newliterature review crises.docx

Chapter 2: Literature Review

2.2) Time Line of Crises

2.3) Brief of Major Crises

2.3.1) 1980- Latin American Debt Crises

Since the early 1980s major crises have occurred with increasing frequency, both in industrial and developing countries. Because of the special role that banks play in the economy as issuers of monetary liabilities and providers of clearing services for non cash payments, these crises have provoked serious concern among policymakers and regulators everywhere. In Latin America, banking crises emerged

1980 Latin American debt crisis

1983 Israel Bank stock crisis

1987 Black Monday

1989-91 US Savings and Loan Crises

1990 Japanese Asset Price Bubble Collapsed

1990's Scandinavian Banking Crises,Swedish Banking Crises,Finnish Banking Crises

1992-93 Black Wednesday

1994-95 Economic Crises in Mexico

1997 Asian Financial Crises

1998 Russian Financial Crises

2000 Turkish Crises

2001 Early 2000 Recession

2001 Argentine Crises

2001 Bursting of dot-com bubble

2007 Financial Crises of 2007-08

2008 Icelandic financial Crises

2010 European sovereign Debt Crises

in the wake of the external debt crisis in 1982. Where policymakers did not respond to banking problems with stringent fiscal and monetary policies and bank regulators did not put disciplined bank restructuring programs in place, the effects of crisis were quite prolonged, in some cases lasting almost a decade. Moreover, even where policymakers managed the crisis by following appropriate policies, resolving banking crises took four or five years and required major adjustments in the real economy. (Weisbrod, 1996).

In the 1960s and 1970s many Latin American countries, notably Brazil, Argentina, and Mexico, borrowed huge sums of money from international creditors for industrialization; especially infrastructure programs. These countries had soaring economies at the time so the creditors were happy to continue to provide loans. Initially, developing countries typically garnered loans through public routes like the World Bank. After 1973, private banks had an influx of funds from oil-rich countries and believed that sovereign debt was a safe investment. (Ferraro, 1994).

Between 1975 and 1982, Latin American debt to commercial banks increased at a cumulative annual rate of 20.4 percent. This heightened borrowing led Latin America to quadruple its external debt from $75 billion in 1975 to more than $315 billion in 1983, or 50 percent of the region's gross domestic product (GDP). Debt service (interest payments and the repayment of principal) grew even faster, reaching $66 billion in 1982, up from $12 billion in 1975. (The Debt Crisis in LatinAmerica)

When the world economy went into recession in the 1970s and 80s, and oil prices skyrocketed, it created a breaking point for most countries in the region. Developing countries also found themselves in a desperate liquidity crunch. Petroleum exporting countries – flush with cash after the oil price increases of 1973-74 – invested their money with international banks, which 'recycled' a major portion of the capital as loans to Latin American governments. (Ferraro, 1994).

As interest rates increased in the United States of America and in Europe in 1979, debt payments also increased making it harder for borrowing countries to pay back their debts. (Schaeffer) (http://www.pearsonhighered.com/assets/hip/us/hip_us_pearsonhighered/samplechapter/0205742343.pdf)

Deterioration in the exchange rate with the US dollar meant that Latin American governments ended up owing tremendous quantities of their national currencies, as well as losing purchasing power. (Cristina & García, 1991)

While the dangerous accumulation of foreign debt occurred over a number of years, the debt crisis began when the international capital markets became aware that Latin America would not be able to pay back its loans. (Dullum) (http://www.wright.edu/~tdung/asiancrisis-hill.htm) (Pastor).

This occurred in August 1982 when Mexico's Finance Minister, Jesus Silva-Herzog declared that Mexico would no longer be able to service its debt. (Pastor)

In the wake of Mexico's default, most commercial banks reduced significantly or halted new lending to Latin America. As much of Latin America's loans were short-term, a crisis ensued when their refinancing was refused. Billions of dollars of loans that previously would have been refinanced were now due immediately

However, some unorthodox economists like Stephen Kanitz attribute the debt crisis not to the high level of indebtedness or to the disorganization of the continent's economy. (http://www.sfmyologie.org/logs/mortgage/mortgage-calculator-extra-payment.html)

They say that the cause of the crisis was leverage limits such as U.S. government banking regulations which forbid its banks from lending over ten times the amount of their capital, a regulation that, when the inflation eroded their lending limits, forced them to cut the access of underdeveloped countries to international savings.(Kanitz).

In response to the crisis most nations abandoned their import substitution industrialization (ISI) models of economy and adopted an export-oriented industrialization strategy, usually the neoliberal strategy encouraged by the IMF, though there are exceptions such as Chile and Costa Rica who adopted reformist strategies. (http://www.dailyfx.com/forex/fundamental/article/guest_commentary/2013/01/28/Guest_Commentary_Trade_Balance_Threatens_European_Miracle.html?view=m) (Bresser-Pereira, 2009)

A massive process of capital outflow, particularly to the United States, served to depreciate the exchange rates, thereby raising the real interest rate. Real GDP growth rate for the region was only 2.3 percent between 1980 and 1985, but in per capita terms Latin America experienced negative growth of almost 9 percent.

2.3.1.1) Reasons

1. Petrodollar Recycling by Commercial Banks to Developing Countries Gave Rise to the Debt Crisis.

Most observers believe the "petrodollar recycling" of the 1970s gave rise to the debt crisis. During that period, the price of oil rose dramatically. Oil-exporting countries in the Middle East deposited billions of dollars in profits they received from the price hike in U.S. and European banks. Commercial banks were eager to make profitable loans to governments and state-owned entities (as well as private companies) in developing countries, using the dollars flowing from the Middle Eastern countries. Developing countries, particularly in Latin America, were also eager to borrow relatively cheap money from the banks. (Carrasco)

2. Decreased Exports and High Interest Rates in the Early 1980s Caused Debtor Countries to Default on Their Foreign Loans.

The frenzied lending and borrowing came to a halt with the global recession in the early 1980s. The significant drop in debtor countries' exports, combined with a strong dollar, (i.e., the value of the dollar increased relative to the value of other currencies) and high global interest rates, depleted foreign exchange reserves that debtor countries relied upon for international financial transactions. (http://www.angelfire.com/nj/GregoryRuggiero/latinamericancrisis.html)

Debtor countries consequently began to feel the strain of having to make timely payments on their foreign debt, which became much more expensive to pay off because the loans carried floating interest rates that increased along with global rates. These problems were compounded by massive capital flight - outward transfers of money by private individuals and entities in developing countries. In August 1982, Mexico stunned the financial world by declaring that it could no longer continue to pay its foreign debt. Not long after Mexico's declaration came similar announcements from other Latin American debtor countries, such as Brazil, Venezuela, Argentina, and Chile. The prospect of massive defaults posed grave problems for creditor countries, such as the United States. Government regulators discovered that commercial bank creditors, particularly the big U.S. ("money center") banks, had dangerously low levels of capital that could be used to absorb losses resulting from massive loan defaults. Policymakers were also worried that there was no central authority or forum that could oversee an orderly resolution of the crisis, such as a global bankruptcy system. (Carrasco) (http://www.angelfire.com/nj/GregoryRuggiero/latinamericancrisis.html)

3. Case-by-Case Debt Restructuring Negotiations Saved the International Financial System from Collapse.

Yet the principal players in the crisis - governments, banks, the IMF and the World Bank - averted a collapse of the international financial system by resorting to case-by-case debt restructuring negotiations, popularly known as the "muddling through" approach. The approach entailed engaging in a series of work-outs with hundreds of commercial bank creditors throughout the world via Bank Advisory Committees or Steering Committees, which were composed of banks with the greatest exposures to debtor countries. (Work-outs for government-to-government lending took place under the auspices of the Paris Club, a forum open only to sovereign states.) Under this approach, commercial banks agreed to (i) provide new loans to debtor countries, and (ii) stretch out external debt payments. In return, debtor countries agreed to abide by IMF and World Bank stabilization and structural adjustment programs intended to correct domestic economic problems that gave rise to the crisis. IMF stabilization programs typically included drastic reductions in government pending in order to reduce fiscal deficits, a tight monetary policy to curb inflation, and steep currency devaluations in order to increase exports. World Bank structural adjustment programs focused on longer-term and deeper "structural" reforms in debtor countries. (Carrasco) (http://www.angelfire.com/nj/GregoryRuggiero/latinamericancrisis.html)

4. "Debt Fatigue" Appeared in the Mid-1980s

After a few years of repeated restructuring deals, "debt fatigue" began to appear. New loans to debtor countries plummeted as commercial bank creditors contemplated the possibility that debtor countries were facing insolvency rather than a temporary drop in their ability to pay back the foreign debt. In October 1985, U.S. Treasury Secretary James Baker proposed a strategy, dubbed the Baker Plan, that attempted to alleviate the debt fatigue. The plan was designed to renew growth in fifteen highly indebted countries through $29 billion in new lending by commercial banks and multilateral institutions in return for structural economic reforms such as privatization of state-owned entities and deregulation of the economy. The strategy failed, however, because the projected financing did not materialize and, to the extent it did, the new lending merely added to debtor countries' already crushing debt burden.During this period, Latin American debtor countries were making massive net outward transfers of resources In light of what appeared to be an intractable problem, government officials, academics, and private entities began to propose plans that would provide debtor countries with debt reliefrather than debt restructuring. In the meantime, various debtor countries suspended debt payments and fell out of compliance with, or otherwise refused to adopt, IMF adjustment programs. This eventually prompted the big creditor banks to admit publicly (by adding to "loan loss reserves") that many of the loans to debtor countries would not be repaid. (Carrasco)

5. The Brady Initiative in 1989 Focused on Debt Reduction Strategies.

The Brady Initiative, announced in March 1989 by U.S.Treasury Secretary Nicholas F. Brady, marked a change in U.S. policy towards the debt crisis. Given the persistently high levels of foreign debt, the Initiative shifted the focus of the strategy from increased lending to voluntary, market-based debt reduction (reduction of outstanding principal) and debt service reduction (reduction of interest payments) in exchange for continued economic reform by debtor countries.(Carrasco)

Debtor countries obtained significant (but not massive) debt relief under the Brady Initiative through: (i) direct cash buybacks; (ii) exchange of existing debt for "discount bonds" (bonds issued by the debtor country with a reduced (discounted) face value but carrying a market rate of interest); (iii) exchange of existing debt for "par bonds" (bonds that carry the same face value as the old loans but carry a below-market interest rate); and (iv) interest rate reduction bonds (bonds that initially carry a below-market interest rate that rises eventually to the market rate). Commercial bank creditors that did not wish to participate in a debt or debt service reduction option could choose to give debtor countries new loans or receive bonds created from interest payments owed by debtor countries. Debtor countries sweetened the deals by providing "enhancements," such as principal and interest collateral (U.S. Treasury bonds) (Carrasco)

6. Brady Deals Combined with Economic Reforms and Increased Flows of Capital to Debtor Countries Led Some Observers in the Early 1990s to Declare that the Debt Crisis was Over.

Commercial bank creditors agreed to Brady deals with a good handful of countries, including Argentina, Costa Rica, Mexico, Nigeria, the Philippines, Venezuela, Uruguay and Brazil. In the meantime, Latin American countries implemented substantial economic reforms. In 1991, the region registered capital inflows that exceeded outflows for the first time since the onset of the debt crisis. This led some observers to proclaim that the debt crisis was over for major Latin American debtor countries. (Carrasco)

2.3.2) Israel Bank stock crisis

The Bank stock crisis was a financial crisis that occurred in Israel in 1983, during which the stocks of the four largest banks in Israel collapsed, and were nationalized by the state.

2.3.2.1) Background

During the 1970s, Bank Hapoalim, and its dominant manager, Yaakov Levinson, began trying to control the bank's stock price in the Tel Aviv Stock Exchange. To this end they recommended to their customers to invest in the bank's stocks. These investments allowed the bank to increase its available capital for investments, loans, etc. To get customers to continue investing in the bank's stock, the bank began buying back its own stock, thus creating the appearance of constant demand for the stock, and constantly increasing its value. The bank also gave out generous loans to allow the customers to continue their investments, also profiting from the interest.

These manipulations, or adjustments of the stock prices, by artificially creating demand, seemed to the other banks like a good way of procuring capital from the public, and they slowly adopted the practice as well. Eventually all major banks manipulated their stock price this way, among them Bank Leumi, Discount Bank, Bank Igud, Bank HaMizrachi, and Bank Clali (General Bank, nowU-Bank). The only prominent bank not to join the adjustments frenzy was HaBank HaBinleumi (a.k.a. the First International Bank of Israel - FIBI).

The adjustments were performed through the use of other companies. For example, Bank Leumi used the "Holdings and Development of The Jewish Colonial Trust Company". The funding for these actions originated in loans from the bank's pension funds and similar sources. Sometimes the banks would practice mutual purchases - one bank would sell its stocks to a second bank, and buy the second bank's stocks for a similar sum.

Under the pressure of the Israeli Securities and Exchange Commission, the banks reported the adjustments in their reports, but these reports were partial, misleading, and sometimes even false. Toward their clients the bank's acted in manner later

described by the Beisky Commission as based in their own interests, ignoring the clients' interests.

The adjustment were made possible, in large part, due the banks' unique ownership structure. Bank Hapoalim was controlled by the Histadrut labor union's Workers Company (Hevrat HaOvdim) and Bank Leumi by the "Jewish Colonial Trust". The Hapoel HaMizrachi organisation had almost none of Bank HaMizrachi's stocks, but all of its control shares. The owners' representatives were usually members of the ruling political parties (especially Alignment, and the National Religious Party, or close to them). The banks' managers ran the banks for owners who understood little of banking, and did not involve themselves in these actions. The fourth major bank to join this practice, Discount Bank, was held by the Recanatti Family. Its head, Rafael Recanatti joined the adjustments practice reluctantly, unable to resist the temptation. They later continued the adjustments, unable to stop.

Also contributing to the possibility of the adjustment was the capital structure of the Israeli market. During the years following the establishment of the State of Israel, the governments used the banks as a channel for procuring capital, and instructed them on how to invest their funds. This level of control, coupled with the control of interest rates, allowed the government to effectively "print money", by getting the banks to buy government bonds. Additionally, the banks usually assumed that since their investments and loans in major players of the Israeli market, such as the Kibutzim, were according to the government's wishes, the government would guarantee these loans.

Due to these reasons, the banks believed they could act as they pleased, without fearing the consequences. The banks used the adjustments to get "easy money" by issuing more and more stocks, until, during the 1980s, the banks' stocks accounted for more than 90% of all issued stocks in the stock market. They used the capital thus gained to give out loans and invest, often without due inspection of the debtor's creditworthiness. Also, the banks grew exponentially, building hundreds of new branches and hiring thousands of new employees. The banks' managers paid themselves lavish salaries, and expended money based on the banks' nominal profits, completely unrelated to their real profits.

The large banks got addicted to the easy capital, but this method soon became a trap. Like the government, fearing recession, the banks avoided any move to limit their expenses. They feared for the pockets and jobs of the managers, but also the fact that the first bank to make such a move would appear inferior compared to the other banks.

All of the regulatory bodies were well aware of the adjustments regime, but aside from slight warnings, easily dismissed by the banks' managers, did nothing, failing even to warn the public. The Minister of the Treasury, Aridor, even remarked on television that had he had the funds to do so, he would invest in the stock market.

The adjustments were based in the promise of a constant rise in the banks' stock prices, irrelevant of the economic situation. The artificial prices thus achieved created an Economic bubble, where everyone involved continued investing growing sums of money for lesser returns. Every new issue of bank stocks further destabilized them, since more of the capital was invested in maintaining the adjustment regime, instead of profitable loans. Also, as the bank stock market share grew, the adjustment became weaker, as every cent (Agora, actually) invested by them became a smaller part of the total invested capital.

The real gain (i.e. over and above the Consumer price index) by investing in the banks' stocks diminished, from a 41% gain in 1980, to 34% in 1981, to 28% in 1982. Other investment options, especially purchasing US Dollars became more appealing, and the banks had to transfer more and more funds from their offshore tax havens to keep maintaining the illusion of safety of investing in their stocks.

2.3.2.2) Crisis

In the beginning of 1983, a crisis occurred in the free stock market (all the non-bank stocks), and large supplies in all market sectors forced the banks to invest very large sums of money maintaining their stocks' stability. During the months of January through March some regulators, among them the Minister of Treasury, Aridor, and the Governor of the Bank of Israel, Mendelbaum, approached the banks several times, trying to get them to gradually reduce their adjustments. Although some bank managers realized they could not continue this for long, they did not stop. Fearing a market collapse, Ministry of Treasury officials kept knowledge of this from the public.

Failing to stop the banks, Ministry of Treasury heads wished to execute a large devaluation of the Shekel, serving as an excuse to stop the adjustments. However, the August 8% devaluation was far too small for that end. Additionally, the supplies in the stock market grew steadily, and reached new heights in September. The public unremittingly sold bank stocks, and purchased US Dollars.

The crisis erupted fully on October 2. That day, the first day of trade after the Sukkot holiday, the public sold more bank stocks than in the entire month of September. On October 4, the Minister of Treasury appeated on television saying "We will not let the public dictate our moves", to say the large supplies would not bring about a devaluation or change of policy.

During those years the public trust in the Minister of Treasury's promises was non existent. Most of the public assumed the Minister would lie at any time, and gave no attention to his statements. Most of all, Aridor's denial made it clear that at this point the public was dictating the government's moves.

Later Aridor met with the banks' managers, who demanded the government limit the public's purchases of US Dollars, and allow it only for plane tickets. They assumed that without an option to save the money themselves, due to the high inflation, the public would be forced to invest in the banks' stocks. Even if their thesis was correct, one can assume such a move would only fuel the panic, and exacerbate the current crisis.

On October 5, the stock exchange again opened with large numbers of sell offers, and on October 6, 1983, nicknamed "Black Thursday", was an onslaught of sales. It was clear a collapse was a matter of days at most, since the banks declared that day they would be unable to absorb additional supplies without government assistance.

That night, in a meeting in Aridor's home, it was decided that the government would purchase the banks' stocks from the public, to prevent the loss of their investments. On Sunday, October 9, the stock exchange remained closed, and stayed closed till October 24. In the meantime a devaluation of 23% was executed. The stocks sold by the public were bought by the Bank of Israel at an average loss of 17%. 35% of the stocks' value was lost.

2.3.2.3) Results

The immediate consequences of the crisis were the loss of a third of the public's investments in them, the acquisition of the banks by the government, at a total cost of 6.9 billion US Dollars (for reference, Israel's entire Gross Domestic Product in 1983 was about US$27 billion), and the nationalization of the major banks (Leumi, Hapoalim, HaMizrachi, Discount, and Clali).

Beisky Commission

Following the scandal, in 1984, the State Comptroller issued a report on the crisis, causing the State Review Committee of the Knesset, on January 7, 1985, to decide on establishing a national commission of inquiry. Heading the commission was Judge Moshe Biesky. The commission presented its findings on April 16, 1986.

The Beisky Commission came to the conclusion that the October 1983 crisis was a direct result of the stock adjustment. The commission pointed to four criminal offenses allegedly performed during the adjustment: financing and giving loans for the purchase of bank stock by the banks themselves; fraud and deceit of the client to get them to purchase stocks; conditioning one service on another; and perjury before the commission.

Following the commission's conclusions, and after a long struggle, the banks' managers were dismissed, but no criminal charges were brought against them, as there was no "public interest" in that, according to the State's Attorney. In 1990 the Supreme Court decided to bring to trial the banks' managers, and the accountants who lied to the commission.

The commission's report states the regulatory bodies acted negligently and irresponsibly, but there were no recommendations for actions against them.

On the administrative side, the commission concluded that investment recommendation should be separated from ownership, that is, the banks should be separated from the Pension Funds and Trust Funds. These recommendations were not executed, due to the banks' pressure, and the government's conflict of interest, as the banks' owner at the time.

The government later sold some of the banks to private investors, selling Bank Hapoalim in 1996, HaMizrachi in 1998. The government also sold a major part of its stock in Discount bank in 2006, and of Leumi in 2005.

In the early years of the 21st century, some of the commission's recommendations were finally put into place. After all four banks were sold by the mid-2000s, the recommendations of the subsequent Bach'ar commission, which reached the same conclusions regarding separating the banks' depository and investment banking/fund management operations as the Beisky commission's were finally carried out as well. It may be argued that the timing of the crisis may have also had some additional positive effect as the implementation of the subsequent tough banking regulations and reforms, albeit somewhat belatedly, were put in place just in time to help Israeli banks avert many of the problems experienced by banks in many other Western countries during the late-2000s financial crisis – by limiting Israeli banks' exposure to risky activities. This helped ensure a stable domestic banking sector which contributed significantly to the relative resilience of the Israeli economy in face of the late-2000s recession.

(Blass, A. and Grossman, R. (2001), ASSESSING DAMAGES: THE 1983 ISRAELI BANK SHARES CRISIS. ContemporaryEconomic Policy, 19: 49–58.)

Black Monday

In finance, Black Monday refers to Monday October 19, 1987, when stock markets around the world crashed, shedding a huge value in a very short time. The crash began in Hong Kong and spread west to Europe, hitting the United States after other markets had already declined by a significant margin. The Dow Jones Industrial Average (DJIA) dropped by 508 points to 1738.74 (22.61%). (Browning,E.S. (2007-10-15). "Exorcising Ghosts of Octobers Past". The Wall Street Journal(Dow Jones & Company). pp. C1–C2. Retrieved 2007-10-15)

2.3.3.1) Market effects

By the end of October, stock markets in Hong Kong had fallen 45.5%, Australia 41.8%, Spain 31%, the United Kingdom 26.45%, the United States 22.68%, and Canada 22.5%. New Zealand's market was hit especially hard, falling

about 60% from its 1987 peak, and taking several years to recover. (Share PriceIndex, 1987-1998, Commercial Framework: Stock exchange, New Zealand OfficialYearbook 2000. Statistics New Zealand, Wellington. Accessed 2007-12-12)

 (The terms Black Monday and Black Tuesday are also applied to October 28 and 29, 1929, which occurred after Black Thursday on October 24, which started the Stock Market Crash of 1929. In Australia and New Zealand the 1987 crash is also referred to as Black Tuesday because of the timezone difference.) The Black Monday decline was the largest one-day percentage decline in the Dow Jones. (Saturday, December 12, 1914, is sometimes erroneously cited as the largest one-day percentage decline of the DJIA.

 In reality, the ostensible decline of 24.39% was created retroactively by a redefinition of the DJIA in 1916. (Setting the Record Straight on the Dow Drop". NewYork Times. 1987-10-26).

Following the stock market crash, a group of 33 eminent economists from various nations met in Washington, D.C. in December 1987, and collectively predicted that “the next few years could be the most troubled since the 1930s” (Group of 7, Meetthe Group of 33". The New York Times. 1987-12-26) However, the DJIA was positive for the 1987 calendar year. It opened on January 2, 1987 at 1,897 points and closed on December 31, 1987 at 1,939 points. The DJIA did not regain its August 25, 1987 closing high of 2,722 points until almost two years later.

2.3.3.2) Timeline

In 1986, the United States economy began shifting from a rapidly growing recovery to a slower growing expansion, which resulted in a "soft landing" as the economy slowed and inflation dropped. The stock market advanced significantly, with the Dow peaking in August 1987 at 2722 points, or 44% over the previous year's closing of 1895 points.On October 14, the DJIA dropped 95.46 points (a then record) to 2412.70, and fell another 58 points the next day, down over 12% from the August 25 all-time high. On Friday, October 16, when all the markets in London were unexpectedly closed due to the Great Storm of 1987, the DJIA closed down another 108.35 points to close at 2246.74 on record volume. American Treasury Secretary James Baker stated concerns about the falling prices. That weekend many investors worried over their stock investments.The crash began in Far Eastern markets the morning of October 19. Later that morning, two U.S. warships shelled an Iranian oil platform in the Persian Gulf in response to Iran's Silkworm missile attack on the U.S. flagged ship MV Sea Isle City. (Motley Fool's Black Monday 10thAnniversary 1987 Timeline". 1997-10-19. Retrieved 2007-10-15)

2.3.3.3) Causes

Potential causes for the decline include program trading, overvaluation, illiquidity, and market psychology.The most popular explanation for the 1987 crash was selling by program traders. U.S. Congressman Edward J. Markey, who had been warning

about the possibility of a crash, stated that "Program trading was the principal cause. In program trading, computers perform rapid stock executions based on external inputs, such as the price of related securities. Common strategies implemented by program trading involve an attempt to engage in arbitrage and portfolio insurance strategies. The trader Paul Tudor Jones predicted and profited from the crash, attributing it to portfolio insurance strategies which were "an accident waiting to happen" and that the "crash was something that was eminently forecastable". Once the market started going down, portfolio insurance futures sellers were "forced to sell on every down-tick" so the "selling would actually cascade instead of dry up".As computer technology became more available, the use of program trading grew dramatically within Wall Street firms.

After the crash, many blamed program trading strategies for blindly selling stocks as markets fell, exacerbating the decline. Some economists theorized the speculative boom leading up to October was caused by program trading, and that the crash was merely a return to normalcy. Either way, program trading ended up taking the majority of the blame in the public eye for the 1987 stock market crash.New York University's Richard Sylla divides the causes into macroeconomic and internal reasons. Macroeconomic causes included international disputes about foreign exchange and interestrates, and fears about inflation.

The internal reasons included innovations with index futures and portfolio insurance. I've seen accounts that maybe roughly half the trading on that day was a small number of institutions with portfolio insurance. Big guys were dumping their stock. Also, the futures market in Chicago was even lower than the stock market, and people tried to arbitrage that. The proper strategy was to buy futures in Chicago and sell in the New York cash market. It made it hard -- the portfolio insurance people were also trying to sell their stock at the same time

Economist Richard Roll believes the international nature of the stock market decline contradicts the argument that program trading was to blame. Program trading strategies were used primarily in the United States, Roll writes. Markets where program trading was not prevalent, such as Australia and Hong Kong, would not have declined as well, if program trading was the cause. These markets might have been reacting to excessive program trading in the United States, but Roll indicates otherwise. The crash began on October 19 in Hong Kong, spread west to Europe, and hit the United States only after Hong Kong and other markets had already declined by a significant margin.

Another common theory states that the crash was a result of a dispute in monetary policy between the G7 industrialized nations, in which the United States, wanting to prop up the dollar and restrict inflation, tightened policy faster than the Europeans. U.S. pressure on Germany to change its monetary policy was one of the factors that unnerved investors in the run-up to the crash. The crash, in this view, was caused

when the dollar-backed Hong Kong stock exchange collapsed, and this caused a crisis in confidence.

