Project Economic Crisis

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The University Democritus of Thrace

Economic Department

Evolution of economic systems

Financial crisis of 20072010 in US

Students: Giorgiana Anca

Marius Dumitrescu

- Komotini !"!-

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Table of contents

I. Introduction / 3

II. Background and causes / 4

##$"$ Gro%th of the housing &u&&le ' (##$$ Easy credit conditions ' )##$*$ Su&-prime lending ' +##$,$ redatory lending ' .##$($ Deregulation ' .

##$)$ #ncreased de&t &urden or over- leveraging ' "!##$+$ /inancial innovation and comple0ity ' ""##$.$ #ncorrect pricing of ris1 ' ""##$2$ 3oom and collapse of the shado% &an1ing system ' "##$"!$ 4ommodity &u&&le ' "*##$""$ Systemic crisis ' ",##$"$ 5ole of economic forecasting ' ",

III. Financial markets impacts / 15

###$"$ #mpacts on financial institutions ' "(###$$ 4redit mar1ets and the shado% &an1ing system ' ")###$*$ 6ealth effects ' "+

###$,$ Glo&al contagion ' ".IV. Effects on the global econom / 1!#7$"$ Glo&al effects ' "2#7$$ U$S$ economic effects ' !#7$*$ 8fficial economic pro9ections ' !

V. "esponses to financial crisis / #1

7$"$ Emergency and short-term responses ' " V.2. Regulatory proposals and long-ter responses ! 21

7$*$ u&lic outrage: 3u&&le Machines; and 7ampire S

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". "ntroduction

The financial crisis of 2007presentis a crisis triggered &y a li&ail out> of &an1s &y national governments and do%nturns in stoc1mar1ets around the %orld$ #n many areas= the housing mar1et has also suffered= resultingin numerous evictions= foreclosures and prolonged vacancies$ #t is considered &y manyeconomists to &e the %orst financial crisissince the Great Depressionof the "2*!s$ #tcontri&uted to the failure of 1ey &usinesses= declines in consumer %ealth estimated in thetrillions of U$S$ dollars= su&stantial financial commitments incurred &y governments=anda significant decline in economic activity$ Many causes have &een proposed= %ith varying

%eight assigned &y e0perts$ 3oth mar1et-&ased and regulatory solutions have &eenimplemented or are under consideration= %hile significant ris1s remain for the %orldeconomyover the !"!?!"" periods$ Although this economic period has at times &eenreferred to as >the Great 5ecession=> this same phrase has &een used to refer to everyrecession of the several preceding decades$

The collapse of a glo&al housing &u&&le= %hich pea1ed in the U$S$ in !!)=caused the values ofsecuritiestied to real estate pricingto plummet thereafter= damagingfinancial institutions glo&ally$ @uestions regarding &an1 solvency= declines in creditavaila&ility= and damaged investor confidence had an impact on glo&al stoc1 mar1ets=%here securities suffered large losses during late !!. and early !!2$ Economies

%orld%ide slo%ed during this period as credit tightened and international trade declined$4ritics argued that credit rating agenciesand investors failed to accurately price the ris1involved %ith mortgage-related financial products= and that governments did not ad9usttheir regulatory practices to address "st century financial mar1ets$ Governments andcentral &an1sresponded %ith unprecedented fiscal stimulus=monetary policye0pansion=and institutional&ailouts$

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"". #ac$ground and causes

The immediate cause or trigger of the crisis %as the &ursting of the United Stateshousing &u&&le %hich pea1ed in appro0imately !!(?!!)$ igh default rates on>su&prime> andad9usta&le rate mortgages BA5MC= &egan to increase

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provide funds to encourage lending and restore faith in the commercial papermar1ets=%hich are integral to funding &usiness operations$ Governments also &ailed out 1eyfinancial institutions and implemented economic stimulus programs= assuming significantadditional financial commitments$

