Global Issues Chapter 7
Terms in this set (54)
-the leading force in the growth of globalization.
-It enables entrepreneurs to start various enterprises and to become competitors of established companies.
-It is essential to innovation and scientific discoveries
-Facilitates risk sharing and provides insurance for risk-takers
the major catalyst in the growth of globalization and national power
Countries with large financial sectors
-inhabitants are richer
Finance is centrally important to all aspects of globalization, name some..
-trade -human rights
-the environment -promoting democracy
The Asian Financial Crisis (detailed)
in 1997 was a precursor to the financial crisis of 08-09. It started in Indonesia and spread to Malaysia, South Korea and other pats of Asia, and the rest of the world. It was largely caused by "hasty and imprudent financial liberalization under foreign pressure, allowing free international flows of short-term capital without enough attention to the downside of this type of globalization."
The Asian Financial Crisis (brief)
Started in Indonesia and caused stock markets to crash and reversed economic growth
The US after the Asian Financial Crisis
The world's sole super power with unlimited options. Overconfident by huge growth in computer and technologies. All of this changed because of terrorist attacks on 9/11
Struggle against terrorism
affected the restoration of the US economic system at home and other countries confidence in our economy. The war on terrorism defense budget grew immensely to fight wars in Afghanistan and Iraq. Money was borrowed from other countries to cover the debts.
Deregulation of Financial Markets
Global financial crisis was caused by:
1. deregulation of financial markets
2. sophisticated financial innovations linked to rapid changes in computer technologies
3.excessive executive compensation
4. low interest rates
5. subprime loans (especially mortgages)
6. speculation in general, (emphasis in housing)
The Great Depression
Because of TGD of the 1930s, implementation of financial regulations to stabilize the economy and give American savers confidence in banks
-Federal Deposit Insurance Corporation
-insures individual bank deposits for up to $250,000
Global financial liberalization
opening banks around the world to competition. By allowing Americans to "shop around" for the banks that best fit them, countries and banks were in competition with each other to secure customers. This was known as "financial deregulation"
countries opening their financial systems to American firms (banks).
Glass-Steagall Act of 1933
prohibited commercial banks from underwriting or marketing securities. The rapid growth of capital flows across national borders and the increasing power of investment bankers eventually led to the collapse of this Act in 1999.
Regulation on banking was less effective because...
sophisticated computer technologies and unquestioning belief in the wisdom of the markets contributed to demands for and acceptance of less regulation. There was a loss of control at all levels, which led to exponential risk taking at many companies, hidden from the public.
violations of financial regulations went largely unpunished because of:
1. insistence on free movement of capital across borders
2. repeal of Depression-era regulations separating commercial and investment banking
3. decreased regulatory enforcement by the Securities and Exchange Commission
4. Allowing banks to measure their own riskiness
5. Failure to update regulations to keep pace with financial innovations
sophisticated financial engineering, an outgrowth of revolutions in computer and telecommunications technologies
Types of financial innovations
-credit debt swaps
-collateralized debt obligations
Complex financial markets
products created in one financial center involved assets in another and were sold to investors in a third market.
Financial innovations led to the financial crisis because...
they were designed by brilliant computer experts to manage risk and make capital less expensive and more available because it instantly had global impacts due to technologies that made electronic transactions faster and less expensive, and moved more quickly than regulation.
Financial engineering designed to reduce risk. It spreads out and separates investments across multiple income streams to reduce risk.
Prior to securitization
Banks, many local, provided loans to customers they often knew and the banks were responsible for the risks involved in making loans. This meant bankers gave loans only to individuals and companies they believed could repay them. With securitiziation, lenders who had no interest in the customers' ability to repay the loan.
Because of securitization...
vast sums of money were available to borrowers. For example, securitication increased the amount of money available to those buying homes, which led to growth in housing prices. It resulted in high default rates (people unable to pay their monthly loan bill) and resulted in the housing crisis (foreclosures, etc.)
bets on the credit worthness of a particular company, like insurance on a loan (i.e., insurance on a loan) Two types of credit derivatives: credit default swaps and collateralized debt obligations
Credit default swaps
widely used, especially by insurance companies such as the American International Group (AIG). Life insurance companies would agree that one would pay the other if a particular borrower, a third party, could not repay its loans. Credit default swaps were used to transfer credit risks away from banks
problem with the credit default swap
the lack of transparency and unregulated. Ultimately, they created confusion and encouraged excessive risk taking. It was too difficult to determine where the risk ended up. Loans were packaged as securities where the risk could be passed on from one to another.
an instrument representing financial value. Can be categorized into debt, equity, or derivative contracts.
