2008 World Financial Crisis - Luis Montero - Paula Cerón - Fabián López

[THE 2008 WORLD FINANCIAL CRISIS]

Paula Cern

Fabin Lpez

Luis Montero

What features of the global economy, and especially of the US, exposed the world to the major crisis that started in 2008?

A

Federal Fund Rates below the neutral interest rate the fed maintain low rates at

real value of 1%, which creates huge increase on

borrowing and low or negative savings

Financial deregulations which leads to certain freedom and low

government control in banks and financial institutions whom of

course are the base of the model under these type of government

Since the dot com crisis the government took measures to increase

the investment and create certain tax exemption to capital gains

mostly but creating fiscal risk and huge government expenditures

and of course increasing the level of debt.

Exceed liquidity coming from China, fuel the housing market giving strong

incentives to buy property of course through mortgage, without any financial

analysis, because it was given in the base on the price of the land not the

property per se.

I

II

III

IV

What was the chain of events that finally triggered it? B

Dot.com

crisis

2000

US economy started to recover

Lenders were convinced that a housing turndown was remote

2001

Prices of

houses

increase

Housing market

takeoff

2003

Fed lowered funds rates 11 times from 6.5% to 1.75%

Flood of liquidity in the economy

Subprime borrowers get easy acces to mortgages

2004

Prices of

houses

increase

Houses were 70%

overvaluated

2006

The market reached its maximum peak

Americans inrease spending trustin in the high value of their homes

Adjustable rate mortgages increase rates

2006

Prices of

houses

increase 10% of all mortgages

were in foreclosure

Borrowers stop paying because of the increase of the interest rates

House market saturated

Credit crunch

2007

Financial institutions had huge losses because the houses that they received were devaluated

Banks become afraid to lend money to anybody , including other banks

2008

Prices of

houses

increase

Large banks

problems

Lehman Brothers was sent to bankrupcy

Bear Stearns and Merrill Lynch were sold

Goldman Sachs and Morgan Stanley became commercial banks

Houses prices

fall

CDOs and

MBSs

securities issued

This products attracted hungry high risk investors

Over optimistic analysis of the future houses prices

Fed lowered

interest rates

to 1.75%

Wrong undervaluation of the risk of the loans

Houses prices were rising steadiily

Less requirements for a mortgage

Why did this problem propagate into something so big? C The U.S. unemployment rate increased to 10.1% by October 2009, the highest rate since 1983 and roughly twice the pre-crisis rate. The reduction in their buying power affected all the world

63 percent of all Americans wealth declined in that period. 77 percent of the richest families had a decrease in total wealth, while only 50 percent of those on the bottom of the pyramid suffered a decrease.

U.S. consumption accounted for

more than a third of the growth in global consumption

between 2000 and 2007

the net debt of commercial banks

located in the United States to their

foreign offices increased by $575

billion

The failure of Lehman Brothers was a severe shock to US financial markets, because it undermined the prevailing assumption that no systemically-important financial institution would be allowed to fail, even if it was not a bank

Foreign banks bought collateralized US debt. Many of these subprime mortgage loans were rebounded into CDOs and sold onto financial institutions around the world. For example, many British and European banks had exposure to these mortgage loans. Therefore, when defaults rose, European banks lost a lot of money.

The banking system is internationally linked. When some banks started to lose money they became reluctant to lend to other.

What policies were used to fight it? D

The president of U.S. subsided

700,000 millions to the banks to

provide liquidity to the

economy. 1 New monetary policy in the USA in which the interest rates and loans were highly control. 2

Elimination of one size fits all

rate in the European union. 3 EU and U.S. reduced

economic help to developing

countries. 4

Why did events happening mostly in the US end up affecting the entire world, including your own country? E

Higher prices in import goods

that were use forindustrializa-

tion and technology

Lost of confidence

in the dollar

The decreased price

of the oil

Less exportation

to the USA

Due to the fact that Latin America economy is

aligned to China economy the effect of the crisis

was manageable. The main affected areas were:

How did the global crisis propagate so badly into Europe?? F

Price of euro went down

Fall of the European Stock Market

Freezing credit for the private sector, lost of short

term liquidity

Increased of unemployment and increased

of inflation

Increased in deficit

The most affected countries were PIIGS

(Portugal, Italy, Greece and Spain)

What will be the long-term scars from this crisis? G There will be a recessions the world

consumption would be slow (i.e. China)

therefore the future will be developed

by small consumption as well as small

grow.

Lack of confidence in the market as

well as in the banks, that would take

some time to heel and of course

unemployment rate would decrease

and the interest rates are going to be

higher to stimulate saving.

The pressure and legislation on the

banks and financial institution would be

more extensive the system its going to

be stabilized but might affect the

profitability as well.

According to Moody's: in the way the

crisis is passing the interest rate would

recover their value to positive values in

real terms; the excess liquidity would be

control by the central banks and they will

benefit on financial integration

U.S. Median price of houses sold

Source: U.S. Department of Commerce

Graph 1

Unemployment rate USA

Source: World Bank

Graph 2

U.S. real Interest rates

Source: U.S. Federal Reserve

Graph 3

U.S. properties with foreclosure activity

Source: U.S. Foreclosure Market Report

Graph 4

U.S. Subprime Lending 2004-2006

Source: U.S. Census Bureau, Harvard University State of the Nations Housing Report

Graph 5

GDP % of growth

Source: World Bank

Graph 6

GDP % of growth of U.S. vs. L.A, Ecuador, Colombia and Costa Rica

Source: World Bank

Graph 7

Target federal funds rates

Source: Federal Reserve Board

Graph 8

Central Government Debt %GDP

Source: World Bank

Graph 9

European Stock Market

Source: World Bank

Graph 10

Euro price (2007 2008)

Source: World Bank

Graph 11

2007 2008

UNEMPOYMENT RATE USA vs. European Union

Source: World Bank

Graph 12

BIBLIOGRAPHIC REFERENCES

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2010.

Reye, Gerardo. Moslares, Carlos. La Union Europea en crisis:2008 2009.

Problemas del Desarrollo. Junio 2010, Vol 41, num. 161.

Dooley, Michael.. Etl. Las dos crisis de economa internacional.CEMLA.

National Bureau of economic. Oct-Nov 2009.

Bumachar, Joao. Goldfajn, Ilan. America Latina durante la crisis: el papel

de los fundamentos.Revista Monetaria. enero- junio 2013