"".1. %ro&t' of t'e 'ousing bubble

3et%een "22+ and !!)= the price of the typical American house increased &y",F$ During the t%o decades ending in !!"= the national median home price rangedfrom $2 to *$" times median household income$ This ratio rose to ,$! in !!,= and ,$) in!!)$ This housing &u&&leresulted in Giantool of Money> Brepresented &y H+! trillion in %orld%ide fi0ed income investmentsCsought higher yields than those offered &y U$S$ Treasury &onds early in the decade$/urther= this pool of money had roughly dou&led in sie from !!! to !!+= yet thesupply of relatively safe= income generating investments had not gro%n as fast$#nvestment &an1s on 6all Street ans%ered this demand %ith the M3S and 4D8= %hich%ere assigned saferatings&y the credit rating agencies$ #n effect= 6all Street connectedthis pool of money to the mortgage mar1et in the U$S$= %ith enormous fees accruing tothose throughout the mortgage supply chain= from the mortgage &ro1er selling the loans=to small &an1s that funded the &ro1ers= to the giant investment &an1s &ehind them$ 3yappro0imately !!*= the supply of mortgages originated at traditional lending standards

had &een e0hausted$ o%ever= continued strong demand for M3S and 4D8 &egan todrive do%n lending standards= as long as mortgages could still &e sold along the supplychain$ Eventually= this speculative &u&&le proved unsustaina&le$

The 4D8 in particular ena&led financial institutions to o&tain investor funds tofinance su&prime and other lending= e0tending or increasing the housing &u&&le andgenerating large fees$ A 4D8 essentially places cash payments from multiple mortgagesor other de&t o&ligations into a single pool= from %hich the cash is allocated to specificsecurities in a priority se

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increase vs$ !!+$ 3y August !!.= 2$F of all U$S$ mortgages outstanding %ere eitherdelin

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"".). Sub-prie lending

The term su&prime refers to the credit

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L&ad loans to satisfy investors appetite for the end product$> Essentially= investment&an1s and hedge funds used financial innovation to synthesie more loans usingderivatives$ >They %ere creating Lloans out of %hole cloth$ 8ne hundred times overNThats %hy the losses are so much greater than the loans$>

Economistaul Krugman argued in January !"! that the simultaneous gro%th ofthe residential and commercial real estate pricing &u&&les undermines the case made &ythose %ho argue that /annie Mae=/reddie Mac=45A or predatory lending %ere primarycauses of the crisis$ #n other %ords= &u&&les in &oth mar1ets developed even though onlythe residential mar1et %as affected &y these potential causes$

"".*. +redatory lending

redatory lending refers to the practice of unscrupulous lenders= to enter into

>unsafe> or >unsound> secured loans for inappropriate purposes$ A classic &ait-and-s%itchmethod %as used &y 4ountry%ide= advertising lo% interest rates for home refinancing$Such loans %ere %ritten into e0tensively detailed contracts= and s%apped for moree0pensive loan products on the day of closing$ 6hereas the advertisement might statethat "F or "$(F interest %ould &e charged= the consumer %ould &e put into an ad9usta&lerate mortgage BA5MC in %hich the interest charged %ould &e greater than the amount ofinterest paid$ This created negative amortiation= %hich the credit consumer might notnotice until long after the loan transaction had &een consummated$

4ountry%ide= sued &y 4alifornia Attorney General Jerry 3ro%n for >Unfair3usiness ractices> and >/alse Advertising> %as ma1ing high cost mortgages >to

homeo%ners %ith %ea1 credit= ad9usta&le rate mortgages BA5MsC that allo%edhomeo%ners to ma1e interest-only payments$>$ 6hen housing prices decreased=homeo%ners in A5Ms then had little incentive to pay their monthly payments= since theirhome e

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and off-&alance sheet financing$ #n other cases= la%s %ere changed or enforcement%ea1ened in parts of the financial system$ Key e0amples include:

