the quiet 1990s, the panic of 2008, and the great recession of 2008-2010 and more? less seriously?
TRANSCRIPT
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The Quiet 1990s, The Panic of 2008,
and The Great Recession of 2008-2010
AND MORE? LESS SERIOUSLY? http://www.youtube.com/watch?v=zP0C-G_iWAg
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The 1990s, the “Belle Epoque”
• Brief Recession July 1990-March 1991• Longest Ever Boom: April 1991 to March 2001
– Inflation declines--- from 4% to an average of 2%– Unemployment falls from 8% to 4%– Rapid productivity growth, rapid growth of GDP but
benefits not equally distributed– Bank failures disappear, very profitable, build up
capital, “Prompt Corrective Action Seems to Work
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The Dot.com Crash 2000• Collapse of stock market focused on
computer/internet/biotech companies.• DJ and S&P barely recover, Nasdaq never (yet)• No Banking Collapse because banks don’t own
stock---stocks widely held, decline in wealth causes consumption to fall
• But huge losses ($1.7 trillion) barely slow continued growth
• Recession: March 2001-November 2001• Economy recovers and grows quickly with low
inflation and low unemployment• Housing Boom begins 2002
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The Panic of 2008 and the Great Recession
• Economy begins to slow December 2007
• Gradually housing boom slows
• Financial crisis starts in late summer 2008
• Panic 2008
• Economy quickly declines
• Unemployment rises rapidly
• Some fear a new Great Depression.
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Why Does It Seem Similar?
• Great Depression of 1929-1933 (1939)
• Real estate market crash• Stock market crash• Bank failures• Credit crunch• Rapid Decline in GDP• Rapid Rise in
Unemployment
• Recession of
2007-2009?• Real estate market crash• Stock market crash• Bank failures• Credit crunch• Rapid Decline in GDP• Rapid Rise in
Unemployment
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But on closer inspection….?• How does the current recession compare to:
– Great Depression– Last two recessions– Two worst prior recessions since the Great
Depression
• Are 1929-1933 & 2007-2010 similar?
• Note: Conventional definition of a recession is two consecutive quarters of real GDP decline
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Today and the Great Depression
60
70
80
90
100
110
Quarters from the Business Cycle Peak
Ind
ex o
f R
eal G
DP
Great Depression Current 1990-1991 2001 1973-1975 1980 and 1981-1982
December 2008
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A Close UpNote: 1980/1981-1982 is a double dip
80
85
90
95
100
105
-4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12
Quarters from the Business Cycle Peak
Ind
ex o
f R
eal G
DP
Great Depression Current 1990-1991 2001 1973-1975 1980 and 1981-1982
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Unemployment1928 6.6%
1929 4.1%
1930 12.4%
1931 21.7%
1932 31.7%
1933 30.0%
2006 4.4%
2007 4.9%
2008 7.2%
Nov 200910.2%
Nov 2010 9.8%
1980 7.2%
1981 8.5%
1982 10.8%
1983 8.3%
1984 7.3%
1985 7.0%
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How Did it Happen?Incentives NOT Symptoms
• Banks and Government Agencies (Fannie Mae, Freddie Mac too huge risks
• Why? Bankers more greedy than before? Are they more risk-taking (sky-divers v. librarians)
• What are the incentives to take risk? The perfect combination is:– Deposit Insurance, “Too Big to Fail”– Incentives to buy lower quality, more risky
mortgages
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How Did it Happen?Incentives NOT Symptoms
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How Did It Happen? Chronology
• Housing Market Boom 2002-2006. At peak prices are up 50%.
• July 2006 -September 2007: High FFrate = 5.75%
• Peak of Business Cycle: December 2007: cutting FF rate4.25%.
• Housing Market Collapse Begins 2007, decline in wealth decline in consumption and investment.
• Direct effect on the banks via subprime mortgagesdecline in lending as their balance sheets deteriorate.
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Collapse
• Fed maintains tight monetary policy: – “new lending facilities” but sterilizes effects. – 2% FF rate steady but too high AprilOctober
2008recession deepens
• PANIC– No panics on commercial banks because of deposit
insurance– But huge uninsured sector of banking—the investment
banks that depend on “Repo” market for funding. – Baer Stearns is bailed out.– Then Lehman Brothers allowed to fail September 15,
2008. Panic. Credit Crunch, huge interest rate spreads
• What should the Fed do?