Some technical analysts claim that the cause was the collapse of the US and European bond markets, which caused interest-sensitive stock groups like savings & loans and money center banks to plunge as well. This is a well documented inter-market relationship: turns in bond markets affect interest-rate-sensitive stocks, which in turn lead the general stock market turns. (Annelena, Lobb (2007-10-15)."Looking Back at Black Monday:A Discussion With Richard Sylla". The Wall StreetJournal Online (Dow Jones & Company). Retrieved 2007-10-15.)

2.3.4) US Savings and Loan Crises

The savings and loan crisis of the 1980s and 1990s (commonly dubbed the S&L crisis) was the failure of about 747 out of the 3,234 savings and loan associations in the United States. A savings and loan or "thrift" is a financial institution that accepts savings deposits and makes mortgage, car and other personal loans to individual members—a cooperative venture known in theUnited Kingdom as a Building Society. "As of December 31, 1995, RTC estimated that the total cost for resolving the 747 failed institutions was $87.9 billion." The remainder of the bailout was anticipated to be paid for by charges on saving and loan accounts. (Financial Audit:Resolution Trust Corporation's 1995 and 1994 Financial Statements" (PDF). U.S.General Accounting Office. July 1996. pp. 8, 13)

William K. Black wrote that Paul Volcker as Chairman of the Federal Reserve helped create a criminogenic environment for the Savings and Loans in 1979 by doubling the interest rate (to reduce inflation): S&Ls made long-term loans at fixed interest using short-term money. When the interest rate increased, the S&Ls could not attract adequate capital and became insolvent. Rather than admit to insolvency, some CEOs of S&Ls became "reactive" control frauds by inventing creative accounting strategies that turned their businesses into Ponzi schemes that looked highly profitable, thereby attracting more investors and growing rapidly, while actually losing money. The push of the Reagan administration for deregulation made it harder to detect such fraud. This had two effects: it meant that the fraud continued longer and substantially increased the economic losses involved, and it attracted "opportunistic" control frauds who were looking for businesses they could subvert into Ponzi schemes. For example, Charles Keating paid $51 million from Michael Milken's junk bond operation for Lincoln Savings and Loan, which at the time had a negative net worth exceeding $100 million.

2.3.4.1) Background

The thrift industry has its origins in the British building society movement that emerged in the late 18th century. American thrifts (known then as "building and loans" or "B&Ls") shared many of the same basic goals: to help working-class men and women save for the future and purchase homes. Thrifts were not-for-profit cooperative organizations that were typically managed by the membership and local institutions that served well-defined groups of aspiring homeowners. While banks offered a wide array of products to individuals and businesses, thrifts often made only home mortgages primarily to working-class men and women. Thrift leaders believed they were part of a broader social reform effort and not a financial industry. According to thrift leaders, B&Ls not only helped people become better citizens by making it easier to buy a home, they also taught the habits of systematic savings and mutual cooperation which strengthened personal morals. ( "Savingsand Loan Industry, US". EH.Net Encyclopedia, edited by Robert Whaples. June 10,2003)

The first thrift was formed in 1831, and for 40 years there were few B&Ls, found in only a handful of Midwestern and Eastern states. This situation changed in the late 19th century as urban growth and the demand for housing related to the Second Industrial Revolution caused the number of thrifts to explode. The popularity of B&Ls led to the creation of a new type of thrift in the 1880s called the "national" B&L. The "nationals" were often for-profit businesses formed by bankers or industrialists that employed promoters to form local branches to sell shares to prospective members. The "nationals" promised to pay savings rates up to four times greater than any other financial institution.

The Depression of 1893 (the Panic of 1893) caused a decline in members, and so "nationals" experienced a sudden reversal of fortunes. Because a steady stream of new members was critical for a "national" to pay both the interest on savings and the hefty salaries for the organizers, the falloff in payments caused dozens of "nationals" to fail. By the end of the 19th century, nearly all the "nationals" were out of business (National Building and Loans Crisis). This led to the creation of the first state regulations governing B&Ls, to make thrift operations more uniform, and the formation of a national trade association to not only protect B&L interests, but also promote business growth. The trade association led efforts to create more uniform accounting, appraisal, and lending procedures. It also spearheaded the drive to have all thrifts refer to themselves as "savings and loans" not B&Ls, and to convince managers of the need to assume more professional roles as financiers. ( "Savingsand Loan Industry, US". EH.Net Encyclopedia, edited by Robert Whaples. June 10,2003)

In the 20th century, the two decades that followed the end of World War II were the most successful period in the history of the thrift industry. The return of millions of servicemen eager to take up their prewar lives led to a dramatic increase in new families, and this "baby boom" caused a surge in new mostly suburban home construction. By the 1940s S&Ls (the name change occurred in the late 1930s)

provided most of the financing for this expansion. The result was strong industry expansion that lasted through the early 1960s.

An important trend involved raising rates paid on savings to lure deposits, a practice that resulted in periodic rate wars between thrifts and even commercial banks. These wars became so severe that in 1966 the United States Congress took the highly unusual move of setting limits on savings rates for both commercial banks and S&Ls. From 1966 to 1979, the enactment of rate controls presented thrifts with a number of unprecedented challenges, chief of which was finding ways to continue to expand in an economy characterized by slow growth, high interest rates and inflation. These conditions, which came to be known as stagflation, wreaked havoc with thrift finances for a variety of reasons. Because regulators controlled the rates thrifts could pay on savings, when interest rates rose depositors often withdrew their funds and placed them in accounts that earned market rates, a process known as disintermediation. At the same time, rising rates and a slow growth economy made it harder for people to qualify for mortgages that in turn limited the ability to generate income ( "Savings and Loan Industry, US". EH.Net Encyclopedia, edited byRobert Whaples. June 10, 2003)

In response to these complex economic conditions, thrift managers came up with several innovations, such as alternative mortgage instruments and interest-bearing checking accounts, as a way to retain funds and generate lending business. Such actions allowed the industry to continue to record steady asset growth and profitability during the 1970s even though the actual number of thrifts was falling. Despite such growth, there were still clear signs that the industry was chafing under the constraints of regulation. This was especially true with the large S&Ls in the western U.S. that yearned for additional lending powers to ensure continued growth. Despite several efforts to modernize these laws in the 1970s, few substantive changes were enacted.

In 1979, the financial health of the thrift industry was again challenged by a return of high interest rates and inflation, sparked this time by a doubling of oil prices. Because the sudden nature of these changes threatened to cause hundreds of S&L failures, Congress finally acted on deregulating the thrift industry. It passed two laws, the Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn–St. Germain Depository Institutions Act of 1982. The deregulation not only allowed thrifts to offer a wider array of savings products (including adjustable rate mortgages, which fixed one important problem), but also significantly expanded their lending authority and reduced supervision, which invited fraud. [5] These changes were intended to allow S&Ls to "grow" out of their problems, and as such represented the first time that the government explicitly sought to increase S&L profits as opposed to promoting housing and homeownership. Other changes in thrift oversight included authorizing the use of more lenient accounting rules to report their financial condition, and the elimination of restrictions on the minimum numbers of S&L stockholders. Such policies, combined with an overall decline in

regulatory oversight (known as forbearance), would later be cited as factors in the collapse of the thrift industry.

2.3.4.2) Causes

Tax Reform Act of 1986

By enacting 26 U.S.C. § 469 (relating to limitations on deductions for passive activity losses and limitations on passive activity credits) to remove many tax shelters, especially for real estate investments, the Tax Reform Act of 1986 significantly decreased the value of many such investments which had been held more for their tax-advantaged status than for their inherent profitability. This contributed to the end of the real estate boom of the early-to-mid-1980s and facilitated the Savings and Loan crisis.[6] Prior to 1986, much real estate investment was done by passive investors. It was common for syndicates of investors to pool their resources in order to invest in property, commercial or residential. They would then hire management companies to run the operation. TRA 86 reduced the value of these investments by limiting the extent to which losses associated with them could be deducted from the investor's gross income. This, in turn, encouraged the holders of loss-generating properties to try to unload them, which contributed further to the problem of sinking real estate values.

Deregulation

The deregulation of S&Ls in 1980 gave them many of the capabilities of banks, without the same regulations as banks. Savings and loan associations could choose to be under either a state or a federal charter. Immediately after deregulation of the federally chartered thrifts, state-chartered thrifts rushed to become federally chartered, because of the advantages associated with a federal charter. In response, states such as California and Texas changed their regulations to be similar to federal regulations. ( Akerlof, G. A.; Romer, P. M. (1993). "Looting: TheEconomic Underworld of Bankruptcy for Profit". Brookings Papers on EconomicActivity (2): 1–73. JSTOR 2534564)

Imprudent real estate lending

In an effort to take advantage of the real estate boom (outstanding U.S. mortgage loans: 1976 $700 billion; 1980 $1.2 trillion) and high interest rates of the late 1970s and early 1980s, many S&Ls lent far more money than was prudent, and to ventures which many S&Ls were not qualified to assess, especially regarding commercial real estate. L. William Seidman, former chairman of both the Federal Deposit Insurance Corporation (FDIC) and the Resolution Trust Corporation, stated, "The banking problems of the '80s and '90s came primarily, but not exclusively,

from unsound real estate lending.” ( "Lessons of the Eighties: What Does theEvidence Show?" (PDF). FDIC. September 18, 1996)

Brokered deposits

Deposit brokers, somewhat like stockbrokers, are paid a commission by the customer to find the best certificate of deposit (CD) rates and place their customers' money in those CDs. Previously, banks and thrifts could only have five percent of their deposits be brokered deposits; the race to the bottom caused this limit to be lifted. A small one-branch thrift could then attract a large number of deposits simply by offering the highest rate. To make money off this expensive money, it had to lend at even higher rates, meaning that it had to make more, riskier investments. This system was made even more damaging when certain deposit brokers instituted a scam known as "linked financing." In "linked financing", a deposit broker would approach a thrift and say he would steer a large amount of deposits to that thrift if the thrift would lend certain people money. The people, however, were paid a fee to apply for the loans and told to give the loan proceeds to the deposit banker.

End of inflation

Another factor was the efforts of the Federal Reserve to wring inflation out of the economy, marked by Paul Volcker's speech of October 6, 1979, with a series of rises in short-term interest rates. This led to a scenario in which increases in the short-term cost of funding were higher than the return on portfolios of mortgage loans, a large proportion of which may have been fixed rate mortgages (a problem that is known as an asset-liability mismatch). Interest rates continued to rise, placing even more pressure on S&Ls as the 1980s dawned and led to increased focus on high interest-rate transactions. Zvi Bodie, professor of finance and economics at Boston University School of Management, writing in the St. Louis Federal Reserve Review wrote, "asset-liability mismatch was a principal cause of the Savings and Loan Crisis". ( Bodie, Zvi. "On Asset-Liability Matching and FederalDeposit and Pension Insurance." Federal Reserve Bank of St. Louis Review.July/August 2006, 88(4), pp. 323-29)

Major causes according to United States League of Savings Institutions

The following is a detailed summary of the major causes for losses that hurt the savings and loan business in the 1980s. (Strunk, Norman; Case, Fred (1988). WhereDeregulation went Wrong: a Look at the Causes behind Savings and Loan Failures inthe 1980s. Chicago: United States League of Savings Institutions. pp. 15–16. ISBN 0-929097-32-7 9780929097329 Check |isbn= value (he)

Lack of net worth for many institutions as they entered the 1980s, and a wholly inadequate net worth regulation.

Decline in the effectiveness of Regulation Q in preserving the spread between the cost of money and the rate of return on assets, basically stemming from inflation and the accompanying increase in market interest rates.

Absence of an ability to vary the return on assets with increases in the rate of interest required to be paid for deposits.

Increased competition on the deposit gathering and mortgage origination sides of the business, with a sudden burst of new technology making possible a whole new way of conducting financial institutions generally and the mortgage business specifically.

Savings and Loans gained a wide range of new investment powers with the passage of the Depository Institutions Deregulation and Monetary Control Act and the Garn–St. Germain Depository Institutions Act. A number of states also passed legislation that similarly increased investment options. These introduced new risks and speculative opportunities which were difficult to administer. In many instances management lacked the ability or experience to evaluate them, or to administer large volumes of nonresidential construction loans.

Elimination of regulations initially designed to prevent lending excesses and minimize failures. Regulatory relaxation permitted lending, directly and through participations, in distant loan markets on the promise of high returns. Lenders, however, were not familiar with these distant markets. It also permitted associations to participate extensively in speculative construction activities with builders and developers who had little or no financial stake in the projects.

Fraud and insider transaction abuses.

A new type and generation of opportunistic savings and loan executives and owners—some of whom operated in a fraudulent manner — whose takeover of many institutions was facilitated by a change in FSLIC rules reducing the minimum number of stockholders of an insured association from 400 to one.

Dereliction of duty on the part of the board of directors of some savings associations. This permitted management to make uncontrolled use of some new operating authority, while directors failed to control expenses and prohibit obvious conflict of interest situations.

A virtual end of inflation in the American economy, together with overbuilding in multifamily, condominium type residences and in commercial real estate in many cities. In addition, real estate values collapsed in the energy states — Texas, Louisiana, and Oklahoma — particularly due to falling oil prices — and weakness occurred in the mining and agricultural sectors of the economy.

Pressures felt by the management of many associations to restore net worth ratios. Anxious to improve earnings, they departed from their traditional lending practices

into credits and markets involving higher risks, but with which they had little experience.

The lack of appropriate, accurate, and effective evaluations of the savings and loan business by public accounting firms, security analysts, and the financial community.

Organizational structure and supervisory laws, adequate for policing and controlling the business in the protected environment of the 1960s and 1970s, resulted in fatal delays and indecision in the examination/supervision process in the 1980s.

Federal and state examination and supervisory staffs insufficient in number, experience, or ability to deal with the new world of savings and loan operations.

The inability or unwillingness of the Bank Board and its legal and supervisory staff to deal with problem institutions in a timely manner. Many institutions, which ultimately closed with big losses, were known problem cases for a year or more. Often, it appeared, political considerations delayed necessary supervisory action.

Major causes and lessons not learned

In 2005, Former bank regulator William K. Black listed a number of lessons that should have been learned from the S&L Crisis that have not been translated into effective governmental action:

Fraud matters, and control frauds pose unique risks.

It is important to understand fraud mechanisms. Economists grossly underestimate its prevalence and impact, and prosecutors have difficulties finding it, even without the political pressure from politicians who receive campaign contributions from the banking industry.

Control fraud can occur in waves created by poorly designed deregulation that creates a criminogenic environment.

Waves of control fraud cause immense damage.

Control frauds convert conventional restraints on abuse into aids to fraud.

Conflicts of interest matter.

Deposit insurance was not essential to S&L control frauds.

There are not enough trained investigators in the regulatory agencies to protect against control frauds.

Regulatory and presidential leadership is important.

Ethics and social forces are restraints on fraud and abuse.

Deregulation matters and assets matter.

The SEC should have a chief criminologist.

Control frauds defeat corporate governance protections and reforms.

Stock options increase looting by control frauds.

The "reinventing government" movement should deal effectively with control frauds

2.3.4.2) Failure

The United States Congress granted all thrifts in 1980, including savings and loan associations, the power to make consumer and commercial loans and to issue transaction accounts. Designed to help the thrift industry retain its deposit base and to improve its profitability, the Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980 allowed thrifts to make consumer loans up to 20 percent of their assets, issue credit cards, accept negotiable order of withdrawal accounts from individuals and nonprofit organizations, and invest up to 20 percent of their assets in commercial real estate loans.

The damage to S&L operations led Congress to act, passing the Economic Recovery Tax Act of 1981 (ERTA) in August 1981 and initiating the regulatory changes by the Federal Home Loan Bank Board allowing S&Ls to sell their mortgage loans and use the cash generated to seek better returns soon after enactment, the losses created by the sales were to be amortized over the life of the loan, and any losses could also be offset against taxes paid over the preceding 10 years. This all made S&Ls eager to sell their loans. The buyers—major Wall Street firms—were quick to take advantage of the S&Ls' lack of expertise, buying at 60%-90% of value and then transforming the loans by bundling them as, effectively, government-backed bonds (by virtue of Ginnie Mae, Freddie Mac, or Fannie Mae guarantees). S&Ls were one group buying these bonds, holding $150 billion by 1986, and being charged substantial fees for the transactions.

In 1982, the Garn-St Germain Depository Institutions Act was passed and increased the proportion of assets that thrifts could hold in consumer and commercial real estate loans and allowed thrifts to invest 5 percent of their assets in commercial loans until January 1, 1984, when this percentage increased to 10 percent. (Pub.L.97–34, Economic Recovery Tax Act of 1981, 95 Stat. 172, H.R. 4242, 13 August1981, Title II, 97th Congress)

A large number of S&L customers' defaults and bankruptcies ensued, and the S&Ls that had overextended themselves were forced into insolvency proceedings themselves.

The Federal Savings and Loan Insurance Corporation (FSLIC), a federal government agency that insured S&L accounts in the same way the Federal Deposit Insurance Corporation insures commercial bank accounts, then had to repay all the depositors whose money was lost. From 1986 to 1989, FSLIC closed or otherwise resolved 296 institutions with total assets of $125 billion. An even more traumatic period followed, with the creation of the Resolution Trust Corporation in 1989 and that agency’s resolution by mid-1995 of an additional 747 thrifts.

A Federal Reserve Bank panel stated the resulting taxpayer bailout ended up being even larger than it would have been because moral hazard and adverse selection incentives that compounded the system’s losses.

There also were state-chartered S&Ls that failed. Some state insurance funds failed, requiring state taxpayer bailouts.

Home State Savings Bank of Cincinnati

In March 1985, it came to public knowledge that the large Cincinnati, Ohio-based Home State Savings Bank was about to collapse. Ohio Gov. Dick Celeste declared a bank holiday in the state as Home State depositors lined up in a "run" on the bank's branches to withdraw their deposits. Celeste ordered the closure of all the state's S&Ls. Only those that were able to qualify for membership in the Federal Deposit Insurance Corporation were allowed to reopen.Claims by Ohio S&L depositors drained the state's deposit insurance funds. A similar event involving Old Court Savings and Loans took place in Maryland.

Midwest Federal Savings & Loan of Minneapolis, Minnesota

Midwest Federal Savings & Loan was a federally chartered savings and loan based in Minneapolis, Minnesota until its failure in 1990. The St. Paul Pioneer Press called the bank's failure the "largest financial disaster in Minnesota history.

The chairman, Hal Greenwood Jr., his daughter, Susan Greenwood Olson, and two former executives, Robert A. Mampel, and Charlotte E. Masica, were convicted of racketeering that led to the institution's collapse. The failure cost taxpayers $1.2 billion.

Presumably the Megadeth song "Foreclosure of a Dream" was written about this particular failure. Megadeth's then bassist Dave Ellefson contributed lyrics to the song after his family's farm in Minnesota was in jeopardy of being lost as a result of the S&L financial crisis.

Lincoln Savings and Loan

The Lincoln Savings led to the Keating five political scandal, in which five U.S. senators were implicated in an influence-peddling scheme. It was named for Charles

Keating, who headed Lincoln Savings and made $300,000 as political contributions to them in the 1980s. Three of those senators—Alan Cranston (D-CA), Don Riegle (D-MI), and Dennis DeConcini (D-AZ)—found their political careers cut short as a result. Two others—John Glenn (D-OH) and John McCain (R-AZ)—were rebuked by the Senate Ethics Committee for exercising "poor judgment" for intervening with the federal regulators on behalf of Keating.

Silverado Savings and Loan

Silverado Savings and Loan collapsed in 1988, costing taxpayers $1.3 billion. Neil Bush, son of then Vice President of the United States George H. W. Bush, was on the Board of Directors of Silverado at the time. Neil Bush was accused of giving himself a loan from Silverado, but he denied all wrongdoing.

The U.S. Office of Thrift Supervision investigated Silverado's failure and determined that Neil Bush had engaged in numerous "breaches of his fiduciary duties involving multiple conflicts of interest." Although Bush was not indicted on criminal charges, a civil action was brought against him and the other Silverado directors by the Federal Deposit Insurance Corporation; it was eventually settled out of court, with Bush paying $50,000 as part of the settlement, the Washington Post reported.

As a director of a failing thrift, Bush voted to approve $100 million in what were ultimately bad loans to two of his business partners. And in voting for the loans, he failed to inform fellow board members at Silverado Savings & Loan that the loan applicants were his business partners.

Neil Bush paid a $50,000 fine, paid for him by Republican supporters, and was banned from banking activities for his role in taking down Silverado, which cost taxpayers $1.3 billion. A Resolution Trust Corporation Suit against Bush and other officers of Silverado was settled in 1991 for $26.5 million.

2.3.4.3) Financial Institutions Reform, Recovery and Enforcement Act of 1989

As a result of the savings and loan crisis, Congress passed the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) which dramatically changed the savings and loan industry and its federal regulation. The highlights of the legislation, signed into law August 9, 1989, were:

The Federal Home Loan Bank Board (FHLBB) and the Federal Savings and Loan Insurance Corporation (FSLIC) were abolished.

The Office of Thrift Supervision (OTS), a bureau of the United States Treasury Department, was created to charter, regulate, examine, and supervise savings institutions.

The Federal Housing Finance Board (FHFB) was created as an independent agency to replace the FHLBB, i.e. to oversee the 12 Federal Home Loan Banks (also called district banks) that represent the largest collective source of home mortgage and community credit in the United States.

The Savings Association Insurance Fund (SAIF) replaced the FSLIC as an ongoing insurance fund for thrift institutions (like the FDIC, the FSLIC was a permanent corporation that insured savings and loan accounts up to $100,000). SAIF is administered by the Federal Deposit Insurance Corp.

The Resolution Trust Corporation (RTC) was established to dispose of failed thrift institutions taken over by regulators after January 1, 1989. The RTC will make insured deposits at those institutions available to their customers.

FIRREA gives both Freddie Mac and Fannie Mae additional responsibility to support mortgages for low- and moderate-income families.

2.3.4.4) Consequences

While not part of the savings and loan crisis, many other banks failed. Between 1980 and 1994 more than 1,600 banks insured by the Federal Deposit Insurance Corporation (FDIC) were closed or received FDIC financial assistance.

From 1986 to 1995, the number of federally insured savings and loans in the United States declined from 3,234 to 1,645. This was primarily, but not exclusively, due to unsound real estate lending.

The market share of S&Ls for single family mortgage loans went from 53% in 1975 to 30% in 1990. U.S. General Accounting Office estimated cost of the crisis to around USD $160.1 billion, about $124.6 billion of which was directly paid for by the U.S. government from 1986 to 1996. That figure does not include thrift insurance funds used before 1986 or after 1996. It also does not include state run thrift insurance funds or state bailouts.

The federal government ultimately appropriated $105 billion to resolve the crisis. After banks repaid loans through various procedures, there was a net loss to taxpayers of approximately $124 billion by the end of 1999.

The concomitant slowdown in the finance industry and the real estate market may have been a contributing cause of the 1990–1991 economic recession. Between 1986 and 1991, the number of new homes constructed dropped from 1.8 to 1 million, the lowest rate since World War II. 

Some commentators believe that a taxpayer-funded government bailout related to mortgages during the savings and loan crisis may have created a moral hazard and acted as encouragement to lenders to make similar higher risk loans during the 2007 subprime mortgage financial crisis.

2.3.5)Japanese Asset Price Bubble Collapsed

The Japanese asset price bubble was an economic bubble in Japan from 1986 to 1991, in which real estate and stock prices were greatly inflated.The bubble's subsequent collapse lasted for more than a decade with stock prices initially bottoming in 2003, although they would descend even further amidst the global crisis in 2008. The Japanese asset price bubble contributed to what some refer to as the Lost Decade. Some economists, such as Paul Krugman, have argued that Japan fell into a liquidity trap during these years.(http://fhayashi.fc2web.com/Prescott1/Postscript_2003/hayashi-prescott.pdf).

2.3.5.1) History

In the decades following the Second World War, Japan implemented stringent tariffs and policies to encourage people to save their income. With more money in banks, loans and credit became easier to obtain, and with Japan running large trade surpluses, the yen appreciated against foreign currencies. This allowed local companies to invest in capital resources much more easily than their competitors overseas, which reduced the price of Japanese-made goods and widened the trade surplus further. And, with the yen appreciating, financial assets became very lucrative. One of the major reasons for the sudden appreciation of the yen was the Plaza Accord. (Saxonhouse, Gary and Stern, Robert (Eds) (2004) Japan's LostDecade: Origins, Consequences and Prospects for Recovery (World Economy SpecialIssues), Wiley-Blackwell)

So much money readily available for investment, combined with financial deregulation, overconfidence and euphoria about the economic prospects, and monetary easing implemented by the Bank of Japan in late 1980s resulted in aggressive speculation, particularly in the Tokyo Stock Exchange and the real estate market. The Nikkei stock index hit its all-time high on December 29, 1989 when it reached an intra-day high of 38,957.44 before closing at 38,915.87. Additionally, banks granted increasingly risky loans.

Prices were highest in Tokyo's Ginza district in 1989, with choice properties fetching over 30 million yen[7] (approximately $215,000 US dollars) per square meter ($20,000 per square foot). Prices were only marginally less in other large business districts of Tokyo. By 2004, prime "A" property in Tokyo's financial districts had slumped to less than 1 percent of its peak, and Tokyo's residential homes were less than a tenth of their peak, but still managed to be listed as the most expensive in the world until being surpassed in the late 2000s by Moscow and other cities. However, since 2012, Tokyo is once again, the world's most expensive city, followed

by Osaka with Moscow as number 4. Tens of trillions of dollars worth were wiped out with the combined collapse of the Tokyo stock and real estate markets. Only in 2007 had property prices begun to rise; however, they began to fall in late 2008 due to the financial crisis. (Saxonhouse, Gary and Stern, Robert (Eds) (2004) Japan's LostDecade: Origins, Consequences and Prospects for Recovery (World Economy SpecialIssues), Wiley-Blackwell)

With the economy driven by its high rates of reinvestment, this crash hit particularly hard. Investments were increasingly directed out of the country, and manufacturing firms lost some degree of their technological edge and Japanese products became less competitive overseas. The Japanese Central Bank set interest rates at approximately zero. When that failed to stop deflation some economists, such as Paul Krugman, advocated inflation targeting.

The easily obtainable credit that had helped create and engorge the real estate bubble continued to be a problem for several years to come, and as late as 1997, banks were still making loans that had a low probability of being repaid. Loan Officers and Investment staff had a hard time finding anything to invest in that would return a profit. They would sometimes resort to depositing their block of investment cash, as ordinary deposits, in a competing bank, which would bring howls of complaint from that bank's Loan Officers and Investment staff. Correcting the credit problem became even more difficult as the government began to subsidize failing banks and businesses, creating many so-called "zombie businesses". Eventually a carry trade developed in which money was borrowed from Japan, invested for returns elsewhere and then the Japanese were paid back, with a nice profit for the trader. (Saxonhouse, Gary and Stern, Robert (Eds) (2004) Japan'sLost Decade: Origins, Consequences and Prospects for Recovery (World EconomySpecial Issues), Wiley-Blackwell)

The time after the bubble's collapse which occurred gradually rather than catastrophically, is known as the "lost decade in Japan. On March 10, 2009, the Nikkei 225 stock index fell to a 27-year low of 7054.98.