#n 8cto&er "2.= resident 5onald 5eagan signed into a% the Garn-St$ Germain

Depository #nstitutions Act= %hich &egan the process of 3an1ing deregulation that

helped contri&ute to the savings and loan crises of the late .!Is'early 2!Is= and thefinancial crises of !!+-!"!$ #n ovem&er "222= resident 3ill 4linton signed into a% the Gramm-each-

3liley Act= %hich repealed part of the Glass-Steagall Actof "2**$ This repeal has&een criticied for reducing the separation &et%een commercial &an1s B%hichtraditionally had a conservative cultureC and investment &an1sB%hich had a moreris1-ta1ing cultureC$

#n !!,= the Securities and E0change 4ommission rela0ed the net capital rule=

%hich ena&led investment &an1s to su&stantially increase the level of de&t they%ere ta1ing on= fueling the gro%th in mortgage-&ac1ed securities supporting su&-prime mortgages$ The SE4 has conceded that self-regulation of investment &an1s

contri&uted to the crisis$ /inancial institutions in the shado% &an1ing systemare not su&9ect to the same

regulation as depository &an1s= allo%ing them to assume additional de&to&ligations relative to their financial cushion or capital &ase$ This %as the casedespite the ong-Term 4apital Managementde&acle in "22.= %here a highly-leveraged shado% institution failed %ith systemic implications$

5egulators and accounting standard-setters allo%ed depository &an1s such as

4itigroup to move significant amounts of assets and lia&ilities off-&alance sheetinto comple0 legal entities called structured investment vehicles= mas1ing the%ea1ness of the capital &ase of the firm or degree of leverageor ris1 ta1en$ 8nene%s agency estimated that the top four U$S$ &an1s %ill have to return &et%een

H(!! &illion and H" trillion to their &alance sheets during !!2$ This increaseduncertainty during the crisis regarding the financial position of the ma9or &an1s$8ff-&alance sheet entities %ere also used &y Enronas part of the scandal that&rought do%n that company in !!"$

As early as "22+= /ed 4hairman Alan Greenspan fought to 1eep the derivatives

mar1et unregulated$ 6ith the advice of the residentIs 6or1ing Group on/inancial Mar1ets=the U$S$ 4ongress and resident allo%ed the self-regulation ofthe over-the-counter derivatives mar1et %hen they enacted the 4ommodity/utures Moderniation Act of !!!$ Derivatives such as credit default s%apsB4DSC can &e used to hedge or speculate against particular credit ris1s$ Thevolume of 4DS outstanding increased "!!-fold from "22. to !!.= %ith estimates

of the de&t covered &y 4DS contracts= as of ovem&er !!.= ranging from USH**to H,+ trillion$ Total over-the-counter B8T4C derivative notional value rose toH).* trillion &y June !!.$ 6arren 3uffettfamously referred to derivatives as>financial %eapons of mass destruction> in early !!*$

2

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"".. "ncreased debt burden or o/er-le/eraging

U$S$ households and financial institutions &ecame increasingly inde&ted oroverleveragedduring the years preceding the crisis$ This increased their vulnera&ility tothe collapse of the housing &u&&le and %orsened the ensuing economic do%nturn$ Key

statistics include:

/ree cash used &y consumers from home e

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"".7. Financial inno/ation and copleity

The term financial innovation refers to the ongoing development of financialproducts designed to achieve particular client o&9ectives= such as offsetting a particularris1 e0posure Bsuch as the default of a &orro%erC or to assist %ith o&taining financing$

E0amples pertinent to this crisis included: the ad9usta&le-rate mortgageO the &undling ofsu&-prime mortgages into mortgage-&ac1ed securities BM3SC or collateralied de&to&ligations B4D8C for sale to investors= a type of securitiationO and a form of creditinsurance called credit default s%aps B4DSC$ The usage of these products e0pandeddramatically in the years leading up to the crisis$ These products vary in comple0ity andthe ease %ith %hich they can &e valued on the &oo1s of financial institutions$

