Financial Crisis- I

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Financial Crisis- I

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Pre-Capitalist Finance

• Money lenders loaned their own money
• From ancient times
• Money was loaned to
• Individuals for consumption
• The state, governments, for roads, wars,
  exploration
• Merchants for trade
• Rise of Banking
• Loans from deposited monies
• Renaissance Italy in 14th Century
• See Shakespeares Merchant of Venice

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Capitalist Finance

• Commercial credit finances trade
• Just as before, money borrowed to buy cheap and
  sell dear
• Industrial credit finances real investment
• Money borrowed to build plants, buy machinery and
  raw materials and hire workers
• Consumer credit finances personal consumption
• From pawnbrokers through installment plans to
  credit cards
• Mortgages to buy homes
• State credit Governments borrow and lend
• Borrows to finance expendiures gt tax revenues
• Lends at home and abroad, e.g., foreign aid

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Financial Institutions - 1

• Banks
• Private banks
• Lend to consumers, business governments
• Objective profit
• National banks
• Central Banks regulate money supply, oversee
  private banking sector
• Development Banks fund investment, consumption,
  buy political support
• Supranational Banks
• International private banks
• World Bank

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Financial Institutions - 2

• Stock markets
• Buy sell stocks
• Stocks are ownership shares, of various sorts
• e.g., some pay dividends, some dont
• Commodity Markets
• Buy sell commodies, e.g., metals, soy beans,
  pork bellies, spot sales futures contracts
  (that can be bought and sold
• Foreign exchange markets
• Buy sell currencies
• Bond Markets
• Buy sell bonds

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Crises Financial Crises

• Many kinds of crises
• Commercial crises
• Industrial crises
• Financial crises
• All are Interrelated
• Remember discussion of growth what has to
  happen
• M-C(MP,L) . . . P . . . C-M
• Or, to be more complete

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Interrelationships

• L - M - C(MS)...P(2)...L . L - M - C(MS)
• M - L M - L
• . . . P(1)... C - M .
  . . . P . . .
• M - MP M - MP
• A rupture at one point circulates to others,
  e.g., if money (M) cant be had for investment,
  then M-L and M-MP cant take place, then no P(1),
  etc.

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Circulation of Crisisin Industrial Circuit - 1

• Crisis of Industrial credit means no M
• No M (no bank credit, no stock sales, etc.), then
  no M-L, M-MP, P, C, M
• No L (refusal of labor market), or no MP (trade
  disruption), then no PC, M
• No P, then no C, M
• No C-M, then no revenue, no profit, no
  beginning again in new period

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Circulation of Crisisin Industrial Circuit - 2

• Crisis of Commerical Credit means breakdown in
  C-M
• Expand C-M.
• C sold to wholesalers (who need credit)
• C sold by wholesalers to retailers (who need
  credit)
• Breakdown in C-M circulates

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Circulation of Crisisin Reproduction of Labor - 1

• No L-M (refusal to enter labor market), then no
  wage), more P(2) , Life but no L. (assuming
  ability to produce consumer goods)
• E.g., frontier, unsubordinated colonials
• No L-M (no jobs), then no wage, less C(MS), more
  P(2) , less L. (assuming some MS purchased with
  savings)
• E.g., downturn, rising unemployment
• In other words a breakdown in the subordination
  of life to labor, or in the reproduction of labor.

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Circulation of Crisisin Reproduction of Labor - 2

• Crisis of Consumer Credit
• E.g., default on consumer debt ? repos
• E.g., defaults on mortgages ? foreclosures
• Surge in Consumer defaults
• ? collapse in consumer demand for durables and
  housing
• Collapse in consumer demand
• ? drop in aggregate demand, drop in both C-M
  and in M C(MS) which provokes fall in
  investment, employment etc.
• Collapse in market for consumer debt
• E.g., mortgages and mortgage-based securities

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Finance Keynesian Models - 1

• All the major components of aggregate demand C,
  I, G, X and M depend on finance
• C consumer demand, depends on consumer credit
• I investment demand, depends on capital markets
  (loans, stocks, bonds, etc.)
• G government expenditures, depend upon
  borrowing, e.g., in US Treasury Bills
• X exports, depend upon commercial credit
• M imports, depend upon commercial credit

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Finance Keynesian Models - 2

• Two-way relationship
• Healthy credit ? growth in C,I,G,X,M.
• Healthy growth ? confident credit markets, but.
• Breakdown in credit ? breakdown in C,I,G,X,M
• Breakdown in C,I,G,X,M ? breakdown in credit
  markets.
• Monetary Policy
• Central bank affects finance through interest
  rates and handling of government debt
• Via reserve requirements, discount rate, open
  market operations
• Regulation of finance part of monetary policy

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Financial Crises Regulation - 1

• Regulations were created because
• the free market was subject to manipulation and
  abuse and regularly produced crises that
  undermined part or all of the economy.
• Examples
• Tulip Mania (1634-1637)
• Bank Panics and Crises of 1792,
  1796-1797,1819,1825,1837,1847,1857,1866, 1873,
  1884, 1893, 1896, 1907
• Wall Street Crash of 1929.

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Financial Crises Regulation - 2

• Primary purposes of regulation
• To create and maintain confidence in various
  financial institutions and their operations
• In order to create and maintain useful flows of
  money to finance consumption, investment, trade
  and government expenditures
• To protect those who depend upon credit from
  misconduct and exploitation

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Financial Crises Regulation - 3

• Financial regulation includes
• Specification of what actions are legal and
  which ones are illegal and
• Specification of what institutions can do what
• Broadly this involves laws passed by congress
• Supervision to enforce laws, prosecute violations
  of laws
• Institutions to supervise, to check to see if
  regulations are being adhered to, investigate
  violations and prosecute them.

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Financial Crises Regulation - 4

• Regulatory institutions in the US include
• Federal Reserve System (Fed)
• Regulates member banks reserves, etc.
• Federal Deposit Insurance Corporation (FDIC)
• Insures deposits, regulates bank deposit behavior
• US Securities and Exchange Commission (SEC)
• Regulates securities markets (stock, bonds, etc.)
• National Credit Union Administration (NCUA)
• Licences, supervises and regulates credit federal
  credit unions
• Commodity Futures Trading Commission (CFTC)
• Oversee and regulate commodities markets, futures
  options

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Great Depression Financial Regulation

• Stock Market Crash of 1929
• October 29, 1929 Black Tuesday
• Financial collapse contributed to collapse of
  economy more generally
• Despite Federal Reserve Act of 1913
• New financial regulations in 1930s
• Farm Credit Administration,
• Federal Securities Act, Glass-Steagall Act
  (creates FDIC, lets Fed set max interest rates on
  SL, splits commercial and investment banking),
• Export-Import Bank created,
• Exchange Stabilization Fund created, Federal
  Farm Mortgage Corporation, SEC created, etc.

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Keynesian Era financial Crises

• Comprehensive financial regulation at home meant
  virtually no domestic financial crises
• Bretton Woods agreement on fixed exchange rates
  with IMF as overseer and lender of last resort
• UNTIL accelerating inflation and growing gov.
  debt, trade deficits and speculative attacks on
  the dollar lead to abandonment of Bretton Woods,
  volitile flexible exchange rates and negative
  interest rates.

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