The Limited Times

Now you can see non-English news...

Bubbles and financial crises

2023-03-19T10:26:44.637Z


Bubbles and financial crises The world is convulsed by a new financial crisis, which began with the bankruptcy of three banks in the United States and worsened with the crisis of confidence in the historic Credit Suisse bank. Faced with this situation, the authorities of both countries reacted quickly, guaranteeing the deposits and liquidity of the system, fearing that the crisis would spread to other sectors and other countr


The world is convulsed by a new financial crisis, which began with the bankruptcy of three banks in the United States and worsened with the crisis of confidence in the historic Credit Suisse bank.

Faced with this situation, the authorities of both countries reacted quickly, guaranteeing the deposits and liquidity of the system, fearing that the crisis would spread to other sectors and other countries.

History shows us that these crises are much more frequent than is thought, that they were almost always associated with sudden falls in the prices of some assets that had risen excessively (“bubbles”), and that their effects can be very severe. .

The experience of the Great Depression shows us that, prior to the bursting of the bubble, the value of investments doubled every year for purely speculative reasons, and when prices fell (25% in two days) an "implosion" occurred. in a chain, which led to the bankruptcy of numerous banks (they financed up to 90% of the purchases of shares), which spread to other sectors and countries, which increased the unemployment rate to more than 25%, which lowered the GDP from some countries in half and lasted more than three years.

However, the Great Depression was neither the first financial crisis nor the last.

The burst of the “tulip bubble” in 1637 (a tulip bulb was sold for the equivalent of 24 tons of wheat) destroyed the economy of the Netherlands with a dynamic very similar to the Great Depression.

The collapse of the South Sea Company in 1720 produced such an impact in England that the government was "forced" to buy the shares of that company, doubling the public debt (supposedly the King and prominent ministers had invested in that company).

Subsequently, we can mention the crises of the Overend & Guerney banks in 1866 and Baring Brothers in 1890 (related to loans to Argentina), that of the Savings and Loan Banks in 1985, the stock market crash on October 19, 1987 ( a 22% drop in one day), the Long Term Capital collapse in 1998, the tech collapse in 2000, the housing crisis of 2008, the financial crisis in Cyprus in 2012, and the crisis in Lebanon in 2021. This list leaves out the financial crises in Argentina and many other countries.

Although there is no single cause of these crises, most of them are associated with the bursting of "bubbles" in asset prices, irresponsible monetary and credit policies on the part of the authorities and/or financial intermediaries, and shortcomings. supervision and legislation.

These crises are amplified by the very characteristics of the financial systems and by the "runs" that are unleashed.

Financial entities are intermediaries that receive funds from savers and lend them to those who need financing.

One of the functions of banks is to intermediate terms, receiving short-term deposits and lending them at longer terms.

To reduce the risks of this mismatch, they keep a part of the deposits in liquid form (reserves) and use their own capital.

Regulators typically set rules between liquid holdings and deposits (reserves) and between the size of loans and capital (capital requirements).

To strengthen the system, institutions were established (central banks, supervisors, and deposit guarantee funds) that act as regulators and as lenders of last resort.

Sometimes, authorities go to extreme measures to avoid systemic crises (such as the Great Depression) by protecting depositors and the system, but leaving shareholders of troubled banks to lose their investments.

After the 1930 crisis, a group of economists from the University of Chicago (before it had been proposed by economists from Harvard) proposed a monetary and banking reform.

Generally known as the "Simons rule" - by one of its authors - the proposal requires a 100% reserve requirement on current account deposits to avoid "monetary creation" through the financial system, and proposes transforming term deposits in bonds that suffer the same fate as the rest of the bonds.

Personally, I am against this proposal.

A 100% reserve would mean that the counterpart of the current accounts would be lent to the issuer of liquidity (the government).

All my students know my position that banks do not create money, that the famous multiplier does not exist.

Converting fixed terms into bonds does not solve the crisis problems associated with bubble bursts either, as the examples mentioned in the previous paragraphs show.

Analysis of the composition of the assets and liabilities of all financial institutions in a country makes it possible to assess the solvency and liquidity risks of that system (and, therefore, its soundness) but it does not make it possible to assess individual situations or the probability of runs for fears

The analysis of the figures of these entities in the United States shows striking strength, but despite this, the bankruptcy of three entities was not avoided and fears grew.

The authorities were forced to act quickly to calm down depositors.

However, robustness should contribute to the success of these measures.

The case of Credit Suisse is different.

It has been dragging credibility problems for several years now, and was capitalized with investments from oil countries, but it was never able to rebuild trust.

The Swiss banking system has assets equivalent to $3.2 trillion (almost four times its GDP) and is well capitalized.

The country has reserves equivalent to more than 1.1 trillion dollars, a surplus of 7% of GDP in the current account of the balance of payments, fiscal balance, and low public debt, so it should not have problems facing the crisis. .

Ricardo Arriazu is an economist.

Source: clarin

All news articles on 2023-03-19

You may like

Life/Entertain 2024-02-04T06:00:03.253Z
News/Politics 2024-02-09T05:16:14.858Z
News/Politics 2024-03-27T07:56:25.580Z

Trends 24h

News/Politics 2024-03-27T16:45:54.081Z
News/Politics 2024-03-28T06:04:53.137Z

Latest

© Communities 2019 - Privacy

The information on this site is from external sources that are not under our control.
The inclusion of any links does not necessarily imply a recommendation or endorse the views expressed within them.