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Road to Recovery
• Turning Point: October 2008 Crisis—failure of Lehman and AIG, general financial panic
• Fed eases monetary policy – Cuts Fed Funds rates, beginning Oct, by Dec 2008, FF= 0.25%
supplemented by TAF Term Auction Facility (Discount Window)
• Monetary Expansion: – Traditional Open Market Ops plus “Quantitative Easing: Fed
buys $750 billion agency mortgage-backed securities and $300 long-term Treasury securities. March 18, 2009
• Should Banks Be Allowed to Fail? Too Big to Fail. October 2008: TARP to buy preferred stock in financial institutions (Troubled Asset Relief Program)
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Road to Recovery?
• Large Fiscal Stimulus: Federal Deficit Estimate to be 10% of GDP 2009 (size of the multiplier?)
• Financial Markets: Major intervention to influence credit flows: March 2009, TALF (Term Asset-Backed Securities Loan Facility) which include autos, credit cards and student loans…….TSLF (Term Securities Lending Facility), CPFF (commercial paper), MMIFF (money market mutual funds….etc.etc.
• Pushing all the buttons.
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Road to Recovery? • Banking Policy: Inconsistent Policy, “Too Big to Fail”
Baer Yes, Lehman No, Bailout of Banks and MMMF• Banking Policy:
– The BIG Banks---May 7, 2009 “Stress Tests” for 19 largest BHCs, all “pass.”
– Remove “toxic assets”??: Public-Private Investment Program for Legacy Assets (postponed) No one will buy them
– Recapitalize—Treasury buys preferred shares, but too much
– Rising smaller bank failures• Banking Policy:
– Policy makers: Banks should not take excessive risks/Banks should not hold excessive reserves?
– Forbearance AGAIN!! Hope economy and subprime loans recover so don’t have to bail out more banks
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Causes for Concern
• TODAY• Recovery Just Beginning• Now Fed (with a Trillion $ in new assets)
concerned to reduce liquiditytoo fast, recession continues, too slow inflation starts up
• Banking policy has not directly addressed the question of bank insolvency, curtailing lending
• Government continues to prop up the insolvent: Fannie Mae, Freddie Mac, Citibank, BA, AIG &GMAC
• Regulatory reaction: Dodd-Frank Act of 2010---will it revive or constrict financial system?
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Prolonged High Levels of Unemployment?
• Yes.• If the recession was brought about because we had
overinvested in certain sectors—housing and finance, then, labor and other factors need to be reallocated
• Restructuring---Bankruptcies are important to reallocate• If a bubble, then people thought they were wealthier than
they were, long-time to adjust consumption patterns.• We can help speed the transfer but we should not
impede the flow.• Monetary and Fiscal Policy are corrective actions that
can be taken---but what reforms are needed?• The right medicine requires the right diagnosis!
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The Cost of 20thC– 21stC Crises
• 1930s– Depositors and stockholders lose $2.5 billion– 2.4% of GDP – $38.7 billion in 2008$.
• 1980s– S&Ls lose $74 Billion and Commercial banks $52
billion.– 3.4% of GDP– $200 billion in 2008$
• 2008-2010 – One estimate of the losses to the banks is $1.7 trillion– 11.6% of 2008 GDP.
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Can We Supervise Banks Better?
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Free market failures or Government policy failures?
• Is it insurance of banks & housing policies? Or greedy/predatory bankers?
• Proposals– New Consumer Protection Agency– Cap banker compensation– Restrict investments– Force derivatives to be exchange trade– New Federal Council of Regulators
• But if root cause of crisis is moral hazard from deposit insurance/Too Big to Fail and policies to increase risky mortgage lending---these then treat the symptoms not the the disease.
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http://www.youtube.com/watch?v=I0OrLXoyZ4M
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OK…You fix the budget
New York Times Interactive Puzzle
http://www.nytimes.com/interactive/2010/11/13/weekinreview/deficits-graphic.html