortgage originations are classified as subprime.
Subprime lending encompasses a variety of credit types, including mortgages, auto loans, and
credit cards.
Collateralized Debt Obligation (CDO)
• CDOs are a type of structured asset-backed security whose value and payments are
derived from a portfolio of fixed-income underlying assets.
• CDOs are split into different risk classes, or tranches, whereby "senior" tranches are
considered the safest securities. Interest and principal payments are made in order of
seniority, so that junior tranches offer higher coupon payments (and interest rates) or
lower prices to compensate for additional default risk.
Note:
• Each CDO is made up of hundreds of individual residential mortgages.
• CDOs that contained subprime mortgages or mortgages underwritten because of
predatory lending were at greatest risk of default.
• They are blamed for precipitating the global crisis and have been called WMD “weapons
of mass destruction.”
Credit Default Swap (CDS)
A CDS is an insurance contract in which the buyer of the CDS makes a series of payments to the
protection seller and, in exchange, receives a payoff if a security (typically a bond or loan or a
collection of loans such as a CDO) goes into default.
NOTE: CDOs are widely thought to have exacerbated the financial crisis, by allowing investors
who did not own a security to purchase insurance in case of its default. AIG almost collapsed
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because of these bets, as it was left on the hook for tens of billions of dollars in collateral payouts
to some of the biggest U.S. and European financial institutions. AIG paid Goldman Sachs $13
billion in taxpayer money as a result of the CDSs it sold to Goldman Sachs.
Policy failure
• US and EU government “populism” over-indebts lower-income groups
• US and EU fiscal low-interest policies fuelled asset bubble (including commodities)
• Global imbalances generated growing and unsustainable G3 debt
Origins of current financial crisis
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Since 1990s deregulation of financial markets: risk pricing replaces prudential
supervision. Rise of derivative “assets” with opaque markets and few players. Bank loans
replaced by bonds etc.
Huge US fiscal deficit, monetary expansion (“Greenspan put”), low savings led to a US
mortgage boom/bust (non traded sector) and a huge current account deficit (traded
sector).
Mortgage bubbles (e.g. 1992 in UK) are familiar with obvious political costs; join
recurrent bubbles in past decade (dotcoms, LTCM, Tequila etc);
But this is by far the most serious systemically because it threatens the global banking
system itself as creditor, and whole US electorate as debtor.
Sub-prime lending
By 2005, one in five mortgages were sub-prime, and they
were particularly popular among recent immigrants trying
to buy a home for the first time, and the poor.
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Repossessions of houses in America as many of these mortgages reset to higher rates.
By late 2007, one in ten homes in Cleveland had been repossessed
As many as two million families will be evicted from their homes as their cases make
their way through the courts.
Collapse of the government backed mortgage system in the USA (Fannie and Freddie)
followed by meltdown of major investment banks (Lehman, Bear, Merrill) exposed to
mortgage market
Mark-to-market asset pricing effects on balance sheets and cumulative liquidity retraction
due to rising risk aversion;
Affecting Insurance (AIG) ; and pensions funds
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Global mortgage boom and bust
The end of the stock market boom
Financial Times, 20 Sept 2008
• “…bank boards and bank executives have failed to understand complex mortgagebacked banking products, as have central bankers, regulators and credit rating agencies.”
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“…a reward system that has granted huge bonuses to those who peddled toxic mortgagerelated products….”
“Almost as absurd has been the degree of leverage racked up by investment banks.”
Despite massive trade shock from G3 economies
(US, Euro area & Japan) decline, developing
economies declined less and recovered better
Developing Countries pursued autonomous policies not dependent on those of IMF strictures:
• Reserve accumulation to insure themselves after learning form 1990s crises
• Countercyclical macro-policies (fiscal, monetary and exch-rate) to stabilize their output
• More extensive safety nets (universal rather than targeted) to sustain demand
World International Reserves (USD million)
http://www.nber.org/public_html/confer/2011/GFC11/Dominguez_Hashimoto_Ito.pdf
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However, income distribution has worsened and poverty risen in the DW
• Managed exchange rates maintain output/employment rather than wages/incomes in the formal
sector.
• The burden falls on the informal sector – lower wages and spending by the poor.
• Remittances from abroad declined.
• World Bank estimates poverty rising due to deceleration in growth
• Decline in job creation while labour force continues to grow
In AICs employment growth is negative (i.e. unemployment
rises), but not in Emerging economies
Increasing trend in G7 sovereign debt has accelerated
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What Does Sovereign Debt Mean?
http://www.investopedia.com/video/play/sovereign-debt-overview/ 3 min
A national government issues Bonds in a foreign currency, in order to finance the issuing
country's growth.
Sovereign debt is generally a riskier investment when it comes from a developing country, and a
safer investment when it comes from a developed country.
The stability of the issuing government is an important factor to consider, when assessing the
risk of investing in sovereign debt, and sovereign credit ratings help investors weigh this risk.
Ref: http://www.investopedia.com/terms/s/sovereign-debt.asp#ixzz1d0utu3rA
lending to banks in turn became Risky- Total bank losses
exceed $2 trillion: 25% of US & EU securitized mortgages
written off
Rapid (and massive) US & EU government response
•Monetary expansion
• Fiscal expansion
• Bank bailouts
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Interest rates in G3 cut to zero (negative in real terms)
Advanced economies’ debt/GDP ratio risen by 35% 2007-14
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Inflation: In the BRICs only India is alarming
Asia the leading example of large reserves actively managed
Income distribution and poverty
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Stabilization and income distribution:
• Output shocks reduce employment; real devaluations reduce real wages
• Decrease of modern sector wage bill cuts informal incomes through lack of demand for the
informal sector
• Poor urban households (casual labour and petty services) particularly hard hit
Developing country employment has suffered much
less than in developed
TheWorld Bank Global Monitoring Report 2010: The Millennium Development Goals (MDGs)
after the Crisis (April 2010)
• WB projects the poverty impact of the crisis
through the effect on growth; also for MDG targets
• “The crisis left an estimated 50 million more
people in extreme poverty in 2009, and some
64 million more will fall into that category by
the end of 2010 relative to a pre-crisis trend”
(p. 102)
• That is 2% of the world population
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Is there an equitable stabilization possible?
• the heterodox stabilization policies of EMs have not protected wages and jobs or contained
the impact on countries’ poverty
Consequences for longer-term inequality and poverty:
• Mainly depends on (a) growth/employment effects; and (b) fiscal redistribution
• Accelerated industrial shift for some countries (esp. Asia) creating employment and skills;
commodity export model for others (esp LAC and SSA), requiring fiscal redistribution
• But greater reliance on domestic investment and saving would possibly favour Small &
medium Enterprises and thus asset redistribution worldwide?