4ertain financial innovation may also have the effect of circumventingregulations= such as off-&alance sheet financing that affects the leverage or capitalcushion reported &y ma9or &an1s$ /or e0ample= Martin 6olf %rote in June !!2: >$$$anenormous part of %hat &an1s did in the early part of this decade ? the off-&alance-sheet

vehicles= the derivatives and the Ishado% &an1ing systemI itself ? %as to find a %ay roundregulation$>

"".. "ncorrect pricing of ris$

The pricing of ris1 refers to the incremental compensation rehigh 4D8s has &een appro0imately * cents on the dollar= %hile the recoveryrate for meanine 4D8Is has &een appro0imately five cents for every dollar$ Thesemassive= practically unthin1a&le= losses have dramatically impacted the &alance sheets of&an1s across the glo&e= leaving them %ith very little capital to continue operations$

Another e0ample relates to A#G=%hich insured o&ligations of various financialinstitutions through the usage of credit default s%aps$ The &asic 4DS transactioninvolved A#G receiving a premium in e0change for a promise to pay money to party A inthe event party 3 defaulted$ o%ever= A#G did not have the financial strength to support

its many 4DS commitments as the crisis progressed and %as ta1en over &y thegovernment in Septem&er !!.$ U$S$ ta0payers provided over H".! &illion in governmentsupport to A#G during !!. and early !!2= through %hich the money flo%ed to variouscounterparties to 4DS transactions= including many large glo&al financial institutions$

The limitations of a %idely-used financial model also %ere not properlyunderstood$ This formula assumed that the price of 4DS %as correlated %ith and couldpredict the correct price of mortgage &ac1ed securities$ 3ecause it %as highly tracta&le= it

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rapidly came to &e used &y a huge percentage of 4D8 and 4DS investors= issuers= andrating agencies$ According to one %ired$com article:

Then the model fell apart$ 4rac1s started appearing early on= %hen financial mar1ets&egan &ehaving in %ays that users of iIs formula hadnIt e0pected$ The crac1s &ecame full-fledged canyons in !!.P%hen ruptures in the financial systemIs foundation s%allo%ed uptrillions of dollars and put the survival of the glo&al &an1ing system in serious peril$$$ iIsGaussian copulaformula %ill go do%n in history as instrumental in causing the unfathoma&lelosses that &rought the %orld financial system to its 1nees$

As financial assets &ecame more and more comple0= and harder and harder tovalue= investors %ere reassured &y the fact that &oth the international &ond ratingagencies and &an1 regulators= %ho came to rely on them= accepted as valid some comple0mathematical models %hich theoretically sho%ed the ris1s %ere much smaller than theyactually proved to &e in practice$ George Soros commented that >The super-&oom got outof hand %hen the ne% products &ecame so complicated that the authorities could nolonger calculate the ris1s and started relying on the ris1 management methods of the

&an1s themselves$ Similarly= the rating agencies relied on the information provided &y theoriginators of synthetic products$ #t %as a shoc1ing a&dication of responsi&ility$>

"".. #oo and collapse of t'e s'ado& ban$ing syste

#n a June !!. speech= resident and 4E8 of the Q /ederal 5eserve 3an1Timothy GeithnerP %ho in !!2 &ecame Secretary of the United States Treasury Pplaced significant &lame for the freeing of credit mar1ets on a >run> on the entities in the>parallel> &an1ing system= also called the shado% &an1ing system$ These entities &ecamecritical to the credit mar1ets underpinning the financial system= &ut %ere not su&9ect tothe same regulatory controls$ /urther= these entities %ere vulnera&le &ecause they&orro%ed short-term in licore of %hat happened> to cause the crisis$ e referred tothis lac1 of controls as >malign neglect$>

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As the shado% &an1ing system e0panded to rival or even surpass conventional &an1ing inimportance= politicians and government officials should have realied that they %ere re-creatingthe 1ind of financial vulnera&ility that made the Great Depression possi&lePand they shouldhave responded &y e0tending regulations and the financial safety net to cover these ne%institutions$ #nfluential figures should have proclaimed a simple rule: anything that does %hat a&an1 does= anything that has to &e rescued in crises the %ay &an1s are= should &e regulated li1e a

