Case Study H Flashcards
(30 cards)
In 2007 how much of the UK economy is accounted for by the financial sector?
7%
Growth of financial services vs growth of economy from 1997-2007?
Financial services grows 6.1%/yr
Economy grows 3%/yr
2 legislations that allowed the UK financial services to grow?
Domestic legislation
European banking legislation
2 ways domestic legislation changed to allow the growth of financial services?
- 1986 financial services act removed restrictive practices on the LSE along with fixed fees and commissions
- also allowed foreign banks to become members of the LSE
How did the European banking legislation allow for growth of the financial services?
- 1989 and 1996 directives allowed banks to operate across the whole EU on the basis of one license
- banks from non member states could also use the system if they operate within Europe and many US and Japanese banks consequently used London as their ‘home’ European base
advantage of liberalisation of the financial services industry? How is this shown by a statistic?
Argued that competition in key markets like mortgages and business finance was lowering the costs of accessing external finance tf improving efficiency
shown by:
-1960s 70% of investment came from profits, by 1990s only 50% - additional amount came from financial services sector
2 disadvantages of liberalisation?
Reliance on borrowing -> volatile economy and lack of saving
Also lots of borrowed money going into property or consumption but overall business investment actually still quite low
Challenges of liberalisation? Why was this bad?
Financial markets becoming more opaque due to lots of transactions between and within financial institutions and also the growing complexity of financial products
This was bad because it left more scope for insiders to manipulate the system leading to financial scandals
Explain a policy response to the scandals of the 80s and 90s? Why did it fail? Why did no one really care?
Greater desire to regulate financial services -> Financial Services Authority (2000) but it wasn’t very good; didn’t want to over-regulate in case of loss of business
No one really cared because the city was doing so well anyway
Two industries driving rapid growth in UK 1990-2008? What 2 underlying problems were overlooked during this period? Why were they overlooked?
IT
Financial services
- in reality lots of growth due to cheap Chinese imports rather than investment
- also heavy reliance on cheap credit -> consumption property speculation
Overlooked due to the FMs but meant UK vulnerable to change
Explain the origin of the US housing market bubble 2001-07?
Decision of fed to ease credit in ‘01-02 -> a surge in lending in housing market (mortgage debt more than doubled from 1997-07) -> too many people with poor credit histories (subprime lending)
Explain how the US housing market bubble worsened?
The bundling of debt: banks started bundling low risk loans and high risk loans in securities packages (MBS)
Thought lenders would be okay even if risky borrowers defaulted since loans were secured on rising values of mortgaged properties (inflation on houses at greater than 15% per year) tf HUGE BUBBLE
Explain how the bubble led to the US Housing Slump ‘06-‘07?
Fed starts to worry about inflation as it spills over to commodities tf raise interest rates -> defaulting on loans of subprime borrowers
Explain the US housing crisis following the defaulting on loans in ‘06-07?
Defaulting -> reclaiming of houses -> huge increases in supply of houses -> house prices crashing -> this undermines collateral -> US financial institutions now holding assets with no value
From ‘06-10 how far did some house prices fall?
A third
Two reasons the US housing crisis spread?
Some European banks had invested directly in the US housing market
Many other banks and FIs held complex securitised products into which US housing debt had been bundled
What was the result of the US housing crisis spreading overseas?
Banks didn’t know who was most exposed to the risk tf no one wanted to lend to each other and so the international money market declines causing liquidity to dry up for firms and consumers too
Explain the bank run on Northern Rock in 2007 and how it was solved?
70% of their funding came from overseas borrowing tf as credit dries up people start queuing up to draw out their money in case they didn’t get it back tf gov steps in and guarantees depositors money
Explain the collapse of The Lehman Brothers in ‘07-08?
US government reluctant to bail out FIs (worried would promote irresponsible behaviour) -> collapse of LB -> panic on FMs -> policymakers act and gov’s and CBs have to underwrite financial services sector
Policy response to crash from British and US government?
British: nationalises RBS and Lloyds
US: gov puts together $700bn credit facility to buy up toxic assets
2 CB responses, also 1 from BofE and 1 from US fed?
2 generalised:
Interest rates slashed to zero
Banks engage in quantitative easing (buy up securities from commercial banks to free up liquidity)
BofE: buys lots of gov bonds
US fed: buys failing MBS
Did the policy response succeed?
Financial disaster is averted
Global recession BUT Recession isn’t too long
Lots of debt taken on by CBs and Govs BUT a lot of the assets bought up can eventually be sold at a profit tf not too bad
How much does the: Global economy contract? Global exports contact? UK economy contact (08-09)? RBS bank lose from 2008 to 2016?
3%
25%
6%
£58bn
2 lessons for Britain following the crash?
Economy was becoming too dependent on financial services and rebalancing tf needed
Regulation of the FS had been inadequate previously