Collaterized debt obligations
linked to mortgage companies which passed on the risk. Mortgages, instead of being held by banks and mortgage companies were sold to investors shortly after the loans closed, and investors packaged them as securities.
created by the Investment Company Act of 1940. Hedge funds implies investment funds with a particular sort of hedging strategy. they allow wealthy investors to avoid many financial regulations, and hedge funds were early participants in financial globalization.
How do hedge funds work?
Essentially, hedge fund managers created portfolios reflecting an assessment of the performance of diverse global markets. As long as the number of participants was relatively small, hedge funds avoided great systemic risks. This changed with revolutions in computer technology that allowed split second timing on huge volumes of trades. An important part of hedge fund strategy is arbitrage.
Simultaneously buying at a lower price in one market and selling at a higher price in another market to make profit
excessive executive compensation is widely perceived as playing a pivotal role in creating the global financial crisis. Most companies rewarded short-term performance without much regard for market fundamentals and long-term earnings. Executives were given stock options, which they could manipulate to earn more money. The more an executive could drive up his or her company's stock price or earning per share, the more money he or she would get.
Low Interest Rates
Fundamental cause of global finaincial crisis was the easy availability of too much money globally. An oversupply of money created unprecedented levels of liquidity and historically low interest rates.
Chairman of the US Federal Reserve who kept interest rates low to allow for increased government and consumer spending. The European Central Bank and the Bank of Japan also reduced interest rates to record lows.
Low interest rates and housing crisis
US government encouraged Americans to purchase homes and to refinance or borrow against the value of homes they owned. Consumers and the government lived beyond their means.
Financial growth of developing countries
As consumers and the government lived beyond their means, they were able to borrow from developing countries that were accumulating huge reserves from the phenomenal growth of global trade. Surplus money in the global system came from a lack of investing into Asian economies following their financial crisis in 1997. Rising oil prices in the Middle East, Russia, and elsewhere enabled countries to earn more money than they could spend rationally. By 2008, banks in emerging economies held $5 til in reserves.
Sovereign wealth funds
created by countries to save and recycle surplus revenues. Became popular when the US was having to borrow money to pay off debts, fight wars, etc. These emerging companies saved that money and in 2012 is projected to have doubled.
High-risk credit given to individuals who fail to meet rigorous standards. Giving loands to people that do not have good credit or a good history of being able to pay back the loans
Fannie Mae and Freddie Mac
Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac)
Subprime loans and the housing crisis
The US government encouraged home ownership and made it seem as though it was a "right" that each person OWNED a home.
Fannie Mae/Freddie Mac and the housing crisis
Both US government corporations made more money available to lenders and borrowers by purchasing loans from the lenders an selling them to investors in the secondary markets. Huge amounts of money gravitated to subprime mortgages in the US and Europe and weak borrowers globally. Governmetns were largely unaware of the risks associated with new forms of financing and unable to prevent the global financial crisis.
a long term loan that does not have a fixed interest rate. The rate can be changed, with low rates at the beginning and high rates at the end. It is also possible, but unlikely, that rates could decline.
involves excessive risk taking, excessive optimism, and the development of a herd mentality
4 stages of speculative bubbles
1. a new technology or invention changes people's expectations and those who are well informed try and profit
2. prices or profits continue to rise, which draws more people into the market
3. the boom passes into euphoria and rational decision-making is suspended
4. the bust is almost inevitable. prices and profits fall, companies and individuals go bankrupt, and the economy plunges into a recession
speculation and financial crsis
a combination of low interest rates, unprecedented liquidity, and a belief that the Internet and various computer technologies virtually guaranteed unending and ever-increasing prosperity facilitated the growth of speculative financial forces.
Taxpayer Relief Act of 1997
exempted profits from taxes gained from selling one's home.
Impact of Global Financial Crisis
-decline in manufacturing and trade
-global power shift
Global power shift
many countries were negatively affected by the financial crisis but Brazil, Russia, India, and China, also known as BRIC countries enhanced the power
US Secretary of the Treasury who initiated the stimulus package to rescue banks on Wall Street
money allocated by governments to financial institutions and selected industries to prevent their collapse and reinvigorate economic growth
the health insurance, pensions and other programs European Governments provide citizens that lessen losses in economic hard times (ie. national health care)
Bank of International Settlements
based in Basel, Switzerland; created to regulate and harmonize banking standards
the new regulatory framework for banking that gives credit-rating agencies an explicit role in determining how much capital is enough to cover certain risks