&an1$

"".10. 3oodity bubble

A commodity price &u&&le %as created follo%ing the collapse in the housing&u&&le$ The price of oilnearly tripled from H(! to H",+ from early !!+to !!.= &eforeplunging as the financial crisis &egan to ta1e hold in late !!.$ E0perts de&ate the causes=%hich include the flo% of money from housing and other investments into commoditiesto speculation and monetary policy or the increasing feeling of ra% materials scarcity in afast gro%ing %orld economy and thus positions ta1en on those mar1ets= such as 4hineseincreasing presence in Africa$ An increase in oil prices tends to divert a larger share ofconsumer spending into gasoline= %hich creates do%n%ard pressure on economic gro%thin oil importing countries= as %ealth flo%s to oil-producing states$

#n testimony &efore the Senate 4ommittee on 4ommerce= Science= andTransportation on June *= !!.= former director of the 4/T4 Division of Trading RMar1ets Bresponsi&le for enforcementC Michael Green&erger specifically named theAtlanta-&ased #ntercontinental E0change= founded &y Goldman Sachs= Morgan Stanleyand 3ritish etroleumas playing a 1ey role in the speculative run-up of oil futures pricestraded off the regulated futures e0changes in ondon and e% Qor1$ George Soros also

testified &efore the 4ommittee$

#t %as also noticed that a copper price &u&&le %as occurring at the same time asthe oil &u&&le$ 4opper traded at a&out H=(!! per tonnefrom "22! until "222= %hen it fellto a&out H"=)!!$ The price slump lasted until !!, %hich sa% a price surge that hadcopperreaching H+=!,! per tonne in !!.$ As of /e&ruary !"! copper %as trading ata&out H)=(!! per tonne and slo%ly falling$

ic1elprices &oomed in the late "22!Is= then the price of nic1el imploded fromaround H("=!!! '*)=+!! per metric tonin theMayof!!+to a&out H""=((!'.=*!! permetric ton in the Januaryof !!2$ rices %ere only 9ust starting to recover as of January

!"!= &ut most of AustraliaIs nic1el mines had gone &an1rupt &y the$ As the price for highgrade nic1el sulphateore recovered in !"!= so did theAustralianmining industry$

"*

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"".11. Systeic crisis

Another analysis= different from the mainstream e0planation= is that the financialcrisis is merely a symptom of another= deeper crisis= %hich is a systemic crisis ofcapitalism itself$ According to Samir Amin= an Egyptian Mar0ist economist= the constant

decrease in GD gro%th rates in 6estern countries since the early "2+!s created agro%ing surplus of capital %hich did not have sufficient profita&le investment outlets inthe real economy$ The alternative %as to place this surplus into the financial mar1et=%hich &ecame more profita&le than productive capital investment= especially %ithsu&seManagerIs capitalism> %hich he argues has replaced >o%nerIs capitalism=>meaning management runs the firm for its &enefit rather than for the shareholders=a variation on theprincipal-agent pro&lemO

3urgeoning e0ecutive compensationO

Managed earnings= mainly a focus on share price rather than the creation of

genuine valueO and The failure of gate1eepers= including auditors= &oards of directors= 6all Street

analysts= and career politicians$

"".12. Role of econoic forecasting

The financial crisis %as not %idely predicted &y mainstream economists= %hoinstead spo1e of The Great Moderation$ A num&er of heterodo0 economistspredicted thecrisis= %ith varying arguments$ Dir1 3eemer in his research credits B%ith supportingargument and estimates of timingC " economists %ith predicting the crisis: Dean 3a1erBUSC= 6ynne Godley BUSC= /red arrison BUKC= Michael udson BUSC= Eric JansenBUSC= Steve Keen BAustraliaC= Ja1o& 3rochner Madsen R Jens K9aer Sorensen

