ISS Lecture 9 Notes
ISS Lecture 9 Notes ISS 315
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This 5 page Class Notes was uploaded by Samantha Shea on Tuesday October 18, 2016. The Class Notes belongs to ISS 315 at Michigan State University taught by Y. Sinha in Fall 2016. Since its upload, it has received 2 views. For similar materials see Global Diversity/Interdepend in Integrative Studies Social Sci at Michigan State University.
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Date Created: 10/18/16
Lecture 9 Tuesday, October 18, 201612:41 PM • market crash happened • Global recession started in 2008 ○ Great shock to most ○ Started as financial meltdown in America ○ Quickly spread to other parts of the world because the world was interconnected Problems in America quickly became global problems § • New Economic Model -‐supposed to put an end to business cycles ○ Markets have gone up and down since the beginning of capitalism § Free markets have been characterized by boom and bust cycles ○ When bubble in market, market itself will pop the bubble § Economic downturn § Market bubble: one sector of economy will forever increase in value □ First bubble in 1600s: Great Tulip Bubble ® People were paying large sums of money for flower § .com bubble: when computers first came on to market, a lot of tech companies opened up and each thought they would always make money because computers were here to stay ○ New economic model was supposed to ensure that markets would not do market corrections and their would not be a downturn in the market ○ Deregulation of businesses would mean markets would be better at managing risks ○ Markets would be better at correcting themselves before bubbles were formed ○ Argued that the less government interference the better • Approach to economic policies was that government should be as free of economic involvement as they possibly could be ○ Government involvement should be minimal in the market because it was assumed that markets were -‐correcting • 1980s: Policies of Ronald Reagan -‐ government should not interfere with market ○ East Asia Crisis of 1997: could not pay back loans they had from Western banks • Austerity measures : cutting back on government spending ○ You get political volatility • 1980s: Policies of Ronald Reagan -‐ government should not interfere with market ○ East Asia Crisis of 1997: could not pay back loans they had from Western banks • Austerity measures : cutting back on government spending ○ You get political volatility ○ People got pissed off ○ Caused years of economic uncertainty in East Asia ○ Caused a great deal of political uncertainty • When our banks were not able to pay back debts, we did not use austerity measures • Double standard: one set of rules for west and others for other countries ○ Problem is global economy • Argument by banks and promoters of New Economic Model was that the crisis experienced was a bubble ○ People saw the bubble coming • Entire global economy is dependent on American consumerism Depends on us buying stuff ○ ○ Without Americans regularly buying stuff, the entire global economy would collapse ○ We have to consumer stuff at and ever increasing rate for model to sustain itself ○ Buy more stuff every year for global economy to keep coming along ○ Aggregate demand -‐people don't want to buy stuff • The income for middle and lower class Americans has been stagnate for decades ○ Bulk of stuff consumed in America is consumed by middle and lower class people § Contradiction § Can't afford to buy what is needed to be bought • Solution: let middle and lower class borrow money to fuel global consumption ○ Government had to step in § Federal reserve (so not really government) lowered the interest rate to encourage borrowing □ You wouldn't have to pay as much money for the money that you borrowed § Government deregulated institutions that lend money so that there is less oversight to who was lending out the money • Regulators and banks thought this was a good idea Everybody assumed that home prices would continue to go up because ○ they have been for decades ○ It didn't matter if people borrowed a lot of money for their house because value would go up and they would be able to pay back their own § It got so bad that a simple two bedroom house could go for as much as a million dollars ○ Everybody assumed that home prices would continue to go up because they have been for decades ○ It didn't matter if people borrowed a lot of money for their house because value would go up and they would be able to pay back their own § It got so bad that a simple two bedroom house could go for as much as a million dollars § Some people didn't care because they figured no matter what they paid for a house, they knew the value would go up the next year and they could get back their money □ HOUSING BUBBLE • Housing bubble crashed and it affected the entire American economy not just housing economy When one sector collapses, the entire economy did ○ ○ When price of houses fell, people could no longer make borrow money against the equity of their home so could no longer pay their mortgages § A lot of people lost their houses ○ Banks now did not know how much money they actually had • Banks very quickly realized they could not trust other banks either because other banks were doing the same thing ○ Global credit crisis: nobody was willing to take the chance to lend money to anybody else • Housing bubble, along with lower interest rates, fuel American consumerism • Banks facilitate transactions & manage risk and make loans Banks focused on securitization of mortgages ○ • When the crisis hit, first thing the banks did was blame lack of government oversight for the crisis ○ On other hand, prior to crisis banks lobbied to try and get rid of government regulations ○ Bank executives were the only people who didn't lose money during the crisis • In economy we have today, majority of people making financial decisions are doing It on behalf of other people ○ Agency is lost ○ Agency is also a problem with the way corporations are structured They are run by a CEO that may not even have any interest in § company they are running □ When companies stock is high, value of CEO portfolio goes up □ Instead of paying CEO money, it is in terms of stock options ® CEO has incentive of raising stock ◊ Make company look better on paper than it actually is § CEO thinks in terms of short term profit and not in terms of bettering the company long term □ Has every incentive to lie to others ® CEO has incentive of raising stock ◊ Make company look better on paper than it actually is § CEO thinks in terms of short term profit and not in terms of bettering the company long term □ Has every incentive to lie to others • A credit agency: assess value of any given investment, bank, company, etc ○ is paid by companies that are being assessed ○ Assessment agency has every incentive to give them a good rating because if not the company will fire them and hire someone who will give them a good rating • Externality-‐ when something you had nothing to do with still effects you • Global system is so interconnected • Glass-‐ Stegall Act 1933: split commercial banks from investment banks ○ Commercial bank is the bank you think of when you think of a bank § You can go here to take out money whenever you feel ○ Investment banks: things that manage people's portfolios § Handle stocks and bonds, etc § You're giving money to a financial advisor who will then invest it into something you tell them to and you could potentially lose that money ○ Supposed to keep these banks separate ○ 1990: repealed so they could now do both at any bank § If gambles did not pay off than the bank did not have enough money to pay back depositors ○ If these banks collapsed, they would hurt the entire economy ○ Government has no choice but to make sure that these banks don't collapse ○ Traditionally, government has insured commercial banks but now that they do both they insure all banks § If banks fail, we have to bail them out • We have seen income inequality starting way back in the 80s • Review of lecture ○ People who fuel demand do not have money to spend ○ Solution: housing bubble ○ Once equity went away global aggregate demand went weak affecting global economy ○ At the same time, foreign countries are taking money and putting in reserve funds reserve funds
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