Financial Crises

Question 1

What is a financial crisis?

Answer 1

When some financial institutions or assets suddenly lose a large part of their nominal value

Question 2

What are economic crises?

Answer 2

Economic recessions, real effects on GDP, GDP growth and unemployment

Question 3

Name 3 things that lose nominal value in financial crises?

Answer 3

Stock prices, exchange rates, interest rates

Question 4

What is a banking crisis?

Answer 4

A crisis with its origin in bank distress

Question 5

2 ways a bank crisis can arise and definitions?

Answer 5

Credit crunch = financial institutions reluctant to lend due to insufficient funds available

Bank run = bank suffers rush of withdrawals from depositors due to low confidence

Question 6

Explain the process of a credit crunch?

Answer 6

Lack of lending -> lack of supply of funds -> increase in interest rates -> potential real effects (eg. Fall in I and C)

Question 7

Explain the process of a bank run?

Answer 7

Bank suffers rush of withdrawals from depositors due to low confidence

Question 8

Why do financial crises spread so quickly between banks?

Answer 8

They all have financial links between them

Question 9

2 policies to avoid banking crises and explanations of what they do?

Answer 9

1) deposit insurance - aims to eliminate depositors not trusting the bank tf prevents bank runs
2) promises of bail out - government gives/lends banks sufficient resources to survive the crisis

Question 10

How much is deposit insurance in the UK?

Answer 10

85K/person

Question 11

What are the consequences of promises of bail outs? 2 good, 2 bad?

Answer 11

Good:
Helps banks survive
Prevents crisis spreading

Bad:
Can cause moral hazard ‘too big to fail’
Debt crisis

Question 12

What is a stock market crisis?

Answer 12

A sudden decline of stock prices across a significant share of a stock market

Question 13

Where do stock markets come from?

Answer 13

Often result from a bubble which can originate from an overvalued asset on the market

Question 14

2 ways to avoid bubbles and explain how?

Answer 14

1) monitoring - deters unwanted activity, enhances information transparency
2) regulation - clear set rules by governments, defines and punishes criminal activity

Question 15

What is a currency crisis?

Answer 15

Crisis as a result of a country having to suddenly devalue its currency

Question 16

What types of exchange rate regimes will be worst affected by a currency crisis?

Answer 16

Fixed and pegged ER regimes

Question 17

How did the 07-08 financial crisis arise? What did it lead to? What were the consequences of it?

Answer 17

• overvaluing of bad mortgages -> bubble in property prices -> financial crisis
• financial crisis -> economic crisis
• economic crisis consequences: fall GDP, increase U, increase reliance from FI on public intervention, increase sovereign debt

Question 18

Briefly describe the Great Depression of 1929? How did it end?

Answer 18

Crash in US stock markets -> depression

Continues til WW2

Question 19

2 facts regarding unemployment and DJIA over the Great Depression?

Answer 19

DJIA lost 89% or value by 1932

Unemployment roughly 17% during 1930s

Question 20

Describe briefly the Mexican peso crisis?

Answer 20

A sudden devaluation of the Mexican currency in 1994

The largest non-military international commitment since the Marshall plan: a $50bn intervention by the US government, the IMF, the Bank of International Settlements and various other actors was required in the form of emergency loans

Question 21

Explain the Asian financial crisis of 1997? (What happened, how it spread, why it was so bad)

Answer 21

A build up of debt by the so-called Asian tigers led to severe pressure on their currencies, many of which operated according to a fixed exchange rate system

Began in Thailand but spread to regional neighbours

Dramatic falls in the value of the currencies of these countries led to unsustainable debt obligations since much of this debt was denominated in US$

Question 22

Explain an example of the government debt crisis? How does it worsen further?

Answer 22

Eurozone crisis: result of large national debt -> contractionary fiscal policy

Large national debt due to bail outs and overspending

Crisis worsens when gov. can’t repay its creditors tf increase interest rates due to defaulting risk tf problems worsens further (money dries up)

Question 23

Consequences of eurozone crisis?

Answer 23

Fall in welfare, fall in GDP, increase in tax, increase U, fall in growth

Question 24

3 factors correlating to financial crises? And explained?

Answer 24

1) deposit insurance: dummy variable, expected negative impact on likelihood of a crisis

2) bank capital+total reserves:total assets ratio
Highlights credit and liquidity risk
Negative impact on prob of crisis

3)non performing loans:total gross loans ratio
If large proportion of assets are underperforming this can indicate higher chance of crisis (if NPL more than double in a year alarm should be raised) +ve correlation

Question 25

See equation for prob. of banking crisis?

Answer 25

Now