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BDenmar1C= Kurt 5iche&cher BUSC=ouriel 5ou&iniBUSC= eter SchiffBUSC= and 5o&ertShillerBUSC$ E0amples of other e0perts %ho gave indications of a financial crisis havealso &een given$

A cover story inBusiness(eekmagaine claims that economists mostly failed to

predict the %orst international economic crisis since the Great Depressionof "2*!s$ The6harton School of the University of ennsylvaniaIs online &usiness 9ournal e0amines%hy economists failed to predict a ma9or glo&al financial crisis$ opular articlespu&lished in the mass media have lead the general pu&lic to &elieve that the ma9ority ofeconomists have failed in their o&ligation to predict the financial crisis$ /or e0ample= anarticle in the e% Qor1 Times informs that economistouriel 5ou&ini%arned of suchcrisis as early as Septem&er !!)= and the article goes on to state that the profession ofeconomics is &ad at predicting recessions$ According to $he )uardian= 5ou&ini %asridiculed for predicting a collapse of the housing mar1et and %orld%ide recession= %hile$he %e& 'ork $imesla&elled him >Dr$ Doom>$

6ithin mainstream financial economics= most &elieve that financial crises aresimply unpredicta&le= follo%ing Eugene /amaIs efficient-mar1et hypothesis and therelated random-%al1 hypothesis= %hich state respectively that mar1ets contain allinformation a&out possi&le future movements= and that the movement of financial pricesare random and unpredicta&le$

""". Financial ar$ets ipacts

""".1. "pacts on financial institutions

The #nternational Monetary /und estimated that large U$S$ and European &an1slost more than H" trillion on to0ic assets and from &ad loans from January !!+ toSeptem&er !!2$ These losses are e0pected to top H$. trillion from !!+-"!$ U$S$ &an1s

losses %ere forecast to hit H" trillion and European &an1 losses %ill reach H"$) trillion$The #M/ estimated that U$S$ &an1s %ere a&out )! percent through their losses= &ut 3ritishand Euro one &an1s only ,! percent$

8ne of the first victims %as orthern 5oc1= a medium-sied 3ritish&an1$ Thehighly leveragednature of its &usiness led the &an1 to re

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initially ignoredO in /e&ruary !!.= ho%ever= the 3ritish government Bhaving failed tofind a private sector &uyerC relented= and the &an1 %as ta1en into pu&lic hands$ orthern5oc1Is pro&lemsproved to &e an early indication of the trou&les that %ould soon &efallother &an1s and financial institutions$

#nitially the companies affected %ere those directly involved in home constructionand mortgage lending such as orthern 5oc1 and 4ountry%ide /inancial= as they couldno longer o&tain financing through the credit mar1ets$ 8ver "!! mortgage lenders %ent&an1rupt during !!+ and !!.$ 4oncerns that investment &an1 3ear Stearns %ouldcollapse in March !!. resulted in its fire-sale to J Morgan 4hase$ The crisis hit its pea1in Septem&er and 8cto&er !!.$ Several ma9or institutions either failed= %ere ac

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This meant that nearly one-third of the U$S$ lending mechanism %as froen andcontinued to &e froen into June !!2$ According to the 3roo1ings #nstitution= thetraditional &an1ing system does not have the capital to close this gap as of June !!2: >#t%ould ta1e a num&er of years of strong profits to generate sufficient capital to supportthat additional lending volume$> The authors also indicate that some forms of

securitiation are >li1ely to vanish forever= having &een an artifact of e0cessively loosecredit conditions$> 6hile traditional &an1s have raised their lending standards= it %as thecollapse of the shado% &an1ing system that is the primary cause of the reduction in fundsavaila&le for &orro%ing$

""".). 4ealt' effects

There is a direct relationship &et%een declines in %ealth= and declines inconsumption and &usiness investment= %hich along %ith government spending represent

the economic engine$ 3et%een June !!+ and ovem&er !!.= Americans lost anestimated average of more than a lender oflast resort> to the >lender of only resort> for a significant portion of the economy$ #n somecases the /ed can no% &e considered the >&uyer of last resort$>