2.3.6) Swedish Banking Crises, Finnish Banking Crises

2.3.6.1) Finnish banking crisis of 1990s

The Finnish Banking Crisis of 1990s was a deep systemic crisis of the entire Finnish financial sector that took place mainly in the years 1991–1993, after several years of debt-based economic boom in the late 1980s. Its total taxpayer cost was roughly 8% of the Finnish GNP, making it the most severe of the contemporary Nordic banking crises. The crisis has been attributed to a combination of macro-economic turbulence, weak regulation, and bank-specific problems. Governmental intervention included bank takeovers, direct monetary assistance and temporary blanket guarantees to the banks.

2.3.6.1.1) Background

Until the 1980s, the Finnish financial market was tightly regulated: the Bank of Finland controlled interest rates, foreign exchange rates, and import and export of currency. Low interest rates caused a chronic excess demand of debt.

In the early 1980s the financial market was mostly deregulated, leading to a massive credit expansion largely based on foreign debt. Soaring stock and real estate prices attracted frentic speculative activity by banks, private companies and individual investors. For this, the period of late 1980s is colloquially known in Finland as kasinotalous ('casino economy').

The banks started to actively participate in profit-seeking, high-risk operations such as company takeovers and foreign investments, for which they had little experience.

The most active role was played by savings banks and their mutually-owned central institution Skopbank, which wanted to break free from the "old-fashioned" retail banking business. Some of Skopbank's operations were very large compared to the bank's equity, and would later cause great losses: in 1987 it acquired Tampella (a Finnish heavy industry manufacturer that went bankrupt in 1990), and in 1988 it granted 400 million FIM of credit to a Virgin Islands hotel project.

Skopbank's strategy was to use massive short-term credit, readily available from the money market, in order to finance their operations and long-term investments on the stock market and in corporate loans. This was often highly profitable during the boom, but also caused increasing losses when interest rates rose (Helibor exceeding 15% at times), the stock market turned down, and debtors started defaulting on their loans.

Ulf Sundqvist, who was chairman of the SDP until resignation in 1993, was convicted of his crimes that contributed to the downfall of STS Bank. Sundqvist became a personification of the crisis.

2.3.6.1.2) Culmination of the crisis

On several occasions during 1990, Skopbank had to resort to overnight debt from the Bank of Finland to cover its liquidity position, as it was unable to raise sufficient funds from the interbank market. Skopbank's liquidity position finally collapsed on September 19, 1991, when other banks would not buy its money market debt papers at all. The Bank of Finland took over the control of Skopbank and bought the majority of its shares.

2.3.6.1.3) Government intervention and aftermath

In 1992, to stabilize the financial sector and to prevent a credit crunch, the government gave a 7.1 billion FIM (€1.2 billion), initially zero-interest convertible

loan to Finnish banks. Most of the banks (with the notable exception of Skopbank) later paid back this loan.

A special state-funded Government Guarantee Fund (Valtion vakuusrahasto) was also set up to support the savings banks, many of which were first consolidated and then broken up; the healthy parts were sold to commercial banks. Ownership of defaulted or nonperforming assets was transferred to a bad bank, OHY Arsenal.

The total public expenditure in support of the banks has been estimated as roughly 50 billion FIM (€8.4 billion), the vast majority of which was spent on the savings banks.

Commercial banks raised capital from their stockholders to cover their losses. The two largest Finnish commercial banks, Suomen Yhdyspankki and Kansallispankki, merged in 1995 to become Merita (later Nordea).

2.3.6.2) Swedish Banking Crises

During 1991 and 1992, a housing bubble in Sweden deflated, resulting in a severe credit crunch and widespread bank insolvency. The causes were similar to those of the subprime mortgage crisis of 2007–2008. In response, the government took the following actions:

The government announced the state would guarantee all bank deposits and creditors of the nation’s 114 banks.

Sweden's government assumed bad bank debts, but banks had to write down losses and issue an ownership interest (common stock) to the government. Shareholders at the remaining large banks were diluted by private recapitalizations (meaning that they sold equity to new investors). Bondholders at all banks were protected.

Nordbanken and Götabanken were granted financial support and nationalized at a cost of 64 billion kronor. The firms' bad debts were transferred to the asset-management companies Securum and Retriva which sold off the assets, mainly real estate, that the banks held as collateral for these debts.

When distressed assets were later sold, the proceeds flowed to the state, and the government was able to recoup more money later by selling its shares in the nationalized banks in public offerings.

Sweden formed the Bank Support Authority to supervise institutions that needed recapitalization.

This bailout initially cost about 4% of Sweden's GDP, later lowered to between 0-2percent of GDP depending on various assumptions due to the value of stock later sold when the nationalized banks were privatized.

In September 2008, economists Brad DeLong and Paul Krugman have proposed the Swedish experiment as a model for what should be done to solve the economic

crisis currently affecting the United States.Swedish leaders who played a role in devising the Swedish solution and have spoken about the implications for other countries include Urban Bäckström and Bo Lundgren.

( Drees, Burkhard; Pazarbasioglu, Ceyla (1998). The Nordic Banking Crisis: Pitfalls in FinancialLiberalization. International Monetary Fund)

2.3.7) Black Wednesday

In politics and economics, Black Wednesday refers to 16 September 1992 when the British Conservative government was forced to withdraw the pound sterling from the European Exchange Rate Mechanism (ERM) after they were unable to keep it above its agreed lower limit. George Soros, the most high profile of the currency market investors, made over GBP£1 billion profit by short selling sterling.

In 1997 the UK Treasury estimated the cost of Black Wednesday at £3.4 billion, with the actual cost being £3.3 billion which was revealed in 2005 under the Freedom of Information Act (FoI).

The trading losses in August and September were estimated at £800 million, but the main loss to taxpayers arose because the devaluation could have made them a profit. The papers show that if the government had maintained $24 billion foreign currency reserves and the pound had fallen by the same amount, the UK would have made a £2.4 billion profit on sterling's devaluation.Newspapers also revealed that the Treasury spent £27 billion of reserves in propping up the pound

2.3.7.1) Prelude

When the ERM was set up in 1979, Britain declined to join. This was a controversial decision, as the Chancellor of the Exchequer, Geoffrey Howe, was staunchly pro-European. His successor Nigel Lawson, a believer in a fixed exchange rate, admired the low inflationary record of West Germany. He attributed it to the strength of the Deutsche Mark and the management of the Bundesbank.

Thus, although Britain had not joined the ERM, from early 1987 to March 1988 the Treasury followed a semi-official policy of 'shadowing' the Deutsche Mark. Matters came to a head in a clash between Lawson and Margaret Thatcher's economic adviser Alan Walters, when Walters claimed that the Exchange Rate Mechanism was "half baked". This led to Lawson resigning as chancellor to be replaced by his old protégé John Major, who, with Douglas Hurd, the then Foreign Secretary, convinced the Cabinet to sign Britain up to the ERM in October 1990, effectively guaranteeing that the British Government would follow an economic and monetary policy that would prevent the exchange rate between the pound and other member currencies from fluctuating by more than 6%.

The pound entered the mechanism at DM 2.95 to the pound. Hence, if the exchange rate ever neared the bottom of its permitted range, DM 2.778, the government would be obliged to intervene. With UK inflation at three times the rate of Germany's, interest rates at 15% and the "Lawson Boom" about to bust, the conditions for joining the ERM were not favourable at that time.

From the beginning of the 1990s, high German interest rates, set by the Bundesbank to counteract inflationary effects related to excess expenditure on German reunification, caused significant stress across the whole of the ERM. The UK and Italy had additional difficulties with their double deficits, while the UK was also hurt by the rapid depreciation of the US Dollar – a currency in which many British exports were priced – that summer. Issues of national prestige and the commitment to a doctrine that the fixing of exchange rates within the ERM was a pathway to a single European currency inhibited the adjustment of exchange rates. In the wake of the rejection of the Maastricht Treaty by the Danish electorate in a referendum in the spring of 1992, and announcement that there would be a referendum in France as well, those ERM currencies that were trading close to the bottom of their ERM bands came under pressure from foreign exchange traders.

2.3.7.2) The currency traders act

The UK's prime minister and cabinet members tried vehemently to prop up a sinking pound and withdrawal from the monetary system the country had joined two years prior was the last resort. Major raised interest rates to 10 percent and authorised the spending of billions of pounds worth of foreign currency reserves to buy up the sterling being frantically sold on the currency markets but the measures failed to prevent the pound falling lower than its minimum level in the ERM.

The Treasury took the decision to defend Sterling's position, believing that to devalue would be to promote inflation. On 16 September the British government announced a rise in the base interest rate from an already high 10 to 12 percent in order to tempt speculators to buy pounds. Despite this and a promise later the same day to raise base rates again to 15 percent, dealers kept selling pounds, convinced that the government would not stick with its promise. By 19:00 that evening, Norman Lamont, then Chancellor, announced Britain would leave the ERM and rates would remain at the new level of 12 percent (however, on the next day interest rate was back on 10%). It was later revealed that the decision to withdraw had been agreed at an emergency meeting during the day between Norman Lamont, Prime Minister John Major, Foreign Secretary Douglas Hurd, President of the Board of Trade Michael Heseltine and Home Secretary Kenneth Clarke (the latter three all being strong pro-Europeans as well as senior Cabinet Ministers), and that the interest rate hike to 15 percent had only been a temporary measure to prevent a rout in the pound that afternoon.

2.3.7.3) Aftermath

Other ERM countries such as Italy, whose currencies had breached their bands during the day, returned to the system with broadened bands or with adjusted central parities. Even in this relaxed form, ERM-I proved vulnerable, and ten months later the rules were relaxed further to the point of imposing very little constraint on the domestic monetary policies of member states.

The effect of the high German interest rates, and high British interest rates, had arguably put Britain into recession as large numbers of businesses failed and the housing market crashed. Some commentators, following Norman Tebbit, took to referring to ERM as an "Eternal Recession Mechanism" after the UK fell into recession during the early 1990s. Whilst many people in the UK recall 'Black Wednesday' as a national disaster, some conservatives claim that the forced ejection from the ERM was a "Golden Wednesday” or "White Wednesday", the day that paved the way for an economic revival, with the Conservatives handing Tony Blair's New Labour a much stronger economy in 1997 than had existed in 1992 as the new economic policy swiftly devised in the aftermath of Black Wednesday led to re-establishment of economic growth with falling unemployment and inflation (the latter having already begun falling before Black Wednesday).

The economic performance after 1992 did little to repair the reputation of the Conservatives. Instead, the government's image had been damaged to the extent that the electorate were more inclined to believe opposition arguments of the time – that the economic recovery ought to be credited to external factors, as opposed to good government policies. The Conservatives had recently won the 1992 general election, and the Gallup poll for September showed a 2.5% Conservative lead. By the October poll, following Black Wednesday, their share of the intended vote in the poll had plunged from 43% to 29%, while Labour jumped into a lead which they held almost continuously (except for several brief periods such as during the 2000 Fuel Protests) for the next 14 years, during which time they won three consecutive general elections under the leadership of Tony Blair (who became party leader in 1994 following the death of his predecessor John Smith).

2.3.8) Economic Crises in Mexico

The 1994 economic crisis in Mexico, widely known as the Mexican peso crisis or the Tequila crisis, was caused by the sudden devaluation of the Mexican peso in December 1994.The impact of the Mexican economic crisis on the Southern Cone and Brazil was labeled the "Tequila effect"

2.3.8.1) Precursors

The crisis is also known in Spanish as el error de diciembre—The December Mistake—a term coined by outgoing president Carlos Salinas de Gortari in reference to his successor Ernesto Zedillo's sudden reversal of the former administration's policy of

tight currency controls. While most analysts agree that devaluation was necessary for economic reasons, Salinas supporters argue that the process was mishandled at the political level.

The root causes of the crisis are usually attributed to Salinas de Gortari's policy decisions while in office, which ultimately strained the nation's finances. As in prior election cycles, a pre-election disposition to stimulate the economy, temporarily and unsustainably, led to post-election economic instability. There were concerns about the level and quality of credit extended by banks during the preceding low-interest rate period, as well as the standards for extending credit.

The country's risk premium was affected by an armed rebellion in Chiapas, causing investors to be wary of investing their money in an unstable region. The Mexican government's finances and cash availability were further hampered by two decades of increasing spending, a period of hyperinflation from 1985 to 1993, debt loads, and low oil prices. Its ability to absorb shocks was hampered by its commitments to finance past spending.

Economists Hufbauer and Schott (2005) from the Institute for International Economics have commented on the macroeconomic policy mistakes that precipitated the crisis:

1994 was the last year of the sexenio, or six-year administration of Carlos Salinas de Gortari who, following the Partido Revolucionario Institucional (PRI) tradition on an election year, launched a high spending splurge and a high deficit.

To finance the deficit (7% of GDP current account deficit), Salinas issued the Tesobonos, a type of debt instrument denominated in pesos but indexed to dollars.

Mexico experienced lax banking or corrupt practices; moreover, some members of the Salinas family collected enormous illicit payoffs.

The EZLN, an insurgent rebellion, officially declared war on the government on January 1; even though the armed conflict ended two weeks later, the grievances and petitions remained a cause of concern, especially amongst some investors.

Macroeconomics 5th Edition by N. Gregory Mankiw explains the country-risk issues precipitating the crisis:

The EZLN's violent uprising in Chiapas in 1994 along with the assassination of presidential candidate Luis Donaldo Colosio made the nation's political future look less certain to investors, who then started placing a larger risk premium on Mexican assets.

Mexico had a fixed exchange rate system that accepted pesos during the reaction of investors to a higher perceived country risk premium and paid out dollars. However, Mexico lacked sufficient foreign reserves to maintain the

fixed exchange rate and was running out of dollars at the end of 1994. The peso then had to be allowed to devalue despite the government's previous assurances to the contrary, thereby scaring investors away and further raising its risk profile.

When the government tried to roll over some of its debt that was coming due, investors were unwilling to buy the debt and default became one of few options.

A crisis of confidence damaged the banking system, which in turn fed a vicious cycle further affecting investor confidence.[2]

2.3.8.2)Crisis

All of the above concerns, along with increasing current account deficit fostered by consumer binding and government spending, caused alarm among those who bought the tesobonos. The investors sold the tesobonos rapidly, depleting the already low central bank reserves. Given the fact that it was an election year, whose outcome might have changed as a result of a pre-election day economic downturn, Banco de México decided to buy Mexican Treasury Securities to maintain the monetary base, thus keeping the interest rates from rising.

This caused an even bigger decline in the dollar reserves. However, nothing was done during the last five months of Salinas' administration. Some critics affirm this maintained Salinas' popularity, as he was seeking international support to become director general of the World Trade Organization. Zedillo took office on December 1, 1994.

A few days after a private meeting with major Mexican entrepreneurs, in which his administration asked them for their opinion of a planned devaluation; Zedillo announced his government would let the fixed rate band increase to 15 percent (up to four pesos per US dollar), by stopping the previous administration's measures to keep it at the previous fixed level. The government, being unable even to hold this line, decided to let it float.

The peso crashed under a floating regime from four pesos to the dollar to 7.2 to the dollar in the space of a week. The United States intervened rapidly, first by buying pesos in the open market, and then by granting assistance in the form of $50 billion in loan guarantees. The dollar stabilized at the rate of six pesos per dollar. By 1996, the economy was growing (peaked at 7% growth in 1999). In 1997, Mexico repaid, ahead of schedule, all US Treasury loans.

2.3.8.3) Financial assistance package

A week of intense currency crisis stabilized some time after US president Bill Clinton, in concert with international organizations, granted a loan to the Mexican government. (Alan Greenspan (September 17, 2007). The Age of Turbulence. ThePenguin Press. p. 159)

Loans and guarantees to Mexico totaled almost $50 billion, with the following contributions:

The United States arranged currency swaps and loan guarantees with a $20 billion total value.

The International Monetary Fund promised an 18 month Stand-by Credit Agreement of around US$17.7 billion.

The Bank for International Settlements offered a $10 billion line of credit. The Bank of Canada offered short term swaps of around US$1 billion.

The Mexican "bailout" attracted criticism in the US Congress and the press for the central role of the former Co-Chairman of Goldman Sachs, U.S. Treasury Secretary Robert Rubin. Rubin used a Treasury Department account under his personal control to distribute $20 billion to bail out Mexican bonds, of which Goldman was a key distributor.In late 1995, Patrick Buchanan wrote "[n]ewly installed President Ernesto Zedillo said he needed the cash to pay off bonds held by Citibank and Goldman Sachs, lest the New World Order come crashing down around the ears of its panicked acolytes."

According to Hannibal Travis, the "former manager of $5 billion in Mexican investments at Goldman Sachs became U.S. Secretary of the Treasury and lobbied for legislation that forced U.S. taxpayers to contribute in excess of $20 billion to bail out investors in Mexican securities, in a form of 'corporate socialism'"

The United States' assistance was provided via the treasury's Exchange Stabilization Fund. This was slightly controversial, as President Bill Clinton tried and failed to pass the Mexican Stabilization Act through Congress. However, use of the ESF allowed the provision of funds without the approval of the legislative branch. By the end of the crisis, the U.S. actually had made a $500 million profit on the loans

(Travis, Hannibal (2007). "Of Blogs, eBooks, and Broadband: Access to Digital Media as a FirstAmendment Right". Hofstra Law Review 35: 148)

2.3.9) Asian Financial Crises

The Asian financial crisis was a period of financial crisis that gripped much of Asia beginning in July 1997, and raised fears of a worldwide economic meltdown due to financial contagion.

The crisis started in Thailand with the financial collapse of the Thai baht after the Thai government was forced to float the baht (due to lack of foreign currency to support its fixed exchange rate), cutting its peg to the US$, after exhaustive efforts to support it in the face of a severe financial overextension that was in part real estate driven. At the time, Thailand had acquired a burden of foreign debt that

made the country effectively bankrupt even before the collapse of its currency. As the crisis spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and other asset prices, and a precipitous rise in private debt.

Indonesia, South Korea and Thailand were the countries most affected by the crisis. Hong Kong, Malaysia, Laos and the Philippines were also hurt by the slump. China, Taiwan, Singapore, Brunei and Vietnam were less affected, although all suffered from a loss of demand and confidence throughout the region.

Foreign debt-to-GDP ratios rose from 100% to 167% in the four large Association of Southeast Asian Nations (ASEAN) economies in 1993–96, then shot up beyond 180% during the worst of the crisis. In South Korea, the ratios rose from 13 to 21% and then as high as 40%, while the other northern newly industrialized countries fared much better. Only in Thailand and South Korea did debt service-to-exports ratios rise.

Although most of the governments of Asia had seemingly sound fiscal policies, the International Monetary Fund (IMF) stepped in to initiate a $40 billion program to stabilize the currencies of South Korea, Thailand, and Indonesia, economies particularly hard hit by the crisis. The efforts to stem a global economic crisis did little to stabilize the domestic situation in Indonesia, however. After 30 years in power, President Suharto was forced to step down on 21 May 1998 in the wake of widespread rioting that followed sharp price increases caused by a drastic devaluation of the rupiah. The effects of the crisis lingered through 1998. In 1998 the Philippines growth dropped to virtually zero. Only Singapore and Taiwan proved relatively insulated from the shock, but both suffered serious hits in passing, the former more so due to its size and geographical location between Malaysia and Indonesia. By 1999, however, analysts saw signs that the economies of Asia were beginning to recover. After the 1997 Asian Financial Crisis, economies in the region are working toward financial stability on financial supervision

2.3.9.1) Dynamics

Until 1999, Asia attracted almost half of the total capital inflow into developing countries. The economies of Southeast Asia in particular maintained high interest rates attractive to foreign investors looking for a high rate of return. As a result the region's economies received a large inflow of money and experienced a dramatic run-up in asset prices. At the same time, the regional economies of Thailand, Malaysia, Indonesia, Singapore, and South Korea experienced high growth rates, 8–12% GDP, in the late 1980s and early 1990s. This achievement was widely acclaimed by financial institutions including IMF and World Bank, and was known as part of the "Asian economic miracle".

In 1994, economist Paul Krugman published an article attacking the idea of an "Asian economic miracle". He argued that East Asia's economic growth had

historically been the result of increasing the level of investment in capital. However, total factor productivity had increased only marginally or not at all. Krugman argued that only growth in total factor productivity, and not capital investment, could lead to long-term prosperity. Krugman himself has admitted that he had not predicted the crisis nor foreseen its depth.

The causes of the debacle are many and disputed. Thailand's economy developed into a bubble fueled by "hot money". More and more was required as the size of the bubble grew. The same type of situation happened in Malaysia, and Indonesia, which had the added complication of what was called "crony capitalism" The short-term capital flow was expensive and often highly conditioned for quick profit. Development money went in a largely uncontrolled manner to certain people only, not particularly the best suited or most efficient, but those closest to the centers of power.

At the time of the mid-1990s, Thailand, Indonesia and South Korea had large private current account deficits and the maintenance of fixed exchange rates encouraged external borrowing and led to excessive exposure to foreign exchange risk in both the financial and corporate sectors.

In the mid-1990s, a series of external shocks began to change the economic environment – the devaluation of the Chinese renminbi and the Japanese yen, raising of US interest rates which led to a strong U.S. dollar, the sharp decline in semiconductor prices; adversely affected their growth. As the U.S. economy recovered from a recession in the early 1990s, the U.S. Federal Reserve Bank under Alan Greenspan began to raise U.S. interest rates to head off inflation. This made the U.S. a more attractive investment destination relative to Southeast Asia, which had been attracting hot money flows through high short-term interest rates, and raised the value of the U.S. dollar. For the Southeast Asian nations which had currencies pegged to the U.S. dollar, the higher U.S. dollar caused their own exports to become more expensive and less competitive in the global markets. At the same time, Southeast Asia's export growth slowed dramatically in the spring of 1996, deteriorating their current account position.

Some economists have advanced the growing exports of China as a contributing factor to ASEAN nations' export growth slowdown, though these economists maintain the main cause of the crises was excessive real estate speculation. China had begun to compete effectively with other Asian exporters particularly in the 1990s after the implementation of a number of export-oriented reforms. Other economists dispute China's impact, noting that both ASEAN and China experienced simultaneous rapid export growth in the early 1990s.

Many economists believe that the Asian crisis was created not by market psychology or technology, but by policies that distorted incentives within the lender–borrower relationship. The resulting large quantities of credit that became

available generated a highly leveraged economic climate, and pushed up asset prices to an unsustainable level. These asset prices eventually began to collapse, causing individuals and companies to default on debt obligations.

The resulting panic among lenders led to a large withdrawal of credit from the crisis countries, causing a credit crunch and further bankruptcies. In addition, as foreign investors attempted to withdraw their money, the exchange market was flooded with the currencies of the crisis countries, putting depreciative pressure on their exchange rates. To prevent currency values collapsing, these countries' governments raised domestic interest rates to exceedingly high levels (to help diminish flight of capital by making lending more attractive to investors) and to intervene in the exchange market, buying up any excess domestic currency at the fixed exchange rate with foreign reserves. Neither of these policy responses could be sustained for long.

Very high interest rates, which can be extremely damaging to an economy that is healthy, wreaked further havoc on economies in an already fragile state, while the central banks were hemorrhaging foreign reserves, of which they had finite amounts. When it became clear that the tide of capital fleeing these countries was not to be stopped, the authorities ceased defending their fixed exchange rates and allowed their currencies to float. The resulting depreciated value of those currencies meant that foreign currency-denominated liabilities grew substantially in domestic currency terms, causing more bankruptcies and further deepening the crisis.

Other economists, including Joseph Stiglitz and Jeffrey Sachs, have downplayed the role of the real economy in the crisis compared to the financial markets. The rapidity with which the crisis happened has prompted Sachs and others to compare it to a classic bank run prompted by a sudden risk shock. Sachs pointed to strict monetary and contractory fiscal policies implemented by the governments on the advice of the IMF in the wake of the crisis, while Frederic Mishkin points to the role of asymmetric information in the financial markets that led to a "herd mentality" among investors that magnified a small risk in the real economy. The crisis has thus attracted interest from behavioral economists interested in market psychology.

Another possible cause of the sudden risk shock may also be attributable to the handover of Hong Kong sovereignty on 1 July 1997. During the 1990s, hot money flew into the Southeast Asia region through financial hubs, especially Hong Kong. The investors were often ignorant of the actual fundamentals or risk profiles of the respective economies, and once the crisis gripped the region, coupled with the political uncertainty regarding the future of Hong Kong as an Asian financial centre led some investors to withdraw from Asia altogether. This shrink in investments only worsened the financial conditions in Asia (subsequently leading to the depreciation of the Thai baht on 2 July 1997).Several case studies on the topic – Application of network analysis of a financial system; explains the interconnectivity of financial markets, and the significance of the robustness of hubs or the main nodes.Any

negative externalities in the hubs creates a ripple effect through the financial system and the economy (and, the connected economies) as a whole

The foreign ministers of the 10 ASEAN countries believed that the well co-ordinated manipulation of their currencies was a deliberate attempt to destabilize the ASEAN economies. Former Malaysian Prime Minister Mahathir Mohamad accused George Soros of ruining Malaysia's economy with "massive currency speculation." (Soros claims to have been a buyer of the ringgit during its fall, having sold it short in 1997.)

At the 30th ASEAN Ministerial Meeting held in Subang Jaya, Malaysia, the foreign ministers issued a joint declaration on 25 July 1997 expressing serious concern and called for further intensification of ASEAN's cooperation to safeguard and promote ASEAN's interest in this regard Coincidentally, on that same day, the central bankers of most of the affected countries were at the EMEAP (Executive Meeting of East Asia Pacific) meeting in Shanghai, and they failed to make the 'New Arrangement to Borrow' operational. A year earlier, the finance ministers of these same countries had attended the 3rd APEC finance ministers meeting in Kyoto, Japan on 17 March 1996, and according to that joint declaration, they had been unable to double the amounts available under the 'General Agreement to Borrow' and the 'Emergency Finance Mechanism'.

As such, the crisis could be seen as the failure to adequately build capacity in time to prevent Currency Manipulation. This hypothesis enjoyed little support among economists, however, who argue that no single investor could have had enough impact on the market to successfully manipulate the currencies' values. In addition, the level of organization necessary to coordinate a massive exodus of investors from Southeast Asian currencies in order to manipulate their values rendered this possibility remote.

