benjamin graham - dornsife.usc.edu · lecture 15: financial crises benjamin graham. what did the...

Financial Crises (2)

Benjamin Graham

Lecture 15: Financial Crises Benjamin Graham

So why did Thailand go down? •  Had lots of foreign currency reserves •  The peg should have been safe •  But the economy was small, so even “lots” of reserves as a

% of GDP were still not that much •  Banks were way over-leveraged • Had made a lot of bad loans

•  Running a current account deficit •  Inflow of capital made people feel rich -- consumption was

up •  Currency was pegged to the dollar, and the dollar was

appreciating compared to the Yen and other Asian currencies


What did the crisis do to the economy?


The Crisis Quickly Spread •  Malaysia, Indonesia, Korea, the Philippines •  Contagion: Crisis in Thailand causes investors to pull out of other

similar countries

• Research is expensive •  Investors take shortcuts • They look at what other people are doing, and they lump similar

countries together


Also Contagion in the Eurozone crisis • What did investors do when they sold all their Greek bonds during

the height of of the crisis? • A. Bought Spanish and Portuguese bonds instead • B. Sold all their Spanish and Portuguese bonds too • C. Took a “wait and see” approach to the rest of Europe

• Side note: During the Global Financial Crisis, investors pulled out of everywhere risky

• Looked for safe places, like U.S. Treasury bills • Allows the U.S. to borrow super cheap • The fact that we lost our AAA rating almost didn’t matter


Legacy of the Asian Financial Crisis •  After a lot of suffering, the region has rebounded well

• Silver Lining: The austerity and caution that followed the Asian Financial Crisis made Asia less vulnerable to the Global Financial Crisis of 2008 -- i.e. no currency crises or bank collapses • But their economies still got hit -- they are dependent on exports

to the U.S. and EU


Why did the Euro make the Greeks feel rich? •  No previous access to credit = no debt •  New access to credit = ability to spend more than you earn

(initially)

•  Expectations of future wealth •  Entry into the European market came alongside the Euro •  Debt-financed investment was, to some degree, justified

• And of course, not only Greece


Loss of Confidence •  Greece lied about their balance sheets to get into the EU • Later announced their current account deficit was double what

they’d been reporting • And then wouldn’t later come clean • Trying to throw technocrats in jail

•  Its expensive for investors to do their own research -- easier just to avoid Greece


Why can’t Greece just correct their government deficit by printing money?

•  A. Because they also have a current account deficit •  B. Because they are on the Euro and Germany won’t agree •  C. Because they are out of foreign reserves •  D. Because the balance of payments is tilted against them


Why hasn’t austerity worked? •  Step 1: You raise tax rates and cut spending •  Step 2: But this causes more recession •  Step 3: Tax revenues fall because no one is producing or earning • Step 4: So you have to raise taxes and cut spending even more • Pro-cyclical fiscal policy

• Step 5: You get mass protests and strikes making things even worse....


The path forward?


benjamin graham - dornsife.usc.edu · lecture 15: financial crises benjamin graham. what did the...

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