Economist Dean 3a1ere0plained the reduction in the availa&ility of credit this%ay:

"+

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Qes= consumers and &usinesses canIt get credit as easily as they could a year ago$ There isa really good reason for tighter credit$ Tens of millions of homeo%ners %ho had su&stantial e

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"V. (ffects on t'e global econoy

"V.1. %lobal effects

A num&er of commentators have suggested that if the li of the crisis had&egun= %ith the %orld starting to ma1e the necessary actions to fi0 the crisis: capital

in9ection &y governmentsO in9ection made systemicallyO interest rate cuts to help&orro%ers$ The United Kingdom had started systemic in9ection= and the %orldIs central&an1s %ere no% cutting interest rates$ U3S emphasied the United States needed toimplement systemic in9ection$ U3S further emphasied that this fi0es only the financialcrisis= &ut that in economic terms >the %orst is still to come>$ U3S

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investment and remittances sent from migrant %or1ers B%hich reached a record H("&illion in !!+= &ut have fallen in many countries sinceC$

3y March !!2= the Ara& %orldhad lost H* trillion due to the crisis$ #n April!!2= unemployment in the Ara& %orld is said to &e a Itime &om&I$ #n May !!2= the

United ations reported a drop in foreign investment in Middle-Eastern economies due toa slo%er rise in demand for oil$ #n June !!2= the 6orld 3an1 predicted a tough year forAra& states$ #n Septem&er !!2= Ara& &an1s reported losses of nearly H, &illion since theonset of the glo&al financial crisis$

"V.2. U.S. econoic effects

5eal gross domestic productP the output of goods and services produced &yla&or and property located in the United States P decreased at an annual rate of

appro0imately ) percent in the fourth for their economies$

The U$S$ /ederal 5eserve 8pen Mar1et 4ommittee release in June !!2 stated:

$$$the pace of economic contraction is slo%ing$ 4onditions in financial mar1ets havegenerally improved in recent months$ ousehold spending has sho%n further signs ofsta&iliing &ut remains constrained &y ongoing 9o& losses= lo%er housing %ealth= andtight credit$ 3usinesses are cutting &ac1 on fi0ed investment and staffing &ut appear to &ema1ing progress in &ringing inventory stoc1s into &etter alignment %ith sales$ Althougheconomic activity is li1ely to remain %ea1 for a time= the 4ommittee continues toanticipate that policy actions to sta&ilie financial mar1ets and institutions= fiscal andmonetary stimulus= and mar1et forces %ill contri&ute to a gradual resumption of

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sustaina&le economic gro%th in a conte0t of price sta&ility$ Economic pro9ections fromthe /ederal 5eserve and 5eserve 3an1 residents include a return to typical gro%thlevels BGDC of -*F in !"!O an unemployment plateau in !!2 and !"! around "!F%ith moderation in !""O and inflation that remains at typical levels around "-F$

V. Responses to financial crisis

V.1. (ergency and s'ort-ter responses

The U$S$ /ederal 5eserveand central &an1s around the %orld have ta1en steps toe0pand money supplies to avoid the ris1 of a deflationary spiral= in %hich lo%er %agesand higher unemployment lead to a self-reinforcing decline in glo&al consumption$ #naddition= governments have enacted large fiscal stimulus pac1ages= &y &orro%ing andspending to offset the reduction in private sector demand caused &y the crisis$ The U$S$e0ecuted t%o stimulus pac1ages= totaling nearly H" trillion during !!. and !!2$

This credit freee &rought the glo&al financial system to the &rin1 of collapse$ Theresponse of the U$S$ /ederal 5eserve= theEuropean 4entral 3an1=and other central &an1s%as immediate and dramatic$ During the last

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&an1ing system and derivatives= and enhanced authority for the /ederal 5eserveto safely%ind-do%n systemically important institutions= among others$ #n January !"!= 8&amaproposed additional regulations limiting the a&ility of &an1s to engage in proprietarytrading$ The proposals %ere du&&ed >The 7olc1er 5ule>= in recognition of aul 7olc1er=%ho has pu&licly argued for the proposed changes$