2.3.9.2) IMF role

Such was the scope and the severity of the collapses involved that outside intervention, considered by many as a new kind of colonialism, became urgently needed. Since the countries melting down were among not only the richest in their region, but in the world, and since hundreds of billions of dollars were at stake, any response to the crisis was likely to be cooperative and international, in this case through the International Monetary Fund (IMF). The IMF created a series of bailouts ("rescue packages") for the most-affected economies to enable affected nations to avoid default, tying the packages to reforms that were intended to make the restored Asian currency, banking, and financial systems more like those of the United States and Europe. In other words, the IMF's support was conditional on a series of drastic economic reforms influenced by neoliberal economic principles called a "structural adjustment package" (SAP). The SAPs called on crisis-struck nations to reduce government spending and deficits, allow insolvent banks and

financial institutions to fail, and aggressively raise interest rates. The reasoning was that these steps would restore confidence in the nations' fiscal solvency, penalize insolvent companies, and protect currency values. Above all, it was stipulated that IMF-funded capital had to be administered rationally in the future, with no favored parties receiving funds by preference. In at least one of the affected countries the restrictions on foreign ownership were greatly reduced.

There were to be adequate government controls set up to supervise all financial activities, ones that were to be independent, in theory, of private interest. Insolvent institutions had to be closed, and insolvency itself had to be clearly defined. In short, exactly the same kinds of financial institutions found in the United States and Europe had to be created in Asia, as a condition for IMF support. In addition, financial systems were to become "transparent", that is, provide the kind of reliable financial information used in the West to make sound financial decisions.

However, the greatest criticism of the IMF's role in the crisis was targeted towards its response. As country after country fell into crisis, many local businesses and governments that had taken out loans in US dollars, which suddenly became much more expensive relative to the local currency which formed their earned income, found themselves unable to pay their creditors. The dynamics of the situation were similar to that of the Latin American debt crisis. The effects of the SAPs were mixed and their impact controversial. Critics, however, noted the contractionary nature of these policies, arguing that in a recession, the traditional Keynesian response was to increase government spending, prop up major companies, and lower interest rates.

The reasoning was that by stimulating the economy and staving off recession, governments could restore confidence while preventing economic loss. They pointed out that the U.S. government had pursued expansionary policies, such as lowering interest rates, increasing government spending, and cutting taxes, when the United States itself entered a recession in 2001, and arguably the same in the fiscal and monetary policies during the 2008–2009 Global Financial Crisis.

The countries most involved almost completely restructured their financial frameworks. They suffered permanent currency devaluations, massive numbers of bankruptcies, collapses of whole sectors of once-booming economies, real estate busts, high unemployment, and social unrest. For most of the countries involved, IMF intervention has been roundly criticized. The role of the International Monetary Fund was so controversial during the crisis that many locals called the financial crisis the "IMF crisis".

Many commentators in retrospect criticized the IMF for encouraging the developing economies of Asia down the path of "fast track capitalism", meaning liberalization of the financial sector (elimination of restrictions on capital flows), maintenance of high domestic interest rates to attract portfolio investment and bank capital, and pegging

of the national currency to the dollar to reassure foreign investors against currency risk.

2.3.9.3) IMF and high interest rates

The conventional high-interest-rate economic wisdom is normally employed by monetary authorities to attain the chain objectives of tightened money supply, discouraged currency speculation, stabilized exchange rate, curbed currency depreciation, and ultimately contained inflation.

In the Asian meltdown, highest IMF officials rationalized their prescribed high interest rates as follows:

From then IMF First Deputy managing director, Stanley Fischer (Stanley Fischer, "The IMF and the Asian Crisis," Forum Funds Lecture at UCLA, Los Angeles on 20 March 1998):

”When their governments "approached the IMF, the reserves of Thailand and South Korea were perilously low, and the Indonesian Rupiah was excessively depreciated. Thus, the first order of business was... to restore confidence in the currency. To achieve this, countries have to make it more attractive to hold domestic currency, which in turn, requires increasing interest rates temporarily, even if higher interest costs complicate the situation of weak banks and corporations...

"Why not operate with lower interest rates and a greater devaluation? This is a relevant tradeoff, but there can be no question that the degree of devaluation in the Asian countries is excessive, both from the viewpoint of the individual countries, and from the viewpoint of the international system. Looking first to the individual country, companies with substantial foreign currency debts, as so many companies in these countries have, stood to suffer far more from… currency (depreciation) than from a temporary rise in domestic interest rates…. Thus, on macroeconomics… monetary policy has to be kept tight to restore confidence in the currency...."

From the then IMF managing director Michel Camdessus ("Doctor Knows Best?" Asiaweek, 17 July 1998, p. 46):

"To reverse (currency depreciation), countries have to make it more attractive to hold domestic currency, and that means temporarily raising interest rates, even if this (hurts) weak banks and corporations."

2.3.9.4) Thailand

From 1985 to 1996, Thailand's economy grew at an average of over 9% per year, the highest economic growth rate of any country at the time. Inflation was kept

reasonably low within a range of 3.4–5.7%. The baht was pegged at 25 to the US dollar.

On 14 May and 15 May 1997, the Thai baht was hit by massive speculative attacks. On 30 June 1997, Prime Minister Chavalit Yongchaiyudh said that he would not devalue the baht. This was the spark that ignited the Asian financial crisis as the Thai government failed to defend the baht, which was pegged to the basket of currencies in which the U.S. dollar was the main component against international speculators.

Thailand's booming economy came to a halt amid massive layoffs in finance, real estate, and construction that resulted in huge numbers of workers returning to their villages in the countryside and 600,000 foreign workers being sent back to their home countries. The baht devalued swiftly and lost more than half of its value. The baht reached its lowest point of 56 units to the US dollar in January 1998. The Thai stock market dropped 75%. Finance One, the largest Thai finance company until then, collapsed.

Without foreign reserves to support the US-Baht currency peg, the Thai government was eventually forced to float the Baht, on 2 July 1997, allowing the value of the Baht to be set by the currency market. On 11 August 1997, the IMF unveiled a rescue package for Thailand with more than $17 billion, subject to conditions such as passing laws relating to bankruptcy (reorganizing and restructuring) procedures and establishing strong regulation frameworks for banks and other financial institutions. The IMF approved on 20 August 1997, another bailout package of $3.9 billion.

By 2001, Thailand's economy had recovered. The increasing tax revenues allowed the country to balance its budget and repay its debts to the IMF in 2003, four years ahead of schedule. The Thai baht continued to appreciate to 29 Baht to the Dollar in October 2010.

2.3.9.4) Indonesia

In June 1997, Indonesia seemed far from crisis. Unlike Thailand, Indonesia had low inflation, a trade surplus of more than $900 million, huge foreign exchange reserves of more than $20 billion, and a good banking sector. But a large number of Indonesian corporations had been borrowing in U.S. dollars. During the preceding years, as the rupiah had strengthened respective to the dollar, this practice had worked well for these corporations; their effective levels of debt and financing costs had decreased as the local currency's value rose.

In July 1997, when Thailand floated the baht, Indonesia's monetary authorities widened the rupiah currency trading band from 8% to 12%. The rupiah suddenly came under severe attack in August. On 14 August 1997, the managed floating exchange regime was replaced by a free-floating exchange rate arrangement. The

rupiah dropped further. The IMF came forward with a rescue package of $23 billion, but the rupiah was sinking further amid fears over corporate debts, massive selling of rupiah, and strong demand for dollars. The rupiah and the Jakarta Stock Exchange touched a historic low in September. Moody's eventually downgraded Indonesia's long-term debt to 'junk bond'.

Although the rupiah crisis began in July and August 1997, it intensified in November when the effects of that summer devaluation showed up on corporate balance sheets. Companies that had borrowed in dollars had to face the higher costs imposed upon them by the rupiah's decline, and many reacted by buying dollars through selling rupiah, undermining the value of the latter further. In February 1998, President Suharto sacked Bank Indonesia Governor J. Soedradjad Djiwandono, but this proved insufficient. Suharto resigned under public pressure in May 1998 and Vice President B. J. Habibie was elevated in his place. Before the crisis, the exchange rate between the rupiah and the dollar was roughly 2,600 rupiah to 1 USD.

The rate plunged to over 11,000 rupiah to 1 USD on 9 January 1998, with spot rates over 14,000 during 23–26 January and trading again over 14,000 for about six weeks during June–July 1998. On 31 December 1998, the rate was almost exactly 8,000 to 1 USD. Indonesia lost 13.5% of its GDP that year.

2.3.9.5) South Korea

The banking sector was burdened with non-performing loans as its large corporations were funding aggressive expansions. During that time, there was a haste to build great conglomerates to compete on the world stage. Many businesses ultimately failed to ensure returns and profitability. The South Korean conglomerates simply absorbed more and more capital investment. Eventually, excess debt led to major failures and takeovers.

For example, in July 1997, South Korea's third-largest car maker, Kia Motors, asked for emergency loans. In the wake of the Asian market downturn, Moody's lowered the credit rating of South Korea from A1 to A3, on 28 November 1997, and downgraded again to B2 on 11 December. That contributed to a further decline in South Korean shares since stock markets were already bearish in November. The Seoul stock exchange fell by 4% on 7 November 1997. On 8 November, it plunged by 7%, its biggest one-day drop to that date. And on 24 November, stocks fell a further 7.2% on fears that the IMF would demand tough reforms. In 1998, Hyundai Motors took over Kia Motors. Samsung Motors' $5 billion venture was dissolved due to the crisis, and eventually Daewoo Motors was sold to the American company General Motors (GM).

The South Korean won, meanwhile, weakened to more than 1,700 per U.S. dollar from around 800. Despite an initial sharp economic slowdown and numerous corporate bankruptcies, South Korea has managed to triple its per capita GDP in

dollar terms since 1997. Indeed, it resumed its role as the world's fastest-growing economy—since 1960, per capita GDP has grown from $80 in nominal terms to more than $21,000 as of 2007. However, like the chaebol, South Korea's government did not escape unscathed. Its national debt-to-GDP ratio more than doubled (approximately 13% to 30%) as a result of the crisis.

In South Korea, the crisis is also commonly referred to as the IMF crisis.

2.3.9.6) Philippines

The Philippine central bank raised interest rates by 1.75 percentage points in May 1997 and again by 2 points on 19 June. Thailand triggered the crisis on 2 July and on 3 July, the Philippine Central Bank intervened to defend the peso, raising the overnight rate from 15% to 32% at the onset of the Asian crisis in mid-July 1997. The peso dropped from 26 pesos per dollar at the start of the crisis to 38 pesos in mid-1999 to 54 pesos as in early August 2001.

The Philippine GDP contracted by 0.6% during the worst part of the crisis, but grew by 3% by 2001, despite scandals of the administration of Joseph Estrada in 2001, most notably the "jueteng" scandal, causing the PSE Composite Index, the main index of the Philippine Stock Exchange, to fall to 1000 points from a high of 3000 points in 1997. The peso's value declined to about 55 pesos to the US dollar. Later that year, Estrada was on the verge of impeachment but his allies in the senate voted against continuing the proceedings.

This led to popular protests culminating in the "EDSA II Revolution", which effected his resignation and elevated Gloria Macapagal-Arroyo to the presidency. Arroyo lessened the crisis in the country. The Philippine peso rose to about 50 pesos by the year's end and traded at around 41 pesos to a dollar in late 2007. The stock market also reached an all-time high in 2007 and the economy was growing by more than 7 percent, its highest in nearly two decades.

2.3.9.7 )Hong Kong

In October 1997, the Hong Kong dollar, which had been pegged at 7.8 to the U.S. dollar since 1983, came under speculative pressure because Hong Kong's inflation rate had been significantly higher than the U.S.'s for years. Monetary authorities spent more than US$1 billion to defend the local currency. Since Hong Kong had more than US$80 billion in foreign reserves, which is equivalent to 700% of its M1 money supply and 45% of its M3 money supply, the Hong Kong Monetary Authority (effectively the city's central bank) managed to maintain the peg.

Stock markets became more and more volatile; between 20 and 23 October the Hang Seng Index dropped 23%. The Hong Kong Monetary Authority then promised to protect the currency. On 15 August 1998, it raised overnight interest rates from 8% to 23%, and at one point to 500%. The HKMA had recognized that speculators

were taking advantage of the city's unique currency-board system, in which overnight rates automatically increase in proportion to large net sales of the local currency. The rate hike, however, increased downward pressure on the stock market, allowing speculators to profit by short selling shares. The HKMA started buying component shares of the Hang Seng Index in mid-August.

The HKMA and Donald Tsang, then the Financial Secretary, declared war on speculators. The Government ended up buying approximately HK$120 billion (US$15 billion) worth of shares in various companies, and became the largest shareholder of some of those companies (e.g., the government owned 10% of HSBC) at the end of August, when hostilities ended with the closing of the August Hang Seng Index futures contract. In 1999, the Government started selling those shares by launching the Tracker Fund of Hong Kong, making a profit of about HK$30 billion (US$4 billion).

2.3.9.8) Malaysia

Before the crisis, Malaysia had a large current account deficit of 5% of its GDP. At the time, Malaysia was a popular investment destination, and this was reflected in KLSE activity which was regularly the most active stock exchange in the world (with turnover exceeding even markets with far higher capitalization like the New York Stock Exchange). Expectations at the time were that the growth rate would continue, propelling Malaysia to developed status by 2020, a government policy articulated in Wawasan 2020. At the start of 1997, the KLSE Composite index was above 1,200, the ringgit was trading above 2.50 to the dollar, and the overnight rate was below 7%.

In July 1997, within days of the Thai baht devaluation, the Malaysian ringgit was "attacked" by speculators. The overnight rate jumped from under 8% to over 40%. This led to rating downgrades and a general sell off on the stock and currency markets. By end of 1997, ratings had fallen many notches from investment grade to junk, the KLSE had lost more than 50% from above 1,200 to under 600, and the ringgit had lost 50% of its value, falling from above 2.50 to under 4.57 on (23 January 1998) to the dollar. The then premier, Mahathir Mohammad imposed strict capital controls and introduced a 3.80 peg against the US dollar.

Malaysian moves involved fixing the local currency to the US dollar, stopping the overseas trade in ringgit currency and other ringgit assets therefore making offshore use of the ringgit invalid, restricting the amount of currency and investments that residents can take abroad, and imposed for foreign portfolio funds, a minimum one-year "stay period" which since has been converted to an exit tax. The decision to make ringgit held abroad invalid has also dried up sources of ringgit held abroad that speculators borrow from to manipulate the ringgit, for example by "selling short." Those who do, have to purchase back the limited ringgit at higher prices, making it unattractive to them.In addition, it also fully suspended the trading

of CLOB (Central Limit Order Book) counters, indefinitely freezing approximately US$4.47 billion worth of shares and affecting 172,000 investors, most of them Singaporeans.

In 1998, the output of the real economy declined plunging the country into its first recession for many years. The construction sector contracted 23.5%, manufacturing shrunk 9% and the agriculture sector 5.9%. Overall, the country's gross domestic product plunged 6.2% in 1998. During that year, the ringgit plunged below 4.7 and the KLSE fell below 270 points. In September that year, various defensive measures were announced to overcome the crisis.

The principal measure taken were to move the ringgit from a free float to a fixed exchange rate regime. Bank Negara fixed the ringgit at 3.8 to the dollar. Capital controls were imposed while aid offered from the IMF was refused. Various task force agencies were formed. The Corporate Debt Restructuring Committee dealt with corporate loans. Danaharta discounted and bought bad loans from banks to facilitate orderly asset realization. Danamodal recapitalized banks.

Growth then settled at a slower but more sustainable pace. The massive current account deficit became a fairly substantial surplus. Banks were better capitalized and NPLs were realised in an orderly way. Small banks were bought out by strong ones. A large number of PLCs were unable to regulate their financial affairs and were delisted. Compared to the 1997 current account, by 2005, Malaysia was estimated to have a US$14.06 billion surplus. Asset values however, have not returned to their pre-crisis highs. In 2005 the last of the crisis measures were removed as the ringgit was taken off the fixed exchange system. But unlike the pre-crisis days, it did not appear to be a free float, but a managed float, like the Singapore dollar.

2.3.9.9) Singapore

As the financial crisis spread the economy of Singapore dipped into a short recession. The short duration and milder effect on its economy was credited to the active management by the government. For example, the Monetary Authority of Singapore allowed for a gradual 20% depreciation of the Singapore dollar to cushion and guide the economy to a soft landing. The timing of government programs such as the Interim Upgrading Program and other construction related projects were brought forward. Instead of allowing the labor markets to work, the National Wage Council pre-emptively agreed to Central Provident Fund cuts to lower labor costs, with limited impact on disposable income and local demand. Unlike in Hong Kong, no attempt was made to directly intervene in the capital markets and the Straits Times Index was allowed to drop 60%. In less than a year, the Singaporean economy fully recovered and continued on its growth trajectory.

2.3.9.10) china

The Chinese currency, the renminbi (RMB), had been pegged to the US dollar at a ratio of 8.3 RMB to the dollar, in 1994. Having largely kept itself above the fray throughout 1997–1998 there was heavy speculation in the Western press that China would soon be forced to devalue its currency to protect the competitiveness of its exports vis-a-vis those of the ASEAN nations, whose exports became cheaper relative to China's. However, the RMB's non-convertibility protected its value from currency speculators, and the decision was made to maintain the peg of the currency, thereby improving the country's standing within Asia. The currency peg was partly scrapped in July 2005 rising 2.3% against the dollar, reflecting pressure from the United States.

Unlike investments of many of the Southeast Asian nations, almost all of China's foreign investment took the form of factories on the ground rather than securities, which insulated the country from rapid capital flight. While China was unaffected by the crisis compared to Southeast Asia and South Korea, GDP growth slowed sharply in 1998 and 1999, calling attention to structural problems within its economy. In particular, the Asian financial crisis convinced the Chinese government of the need to resolve the issues of its enormous financial weaknesses, such as having too many non-performing loans within its banking system, and relying heavily on trade with the United States.

2.3.9.11) United States and Japan

The "Asian flu" had also put pressure on the United States and Japan. Their markets did not collapse, but they were severely hit. On 27 October 1997, the Dow Jones industrial plunged 554 points or 7.2%, amid ongoing worries about the Asian economies. The New York Stock Exchange briefly suspended trading. The crisis led to a drop in consumer and spending confidence (see 27 October 1997 mini-crash). Indirect effects included the dot-com bubble, and years later the housing bubble and the Subprime mortgage crisis.

Japan was affected because its economy is prominent in the region. Asian countries usually run a trade deficit with Japan because the latter's economy was more than twice the size of the rest of Asia together; about 40% of Japan's exports go to Asia. The Japanese yen fell to 147 as mass selling began, but Japan was the world's largest holder of currency reserves at the time, so it was easily defended, and quickly bounced back. GDP real growth rate slowed dramatically in 1997, from 5% to 1.6% and even sank into recession in 1998, due to intense competition from cheapened rivals. The Asian financial crisis also led to more bankruptcies in Japan. In addition, with South Korea's devalued currency, and China's steady gains, many companies complained outright that they could not compete

Another longer-term result was the changing relationship between the U.S. and Japan, with the U.S. no longer openly supporting the highly artificial trade

environment and exchange rates that governed economic relations between the two countries for almost five decades after World War II.

2.3.9.12) Consequences

Asia

The crisis had significant macroeconomic-level effects, including sharp reductions in values of currencies, stock markets, and other asset prices of several Asian countries. The nominal U.S. dollar GDP of ASEAN fell by US$9.2 billion in 1997 and $218.2 billion (31.7%) in 1998. In South Korea, the $170.9 billion fall in 1998 was equal to 33.1% of the 1997 GDP. Many businesses collapsed, and as a consequence, millions of people fell below the poverty line in 1997–1998. Indonesia, South Korea and Thailand were the countries most affected by the crisis.

The above tabulation shows that despite the prompt raising of interest rates to 32% in the Philippines upon the onset of crisis in mid-July 1997, and to 65% in Indonesia upon the intensification of crisis in 1998, their local currencies depreciated just the same and did not perform better than those of South Korea, Thailand, and Malaysia, which countries had their high interest rates set at generally lower than 20% during the Asian crisis. This created grave doubts on the credibility of IMF and the validity of its high-interest-rate prescription to economic crisis.

The economic crisis also led to a political upheaval, most notably culminating in the resignations of President Suharto in Indonesia and Prime Minister General Chavalit Yongchaiyudh in Thailand. There was a general rise in anti-Western sentiment, with George Soros and the IMF in particular singled out as targets of criticisms. Heavy U.S. investment in Thailand ended, replaced by mostly European investment, though Japanese investment was sustained.[citation needed] Islamic and other separatist movements intensified in Southeast Asia as central authorities weakened.

More long-term consequences included reversal of the relative gains made in the boom years just preceding the crisis. Nominal US dollar GDP per capital fell 42.3% in Indonesia in 1997, 21.2% in Thailand, 19% in Malaysia, 18.5% in South Korea and 12.5% in the Philippines. The CIA World Factbook reported that the per capita income (measured by purchasing power parity) in Thailand declined from $8,800 to $8,300 between 1997 and 2005; in Indonesia it increased from $2,628 to $3,185; in Malaysia it declined from $11,100 to $10,400. Over the same period, world per capita income rose from $6,500 to $9,300. Indeed, the Central Intelligence Agency's analysis asserted that the economy of Indonesia was still smaller in 2005 than it had been in 1997, suggesting an impact on that country similar to that of the Great Depression. Within East Asia, the bulk of investment and a significant amount of economic weight shifted from Japan and ASEAN to China and India.

The crisis has been intensively analyzed by economists for its breadth, speed, and dynamism; it affected dozens of countries, had a direct impact on the livelihood of

millions, happened within the course of a mere few months, and at each stage of the crisis leading economists, in particular the international institutions, seemed a step behind. Perhaps more interesting to economists was the speed with which it ended, leaving most of the developed economies unharmed. These curiosities have prompted an explosion of literature about financial economics and a litany of explanations why the crisis occurred. A number of critiques have been leveled against the conduct of the IMF in the crisis, including one by former World Bank economist Joseph Stiglitz. Politically there were some benefits. In several countries, particularly South Korea and Indonesia, there was renewed push for improved corporate governance. Rampaging inflation weakened the authority of the Suharto regime and led to its toppling in 1998, as well as accelerating East Timor's independence.

Outside Asia

After the Asian crisis, international investors were reluctant to lend to developing countries, leading to economic slowdowns in developing countries in many parts of the world. The powerful negative shock also sharply reduced the price of oil, which reached a low of about $11 per barrel towards the end of 1998, causing a financial pinch in OPEC nations and other oil exporters. In response to a severe fall in oil prices, the supermajors that emerged in the late-1990s, undertook some major mergers and acquisitions between 1998 and 2002 – often in an effort to improve economies of scale, hedge against oil price volatility, and reduce large cash reserves through reinvestment.

The reduction in oil revenue also contributed to the 1998 Russian financial crisis, which in turn caused Long-Term Capital Management in the United States to collapse after losing $4.6 billion in 4 months. A wider collapse in the financial markets was avoided when Alan Greenspan and the Federal Reserve Bank of New York organized a $3.625 billion bailout. Major emerging economies Brazil and Argentina also fell into crisis in the late 1990s (see Argentine debt crisis).

The crisis in general was part of a global backlash against the Washington Consensus and institutions such as the IMF and World Bank, which simultaneously became unpopular in developed countries following the rise of the anti-globalization movement in 1999. Four major rounds of world trade talks since the crisis, in Seattle, Doha, Cancún, and Hong Kong, have failed to produce a significant agreement as developing countries have become more assertive, and nations are increasingly turning toward regional or bilateral free trade agreements (FTAs) as an alternative to global institutions.

Many nations learned from this, and quickly built up foreign exchange reserves as a hedge against attacks, including Japan, China, South Korea. Pan Asian currency swaps were introduced in the event of another crisis. However, interestingly enough, such nations as Brazil, Russia, and India as well as most of East Asia began

copying the Japanese model of weakening their currencies, restructuring their economies so as to create a current account surplus to build large foreign currency reserves. This has led to an ever increasing funding for US treasury bonds, allowing or aiding housing (in 2001–2005) and stock asset bubbles (in 1996–2000) to develop in the United States.

2.3.10) Russian Financial Crises

The Russian financial crisis (also called "Ruble crisis" or the "Russian Flu") hit Russia on 17 August 1998. It resulted in the Russian government devaluing the ruble and defaulting on its debt

2.3.10.1) Background and course of events

Declining productivity, an artificially high fixed exchange rate between the ruble and foreign currencies to avoid public turmoil, and a chronic fiscal deficit were the reasons that led to the crisis. The economic cost of the first war in Chechnya, estimated at $5.5 billion (not including the rebuilding of the ruined Chechen economy), also contributed to the crisis. In the first half of 1997, the Russian economy showed some signs of improvement. However, soon after this, the problems began to gradually intensify.

Two external shocks, the Asian financial crisis that had begun in 1997 and the following declines in demand for (and thus price of) crude oil and nonferrous metals, severely impacted Russian foreign exchange reserves. When the East Asian financial crisis broke out in 1997, prices for Russia's two most valuable sources of capital flows, energy and metals, plummeted. Given Russia’s fragile economy, the rapid decline in the value of those two capital sources resulted in an economic chaos in the country where GDP per capita fell, unemployment soared, and global investors liquidated their Russian assets.

A political crisis came to a head in March when Russian president Boris Yeltsin suddenly dismissed Prime Minister Viktor Chernomyrdin and his entire cabinet on 23 March 1998. Yeltsin named Energy Minister Sergei Kiriyenko, then 35 years old, as acting prime minister. On 29 May 1998, Yeltsin appointed Boris Fyodorov as Head of the State Tax Service. The growth of internal loans could only be provided at the expense of the inflow of foreign speculative capital, which was attracted by very high interest rates.

In an effort to prop up the currency and stem the flight of capital, in June 1998 Kiriyenko hiked GKO interest rates to 150%. The situation was worsened by irregular internal debt payments. Despite government efforts, the debts on wages continued to grow, especially in the remote regions. By the end of 1997, the situation with the tax receipts was very tense, and it had a negative effect on the financing of major budget items (pensions, communal utilities, transportation etc.).

A $22.6 billion International Monetary Fund and World Bank financial package was approved on 13 July 1998 to support reforms and stabilize the Russian market by swapping out an enormous volume of the quickly maturing GKO short-term bills into long-term Eurobonds. This had started to be implemented with some success by 24 July 1998, yet the Russian government decided to keep the exchange rate of the ruble within a narrow band. Although many economists, including Andrei Illarionov and George Soros, urged the government to abandon its support of the ruble.

