The Good, The Bad, and The UglyThe Global Financial Crisis

The Good the Bad and the Ugly• Those requiring a bail out, and those loaning money

– The Good• Similarities: Low to no debt, exporting base, solid banks, prudent lending• Examples include Canada, India, China, Australia, Germany, and Saudi Arabia

to name the major ones.– The Bad

• Those countries that have experienced a bailout• Require lender of the last resort (domestic and/or IMF). Insolvent, or too

big to fail banks with toxic assets. Took on large risk, and most have had a housing bubble.

• Examples U.S., Iceland (past)– The Ugly

• Future or current bailouts• Those countries currently experiencing financial meltdown• E.g. Ireland poster example

(Possibly Portugal and Spain and more in the not so distant future. . . . )

The Bad

Iceland• First Country to collapse in the GFC, October 2008• In 2004 the economy moved to a transaction based economy on three large

banks that expanded across Europe and the U.K.• The housing market boomed, as debt could be sold through U.S. CDOs with

a high rating, AAA.• Icelandic Banks offered higher returns to European depositors and lenders.

Insurance deposits existed, but were inadequate to cover liabilities.• Banks grew to over $ 140 billion • Deficit from foreign investment was negative 125 percent GDP!• Bubble burst, October 2008, markets lost trust in Icelandic banks: Lending

stopped and deposits withdrew. Bank run hits Iceland, spreads across the U.K.

• All three large banks failed. Banks were too large for government to insure.• November 19, 2008, a $6 billion economic stabilization program supported

supported by the IMF and individual countries. • Iceland today: IMF said the NOV 14, 2010, relief should be given to the

homeowners in order to prevent more foreclosures, but economy is stable.

The Good

China

• China avoids GFC– Prudent lending– Large inflow of capital investments– projected growth of 9%

• Before the crisis China maintained a high savings rate, leading to a surplus which was used to buy U.S. Government securities, lending us $900 billion to date.

• China’s domestic demand increased filling void created by U.S. recession.• Chinese exports decrease from 40 to 20 percent over the past decade. • China Attempts to keep currency artificially low to increase exports. IMF

warned China such action may result in unstable growth.• QE2 will increase the amount of dollars in the U.S. economy which,

decreases the value of the dollar effectively making Chinese exports more expensive. Since China relies on U.S. demand any appreciation of their currency will make Chinese goods more expensive to American consumers.

The Good

Germany • Comprised of lender savers whose contributions to the global pool of

money were second only to China.• German international banks ended up owning much of the toxic assets

produced by the U.S. housing market.• In GFC, the German government was able to fund a rescue package so

that they did not need EU support.• Euro problem

» Shared currency/Interest Rate/Exchange Rate for very different countriesGermany: 8% unemployment / $175 Billion SurplusIreland: 13.6 % unemployment / $75.4 million SURPLUSSpain: 19% unemployment / $84 Billion Deficit

• Germany would have a higher D-Mark and appreciating currency, but is held to the EU policies.

• Spain would require long term low interest rate and devalued Peseta in order to stimulate their economy.

• The EU will increase the interest rate , but the effect will be very different for different countries.

The Ugly

Ireland• Housing Bubble and banking crisis much like the U.S.• The Anglo Irish Bank (Worst) was nationalized, and the

Nationwide Building Society both required 40 billion Euros in order to bail them out. That is 25 percent of Ireland’s GDP.

• Problem: To clean up the banks Ireland needed a plan similar to TARP.

• Government ran a large deficit in attempt to save their banking system, and guarantee sovereign debt.

• IMF and foreign bondholders owning bonds in the form of sovereign debt, stepped in and forced budget cuts and raised the pension age to lower the Irish deficit.

• Problems remain: Ireland has no influence on Euro zone exchange rate, and increases to the exchange rate will dampen a recovery.

IRISH EQUITY MARKET

Basel II • Purpose

Was established to set guidelines for capital ratios for international banks.

• Banks use credit rating agencies to manage risk.Moral Hazards Similar to U.S.

• Banks must cover operational risks with capital.• Supervisors can evaluate the risk levels of banks.

Moral Hazard / Asymmetric Information• Suppose to allow for greater transparency, to alleviate

moral hazard by limiting asymmetric information.• Problems

Allows for too little “skin in the game” yielding riskier decisions in housing markets.

• PurposeNeeded to reinforce less riskier investment vehicles, and capital reserve ratios that could weather a financial downturn.

• Core Tier 1 capital requirement raised from 2.5 to 4.5 percent.• Added a capital conservation buffer of 2.5 percent, thus the tier 1

reserves required will be 7 percent by 2015.• Counter-cyclical buffer of 2.5 percent will be added between

2016 and 2019. Banks will be fined for holding less than 2.5 for this recession specific reserve.

• Future Look: Banks that are systemically important will require even greater reserves, but no figure has been approved. Nor, have the Basel Committee and FSB garnished a time line.

• Progress– Countries will be required to hold similar reserves, lessening the

likelihood of another Iceland

Basel III

GLOBAL REFORM

KEY

BAILOUT MONEY

THE BAD & THE UGLY

THE GOOD

Regulation Changes