A variety of regulatory changes have &een proposed &y economists= politicians=9ournalists= and &usiness leaders to minimie the impact of the current crisis and preventrecurrence$ o%ever= as of ovem&er !!2= many of the proposed solutions have not yet&een implemented$ These include:

3en 3ernan1e: Esta&lish resolution procedures for closing trou&led financial

institutions in the shado% &an1ing system= such as investment &an1s and hedgefunds$

Joseph Stiglit: 5estrict the leverage that financial institutions can assume$

5e Bi$e$= pay insurance premiums to the government during &oom periods= ine0change for payments during a do%nturn$C$

M Treasury: 4ontingent capital or capital insurance held &y the private sector

could supplement common e

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A$ Michael SpenceandGordon 3ro%n: Esta&lish an early-%arning system to help

detect systemic ris1$ iall /erguson and Jeffrey Sachs: #mpose haircuts on &ondholders and

counterparties prior to using ta0payer money in &ailouts$ #n other %ords=&ondholders %ith a claim of H"!! %ould have their claim reduced to H.!= creating

H! in eMain Street$> 8n the day it%as introduced= it had the support of representatives$

7olc1er 5ule - Bin USC - Endorsed &y resident 3arac1 8&amaon January "=

!"!$ At its heart= it is a proposal &y US economist aul 7olc1erto restrict &an1sfrom ma1ingspeculativeinvestments that do not &enefit their customers$ 7olc1erhas argued that such speculative activity played a 1ey role in the financial crisis of!!+?!"!$

V.). +ublic outrage 8#ubble 9ac'ines8 and 8Vapire S:uid8

The financial crises have provo1ed an outpouring of articles and &oo1s outside ofthe scholarly and financial press$ Most nota&le have &een articles and &oo1s &y author

6illiam Greider= economist Michael udson= author and former &ond salesman Michaele%is= 4ongressman 5on aul= author Kevin hillips= and 5olling Stone nationalcorrespondent Matt Tai&&i$ #n addition= a num&er of &logs e0perienced phenomenalgro%th= including The 3aseline Scenario &yJames K%a1and Simon Johnson= The 3igicture &y 3arry 5itholt= 4alculated 5is1&y 3ill Mc3ride= and ero edge&y >TylerDurden$>

*

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Matt Tai&&i in particular created an inflection point in popular perceptions of thecrises %ith his July !!2 article= >The Great American 3u&&le Machine: o% Goldman-Sachs &le% up the economy>= in %hich he descri&ed Goldman Sachs as >a great vampires

V". References

D%ight Merriam= artner= 5o&inson R 4ole= $he ause of the +ousing

Bubble the Burst and the "ecession Finall "e6ealed, It7s )ro&th 0anagement;2 ovem&er !!2 availa&le at http:''imla&log$%ordpress$com'!!2'""'!2'the-cause-of-the-housing-&u&&le-the-&urst-and-the-recession-finally-revealed-itFEF.!F22s-gro%th-management'O

Joe Kay ? 8 economic gro&th slo&s as housing bubble deflates9= . April

!!+= availa&le at 'ttp!!&&&.&s&s.org!articles!2007!apr2007!gdp-a2.s'tl O

$he :2; 8 Financial risis Background < Its )lobal Impact9 pu&lished in

AS 5evie% 8il Mar1et Trends= 2 Septem&er !!.= availa&le athttp:''%%%$all&usiness$com'&an1ing-finance'&an1ing-lending-credit-services-mortgage'""(2"+2)-"$htmlO

Anup Shah= )lobal Financial risis9= ( July !!2= availa&le at

'ttp!!&&&.globalissues.org!article!7!global-financial-crisis

http:''en$%i1ipedia$org'%i1i'/inancialVcrisisVofV!!+FEF.!F2*!"!