On 12 May 1998, coal miners went on strike over unpaid wages, blocking the Trans-Siberian Railway. By 1 August 1998 there were approximately $12.5 billion in debt owed to Russian workers. On 14 August 1998 the exchange rate of the Russian ruble to the US dollar was still 6.29. Despite the bailout, July 1998 monthly interest payments on Russia’s debt rose to a figure 40 percent higher than its monthly tax collections.

Additionally, on 15 July 1998, the State Duma dominated by left-wing parties refused to adopt most of the government anti-crisis plan so that the government was forced to rely on presidential decrees. On 29 July Yeltsin interrupted his vacation in Valdai Hills region and flew to Moscow, prompting fears of a Cabinet reshuffle, but he only replaced Federal Security Service Chief Nikolay Kovalyov with Vladimir Putin.

At the time, Russia employed a "floating peg" policy toward the ruble, meaning that the Central Bank decided that at any given time the ruble-to-dollar (or RUR/USD) exchange rate would stay within a particular range. If the ruble threatened to devalue outside of that range (or "band"), the Central Bank would intervene by spending foreign reserves to buy rubles. For instance, during the year prior before the crisis, the Central Bank aimed to maintain a band of 5.3 to 7.1 RUR/USD, meaning that it would buy rubles if the market exchange rate threatened to exceed 7.1 rubles per dollar. Similarly, it would sell rubles if the market exchange rate threatened to drop below 5.3.

The inability of the Russian government to implement a coherent set of economic reforms led to a severe erosion in investor confidence and a chain reaction that can be likened to a run on the Central Bank. Investors fled the market by selling rubles and Russian assets (such as securities), which also put downward pressure on the ruble. This forced the Central Bank to spend its foreign reserves to defend Russia's currency, which in turn further eroded investor confidence and undermined the ruble. It is estimated that between 1 October 1997 and 17 August 1998, the Central Bank expended approximately $27 billion of its U.S. dollar reserves to maintain the floating peg.

It was later revealed that about $5 billion of the international loans provided by the World Bank and International Monetary Fund were stolen upon the funds' arrival in Russia on the eve of the meltdown.

On 13 August 1998, the Russian stock, bond, and currency markets collapsed as a result of fears from investors that the government would devalue the ruble, default on domestic debt, or both. Annual yields on the ruble denominated bonds were more than 200 percent. The stock market had to be closed for 35 minutes as prices plummeted. When this happened, it was down 65 percent with a small number of shares actually traded. From January to August 1998 the stock market had lost more than 75 percent of its value, 39 percent in the month of May alone.

2.3.10.2) Crisis and effects

On 17 August 1998, the Russian government devalued the ruble, defaulted on domestic debt, and declared a moratorium on payment to foreign creditors. [7] On that day the Russian government and the Central Bank of Russia issued a "Joint Statement" announcing, in essence, that:

1. the ruble/dollar trading band would expand from 5.3–7.1 RUR/USD to 6.0–9.5 RUR/USD;

2. Russia's ruble-denominated debt would be restructured in a manner to be announced at a later date; and, to prevent mass Russian bank default,

3. a temporary 90-day moratorium would be imposed on the payment of some bank obligations, including certain debts and forward currency contracts.

On 17 August 1998 the government declared in the Joint Statement of the Government of the Russian Federation and the Central Bank of the Russian Federation that the state securities (GKOs and OFZs), with due dates through 31 December 1999, would be transformed into new securities. The terms of the GKO/OFZ restructuring were also determined in the following acts:

Decree of the Government of the Russian Federation №1007 of 25 August 1998

Decree of the President of the Russian Federation №888 of 25 August 1998 Decree №1787-р of 12 December 1998 on novation of state securities Federal Law on Top-Priority Measures in the Field of Budget and Tax Policy

GKO bondholders made few attempts to pursue litigation in domestic courts.

At the same time, in addition to widening the currency band, authorities also announced that they intended to allow the RUR/USD rate to move more freely within the wider band.

At the time, the Moscow Interbank Currency Exchange (or "MICEX") set a daily "official" exchange rate through a series of iteractive auctions based on written bids submitted by buyers and sellers. When the buy and sell prices matched, this "fixed" or "settled" the official MICEX exchange rate, which would then be published by Reuters. The MICEX rate was (and is) commonly used by banks and currency dealers

worldwide as the reference exchange rate for transactions involving the Russian ruble and foreign currencies.

From 17 to 25 August 1998, the ruble steadily depreciated on the MICEX, moving from 6.43 to 7.86 RUR/USD. On 26 August 1998, the Central Bank terminated ruble-dollar trading on the MICEX, and the MICEX did not fix a ruble-dollar rate that day.

On 2 September 1998 the Central Bank of the Russian Federation decided to abandon the "floating peg" policy and float the ruble freely. By 21 September 1998 the exchange rate had reached 21 rubles for one US dollar, meaning it had lost two thirds of its value of less than a month earlier.

On 28 September 1998 Boris Fyodorov was discharged from the position of the Head of the State Tax Service.

The moratorium imposed by the Joint Statement expired on 15 November 1998, and the Russian government and Central Bank did not renew it. (Stiglitz, Joseph (9 April2003). "The ruin of Russia". The Guardian (London). Retrieved 21 April 2010.)

2.3.10.3) Inflation

Russian inflation in 1998 reached 84 percent and welfare costs grew considerably. Many banks, including Inkombank, Oneximbank and Tokobank, were closed down as a result of the crisis. The salaries of miners alone were to consume $919 million, more than one percent of the federal budget. By August 1998, the government had paid $4 billion to settle miners’ strikes. Prices for almost all Russian food items had gone up by almost 100%, while imports had quadrupled in price.

Many citizens were stocking up for bad times and throughout the country shop shelves were being emptied, leaving a shortage of even the most basic items, such as vegetable oil, sugar, matches or washing powder. The crisis reduced demand for food and lowered food consumption, because substantial depreciation of the ruble significantly raised domestic prices for food products. The crisis also increased social tension. The middle class that was already forming by that time had some hope for stability.

The confidence of crisis prevention crumbled as millions of people lost their life savings due to banks closing. On 7 October 1998, demonstrations were held in many cities: around 100,000 took to the streets in Moscow, In Vladivostok 4,000, in Krasnoyarsk 3,000 and in Yekaterinburg 6,000. Defence Minister Igor Sergeyev cancelled his scheduled visit to Greece in the first week of October 1998, in order to be at hand should matters get out of control. Select military units were placed in a state of readiness. On 20 October 1998, President Boris Yeltsin also signed a presidential decree banning "mass protests" in Moscow between the hours of 10 pm and 7 a.m.and limiting them to a maximum of five days.

As the crisis deepened, regional governors had been introducing emergency measures: In Krasnoyarsk Krai in Siberia, governor Aleksandr Lebed, had signed a resolution to hold down prices "using administrative methods", a television report said. The authorities in the far eastern city of Vladivostok had banned deliveries of food to areas beyond the port city, and there had been talks of introducing rationing there. In Russia's Kaliningrad enclave on the Baltic, the governor announced a suspension of tax payments to the federal authorities.

( Russian Financial Crisis of 1998: An Economic Investigation, International Journal of AppliedEconometrics and Quantitative Studies Vol. 1-4 ,2004)

2.3.10.4) Fiscal

Regional budgets also suffered from the 1998 crisis. Spending declined from 18.2% of the GDP in 1997 to 14.8% of the GDP. Spending on the economy (by 1.5% of the GDP) and social expenditures (by 1.6% of the GDP) were reduced especially heavily. The expenditures continued to decline in the following period. They dropped another 1% of the GDP in 1999 to 13.8% of the GDP, and to 10.8% of the GDP in the first quarter of 2000. One of the main factors in the reduction was the decline in subsidies for housing and municipal services, from 3.5% to 2.7% of the GDP.

2.3.10.5) Agriculture

The main effect of the crisis on Russian agricultural policy has been a dramatic drop in federal subsidies to the sector, about 80 percent in real terms compared with 1997, though subsidies from regional budgets fell less.

2.3.10.6) Political fallout

The financial collapse resulted in a political crisis as Yeltsin, with his domestic support evaporating, had to contend with an emboldened opposition in the parliament. A week later, on 23 August 1998, Yeltsin fired Kiriyenko and declared his intention of returning Chernomyrdin to office as the country slipped deeper into economic turmoil. Powerful business interests, fearing another round of reforms that might cause leading enterprises to fail, welcomed Kiriyenko's fall, as did the Communists.

Yeltsin, who began to lose his hold on power as his health deteriorated, wanted Chernomyrdin back; in a televised address to the nation, Yeltsin said that “heavyweights” such as Chernomyrdin, who was ousted as prime minister in March 1998 for failing to vigorously promote economic reforms, were needed to stem the nation's financial collapse. Yeltsin also suggested that Chernomyrdin would be named his successor as president when Yeltsin's term expired in 2000. But the legislature refused to give its approval. After the Duma rejected Chernomyrdin's candidacy twice, Yeltsin, his power clearly on the wane, backed down. Instead, he

nominated Foreign Minister Yevgeny Primakov, who on 11 September 1998 was approved by the State Duma by an overwhelming majority.

Primakov's appointment restored political stability, because he was seen as a compromise candidate able to heal the rifts between Russia's quarreling interest groups. There was popular enthusiasm for Primakov as well. Primakov promised to make the payment of wage and pension his government’s first priority, and invited members of the leading parliamentary factions into his Cabinet.

Communists and the Federation of Independent Trade Unions of Russia staged a nationwide strike on 7 October 1998 and called on President Yeltsin to resign. On 9 October 1998, Russia, which was also suffering from a bad harvest, appealed for international humanitarian aid, including food. ( Russian Financial Crisis of 1998: AnEconomic Investigation, International Journal of Applied Econometrics andQuantitative Studies Vol. 1-4 ,2004)

2.3.10.7) Recovery

Russia bounced back from the August 1998 financial crash with surprising speed. Much of the reason for the recovery is that world oil prices rapidly rose during 1999–2000 (just as falling energy prices on the world market helped to deepen Russia's financial troubles), so that Russia ran a large trade surplus in 1999 and 2000. Another reason is that domestic industries, such as food processing, had benefited from the devaluation, which caused a steep increase in the prices of imported goods.

Also, since Russia's economy was operating to such a large extent on barter and other non-monetary instruments of exchange, the financial collapse had far less of an impact on many producers than it would had the economy been dependent on a banking system. Finally, the economy had been helped by an infusion of cash. As enterprises were able to pay off debts in back wages and taxes, in turn consumer demand for goods and services produced by the Russian industry began to rise.

For the first time in many years, in 2000 unemployment fell as enterprises added workers. Since the 1998 crisis, the Russian government has managed to keep social and political pressures under control, and this has played a vital role in bringing about the current recovery.

2.3.10.8) Effects on countries in the world

The financial crisis spread panic throughout the world financial system.

2.3.10.8.1) Baltic states

The Russian crisis affected Baltic countries more than expected. Estonia, Latvia and Lithuania sank into recession. Figures for 1999 showed a heavy decline in exports

from these countries to Russia, in addition to a significant decline in growth rates of these economies. Food and beverage as well as processing industries as a whole have suffered the most.

2.3.10.8.2) Belarus

Overall, economic activity slowed down substantially in the immediate aftermath of the Russian crisis, with output growth falling from about 8.5 percent in 1998 to 3.4 percent in 1999. Both exports and imports contracted substantially, resulting in a drop in the current account deficit from a 6.1 percent GDP in 1998 to 2.2 percent in 1999. Externally, exports to Russia, which accounted for more than 60 percent of total exports, fell during the second half of 1998 by 10 percent.

Demand for Belarusian products was weak through 1999, showing signs of recovery only during the final quarter, with the revival of economic activity in Russia. Also, in the first quarter of 1999, compared to 1998, except for investments, all budget expenditures were smaller. The biggest cuts were made in national security (a 1.9 GDP, compared to 2.5 percent in the first quarter of 1998) and social policy (1.5 and 2.4 percent of GDP, respectively) where expenditures were lowered almost by one third.

2.3.10.8.3) Kazakhstan

The Russian crisis was a hard blow to the Kazakh economy. Kazakhstan lost its pricing competitiveness and its exports were in shambles. On the other hand, cheap Russian goods were flowing into the country, essentially killing domestic industries. There was huge pressure on the tenge, the Kazakh currency, and Kazakhstan's balance of payments worsened. However, the NBK continued to maintain the value of the tenge. In fact, they had spent close to a billion dollars to maintain the level of tenge. Their foreign exchange reserves halved.

2.3.10.8.4) Moldova

Moldova received an IMF special mission advising the government on how to cope with the effects of the Russian crisis. At that time Russia bought 85% of Moldova's wine and brandy, as well as most of its canned goods and tobacco. After the ruble crashed, most Russian importers put deals with Moldova on hold. Moldovan president Petru Lucinschi was quoted as saying that the Russian crisis had cost Moldova as much as five per cent of its GDP. The country's parliament was discussing a programme aimed at reducing imports and searching for new markets outside Russia.

2.3.10.8.5) Ukraine

The crisis cost the Ukraine a lot as well: the Hryvnia devaluated by 60%, domestic prices increased by 20%, and the National Bank of Ukraine lost 40% of its gross reserves.

2.3.10.8.6) United States

The U.S. stock market, following a decade of rapid and accelerating increases, began to slip in early August 1998, amid fears about Asia and Russia. The Dow Jones Industrial Average fell 984 points, or 11.5%, in 3 days at the end of August, to a level 19% below its July peak. This more than erased the year's market gains. The U.S. stock market remained depressed until October, when a series of interest rate reductions by the Federal Reserve propelled it back upward.

2.3.10.8.7) Uzbekistan

In the central Asian state, the government banned free unlicensed sales of food, most of which is imported from Russia, as a preventative measure against prices rising and subsequent panic.

2.3.11) Turkish Crises

Throughout the 1980s and 1990s, Turkey relied heavily on foreign investment for economic growth, with trade above 40% of GNP.The Turkish government and banking systems lacked the financial means to support meaningful economic growth. The government was already running enormous budget deficits, and one of the ways it managed to sustain these was by selling huge quantities of high-interest bonds to Turkish banks. Continuing inflation (likely a result of the enormous flow of foreign capital into Turkey) meant that the government could avoid defaulting on the bonds in the short term. As a consequence, Turkish banks came to rely on these high-yield bonds as a primary investment. (Ahmad, F. (2003). Turkey: The Quest forIdentity. Oxford: Oneworld.)

2.3.11.1) Political instability

In March 1996 a Coalition was formed between the Motherland Party's Mesut Yilmaz and the True Path Party's Tansu Çiller. The plan was for Yilmaz and Cillar to alternate the Prime Ministry. However, there was much public distraction caused by leader of the Welfare Party Necmettin Erbakan's threats to investigate Cillar for corruption. Meanwhile, Erbakan, who had been excluded from the coalition, did everything he could to rally support for an Islamic NATO, and an Islamic version of the European Union.

The Motherland Coalition collapsed in part because of Erbakan's widespread public support. Addition tensions wreaked havoc on the government. Yilmaz was forced to resign on June 6, 1996 with the government having lasted for only 90 days. Erbakan became Prime Minister on June 29 as the head of a Welfare/True Path coalition. The

success of the new Welfare-Path Coalition was viewed with hostility by the military. Erbakan's explicitly Islamist politicies resulted in a post modern coup in which the military forced Erbakan to yield power to Demeril who yielded to Yilmaz on June 19, 1997. The political fighting between Yilmaz and Cillar one on side, and Erbakan on the other would continue, making coalitions difficult to create. In addition, corruption was rampant at this time. People were highly disillusioned with their government. This lack of faith and efficacy would cause foreign nations to carefully examine any investment in Turkey. (Ahmad, F. (2003). Turkey: The Quest forIdentity. Oxford: Oneworld.)

2.3.11.2) Foreign divestment

The International Monetary Fund (IMF) team in 1996 warned of an impending financial crisis because of the deficit, which soon came into being. Turkey's unstable political landscape led many foreign investors to divest from the country. As foreign investors observed the political turmoil and the government's attempts to eliminate the budget deficit, they withdrew $70 billion worth of capital from the country in a matter of months. This left a vacuum of capital that Turkish banks were unable to alleviate because the government was no longer able to pay off its bonds. With no capital to speak of, the Turkish economy slowed dramatically.

2.3.11.3) Stabilization efforts

In November 2000, the IMF provided Turkey with $11.4 billion in loans and Turkey sold many of its state-owned industries in an effort to balance the budget. In the case of Turkish Airlines, advertisements were placed in newspapers to attract offers for a 51% stake in the company. By 2000 there was massive unemployment, a lack of medicine, tight credit, slow production to fight inflation and increasing taxes. Stabilisation efforts had yet to produce any meaningful effects, and the IMF loan was widely seen as insufficient.

2.3.11.4) The crash

Turkey's financial and political instability called for a positive government stance to assuage fears of a total economic collapse. However, on February 19, 2001, Prime Minister Ecevit emerged from a meeting with President Sezer saying, "This is a serious crisis." His unfortunate choice of words, resulting from a heated debate, made a bad situation worse. Stocks plummeted and the interest rate reached 3,000%. Large quantities of lira were exchanged for dollars or euro, causing the Turkish Central bank to lose $5 billion of its reserves. Ecevit's statement, amid such unstable, unpropitious times, looked for many like an admission of defeat government.

The crash triggered even more economic turmoil. In the first eight months of 2001, 14,875 jobs were lost, the dollar rose to 1,500,000 liras, and income inequality had risen from its already high level.

2.3.11.5) Significance

The crash was emblematic of the political and economic problems that had been wearing on Turkey for years. Confidence in the government had been eroded by corruption and the inability to form lasting coalitions. The stock market crash revealed Turkey's economic situation to be not only extremely fragile but also entirely dependent on foreign investment. Although not as significant as decreased foreign investment or the massive budget deficit, the crash highlights Turkey's recent political instability

(Ahmad, F. (2003). Turkey: The Quest for Identity. Oxford: Oneworld.)

2.3.12) Early 2000 Recession

The early 2000s recession was a decline in economic activity which mainly occurred in developed countries. The recession affected the European Union during 2000 and 2001 and the United States in 2002 and 2003. The UK, Canada and Australia avoided the recession, while Russia, a nation that did not experience prosperity during the 1990s, in fact began to recover from said situation Japan's 1990s recession continued. This recession was predicted by economists, because the boom of the 1990s (accompanied by both low inflation and low unemployment) had already ceased in East Asia during the 1997 Asian financial crisis. The recession wasn't as significant as either of the two previous worldwide recessions. Some economists in the United States object to characterizing it as a recession since there were no two consecutive quarters of negative growth. (Martel, Jennifer L.; LangdonEngland, David S. (2001). "2000: The Job Market in 2000: Slowing Down as the YearEnded". Monthly Labor Review (Bureau of Labor Statistics) 124 (2): 3–30)

2.3.12.1) United States

After the relatively mild 1990-91 recession ended in March 1991, the country hit a belated unemployment rate peak of 7.8% in mid-1992. Job growth was initially muted by large layoffs among defense related industries.However, payroll gains accelerated in 1992 and experienced robust growth through the year 2000.

As the Dot Com bubble occurred in the mid and late 1990s, assorted predictions that eventually the bubble would burst emerged frequently. Because of the October 27, 1997 mini-crash in the wake of the Asian crisis, the predictions about a future burst increased, causing an uncertain climate on economy during the first months of 1998, while the Federal Reserve raised interest rates six times between June 1999 and May 2000 in an effort to cool the economy to a soft landing. The actual burst of the stock market bubble occurred in the form of the NASDAQ crash in March 2000. Growth in gross domestic product slowed considerably in the third quarter of 2000 to the lowest rate since a contraction in the first quarter of 1991. (Martel, Jennifer L.;Langdon England, David S. (2001). "2000: The Job Market in 2000: Slowing Down as

the Year Ended". Monthly Labor Review (Bureau of Labor Statistics) 124 (2): 3–30)(Michael J. Mandel (February 23, 2004). "Inventing The "Clinton Recession"".Business Week Online.)

The NBER's Business Cycle Dating Committee has determined that a peak in business activity occurred in the U.S. economy in March 2001. A peak marks the end of an expansion and the beginning of a recession. The determination of a peak date in March is thus a determination that the expansion that began in March 1991 ended in March 2001 and a recession began The expansion lasted almost 10 years, the longest in the NBER's chronology . According to the National Bureau of Economic Research (NBER), which is the private, nonprofit, nonpartisan organization charged with determining economic recessions, the U.S. economy was in recession from March 2001 to November 2001 , a period of eight months at the beginning of President George W. Bush's term of office. However, economic conditions did not satisfy the common shorthand definition of recession, which is "a fall of a country's real gross domestic product in two or more successive quarters," and has led to some confusion about the procedure for determining the starting and ending dates of a recession.

The NBER's Business Cycle Dating Committee (BCDC) uses monthly, rather than quarterly, indicators to determine peaks and troughs in business activity,as can be seen by noting that starting and ending dates are given by month and year, not quarters. However, controversy over the precise dates of the recession led to the characterization of the recession as the "Clinton Recession" by Republicans, if it could be traced to the final term of President Bill Clinton. A move in the recession date in a 2004 report by the Council of Economic Advisors to several months before the one given by the NBER was seen as politically motivated. BCDC members suggested they would be open to revisiting the dates of the recession as newer and more definitive data became available. In early 2004, NBER President Martin Feldstein said:

"It is clear that the revised data have made our original March date for the start of the recession much too late. We are still waiting for additional monthly data before making a final judgment. Until we have the additional data, we cannot make a decision."

From 2000 to 2001, the Federal Reserve in a move to quell the stock market, made successive interest rate increases, credited in part for "plunging the country into a recession." Using the stock market as an unofficial benchmark, a recession would have begun in March 2000 when the NASDAQ crashed following the collapse of the Dot-com bubble. The Dow Jones Industrial Average was relatively unscathed by the NASDAQ's crash until the September 11, 2001 attacks, after which the DJIA suffered its worst one-day point loss and biggest one-week losses in history up to that point. The market rebounded, only to crash once more in the final two quarters of 2002. In the final three quarters of 2003, the market finally rebounded permanently,

agreeing with the unemployment statistics that a recession defined in this way would have lasted from 2001 through 2003. (Henderson, Nell (January 22, 2004).Economists Say Recession Started in 2000. The Washington Pos)

The Labor Department estimates that a net 1.761 million jobs were shed in 2001, with an additional net 545,000 lost during 2002. 2003 saw a small gain of a mere 62,000 jobs. Unemployment rose from 4.2% in February 2001 to 5.5% in November 2001, but did not peak until June 2003 at 6.3%, after which it declined to 5% by mid-2005.

2.3.12.2) Canada

Canada's economy is closely linked to that of the United States, and economic conditions south of the border tend to quickly make their way north. Canada's stock markets were especially hard hit by the collapse in high-tech stocks. For much of the 1990s the rapid rise of the TSX had almost wholly been attributed to two stocks: Nortel and BCE. Both companies were hard hit by the downturn, especially Nortel, which was forced to lay off much of its workforce. The events of September 11 also hurt the Canadian stock markets and were especially devastating to the already troubled airline sector.

However in the wider economy, Canada was surprisingly unhurt by these events. While growth slowed, the economy never actually entered a recession. This was the first time that Canada had avoided following the United States into an economic downturn. The rate of job creation in Canada continued at the rapid pace of the 1990s. A number of explanations have been advanced to explain this. Canada was not as directly affected by 9/11 and the subsequent wars, and the downward pressure of these events was more muted. Canada's fiscal management during the period has been praised as the federal government continued to bring in large surpluses throughout this period, in sharp contrast to the United States. Unlike the United States no major tax cuts or major new expenditures were introduced. However, during this time, Canada did pursue an expansionary monetary policy in an effort to reduce the effects of a possible recession. Many provincial governments suffered greater problems with a number of them returning to deficits, which was blamed on the fiscal imbalance. 2003 saw elections in six Canadian provinces and in only one did the governing party not lose seats.

2.3.12.3) Russia

The Soviet Union's last year of economic growth was 1989, and throughout the 1990s, recession ensued in the Former Soviet Republics. In May 1998, following the 1997 crash of the East Asian economy, things began to get even worse in Russia. In August 1998, the value of the ruble fell 34% and people clamored to get their money out of banks (see 1998 Russian financial crisis). The government acted by dragging its feet on privatization programs. Russians responded to this situation with approval by electing the more pro-dirigist and less liberal Vladimir Putin as

President in 2000. Putin proceeded to reassert the role of the federal government, and gave it power it had not seen since the Soviet era. State-run businesses were used to out-compete some of the more wealthy rivals of Putin. Putin's policies were popular with the Russian people, gaining him re-election in 2004. At the same time, the export-oriented Russian economy enjoyed considerable influx of foreign currency thanks to rising worldwide oil prices (from $15 per barrel in early 1999 to an average of $30 per barrel during Putin's first term). The early 2000s recession was avoided in Russia due to rebound in exports and, to some degree, a return to dirigisme.

2.3.12.4) Japan

Japan's recession, which started in the early 1990s, continued into the 2000s, with deflation being the main problem. Deflation began plaguing Japan in the fiscal year ending 1999, and by 2005 the yen had 103% of its 2000 buying power. The Bank of Japan attempted to cultivate inflation with high liquidity and a nominal 0% interest rate on loans. Other aspects of the Japanese economy were good during the early 2000s; unemployment remained relatively low, and China became somewhat dependent on Japanese exports. The bear market, however, continued in Japan despite the best efforts of the Bank.

2.3.12.5) European Union

Transition left the economy of the European Union in a cautiously optimistic state during the early 2000s. The most difficult years were 2000-2001, precipitating the worst years of the American recession. The European Union introduced a new currency on January 1, 1999. The euro, which was met with much anticipation, had its value immediately plummet, and it continued to be a weak currency throughout 2000 and 2001. Inflation struck the Eurozone for a few months in summer 2001 but the economy deflated within months. In 2002, the value of the euro began to rapidly rise (reaching parity with the US Dollar on July 15, 2002). This hurt business for companies based in Europe, as the profits made abroad (especially in the Americas) had an unfavorable exchange rate.

France and Germany both entered recession towards the end of 2001, but in May 2002 both countries declared that their recessions had ended after a mere six months each. However, some European Union countries - including the United Kingdom - managed to avoid sliding into recession during this period.

2.3.13) Argentine Crises

The Argentine economic crisis (1999–2002) was a major downturn in Argentina's economy. It began in 1999 with a decrease of real Gross Domestic Product (GDP). The crisis caused the fall of the government, default on the country's foreign debt, widespread unemployment, riots, the rise of alternative currencies and the end of the peso's fixed exchange rate to the US dollar.

By 2002 GDP growth had returned, surprising economists and the business media. As of 2012, the default had not been completely resolved, although the government had repaid its IMF loans in full. ( David Litterick (4 December 2001). "Argentinebonds slump to new lows". The Telegraph. )

2.3.13.1) Origins

Argentina's many years of military dictatorship (alternating with weak, short-lived democratic governments) caused significant economic problems. During the so-called National Reorganization Process (1976–1983), the country went into debt for never-finished projects, the Falklands War, and state takeover of private debts. The Neoliberal economic platform was introduced during this period. By the end of the military government the country's industries were severely affected—unemployment, calculated at 18% (though official figures claimed 5%), was at its highest point since the Great Depression.

In 1983, democracy was restored with the election of president Raúl Alfonsín. The new government intended to stabilize the economy and create a new currency (the austral, the first of its kind without peso in its name), for which new loans were required. The state eventually became unable to service this debt and confidence collapsed.

Inflation, which had stayed between 10 and 20% per month, spiraled out of control. In July 1989, Argentina saw 200% inflation for the month, peaking at 5,000% for the year. During the Alfonsin administration, unemployment did not substantially increase, but real wages fell by almost half (to the lowest level in fifty years). Prices for state-run utilities, telephone service, and gas increased substantially. Amid riots, President Alfonsín resigned five months before the end of his term and President-elect Carlos Menem took office early. (Krauss, Clifford (10 June 2000). "One-DayNational Strike Freezes Much of Argentina (page 1 of 2)". The New York Times.Archived from the original on 24 September 2012. Retrieved 24 September 2012.)

2.3.13.2) 1990s

After a second bout of hyperinflation, Domingo Cavallo was appointed Minister of the Economy in late 1990.In 1991, he fixed the value of Argentine currency at ₳10,000 per U.S. dollar. Australs could be freely converted to dollars at banks. To secure this "convertibility" the Central Bank of Argentina had to keep its U.S. dollar foreign exchange reserves at the same level as the cash in circulation. The initial aim of such measures was to ensure the acceptance of domestic currency because, after the 1989 and 1990 hyperinflation, Argentinians had started to demand payment in U.S. dollars. This regime was later modified by a law (Ley de Convertibilidad) which restored the Argentine peso as the national currency.

The convertibility law reduced inflation sharply and thereafter preserved the value of the currency. This raised the quality of life for many citizens who could again

afford to travel abroad, buy imported goods or ask for credit in dollars at traditional interest rates.

Argentina still had external public debt that it needed to roll over.

The fixed exchange rate reduced the cost of imports, which produced a flight of dollars from the country, as well as the progressive loss of industrial infrastructure and employment.

Government spending remained too high and corruption was rampant. Argentina's public debt grew enormously during the 1990s without showing that it could service the debt. The International Monetary Fund kept lending money to Argentina and extending its payment schedules. Massive tax evasion and money laundering contributed to the movement of funds toward offshore banks. A congressional committee started investigations in 2001 over accusations that Central Bank governor (Pedro Pou) and members of the board of directors had overlooked money laundering within Argentina's financial system. Clearstream was accused of being instrumental in this process.

Other Latin American countries, including Mexico and Brazil (both important trade partners for Argentina), faced economic crises of their own, leading to mistrust of the regional economy. The influx of foreign currency provided by the privatisation of state companies had ended. After 1999, Argentine exports were harmed by the devaluation of the Brazilian real and the dollar. A considerable international revaluation of the dollar directly weakened the peso relative to Argentina's trading partners: Brazil (30% of total trade flows) and the Euro area (23% of total trade flows).

By 1999, newly elected President Fernando de la Rúa faced a country with critically high unemployment and economic damage due to the continued borrowing. In 1999, Argentina's GDP dropped 4% and the country entered a three-year long recession. Economic stability became economic stagnation (even deflation at times) and the economic measures taken did nothing to avert it. The government continued its predecessor's economic policies. Devaluing the peso by abandoning the exchange peg was considered political suicide and a recipe for economic disaster. By the end of the century, complementary currencies had emerged. (ElCentral recuperó las reservas del pago al Fondo Monetario - lanacion.com".Lanacion.com.ar)

While the provinces had always issued complementary currency in the form of bonds and drafts to manage shortages of cash, the scale of such borrowing reached unprecedented levels during this period. This led to their being called "quasi-currencies". The strongest of them was Buenos Aires's Patacón. The national government issued its own quasi-currency—the LECOP.

In a 2001 interview, journalist Peter Katel identified three factors, converging at "the worst possible time", to explain why the Argentinian economy unraveled:

1. The fixed exchange rate between Argentine peso and the US dollar (created at the start of the 1990s by the Economy Minister at the time, Domingo Cavallo).

2. The large amounts of borrowing by former Argentine president, Carlos Menem.

3. An increase in debt due to reduced tax revenues.

2.3.13.3) Rates, riots, resignations and default

Since the early 1990s, Argentina had relied on the IMF to provide the country with reliable access to credit and to guide its economic reforms. When the recession began, the national deficit widened to 2.5% of GDP in 1999 and its external debt surpassed 50% of GDP. Seeing these levels as excessive, the IMF advised the government to balance its budget by implementing austerity measures to sustain investor confidence. The De la Rúa administration implemented US$1.4 billion in cuts in its first weeks in office in late 1999. In June 2000, with unemployment at 14% and projections of 3.5% GDP growth for the year, austerity was furthered by US$938 million in spending cuts and US$2 billion in tax increases. Following vice president Carlos Álvarez' resignation in October 2000 over bribery suspicions in the Upper House, the crisis accelerated.

GDP growth projections proved to be overly optimistic (instead of growing, real GDP shrank 0.8%), and lagging tax receipts prompted the government to freeze spending and cut retirement benefits again in November 2000.In early November, Standard & Poor's placed Argentina on a credit watch, and a treasury bill auction required paying 16% interest (up from 9% in July); this was the second highest rate of any country in South America at the time.

Rising bond yields forced the country to turn to major international lenders, such as the IMF, World Bank and the U.S. Treasury, which would lend to the government at below-market rates, and to comply with the accompanying conditions. Several more rounds of belt-tightening followed. José Luis Machinea resigned as Minister of Economy in February 2001. He was replaced with Ricardo López Murphy, who lasted 8 days in the office before being replaced with Cavallo. In July 2001, Standard and Poor's cut the credit rating of the country to B–

In July 2001 the government instituted an unpopular across-the-board pay cut of up to 13% to all civil servants and an equivalent cut to government pension benefits—De la Rúa's seventh austerity round triggering nationwide strikes and, starting in August, it paid salaries of the highest-paid employees in I.O.U.s instead of money.This further depressed the weakened economy. The unemployment rate rose to 16.4% in August 2001 up from a 14.7% a month earlier, and it reached 20% by December. In October 2001, public discontent with the economic conditions was expressed in the nationwide election. President Fernando de la Rúa's alliance lost

seats in both chambers of the Argentine National Congress, leaving it in the minority. Over 20% of voters chose to enter so-called "anger votes", returning blank or defaced ballots rather than indicate support of any candidate.

The crisis intensified when, on 5 December 2001, the IMF refused to release a US$1.3 billion tranche of its loan, citing the failure of the Argentinean government to reach previously agreed-upon budget deficit targets, and demanded further budget cuts, amounting to 10% of the federal budget. On 4 December, Argentinean bond yields stood at 34% over U.S. treasury bonds, and, by 11 December, the spread jumped to 42%.

By the end of November 2001, people began withdrawing large sums of dollars from their bank accounts, turning pesos into dollars and sending them abroad, causing a bank run. On 2 December 2001 the government enacted measures, informally known as the corralito, that effectively froze all bank accounts for twelve months, allowing for only minor sums of cash to be withdrawn, initially $250 a week.("Argentina Unraveling". The New York Times. 2001–12–21.)

2.3.13.4) December 2001 riots and political turmoil

The freeze enraged many Argentines who took to the streets of important cities, especially Buenos Aires. They engaged in protests that became known as cacerolazo (banging pots and pans). These protests occurred especially in 2001 and 2002. At first the cacerolazos were simply noisy demonstrations, but soon they included property destruction,often directed at banks, foreign-owned privatized companies, and especially big American and European companies.

Confrontations between the police and citizens became a common sight, and fires were set on Buenos Aires avenues. De la Rúa declared a state of emergency, but the situation worsened, precipitating the violent protests of 20 and 21 December 2001 in Plaza de Mayo, where clashes between demonstrators and the police ended up with several people dead, and precipitated the fall of the government. De la Rúa eventually fled the Casa Rosada in a helicopter on 21 December.

Following presidential succession procedures established in the Constitution, the Senate chairman was next in the line of succession in the absence of president and vice-president.[45] Accordingly, Ramón Puerta took office as a caretaker head of state, and the Legislative Assembly (a body formed by merging both chambers of the Congress) was convened. By law, the candidates were the members of the Senate plus the Governors of the Provinces; Adolfo Rodríguez Saá, then governor of San Luis, was eventually appointed as the new interim president.

2.3.13.4.1) Debt default

During the last week of 2001, the Rodriguez Saá government defaulted on the larger part of the public debt, totalling US$132 billion. The amount approximately represented one seventh of all the money borrowed by the Third World.

Politically, the most heated debate involved the date of the following elections—proposals ranged from March 2002 to October 2003 (the end of De la Rúa's term).

Rodríguez Saá's economic team came up with a scheme designed to preserve the convertibility regime, dubbed the "Third Currency" Plan. It consisted of creating a new, non-convertible currency called Argentino coexisting with convertible pesos and U.S. dollars. It would only circulate as cash (checks, promissory notes or other instruments could be denominated in pesos or dollars but not in Argentinos) and would be partially guaranteed with federally managed land—to counterbalance inflationary tendencies.

Argentinos having legal status would be used to redeem all complementary currency already in circulation—whose acceptance as a means of payment was quite uneven. It was hoped that convertibility would restore public confidence, while the non-convertible nature of this currency would allow for a measure of fiscal flexibility (unthinkable with pesos) that could ameliorate the crippling recession. Critics called this plan merely a "controlled devaluation"; its advocates countered that since controlling a devaluation is perhaps its thorniest issue, this criticism was a praise in disguise. The "Third Currency" plan had enthusiastic supporters among mainstream economists (the most well-known being perhaps Martín Redrado, a former central bank president) citing technical arguments. However, it was not implemented because the Rodríguez Saá government lacked the required political support.

Rodríguez Saá, lost the support of his own party and resigned before the end of the year. The Legislative Assembly convened again, appointing Peronist Eduardo Duhalde—then a Senator for the Buenos Aires province—in his place.

2.3.13.4.2) End of fixed exchange rate

After much deliberation, in January 2002 Duhalde abandoned the peso–dollar parity that had been in place for ten years. In a matter of days, the peso lost a large part of its value in the unregulated market. A provisional "official" exchange rate was set at 1.4 pesos per dollar.

In addition to the corralito, the Ministry of Economy dictated the pesificación, by which all bank accounts denominated in dollars would be converted to pesos at an official rate. This measure angered most savings holders and attempts were made to declare it unconstitutional.

After a few months, the exchange rate was left to float more or less freely. The peso further depreciated, which prompted increased inflation (since Argentina depended heavily on imports, and had no means to replace them locally at the time).

Inflation and unemployment worsened during 2002. By that time the exchange rate had reached nearly 4 pesos per dollar, while the accumulated inflation since the devaluation was about 80%; considerably less than predicted by most orthodox economists. The quality of life of the average Argentine was lowered proportionally; many businesses closed or went bankrupt, many imported products became virtually inaccessible, and salaries were left as they were before the crisis.

Since the supply of pesos did not meet the demand for cash (even after the devaluation) complementary currencies kept circulating alongside them. Fears of hyperinflation as a consequence of devaluation quickly eroded their attractiveness, originally stated in convertible pesos. Their acceptability now ultimately depended on the State's irregular willingness to take them as payment of taxes and other charges.

While the Patacón was frequently accepted at the same value as the peso, Entre Ríos's Federal was among the worst-faring, discounted by an average 30% as even the provincial government that had issued them was reluctant to accept them. There were also frequent rumors that the Government would simply banish complementary currency overnight (instead of redeeming them, even at disadvantageous rates), leaving their holders with useless printed paper.

2.3.13.4.3) immediate effects

Aerolíneas Argentinas was one of the most affected Argentine companies, canceling all international flights for various days in 2002. The airline came close to bankruptcy, but survived.

Several thousand newly homeless and jobless Argentines found work as cartoneros, or cardboard collectors. A 2003 estimated 30,000 to 40,000 people scavenged the streets for cardboard to sell to recycling plants. Such desperate measures were common given the unemployment rate of nearly 25%

Argentine agricultural products were rejected in some international markets, for fear they might arrive damaged by the chaos. The United States Department of Agriculture put restrictions on Argentine food and drug exports.

2.3.13.4.4) Recovery

Duhalde eventually stabilised the situation to a certain extent, and called for elections. On 25 May 2003, Néstor Kirchner took office as the new president. Kirchner kept Duhalde's Minister of Economy, Roberto Lavagna, in his post.

Lavagna, a respected economist with centrist views, showed a considerable aptitude at managing the crisis, with the help of heterodox measures.

The economic outlook was completely different from that of the 1990s; the devalued peso made Argentine exports cheap and competitive abroad and discouraged imports. In addition, the high price of soy in the international market produced massive amounts of foreign currency (with China becoming a major buyer of Argentina's soy products).

The government encouraged import substitution and accessible credit for businesses, staged an aggressive plan to improve tax collection, and allocated large sums for social welfare, while controlling expenditure in other fields.

The peso slowly rose, reaching a 3-to-1 rate to the dollar. Agricultural exports grew and tourism returned.

The huge trade surplus ultimately caused such an inflow of dollars that the government was forced to begin intervening to keep the peso from rising further, which would break the tax collection scheme (largely based on import taxes and royalties) and discourage further reindustrialisation. The central bank started rebuilding its dollar reserves.

By December 2005, foreign currency reserves had reached US$28 billion (they were later reduced by the payment of the full debt to the IMF in January 2006). The downside of this reserve accumulation strategy is that the dollars had to be bought with freshly issued pesos, which risked inflation. The central bank sterilized its purchases by selling Treasury letters. In this way the exchange rate stabilised near 3:1.

The currency exchange issue was complicated by two mutually opposing factors: a sharp increase in imports since 2004 (which raised the demand for dollars), and the return of foreign investment (which brought fresh currency from abroad) after the successful restructuring of about three quarters of the external debt. The government set up controls and restrictions aimed at keeping short-term speculative investment from destabilising financial markets.

Argentina's recovery suffered a minor setback in 2004 when rising industrial demand caused a short-lived energy crisis. Argentina managed to return to growth: GDP jumped 8.8% in 2003, 9.0% in 2004, 9.2% in 2005, 8.5% in 2006 and 8.7% in 2007. Though wages averaged a 17% annual increase from 2002-2008(jumping 25% in the year to May 2008), inflation ate away at these increases: 12.5% in 2005; 10% in 2006; nearly 15% in 2007 and over 20% during 2008. The government was accused of manipulating inflation statistics leading for example, The Economist magazine to turn to private sources instead. This prompted the government to increase export tariffs and to pressure retailers into one price freeze after another in a bid to stabilize prices, so far with little effect.

While unemployment has been considerably reduced (it hovered around 8.5% after 2006), Argentina has so far failed to reach an equitable distribution of income (the wealthiest 10% of the population receives 31 times more income than the poorest 10%). This level of inequality compares favorably to levels in most of Latin America.

2.3.13.4.5) Cooperatives

During the economic collapse, many business owners and foreign investors sent their money overseas. As a result, many small and medium enterprises closed due to lack of capital, thereby exacerbating unemployment. Many workers at these enterprises, faced with a sudden loss of employment and no source of income, decided to reopen the closed facilities on their own, as self-managed cooperatives.

Worker managed cooperative businesses include ceramics factory Zanon (FaSinPat), to the four-star Hotel Bauen, to suit factory Brukman, to printing press Chilavert, and many others. In some cases, former owners sent police to remove workers from these workplaces; this was sometimes successful but in other cases workers defended occupied workplaces against the state, the police and the bosses.

A survey by an Buenos Aires newspaper found that around 1/3 of the population had participated in general assemblies. The assemblies used to take place in street corners and public spaces, and generally discussed ways of helping each other in the face of eviction, or organizing around issues such as health care, collective food buying, or food distribution programs. Some assemblies created new structures of health care and schooling. Neighborhood assemblies met once a week in a large assembly to discuss issues affecting the larger community In 2004, a documentary covering these events was released.

Some businesses were legally purchased by the workers for nominal fees, while others remain occupied by workers who have no legal standing (and in some cases reject negotiations). The Argentine government is considering a Law of Expropriation that would transfer some occupied businesses to their worker-managers.

2.3.13.5) Effects on wealth distribution

Although GDP grew consistently and quickly after 2003, it only reached the levels of 1998 (the last year before the recession) in late 2004. Other macroeconomic indicators followed suit. A study by Equis, an independent counseling organization, found out that two measures of economic inequality, the Gini coefficient and the wealth gap between the 10% poorest and the 10% richest among the population, grew continuously since 2001, and decreased for the first time in March 2005.

2.3.13.6) Debt restructuring

When the default was declared in 2002, foreign investment stopped and capital flow ceased almost completely. The Argentine government faced severe challenges trying to refinance its debt.

The government reached an agreement in 2005 by which 76% of the defaulted bonds were exchanged for others, with a nominal value of 25–35% of the original and at longer terms. In 2008, President Cristina Fernández de Kirchner announced she was studying a reopening of the negotiations to gain agreement from the remaining 24% of the debt.

2.3.13.7) Criticism of the IMF

The International Monetary Fund accepted no discounts in its part of the Argentine debt. Some payments were refinanced or postponed on agreement. However, IMF authorities at times expressed harsh criticism of the discounts and actively lobbied for the private creditors.

In a speech before the United Nations General Assembly on September 21, 2004, President Kirchner said that "An urgent, tough, and structural redesign of the International Monetary Fund is needed, to prevent crises and help in [providing] solutions". Implicitly referencing the fact that the intent of the original Bretton Woods system was to encourage economic development, Kirchner warned that the IMF today must "change that direction, which took it from being a lender for development to a creditor demanding privileges".

During the weekend of October 1–2, 2004, at the annual meeting of the IMF/World Bank, leaders of the IMF, the European Union, the Group of Seven industrialised nations, and the Institute of International Finance (IIF), warned President Kirchner that Argentina had to come to an immediate debt-restructuring agreement with creditors, increase its primary budget surplus to slow debt increases, and impose structural reforms to prove to the world financial community that it deserved loans and investment.

In 2005, turned its primary surplus into an actual surplus, Argentina began paying the IMF on schedule, with the intention of regaining financial independence. On December 15, 2005, following a similar action by Brazil, President Kirchner suddenly announced that Argentina would pay the whole debt to the IMF. The debt payments, totaling 9.810 billion USD, were previously scheduled as installments until 2008. Argentina paid it with the central bank's foreign currency reserves. The payment was made on January 6, 2006.

In a June 2006 report, a group of independent experts hired by the IMF to revise the work of its Independent Evaluation Office (IEO) stated that the assessment of the Argentine case suffered from manipulation and lack of collaboration on the part of

the IMF; the IEO is claimed to have unduly softened its conclusions to avoid criticizing the IMF's board of directors

2.3.14) Bursting of dot-com bubble

The dot-com bubble (also referred to as the dot-com boom, the Internet bubble and the Information Technology Bubble[1]) was a historic speculative bubble covering roughly 1997 – 2000 (with a climax on March 10, 2000, with the NASDAQ peaking at 5132.52 in intraday trading before closing at 5048.62) during which stock markets in industrialized nations saw their equity value rise rapidly from growth in the Internet sector and related fields. While the latter part was a boom and bust cycle, the Internet boom is sometimes meant to refer to the steady commercial growth of the Internet with the advent of the World Wide Web, as exemplified by the first release of the Mosaic web browser in 1993, and continuing through the 1990s.

The period was marked by the founding (and, in many cases, spectacular failure) of a group of new Internet-based companies commonly referred to as dot-coms. Companies were seeing their stock prices shoot up if they simply added an "e-" prefix to their name and/or a ".com" to the end, which one author called "prefix investing".

A combination of rapidly increasing stock prices, market confidence that the companies would turn future profits, individual speculation in stocks, and widely available venture capital created an environment in which many investors were willing to overlook traditional metrics such as P/E ratio in favor of confidence in technological advancements.

The collapse of the bubble took place during 2000-2001. Some companies, such as Pets.com, failed completely. Others lost a large portion of their market capitalization but remained stable and profitable, e.g., Cisco, whose stock declined by 86%. Some later recovered and surpassed their dot-com-bubble peaks, e.g., Amazon.com, whose stock went from 107 to 7 dollars per share, but a decade later exceeded 200.

2.3.14.1) Bubble growth

Venture capitalists saw record-setting growth as dot-com companies experienced meteoric rises in their stock prices and therefore moved faster and with less caution than usual, choosing to mitigate the risk by starting many contenders and letting the market decide which would succeed. The low interest rates in 1998–99 helped increase the start-up capital amounts. A canonical "dot-com" company's business model relied on harnessing network effects by operating at a sustained net loss and to build market share (or mind share). These companies offered their services or end product for free with the expectation that they could build enough brand awareness to charge profitable rates for their services later. The motto "get big fast" reflected this strategy.

Soaring stocks

In financial markets, a stock market bubble is a self-perpetuating rise or boom in the share prices of stocks of a particular industry. The term may be used with certainty only in retrospect when share prices have since crashed. A bubble occurs when speculators note the fast increase in value and decide to buy in anticipation of further rises, rather than because the shares are undervalued. Typically many companies thus become grossly overvalued. When the bubble "bursts," the share prices fall dramatically, and many companies go out of business.

American news media, including respected business publications such as Forbes and the Wall Street Journal, encouraged the public to invest in risky companies, despite many of the companies' disregard for basic financial and even legal principles.

Andrew Smith has argued that the Financial Industry's handling of Initial Public offerings tended to benefit the banks and initial investors rather than the company itself. This is because company staff were typically barred from reselling their shares for a lock-in period of 12 to 18 months and so did not benefit from the common pattern of a huge short-lived spike in the share price on the day of the launch. By contrast, the financiers and other initial investors were typically entitled to sell at the peak price, and so could immediately profit from short-term price rises. Smith argues that the high profitability of the IPOs to Wall Street was a significant factor the course of events of the bubble. He writes:

"...But did the kids [the often young dotcom entrepreneurs] dupe the establishment by drawing them into fake companies, or did the establishment dupe the kids by introducing them to Mammon and charging a commission on it?"

In spite of this, however, a few company founders made vast fortunes when their companies were bought out at an early stage in the dot-com stock market bubble. These early successes made the bubble even more buoyant. An unprecedented amount of personal investing occurred during the boom, and the press reported the phenomenon of people quitting their jobs to become full-time day traders.

According to dot-com theory, an Internet company's survival depended on expanding its customer base as rapidly as possible, even if it produced large annual losses. For instance, Google and Amazon did not see any profit in their first years. Amazon was spending on expanding customer base and alerting people to its existence and Google was busy spending on creating more powerful machine capacity to serve its expanding search engine. The phrase "Get large or get lost" was the wisdom of the day. At the height of the boom, it was possible for a promising dot-com to make an initial public offering (IPO) of its stock and raise a substantial amount of money even though it had never made a profit — or, in some cases, earned any revenue whatsoever. In such a situation, a company's lifespan was measured by its burn rate: that is, the rate at which a non-profitable company lacking a viable business model ran through its capital served as the metric.

Public awareness campaigns were one of the ways in which dot-coms sought to expand their customer bases. These included television ads, print ads, and targeting of professional sporting events. Many dot-coms named themselves with onomatopoeic nonsense words that they hoped would be memorable and not easily confused with a competitor. Super Bowl XXXIV in January 2000 featured 17 dot-com companies that each paid over $2 million for a 30-second spot. By contrast, in January 2001, just three dot-coms bought advertising spots during Super Bowl XXXV. In a similar vein, CBS-backed iWon.com gave away $10 million to a lucky contestant on an April 15, 2000 half-hour primetime special that was broadcast on CBS.

Not surprisingly, the "growth over profits" mentality and the aura of "new economy" invincibility led some companies to engage in lavish internal spending, such as elaborate business facilities and luxury vacations for employees. Executives and employees who were paid with stock options instead of cash became instant millionaires when the company made its initial public offering; many invested their new wealth into yet more dot-coms.

Cities all over the United States sought to become the "next Silicon Valley" by building network-enabled office space to attract Internet entrepreneurs. Communication providers, convinced that the future economy would require ubiquitous broadband access, went deeply into debt to improve their networks with high-speed equipment and fiber optic cables. Companies that produced network equipment like Nortel Networks were irrevocably damaged by such over-extension; Nortel declared bankruptcy in early 2009. Companies like Cisco, which did not have any production facilities, but bought from other manufacturers, were able to leave quickly and actually do well from the situation as the bubble burst and products were sold cheaply.

In the struggle to become a technology hub, many cities and states used tax money to fund technology conference centers, advanced infrastructure, and created favorable business and tax law to encourage development of the dot com industry in their locale. Virginia's "Technology Corridor" is a prime example of this activity. Large quantities of high speed fiber links were laid, and the State and local governments gave tax exemptions to technology firms. Many of these buildings could be viewed along I-495, after the burst, as vacant office buildings.

Similarly, in Europe the vast amounts of cash the mobile operators spent on 3G licences in Germany, Italy, and the United Kingdom, for example, led them into deep debt. The investments were far out of proportion to both their current and projected cash flow, but this was not publicly acknowledged until as late as 2001 and 2002. Due to the highly networked nature of the IT industry, this quickly led to problems for small companies dependent on contracts from operators. One example is of a then Finnish mobile network company Sonera, which paid huge sums in German broadband auction then dubbed as 3G licenses. 3rd generation networks however

took years to catch on and Sonera ended up as a part of TeliaSonera, then simply Telia.

2.3.14.2) The bubble bursts

The technology-heavy NASDAQ Composite index peaked at 5,048 in March 2000, reflecting the high point of the dot-com bubble.

Over 1999 and early 2000, the U.S. Federal Reserve increased interest rates six times, and the economy began to lose speed. The dot-com bubble burst, numerically, on Friday, March 10, 2000, when the technology heavy NASDAQ Composite index, peaked at 5,048.62 (intra-day peak 5,132.52), more than double its value just a year before. The NASDAQ fell slightly after that, but this was attributed to correction by most market analysts; the actual reversal and subsequent bear market may have been triggered by the adverse findings of fact in the United States v. Microsoft case which was being heard in federal court.The findings, which declared Microsoft a monopoly, were widely expected in the weeks before their release on April 3. The following day, April 4, the NASDAQ fell from 4,283 points to 3,649 and rebounded back to 4,223, forming an intraday chart that looked like a stretched V. At the time, this represented the most volatile day in the history of the NASDAQ.

On March 20, 2000, after the NASDAQ had lost more than 10 percent from its peak, financial magazine Barron's shocked the market with its cover story "Burning Up". Sean Parker stated: "During the next 12 months, scores of highflying Internet upstarts will have used up all their cash. If they can't scare up any more, they may be in for a savage shakeout. An exclusive survey of the likely losers." The article pointed out: "America's 371 publicly traded Internet companies have grown to the point that they are collectively valued at $1.3 trillion, which amounts to about 8% of the entire U.S. stock market."

By 2001, the bubble was deflating at full speed. A majority of the dot-coms ceased trading after burning through their venture capital, many having never made a profit. Investors often referred to these failed dot-coms as "dot-bombs."

2.3.14.3) Aftermath

On January 10, 2000, America Online, a favorite of dot-com investors and pioneer of dial-up Internet access, announced plans to merge with Time Warner, the world's largest media company, in the second-largest M&A transaction worldwide. The transaction has been described as "the worst in history". Within two years, boardroom disagreements drove out both of the CEOs who made the deal, and in October 2003 AOL Time Warner dropped "AOL" from its name.

Several communication companies could not weather the financial burden and were forced to file for bankruptcy. One of the more significant players, WorldCom, was found practicing illegal accounting practices to exaggerate its profits on a yearly basis. WorldCom's stock price fell drastically when this information went public, and it eventually filed the third-largest corporate bankruptcy in U.S. history. Other examples include NorthPoint Communications, Global Crossing, JDS Uniphase, XO Communications, and Covad Communications. Companies such as Nortel, Cisco and Corning were at a disadvantage because they relied on infrastructure that was never developed which caused the stock of Corning to drop significantly.

Many dot-coms ran out of capital and were acquired or liquidated; the domain names were picked up by old-economy competitors or domain name investors. Several companies and their executives were accused or convicted of fraud for misusing shareholders' money, and the U.S. Securities and Exchange Commission fined top investment firms like Citigroup and Merrill Lynch millions of dollars for misleading investors. Various supporting industries, such as advertising and shipping, scaled back their operations as demand for their services fell. A few large dot-com companies, such as Amazon.com and eBay, survived the turmoil and appear assured of long-term survival, while others such as Google have become industry-dominating mega-firms.

The stock market crash of 2000–2002 caused the loss of $5 trillion in the market value of companies from March 2000 to October 2002. The 9/11 terrorist destruction of the World Trade Center's Twin Towers, killing almost 700 employees of Cantor-Fitzgerald, accelerated the stock market drop; the NYSE suspended trading for four sessions. When trading resumed, some of it was transacted in temporary new locations.

More in-depth analysis shows that 90% of the dot-coms companies survived through 2004. With this, it is safe to assume that the assets lost from the Stock Market do not directly link to the closing of firms. More importantly, however, it can be concluded that even companies who were categorized as the "small players" were adequate enough to endure the destruction of the financial market during 2000-2002. Additionally, retail investors who felt burned by the burst transitioned their investment portfolios to more cautious positions.

Nevertheless, laid-off technology experts, such as computer programmers, found a glutted job market. University degree programs for computer-related careers saw a noticeable drop in new students. Anecdotes of unemployed programmers going back to school to become accountants or lawyers were common.

Turning to the long-term legacy of the bubble, Fred Wilson, who was a venture capitalist during it, said:

"A friend of mine has a great line. He says 'Nothing important has ever been built without irrational exuberance'. Meaning that you need some of this mania to cause

investors to open up their pocketbooks and finance the building of the railroads or the automobile or aerospace industry or whatever. And in this case, much of the capital invested was lost, but also much of it was invested in a very high throughput backbone for the Internet, and lots of software that works, and databases and server structure. All that stuff has allowed what we have today, which has changed all our lives. …that's what all this speculative mania built."

2.3.15) Financial Crises of 2007-08

The financial crisis of 2007–2008, also known as the Global Financial Crisis and 2008 financial crisis, is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s.[1] It resulted in the threat of total collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. In many areas, the housing market also suffered, resulting in evictions, foreclosures and prolonged unemployment. The crisis played a significant role in the failure of key businesses, declines in consumer wealth estimated in trillions of US dollars, and a downturn in economic activity leading to the 2008–2012 global recession and contributing to the European sovereign-debt crisis.[2][3] The active phase of the crisis, which manifested as a liquidity crisis, can be dated from August 7, 2007, when BNP Paribas terminated withdrawals from three hedge funds citing "a complete evaporation of liquidity".

The bursting of the U.S. housing bubble, which peaked in 2006, caused the values of securities tied to U.S. real estate pricing to plummet, damaging financial institutions globally. The financial crisis was triggered by a complex interplay of policies that encouraged home ownership, providing easier access to loans for subprime borrowers, overvaluation of bundled sub-prime mortgages based on the theory that housing prices would continue to escalate, questionable trading practices on behalf of both buyers and sellers, compensation structures that prioritize short-term deal flow over long-term value creation, and a lack of adequate capital holdings from banks and insurance companies to back the financial commitments they were making.Questions regarding bank solvency, declines in credit availability and damaged investor confidence had an impact on global stock markets, where securities suffered large losses during 2008 and early 2009. Economies worldwide slowed during this period, as credit tightened and international trade declined.Governments and central banks responded with unprecedented fiscal stimulus, monetary policy expansion and institutional bailouts. In the U.S., Congress passed the American Recovery and Reinvestment Act of 2009. In the EU, the UK responded with austerity measures of spending cuts and tax increases without export growth and it has since slid into a double-dip recession.

Many causes for the financial crisis have been suggested, with varying weight assigned by experts. The U.S. Senate's Levin–Coburn Report asserted that the crisis was the result of "high risk, complex financial products; undisclosed conflicts of interest; the failure of regulators, the credit rating agencies, and the market itself to

rein in the excesses of Wall Street." The 1999 repeal of the Glass-Steagall Act effectively removed the separation between investment banks and depository banks in the United States. Critics argued that credit rating agencies and investors failed to accurately price the risk involved with mortgage-related financial products, and that governments did not adjust their regulatory practices to address 21st-century financial markets. Research into the causes of the financial crisis has also focused on the role of interest rate spreads.

In the immediate aftermath of the financial crisis palliative fiscal and monetary policies were adopted to lessen the shock to the economy. In July 2010, the Dodd-Frank regulatory reforms were enacted to lessen the chance of a recurrence.

2.3.15.1) Background

The immediate cause or trigger of the crisis was the bursting of the United States housing bubble which peaked in approximately 2005–2006.Already-rising default rates on "subprime" andadjustable-rate mortgages (ARM) began to increase quickly thereafter. As banks began to give out more loans to potential home owners, housing prices began to rise.

Easy availability of credit in the US, fueled by large inflows of foreign funds after the Russian debt crisis and Asian financial crisis of the 1997–1998 period, led to a housing construction boom and facilitated debt-financed consumer spending. Lax lending standards and rising real estate prices also contributed to the Real estate bubble. Loans of various types (e.g., mortgage, credit card, and auto) were easy to obtain and consumers assumed an unprecedented debt load.

As part of the housing and credit booms, the number of financial agreements called mortgage-backed securities (MBS) and collateralized debt obligations (CDO), which derived their value from mortgage payments and housing prices, greatly increased. Such financial innovation enabled institutions and investors around the world to invest in the U.S. housing market. As housing prices declined, major global financial institutions that had borrowed and invested heavily in subprime MBS reported significant losses.

Falling prices also resulted in homes worth less than the mortgage loan, providing a financial incentive to enter foreclosure. The ongoing foreclosure epidemic that began in late 2006 in the U.S. continues to drain wealth from consumers and erodes the financial strength of banking institutions. Defaults and losses on other loan types also increased significantly as the crisis expanded from the housing market to other parts of the economy. Total losses are estimated in the trillions of U.S. dollars globally.

While the housing and credit bubbles were building, a series of factors caused the financial system to both expand and become increasingly fragile, a process called financialization. U.S. Government policy from the 1970s onward has emphasizedderegulation to encourage business, which resulted in less oversight of

activities and less disclosure of information about new activities undertaken by banks and other evolving financial institutions. Thus, policymakers did not immediately recognize the increasingly important role played by financial institutions such as investment banks and hedge funds, also known as the shadow banking system. Some experts believe these institutions had become as important as commercial (depository) banks in providing credit to the U.S. economy, but they were not subject to the same regulations.

These institutions, as well as certain regulated banks, had also assumed significant debt burdens while providing the loans described above and did not have a financial cushion sufficient to absorb large loan defaults or MBS losses. These losses impacted the ability of financial institutions to lend, slowing economic activity. Concerns regarding the stability of key financial institutions drove central banks to provide funds to encourage lending and restore faith in the commercial paper markets, which are integral to funding business operations. Governments also bailed out key financial institutions and implemented economic stimulus programs, assuming significant additional financial commitments.

The U.S. Financial Crisis Inquiry Commission reported its findings in January 2011. It concluded that "the crisis was avoidable and was caused by: Widespread failures in financial regulation, including the Federal Reserve’s failure to stem the tide of toxic mortgages; Dramatic breakdowns in corporate governance including too many financial firms acting recklessly and taking on too much risk; An explosive mix of excessive borrowing and risk by households and Wall Street that put the financial system on a collision course with crisis; Key policy makers ill prepared for the crisis, lacking a full understanding of the financial system they oversaw; and systemic breaches in accountability and ethics at all levels."

2.3.15.2) Subprime lending

During a period of intense competition between mortgage lenders for revenue and market share, and when the supply of creditworthy borrowers was limited, mortgage lenders relaxed underwriting standards and originated riskier mortgages to less creditworthy borrowers. In the view of some analysts, the relatively conservative Government Sponsored Enterprises (GSEs) policed mortgage originators and maintained relatively high underwriting standards prior to 2003. However, as market power shifted from securitizers to originators and as intense competition from private securitizers undermined GSE power, mortgage standards declined and risky loans proliferated. The worst loans were originated in 2004–2007, the years of the most intense competition between securitizers and the lowest market share for the GSEs.

2.3.15.3) U.S. subprime lending expanded dramatically 2004–2006

As well as easy credit conditions, there is evidence that competitive pressures contributed to an increase in the amount of subprime lending during the years preceding the crisis. Major U.S. investment banks and government sponsored

enterprises like Fannie Mae played an important role in the expansion of lending, with GSEs eventually relaxing their standards to try to catch up with the private banks. A contrarian view is that Fannie Mae and Freddie Mac led the way to relaxed underwriting standards, starting in 1995, by advocating the use of easy-to-qualify automated underwriting and appraisal systems, by designing the no-down payment products issued by lenders, by the promotion of thousands of small mortgage brokers, and by their close relationship to subprime loan aggregators such as Countrywide.

Depending on how “subprime” mortgages are defined, they remained below 10% of all mortgage originations until 2004, when they spiked to nearly 20% and remained there through the 2005–2006 peak of the United States housing bubble.

Some scholars, like American Enterprise Institute fellow Peter J. Wallison, believe that the roots of the crisis can be traced directly to affordable housing policies initiated by HUD in the 1990s and to massive risky loan purchases by government sponsored entities Fannie Mae and Freddie Mac. Based upon information in the SEC's December 2011 securities fraud case against 6 ex-executives of Fannie and Freddie, Peter Wallison and Edward Pinto have estimated that, in 2008, Fannie and Freddie held 13 million substandard loans totaling over $2 trillion.

The majority report of the Financial Crisis Inquiry Commission (written by the 6 Democratic appointees without Republican participation), studies by Federal Reserve economists, and the work of several independent scholars dispute Wallison's assertions. They note that GSE loans performed better than loans securitized by private investment banks, and performed better than some loans originated by institutions that held loans in their own portfolios. Paul Krugman has even claimed that the GSE never purchased subprime loans – a claim that is widely disputed.

On September 30, 1999, The New York Times reported that the Clinton Administration pushed for more lending to low and moderate income borrowers, while the mortgage industry sought guarantees for sub-prime loans:

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits. In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers... In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980s.

In 2001, the independent research company, Graham Fisher & Company, stated that HUD’s 1995 “National Homeownership Strategy: Partners in the American

Dream,” a 100-page affordable housing advocacy document, promoted “the relaxation of credit standards.”

In the early and mid-2000s (decade), the Bush administration called numerous times for investigation into the safety and soundness of the GSEs and their swelling portfolio of subprime mortgages. On September 10, 2003, the House Financial Services Committee held a hearing at the urging of the administration to assess safety and soundness issues and to review a recent report by the Office of Federal Housing Enterprise Oversight (OFHEO) that had uncovered accounting discrepancies within the two entities. The hearings never resulted in new legislation or formal investigation of Fannie Mae and Freddie Mac, as many of the committee members refused to accept the report and instead rebuked OFHEO for their attempt at regulation. Some believe this was an early warning to the systemic risk that the growing market in subprime mortgages posed to the U.S. financial system that went unheeded.

A 2000 United States Department of the Treasury study of lending trends for 305 cities from 1993 to 1998 showed that $467 billion of mortgage lending was made by Community Reinvestment Act(CRA)-covered lenders into low and mid level income (LMI) borrowers and neighborhoods, representing 10% of all U.S. mortgage lending during the period. The majority of these were prime loans. Sub-prime loans made by CRA-covered institutions constituted a 3% market share of LMI loans in 1998,[46] but in the run-up to the crisis, fully 25% of all sub-prime lending occurred at CRA-covered institutions and another 25% of sub-prime loans had some connection with CRA. In addition, an analysis by the Federal Reserve Bank of Dallas in 2009, however, concluded that the CRA was not responsible for the mortgage loan crisis, pointing out that CRA rules have been in place since 1995 whereas the poor lending emerged only a decade later. Furthermore, most sub-prime loans were not made to the LMI borrowers targeted by the CRA, especially in the years 2005–2006 leading up to the crisis. Nor did it find any evidence that lending under the CRA rules increased delinquency rates or that the CRA indirectly influenced independent mortgage lenders to ramp up sub-prime lending.

To other analysts the delay between CRA rule changes (in 1995) and the explosion of subprime lending is not surprising, and does not exonerate the CRA. They contend that there were two, connected causes to the crisis: the relaxation of underwriting standards in 1995 and the ultra-low interest rates initiated by the Federal Reserve after the terrorist attack on September 11, 2001. Both causes had to be in place before the crisis could take place. Critics also point out that publicly announced CRA loan commitments were massive, totaling $4.5 trillion in the years between 1994 and 2007. They also argue that the Federal Reserve’s classification of CRA loans as “prime” is based on the faulty and self-serving assumption: that high-interest-rate loans (3 percentage points over average) equal “subprime” loans.

Economist Paul Krugman argued in January 2010 that the simultaneous growth of the residential and commercial real estate pricing bubbles and the global nature of

the crisis undermines the case made by those who argue that Fannie Mae, Freddie Mac, CRA, or predatory lending were primary causes of the crisis. In other words, bubbles in both markets developed even though only the residential market was affected by these potential causes. In his Dissent to the Financial Crisis Inquiry Commission, Peter J. Wallison wrote: "It is not true that every bubble—even a large bubble—has the potential to cause a financial crisis when it deflates." Wallison notes that other developed countries had "large bubbles during the 1997–2007 period" but "the losses associated with mortgage delinquencies and defaults when these bubbles deflated were far lower than the losses suffered in the United States when the 1997–2007 [bubble] deflated." According to Wallison, the reason the U.S. residential housing bubble (as opposed to other types of bubbles) led to financial crisis was that it was supported by a huge number of substandard loans – generally with low or no downpayments.

Others have pointed out that there were not enough of these loans made to cause a crisis of this magnitude. In an article in Portfolio Magazine, Michael Lewis spoke with one trader who noted that "There weren’t enough Americans with [bad] credit taking out [bad loans] to satisfy investors' appetite for the end product." Essentially, investment banks and hedge funds used financial innovation to enable large wagers to be made, far beyond the actual value of the underlying mortgage loans, using derivatives called credit default swaps, collateralized debt obligations andsynthetic CDOs.

As of March 2011 the FDIC has had to pay out $9 billion to cover losses on bad loans at 165 failed financial institutions. The Congressional Budget Office estimated, in June 2011, that the bailout to Fannie Mae and Freddie Mac exceeds $300 billion (calculated by adding the fair value deficits of the entities to the direct bailout funds at the time).

2.3.15.4) Growth of the housing bubble

A graph showing the median and average sales prices of new homes sold in the United States between 1963 and 2008. Between 1997 and 2006, the price of the typical American house increased by 124%. During the two decades ending in 2001, the national median home price ranged from 2.9 to 3.1 times median household income. This ratio rose to 4.0 in 2004, and 4.6 in 2006. This housing bubble resulted in many homeowners refinancing their homes at lower interest rates, or financing consumer spending by taking out second mortgages secured by the price appreciation.

In a Peabody Award winning program, NPR correspondents argued that a "Giant Pool of Money" (represented by $70 trillion in worldwide fixed income investments) sought higher yields than those offered by U.S. Treasury bonds early in the decade. This pool of money had roughly doubled in size from 2000 to 2007, yet the supply of relatively safe, income generating investments had not grown as fast. Investment banks on Wall Street answered this demand with products such as the mortgage-

backed security and the collateralized debt obligation that were assigned safe ratings by the credit rating agencies.

In effect, Wall Street connected this pool of money to the mortgage market in the U.S., with enormous fees accruing to those throughout the mortgage supply chain, from the mortgage broker selling the loans, to small banks that funded the brokers and the large investment banks behind them. By approximately 2003, the supply of mortgages originated at traditional lending standards had been exhausted, and continued strong demand began to drive down lending standards.

The collateralized debt obligation in particular enabled financial institutions to obtain investor funds to finance subprime and other lending, extending or increasing the housing bubble and generating large fees. This essentially places cash payments from multiple mortgages or other debt obligations into a single pool from which specific securities draw in a specific sequence of priority. Those securities first in line received investment-grade ratings from rating agencies. Securities with lower priority had lower credit ratings but theoretically a higher rate of return on the amount invested.

By September 2008, average U.S. housing prices had declined by over 20% from their mid-2006 peak. As prices declined, borrowers with adjustable-rate mortgages could not refinance to avoid the higher payments associated with rising interest rates and began to default. During 2007, lenders began foreclosure proceedings on nearly 1.3 million properties, a 79% increase over 2006. This increased to 2.3 million in 2008, an 81% increase vs. 2007.By August 2008, 9.2% of all U.S. mortgages outstanding were either delinquent or in foreclosure. By September 2009, this had risen to 14.4%.

2.3.15.5) Easy credit conditions

Lower interest rates encouraged borrowing. From 2000 to 2003, the Federal Reserve lowered the federal funds rate target from 6.5% to 1.0%. This was done to soften the effects of the collapse of the dot-com bubble and the September 2001 terrorist attacks, as well as to combat a perceived risk of deflation. As early as 2002 it was apparent that credit was fueling housing instead of business investment as some economists went so far as to advocate that the Fed "needs to create a housing bubble to replace the Nasdaq bubble".

2.3.15.6) U.S. current account deficit.

Additional downward pressure on interest rates was created by the high and rising U.S. current account deficit, which peaked along with the housing bubble in 2006. Federal Reserve chairman Ben Bernanke explained how trade deficits required the U.S. to borrow money from abroad, in the process bidding up bond prices and lowering interest rates.

Bernanke explained that between 1996 and 2004, the U.S. current account deficit increased by $650 billion, from 1.5% to 5.8% of GDP. Financing these deficits

required the country to borrow large sums from abroad, much of it from countries running trade surpluses. These were mainly the emerging economies in Asia and oil-exporting nations. The balance of payments identity requires that a country (such as the U.S.) running a current account deficit also have a capital account (investment) surplus of the same amount. Hence large and growing amounts of foreign funds (capital) flowed into the U.S. to finance its imports.

All of this created demand for various types of financial assets, raising the prices of those assets while lowering interest rates. Foreign investors had these funds to lend either because they had very high personal savings rates (as high as 40% in China) or because of high oil prices. Ben Bernanke has referred to this as a "saving glut".

A flood of funds (capital or liquidity) reached the U.S. financial markets. Foreign governments supplied funds by purchasing Treasury bonds and thus avoided much of the direct impact of the crisis. U.S. households, on the other hand, used funds borrowed from foreigners to finance consumption or to bid up the prices of housing and financial assets. Financial institutions invested foreign funds in mortgage-backed securities.

The Fed then raised the Fed funds rate significantly between July 2004 and July 2006. This contributed to an increase in 1-year and 5-year adjustable-rate mortgage (ARM) rates, making ARM interest rate resets more expensive for homeowners. This may have also contributed to the deflating of the housing bubble, as asset prices generally move inversely to interest rates, and it became riskier to speculate in housing. U.S. housing and financial assets dramatically declined in value after the housing bubble burst.

2.3.15.7) Weak and fraudulent underwriting practices

Testimony given to the Financial Crisis Inquiry Commission by Richard M. Bowen III on events during his tenure as the Business Chief Underwriter for Correspondent Lending in the Consumer Lending Group for Citigroup (where he was responsible for over 220 professional underwriters) suggests that by the final years of the U.S. housing bubble (2006–2007), the collapse of mortgage underwriting standards was endemic. His testimony stated that by 2006, 60% of mortgages purchased by Citi from some 1,600 mortgage companies were "defective" (were not underwritten to policy, or did not contain all policy-required documents) – this, despite the fact that each of these 1,600 originators was contractually responsible (certified via representations and warrantees) that its mortgage originations met Citi's standards. Moreover, during 2007, "defective mortgages (from mortgage originators contractually bound to perform underwriting to Citi's standards) increased... to over 80% of production".

In separate testimony to Financial Crisis Inquiry Commission, officers of Clayton Holdings—the largest residential loan due diligence and securitization surveillance company in the United States and Europe—testified that Clayton's review of over 900,000 mortgages issued from January 2006 to June 2007 revealed that scarcely

54% of the loans met their originators’ underwriting standards. The analysis (conducted on behalf of 23 investment and commercial banks, including 7 "too big to fail" banks) additionally showed that 28% of the sampled loans did not meet the minimal standards of any issuer. Clayton's analysis further showed that 39% of these loans (i.e. those not meeting any issuer's minimal underwriting standards) were subsequently securitized and sold to investors.

There is strong evidence that the GSEs – due to their large size and market power – were far more effective at policing underwriting by originators and forcing underwriters to repurchase defective loans. By contrast, private securitizers have been far less aggressive and less effective in recovering losses from originators on behalf of investors.

2.3.15.8) Predatory lending

Predatory lending refers to the practice of unscrupulous lenders, enticing borrowers to enter into "unsafe" or "unsound" secured loans for inappropriate purposes. A classic bait-and-switch method was used by Countrywide Financial, advertising low interest rates for home refinancing. Such loans were written into extensively detailed contracts, and swapped for more expensive loan products on the day of closing. Whereas the advertisement might state that 1% or 1.5% interest would be charged, the consumer would be put into an adjustable rate mortgage (ARM) in which the interest charged would be greater than the amount of interest paid. This created negative amortization, which the credit consumer might not notice until long after the loan transaction had been consummated.

Countrywide, sued by California Attorney General Jerry Brown for "unfair business practices" and "false advertising" was making high cost mortgages "to homeowners with weak credit, adjustable rate mortgages (ARMs) that allowed homeowners to make interest-only payments". When housing prices decreased, homeowners in ARMs then had little incentive to pay their monthly payments, since their home equity had disappeared. This caused Countrywide's financial condition to deteriorate, ultimately resulting in a decision by the Office of Thrift Supervision to seize the lender.

Former employees from Ameriquest, which was United States' leading wholesale lender, described a system in which they were pushed to falsify mortgage documents and then sell the mortgages to Wall Street banks eager to make fast profits. There is growing evidence that such mortgage frauds may be a cause of the crisis.

2.3.15.9) Deregulation

Critics such as economist Paul Krugman and U.S. Treasury Secretary Timothy Geithner have argued that the regulatory framework did not keep pace with financial innovation, such as the increasing importance of the shadow banking system, derivatives and off-balance sheet financing. A recent OECD study[86]

suggest that bank regulation based on the Basel accords encourage unconventional business practices and contributed to or even reinforced the financial crisis. In other cases, laws were changed or enforcement weakened in parts of the financial system. Key examples include:

• Jimmy Carter's Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA) phased out a number of restrictions on banks' financial practices, broadened their lending powers, allowed credit unions and savings and loans to offer checkable deposits, and raised the deposit insurance limit from $40,000 to $100,000 (thereby potentially lessening depositor scrutiny of lenders' risk management policies.)

• In October 1982, U.S. President Ronald Reagan signed into law the Garn–St. Germain Depository Institutions Act, which provided for adjustable-rate mortgage loans, began the process of banking deregulation,[citation needed] and contributed to the savings and loan crisis of the late 1980s/early 1990s.

• In November 1999, U.S. President Bill Clinton signed into law the Gramm–Leach–Bliley Act, which repealed part of the Glass–Steagall Act of 1933. This repeal has been criticized for reducing the separation between commercial banks (which traditionally had fiscally conservative policies) and investment banks (which had a more risk-taking culture). However, the vast majority of failures were at institutions that were created by Glass-Steagall.

• In 2004, the U.S. Securities and Exchange Commission relaxed the net capital rule, which enabled investment banks to substantially increase the level of debt they were taking on, fueling the growth in mortgage-backed securities supporting subprime mortgages. The SEC has conceded that self-regulation of investment banks contributed to the crisis.

• Financial institutions in the shadow banking system are not subject to the same regulation as depository banks, allowing them to assume additional debt obligations relative to their financial cushion or capital base. This was the case despite the Long-Term Capital Management debacle in 1998, where a highly leveraged shadow institution failed with systemic implications.

• Regulators and accounting standard-setters allowed depository banks such as Citigroup to move significant amounts of assets and liabilities off-balance sheet into complex legal entities called structured investment vehicles, masking the weakness of the capital base of the firm or degree of leverage or risk taken. One news agency estimated that the top four U.S. banks will have to return between $500 billion and $1 trillion to their balance sheets during 2009. This increased uncertainty during the crisis regarding the financial position of the major banks. Off-balance sheet entities were also used by Enron as part of the scandal that brought down that company in 2001.

• As early as 1997, Federal Reserve chairman Alan Greenspan fought to keep the derivatives market unregulated. With the advice of the President's Working Group on Financial Markets, the U.S. Congress and President allowed the self-regulation of the over-the-counter derivatives market when they enacted the Commodity Futures Modernization Act of 2000. Derivatives such as credit default swaps (CDS) can be used to hedge or speculate against particular credit risks. The volume of CDS outstanding increased 100-fold from 1998 to 2008, with estimates of the debt covered by CDS contracts, as of November 2008, ranging from US$33 to $47 trillion. Total over-the-counter (OTC) derivative notional value rose to $683 trillion by June 2008. Warren Buffett famously referred to derivatives as "financial weapons of mass destruction" in early 2003.

2.3.15.10) Increased debt burden or over-leveraging

Leverage ratios of investment banks increased significantly 2003–07

Prior to the crisis, financial Institutions became highly leveraged, increasing their appetite for risky investments and reducing their resilience in case of losses. Much of this leverage was achieved using complex financial instruments such as off-balance sheet securitization and derivatives, which made it difficult for creditors and regulators to monitor and try to reduce financial institution risk levels. These instruments also made it virtually impossible to reorganize financial institutions in bankruptcy, and contributed to the need for government bailouts.

2.3.15.11) incorrect pricing of risk

A protester on Wall Street in the wake of the AIG bonus payments controversy is interviewed by news media. The pricing of risk refers to the incremental compensation required by investors for taking on additional risk, which may be measured by interest rates or fees. Several scholars have argued that a lack of transparency about banks' risk exposures prevented markets from correctly pricing risk before the crisis, enabled the mortgage market to grow larger than it otherwise would have, and made the financial crisis far more disruptive than it would have been if risk levels had been disclosed in a straightforward, readily understandable format.

For a variety of reasons, market participants did not accurately measure the risk inherent with financial innovation such as MBS and CDOs or understand its impact on the overall stability of the financial system. For example, the pricing model for CDOs clearly did not reflect the level of risk they introduced into the system. Banks estimated that $450bn of CDO were sold between "late 2005 to the middle of 2007"; among the $102bn of those that had been liquidated, JPMorgan estimated that the average recovery rate for "high quality" CDOs was approximately 32 cents on the dollar, while the recovery rate for mezzanine CDO was approximately five cents for every dollar.

Another example relates to AIG, which insured obligations of various financial institutions through the usage of credit default swaps. The basic CDS transaction involved AIG receiving a premium in exchange for a promise to pay money to party A in the event party B defaulted. However, AIG did not have the financial strength to support its many CDS commitments as the crisis progressed and was taken over by the government in September 2008. U.S. taxpayers provided over $180 billion in government support to AIG during 2008 and early 2009, through which the money flowed to various counterparties to CDS transactions, including many large global financial institutions.

The limitations of a widely used financial model also were not properly understood. This formula assumed that the price of CDS was correlated with and could predict the correct price of mortgage-backed securities. Because it was highly tractable, it rapidly came to be used by a huge percentage of CDO and CDS investors, issuers, and rating agencies.

As financial assets became more and more complex, and harder and harder to value, investors were reassured by the fact that both the international bond rating agencies and bank regulators, who came to rely on them, accepted as valid some complex mathematical models which theoretically showed the risks were much smaller than they actually proved to be.

Moreover, a conflict of interest between professional investment managers and their institutional clients, combined with a global glut in investment capital, led to bad investments by asset managers in over-priced credit assets. Professional investment managers generally are compensated based on the volume of client assets under management. There is, therefore, an incentive for asset managers to expand their assets under management in order to maximize their compensation. As the glut in global investment capital caused the yields on credit assets to decline, asset managers were faced with the choice of either investing in assets where returns did not reflect true credit risk or returning funds to clients. Many asset managers chose to continue to invest client funds in over-priced (under-yielding) investments, to the detriment of their clients, in order to maintain their assets under management. This choice was supported by a "plausible deniability" of the risks associated with subprime-based credit assets because the loss experience with early "vintages" of subprime loans was so low.

Despite the dominance of the above formula, there are documented attempts of the financial industry, occurring before the crisis, to address the formula limitations, specifically the lack of dependence dynamics and the poor representation of extreme events. The volume "Credit Correlation: Life After Copulas", published in 2007 by World Scientific, summarizes a 2006 conference held by Merrill Lynch in London where several practitioners attempted to propose models rectifying some of the copula limitations. See also the article by Donnelly and Embrechts and the book by Brigo, Pallavicini and Torresetti, that reports relevant warnings and research on CDOs appeared in 2006.

Mortgage risks were underestimated by every institution in the chain from originator to investor by underweighting the possibility of falling housing prices based on historical trends of the past 50 years. Limitations of default and prepayment models, the heart of pricing models, led to overvaluation of mortgage and asset-backed products and their derivatives by originators, securitizers, broker-dealers, rating-agencies, insurance underwriters and investors.

2.3.15.12) Boom and collapse of the shadow banking system

There is strong evidence that the riskiest, worst performing mortgages were funded through the "shadow banking system" and that competition from the shadow banking system may have pressured more traditional institutions to lower their own underwriting standards and originate riskier loans.

In a June 2008 speech, President and CEO of the New York Federal Reserve Bank Timothy Geithner—who in 2009 became Secretary of the United States Treasury—placed significant blame for the freezing of credit markets on a "run" on the entities in the "parallel" banking system, also called the shadow banking system. These entities became critical to the credit markets underpinning the financial system, but were not subject to the same regulatory controls. Further, these entities were vulnerable because of maturity mismatch, meaning that they borrowed short-term in liquid markets to purchase long-term, illiquid and risky assets. This meant that disruptions in credit markets would make them subject to rapid deleveraging, selling their long-term assets at depressed prices. He described the significance of these entities:

In early 2007, asset-backed commercial paper conduits, in structured investment vehicles, in auction-rate preferred securities, tender option bonds and variable rate demand notes, had a combined asset size of roughly $2.2 trillion. Assets financed overnight in triparty repo grew to $2.5 trillion. Assets held in hedge funds grew to roughly $1.8 trillion. The combined balance sheets of the then five major investment banks totaled $4 trillion. In comparison, the total assets of the top five bank holding companies in the United States at that point were just over $6 trillion, and total assets of the entire banking system were about $10 trillion. The combined effect of these factors was a financial system vulnerable to self-reinforcing asset price and credit cycles.

Paul Krugman, laureate of the Nobel Prize in Economics, described the run on the shadow banking system as the "core of what happened" to cause the crisis. He referred to this lack of controls as "malign neglect" and argued that regulation should have been imposed on all banking-like activity.

The securitization markets supported by the shadow banking system started to close down in the spring of 2007 and nearly shut-down in the fall of 2008. More than a third of the private credit markets thus became unavailable as a source of funds. According to the Brookings Institution, the traditional banking system does not have the capital to close this gap as of June 2009: "It would take a number of years of

strong profits to generate sufficient capital to support that additional lending volume." The authors also indicate that some forms of securitization are "likely to vanish forever, having been an artifact of excessively loose credit conditions."

2.3.15.13) Commodities boom

Rapid increases in a number of commodity prices followed the collapse in the housing bubble. The price of oil nearly tripled from $50 to $147 from early 2007 to 2008, before plunging as the financial crisis began to take hold in late 2008. Experts debate the causes, with some attributing it to speculative flow of money from housing and other investments into commodities, some to monetary policy, and some to the increasing feeling of raw materials scarcity in a fast growing world, leading to long positions taken on those markets, such as Chinese increasing presence in Africa.

An increase in oil prices tends to divert a larger share of consumer spending into gasoline, which creates downward pressure on economic growth in oil importing countries, as wealth flows to oil-producing states. A pattern of spiking instability in the price of oil over the decade leading up to the price high of 2008 has been recently identified. The destabilizing effects of this price variance has been proposed as a contributory factor in the financial crisis.

In testimony before the Senate Committee on Commerce, Science, and Transportation on June 3, 2008, former director of the CFTC Division of Trading & Markets (responsible for enforcement) Michael Greenberger specifically named the Atlanta-based Inter continental Exchange, founded by Goldman Sachs, Morgan Stanley and BP as playing a key role in speculative run-up of oil futures prices traded off the regulated futures exchanges in London and New York. However, the Inter continental Exchange (ICE) had been regulated by both European and U.S. authorities since its purchase of the International Petroleum Exchange in 2001. Mr Greenberger was later corrected on this matter.

2.3.15.14) Role of economic forecasting

The financial crisis was not widely predicted by mainstream economists, who instead spoke of the Great Moderation. A number of heterodox economists predicted the crisis, with varying arguments. Dirk Bezemer in his research credits (with supporting argument and estimates of timing) 12 economists with predicting the crisis: Dean Baker (US), Wynne Godley (UK), Fred Harrison (UK), Michael Hudson (US), Eric Janszen (US), Steve Keen (Australia), Jakob Brøchner Madsen & Jens Kjaer Sørensen (Denmark), Kurt Richebächer (US), Nouriel Roubini (US), Peter Schiff (US), and Robert Shiller (US). Examples of other experts who gave indications of a financial crisis have also been given. Not surprisingly, the Austrian economic school regarded the crisis as a vindication and classic example of a predictable credit-fueled bubble that could not forestall the disregarded but inevitable effect of an

artificial, manufactured laxity in monetary supply, a perspective that even former Fed Chair Alan Greenspan in Congressional testimony confessed himself forced to return to.

A cover story in BusinessWeek magazine claims that economists mostly failed to predict the worst international economic crisis since the Great Depression of 1930s. The Wharton School of the University of Pennsylvania's online business journal examines why economists failed to predict a major global financial crisis. Popular articles published in the mass media have led the general public to believe that the majority of economists have failed in their obligation to predict the financial crisis. For example, an article in the New York Times informs that economist Nouriel Roubini warned of such crisis as early as September 2006, and the article goes on to state that the profession of economics is bad at predicting recessions. According to The Guardian, Roubini was ridiculed for predicting a collapse of the housing market and worldwide recession, while The New York Times labelled him "Dr. Doom".

Shiller, an expert in housing markets, wrote an article a year before the collapse of Lehman Brothers in which he predicted that a slowing US housing market would cause the housing bubble to burst, leading to financial collapse. Schiff regularly appeared on television in the years before the crisis and warned of the impending real estate collapse.

Within mainstream financial economics, most believe that financial crises are simply unpredictable, following Eugene Fama's efficient-market hypothesis and the related random-walk hypothesis, which state respectively that markets contain all information about possible future movements, and that the movement of financial prices are random and unpredictable. Recent research casts doubt on the accuracy of "early warning" systems of potential crises, which must also predict their timing.

2.3.15.15) Impact on financial markets

2.3.15.15.1) US stock market

The US stock market peaked in October 2007, when the Dow Jones Industrial Average index exceeded 14,000 points. It then entered a pronounced decline, which accelerated markedly in October 2008. By March 2009, the Dow Jones average had reached a trough of around 6,600. Four years later, it hit an all-time high. It is probable, but debated, that the Federal Reserve's aggressive policy of quantitative easing spurred the partial recovery in the stock market.

Market strategist Phil Dow believes distinctions exist "between the current market malaise" and the Great Depression. He says the Dow Jones average's fall of more than 50% over a period of 17 months is similar to a 54.7% fall in the Great Depression, followed by a total drop of 89% over the following 16 months. "It's very troubling if you have a mirror image," said Dow. Floyd Norris, the chief financial correspondent of The New York Times, wrote in a blog entry in March 2009 that the decline has not been a mirror image of the Great Depression, explaining that

although the decline amounts were nearly the same at the time, the rates of decline had started much faster in 2007, and that the past year had only ranked eighth among the worst recorded years of percentage drops in the Dow. The past two years ranked third, however.

2.3.15.15.2) Financial institutions

The first notable event signaling a possible financial crisis occurred in the United Kingdom on August 9, 2007, when BNP Paribas, citing "a complete evaporation of liquidity", blocked withdrawals from three hedge funds. The significance of this event was not immediately recognized but soon led to a panic as investors and savers attempted to liquidate assets deposited in highly leveraged financial institutions.

The International Monetary Fund estimated that large U.S. and European banks lost more than $1 trillion on toxic assets and from bad loans from January 2007 to September 2009. These losses are expected to top $2.8 trillion from 2007 to 2010. U.S. banks losses were forecast to hit $1 trillion and European bank losses will reach $1.6 trillion. The International Monetary Fund (IMF) estimated that U.S. banks were about 60% through their losses, but British and eurozone banks only 40%.

One of the first victims was Northern Rock, a medium-sized British bank. The highly leveraged nature of its business led the bank to request security from the Bank of England. This in turn led to investor panic and a bank run in mid-September 2007. Calls by Liberal Democrat Treasury Spokesman Vince Cable to nationalise the institution were initially ignored; in February 2008, however, the British government (having failed to find a private sector buyer) relented, and the bank was taken into public hands. Northern Rock's problems proved to be an early indication of the troubles that would soon befall other banks and financial institutions.

Initially the companies affected were those directly involved in home construction and mortgage lending such as Northern Rock and Countrywide Financial, as they could no longer obtain financing through the credit markets. Over 100 mortgage lenders went bankrupt during 2007 and 2008. Concerns that investment bank Bear Stearns would collapse in March 2008 resulted in its fire-sale to JP Morgan Chase. The financial institution crisis hit its peak in September and October 2008. Several major institutions either failed, were acquired under duress, or were subject to government takeover. These included Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac, Washington Mutual, Wachovia, Citigroup, and AIG.

2.3.15.15.3) Credit markets and the shadow banking system

During September 2008, the crisis hit its most critical stage. There was the equivalent of a bank run on the money market mutual funds, which frequently invest in commercial paper issued by corporations to fund their operations and payrolls. Withdrawal from money markets were $144.5 billion during one week, versus $7.1 billion the week prior. This interrupted the ability of corporations to

rollover (replace) their short-term debt. The U.S. government responded by extending insurance for money market accounts analogous to bank deposit insurance via a temporary guarantee and with Federal Reserve programs to purchase commercial paper. The TED spread, an indicator of perceived credit risk in the general economy, spiked up in July 2007, remained volatile for a year, then spiked even higher in September 2008, reaching a record 4.65% on October 10, 2008.

In a dramatic meeting on September 18, 2008, Treasury Secretary Henry Paulson and Fed chairman Ben Bernanke met with key legislators to propose a $700 billion emergency bailout. Bernanke reportedly told them: "If we don't do this, we may not have an economy on Monday." The Emergency Economic Stabilization Act, which implemented the Troubled Asset Relief Program(TARP), was signed into law on October 3, 2008.

Economist Paul Krugman and U.S. Treasury Secretary Timothy Geithner explain the credit crisis via the implosion of the shadow banking system, which had grown to nearly equal the importance of the traditional commercial banking sector as described above. Without the ability to obtain investor funds in exchange for most types of mortgage-backed securities or asset-backed commercial paper, investment banks and other entities in the shadow banking system could not provide funds to mortgage firms and other corporations.

This meant that nearly one-third of the U.S. lending mechanism was frozen and continued to be frozen into June 2009. According to the Brookings Institution, the traditional banking system does not have the capital to close this gap as of June 2009: "It would take a number of years of strong profits to generate sufficient capital to support that additional lending volume." The authors also indicate that some forms of securitization are "likely to vanish forever, having been an artifact of excessively loose credit conditions." While traditional banks have raised their lending standards, it was the collapse of the shadow banking system that is the primary cause of the reduction in funds available for borrowing.

2.3.15.15.4) Wealth effects

There is a direct relationship between declines in wealth, and declines in consumption and business investment, which along with government spending represent the economic engine. Between June 2007 and November 2008, Americans lost an estimated average of more than a quarter of their collective net worth.[citation needed] By early November 2008, a broad U.S. stock index the S&P 500, was down 45% from its 2007 high. Housing prices had dropped 20% from their 2006 peak, with futures markets signaling a 30–35% potential drop. Total home equity in the United States, which was valued at $13 trillion at its peak in 2006, had dropped to $8.8 trillion by mid-2008 and was still falling in late 2008. Total retirement assets, Americans' second-largest household asset, dropped by 22%, from $10.3 trillion in 2006 to $8 trillion in mid-2008. During the same period, savings and investment assets (apart from retirement savings) lost $1.2 trillion and pension assets lost $1.3

trillion. Taken together, these losses total a staggering $8.3 trillion. Since peaking in the second quarter of 2007, household wealth is down $14 trillion.

Further, U.S. homeowners had extracted significant equity in their homes in the years leading up to the crisis, which they could no longer do once housing prices collapsed. Free cash used by consumers from home equity extraction doubled from $627 billion in 2001 to $1,428 billion in 2005 as the housing bubble built, a total of nearly $5 trillion over the period. U.S. home mortgage debt relative to GDP increased from an average of 46% during the 1990s to 73% during 2008, reaching $10.5 trillion.

To offset this decline in consumption and lending capacity, the U.S. government and U.S. Federal Reserve have committed $13.9 trillion, of which $6.8 trillion has been invested or spent, as of June 2009. In effect, the Fed has gone from being the "lender of last resort" to the "lender of only resort" for a significant portion of the economy. In some cases the Fed can now be considered the "buyer of last resort".

In November 2008, economist Dean Baker observed: "There is a really good reason for tighter credit. Tens of millions of homeowners who had substantial equity in their homes two years ago have little or nothing today. Businesses are facing the worst downturn since the Great Depression. This matters for credit decisions. A homeowner with equity in her home is very unlikely to default on a car loan or credit card debt. They will draw on this equity rather than lose their car and/or have a default placed on their credit record. On the other hand, a homeowner who has no equity is a serious default risk. In the case of businesses, their creditworthiness depends on their future profits. Profit prospects look much worse in November 2008 than they did in November 2007... While many banks are obviously at the brink, consumers and businesses would be facing a much harder time getting credit right now even if the financial system were rock solid. The problem with the economy is the loss of close to $6 trillion in housing wealth and an even larger amount of stock wealth.

At the heart of the portfolios of many of these institutions were investments whose assets had been derived from bundled home mortgages. Exposure to these mortgage-backed securities, or to the credit derivatives used to insure them against failure, caused the collapse or takeover of several key firms such as Lehman Brothers, AIG, Merrill Lynch, and HBOS.

2.3.15.15.5) European contagion

The crisis rapidly developed and spread into a global economic shock, resulting in a number of European bank failures, declines in various stock indexes, and large reductions in the market value of equities and commodities.

Both MBS and CDO were purchased by corporate and institutional investors globally. Derivatives such as credit default swaps also increased the linkage between large financial institutions. Moreover, the de-leveraging of financial institutions, as assets

were sold to pay back obligations that could not be refinanced in frozen credit markets, further accelerated the solvency crisis and caused a decrease in international trade.

World political leaders, national ministers of finance and central bank directors coordinated their efforts to reduce fears, but the crisis continued. At the end of October 2008 a currency crisis developed, with investors transferring vast capital resources into stronger currencies such as the yen, the dollar and the Swiss franc, leading many emergent economies to seek aid from the International Monetary Fund.

2.3.15.15.6) Effects on the global economy

A number of commentators have suggested that if the liquidity crisis continues, there could be an extended recession or worse. The continuing development of the crisis has prompted in some quarters fears of a global economic collapse although there are now many cautiously optimistic forecasters in addition to some prominent sources who remain negative. The financial crisis is likely to yield the biggest banking shakeout since the savings-and-loan meltdown. Investment bank UBS stated on October 6 that 2008 would see a clear global recession, with recovery unlikely for at least two years. Three days later UBS economists announced that the "beginning of the end" of the crisis had begun, with the world starting to make the necessary actions to fix the crisis: capital injection by governments; injection made systemically; interest rate cuts to help borrowers. The United Kingdom had started systemic injection, and the world's central banks were now cutting interest rates. UBS emphasized the United States needed to implement systemic injection. UBS further emphasized that this fixes only the financial crisis, but that in economic terms "the worst is still to come". UBS quantified their expected recession durations on October 16: the Eurozone's would last two quarters, the United States' would last three quarters, and the United Kingdom's would last four quarters. The economic crisis in Iceland involved all three of the country's major banks. Relative to the size of its economy, Iceland’s banking collapse is the largest suffered by any country in economic history.

At the end of October UBS revised its outlook downwards: the forthcoming recession would be the worst since the early 1980s recession with negative 2009 growth for the U.S., Eurozone, UK; very limited recovery in 2010; but not as bad as the Great Depression.

The Brookings Institution reported in June 2009 that U.S. consumption accounted for more than a third of the growth in global consumption between 2000 and 2007. "The US economy has been spending too much and borrowing too much for years and the rest of the world depended on the U.S. consumer as a source of global demand." With a recession in the U.S. and the increased savings rate of U.S. consumers, declines in growth elsewhere have been dramatic. For the first quarter of 2009, the annualized rate of decline in GDP was 14.4% in Germany, 15.2% in Japan, 7.4% in the UK, 18% in Latvia, 9.8% in the Euro area and 21.5% for Mexico.

Some developing countries that had seen strong economic growth saw significant slowdowns. For example, growth forecasts in Cambodia show a fall from more than 10% in 2007 to close to zero in 2009, and Kenya may achieve only 3–4% growth in 2009, down from 7% in 2007. According to the research by the Overseas Development Institute, reductions in growth can be attributed to falls in trade, commodity prices, investment and remittances sent from migrant workers (which reached a record $251 billion in 2007, but have fallen in many countries since). This has stark implications and has led to a dramatic rise in the number of households living below the poverty line, be it 300,000 in Bangladesh or 230,000 in Ghana.

The World Bank reported in February 2009 that the Arab World was far less severely affected by the credit crunch. With generally good balance of payments positions coming into the crisis or with alternative sources of financing for their large current account deficits, such as remittances, Foreign Direct Investment (FDI) or foreign aid, Arab countries were able to avoid going to the market in the latter part of 2008. This group is in the best position to absorb the economic shocks. They entered the crisis in exceptionally strong positions. This gives them a significant cushion against the global downturn. The greatest impact of the global economic crisis will come in the form of lower oil prices, which remains the single most important determinant of economic performance. Steadily declining oil prices would force them to draw down reserves and cut down on investments. Significantly lower oil prices could cause a reversal of economic performance as has been the case in past oil shocks. Initial impact will be seen on public finances and employment for foreign workers.

2.3.15.15.7) U.S. economic effects

The output of goods and services produced by labor and property located in the United States—decreased at an annual rate of approximately 6% in the fourth quarter of 2008 and first quarter of 2009, versus activity in the year-ago periods. 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 average hours per work week declined to 33, the lowest level since the government began collecting the data in 1964.Typical American families did not fare as well, nor did those "wealthy-but-not wealthiest" families just beneath the pyramid's top. On the other hand, half of the poorest families did not have wealth declines at all during the crisis. The Federal Reserve surveyed 4,000 households between 2007 and 2009, and found that the total wealth of 63 percent of all Americans 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.

2.3.15.16) Government responses

2.3.15.16.1) Emergency and short-term responses

The U.S. Federal Reserve and central banks around the world have taken steps to expand money supplies to avoid the risk of a deflationary spiral, in which lower wages and higher unemployment lead to a self-reinforcing decline in global

consumption. In addition, governments have enacted large fiscal stimulus packages, by borrowing and spending to offset the reduction in private sector demand caused by the crisis. The U.S. executed two stimulus packages, totaling nearly $1 trillion during 2008 and 2009. The U.S. Federal Reserve's new and expanded liquidity facilities were intended to enable the central bank to fulfill its traditional lender-of-last-resort role during the crisis while mitigating stigma, broadening the set of institutions with access to liquidity, and increasing the flexibility with which institutions could tap such liquidity.

This credit freeze brought the global financial system to the brink of collapse. The response of the Federal Reserve, the European Central Bank, and other central banks was immediate and dramatic. During the last quarter of 2008, these central banks purchased US$2.5 trillion of government debt and troubled private assets from banks. This was the largest liquidity injection into the credit market, and the largest monetary policy action, in world history. The governments of European nations and the USA also raised the capital of their national banking systems by $1.5 trillion, by purchasing newly issued preferred stock in their major banks. In October 2010, Nobel laureate Joseph Stiglitz explained how the U.S. Federal Reserve was implementing another monetary policy —creating currency— as a method to combat the liquidity trap. By creating $600 billion and inserting[clarification needed] this directly into banks, the Federal Reserve intended to spur banks to finance more domestic loans and refinance mortgages. However, banks instead were spending the money in more profitable areas by investing internationally in emerging markets. Banks were also investing in foreign currencies, which Stiglitz and others point out may lead to currency wars while China redirects its currency holdings away from the United States.

Governments have also bailed out a variety of firms as discussed above, incurring large financial obligations. To date, various U.S. government agencies have committed or spent trillions of dollars in loans, asset purchases, guarantees, and direct spending. For a summary of U.S. government financial commitments and investments related to the crisis, see CNN – Bailout Scorecard. Significant controversy has accompanied the bailout, leading to the development of a variety of "decision making frameworks", to help balance competing policy interests during times of financial crisis.

2.3.15.16.2) Regulatory proposals and long-term responses

Further information: Obama financial regulatory reform plan of 2009, Regulatory responses to the subprime crisis, and Subprime mortgage crisis solutions debate

United States President Barack Obama and key advisers introduced a series of regulatory proposals in June 2009. The proposals address consumer protection, executive pay, bank financial cushions or capital requirements, expanded regulation of the shadow banking system and derivatives, and enhanced authority for the Federal Reserve to safely wind-down systemically important institutions, among others. In January 2010, Obama proposed additional regulations limiting the ability

of banks to engage in proprietary trading. The proposals were dubbed "TheVolcker Rule", in recognition of Paul Volcker, who has publicly argued for the proposed changes.

The U.S. Senate passed a regulatory reform bill in May 2010, following the House which passed a bill in December 2009. These bills must now be reconciled. The New York Times provided a comparative summary of the features of the two bills, which address to varying extent the principles enumerated by the Obama administration.

For instance, the Volcker Rule against proprietary trading is not part of the legislation, though in the Senate bill regulators have the discretion but not the obligation to prohibit these trades.

European regulators introduced Basel III regulations for banks. It increased capital ratios, limits on leverage, narrow definition of capital (to exclude subordinated debt), limit counter-party risk, and new liquidity requirements. Critics argue that Basel III doesn’t address the problem of faulty risk-weightings. Major banks suffered losses from AAA-rated created by financial engineering (which creates apparently risk-free assets out of high risk collateral) that required less capital according to Basel II. Lending to AA-rated sovereigns has a risk-weight of zero, thus increasing lending to governments and leading to the next crisis. Johan Norberg argues that regulations (Basel III among others) have indeed led to excessive lending to risky governments (see European sovereign-debt crisis) and the ECB pursues even more lending as the solution.

2.3.15.16.3) United States Congress response

At least two major reports were produced by Congress: the Financial Crisis Inquiry Commission report, released January 2011, and a report by the United States Senate Homeland Security Permanent Subcommittee on Investigations entitled Wall Street and the Financial Crisis: Anatomy of a Financial Collapse (released April 2011).

• On December 11, 2009 – House cleared bill H.R.4173 – Wall Street Reform and Consumer Protection Act of 2009.

• On April 15, 2010 – Senate introduced bill S.3217 – Restoring American Financial Stability Act of 2010.

• On July 21, 2010 – the Dodd–Frank Wall Street Reform and Consumer Protection Act was enacted.