Economic independence for all. . . .

FINANCIAL CRISIS
Based on data from 1876 to 2010

Causes and Remedies

Bachelor of Business Administration 14th Batch, Section: B GROUP-05 Department of Finance Faculty of Business Studies Page 1 of 45 University of Dhaka

FINANCIAL CRISIS: CAUSES AND REMEDIES

Submitted to, Md. Mukhlesur Rahman

Lecturer Department of Finance Faculty of Business Studies University of Dhaka

Submitted by,

Group: 05, Section: B

MD WALID-AL-ZUBAYER ZUBAIRIA KHAN ISHRAT JAHAN SHARMIN ESHRAT JAHAN ESHITA M. ABDUL KAIUM SHARMIN AKTER 14-004 14-050 14-058 14-110 14-112 14-114

BBA, 14th Batch Department of Finance University of Dhaka

Date of Submission: April 21, 2010

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LETTER OF TRANSMITTAL
April 21, 2010 Md. Mukhlesur Rahman Lecturer, Department of Finance Faculty of Business Studies University of Dhaka Subject: Submission of term-paper. Sir, It is an immense pleasure for us to submit the term paper on Financial Crisis: Causes and Remedies, which is prepared as a partial requirement of the course named Economics of Money and banking (F-305) of BBA program under Department of Finance of Faculty of Business Studies, University of Dhaka. This study has given us the opportunity to learn about the Global financial crisis as well as its impact on the world economy. Moreover, this study provided us the privilege to know about bad effect of financial crisis on the economy of Bangladesh, which in turn, compels the nation to lag behind. The experiences that we have gathered through this study will help us in our career, indeed. We would like to convey our special thanks and gratitude to you for patronizing our effort & for giving us proper guidance and valuable advice. We have put our best effort to ensure the authenticity of the report. We earnestly request you to call us if you think any further work should be done on the topic that you have chosen for us.

Thanking you

GROUP-05
MD. WALID-AL-ZUBAYER ZUBAIRIA KHAN ISHRAT JAHAN SHARMIN ESHRAT JAHAN ESHITA M. ABDUL KAIUM SHARMIN AKTER Section: B, Batch No: 14 Department of Finance Faculty of Business Studies University of Dhaka Page 3 of 45 14-004 14-050 14-058 14-110 14-112 14-114

PREFACE
After the successful completion of the course named Economics of Money and banking (F305) of the BBA program, preparation for the term paper provides us an opportunity to reduce the gap between the theoretical knowledge & practical experience. To enhance the analytical competence, we were given the onus to prepare a report on Financial Crisis: Causes and Remedies which has undoubtedly put fresh impetus to our understanding of the financial Crisis all over the world.

We worked on financial crisis which is the responsible for expanding the gap between rich and poor. With the progress of the report, we tried to demonstrate the objective of the report which is the causes and remedies of financial crisis. Moreover, we attempted to portray an unbiased relationship among financial crisis, recession and depression. The intention of the relationship is to show that how an economy can move forward to ensure security towards their societies and on the other hand, how it should respond to the crises that take place due to economic mismanagement of any related economy.

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ACKNOWLEDGEMENT
First, our heartfelt gratitude should go to the Beneficent, the Merciful & Almighty Allah for giving us the strength and patience to prepare this report within the scheduled time. We are deeply indebted to our course teacher, Md. Mukhlesur Rahman, Lecturer, Department of Finance, University of Dhaka, for his kind cooperation and valuable contribution in preparing the report. We also like to convey our thanks to those who helped us by providing necessary information regarding the report. At last, all the members of Group-05 should be acknowledged for their nice & dedicated service behind the making of the report.

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C O N T E N T S

Letter of Transmittal-----------------------------------------------------------------------------------03 Preface-----------------------------------------------------------------------------------------------------04 Acknowledgement--------------------------------------------------------------------------------------05 Executive Summary------------------------------------------------------------------------------------07 Chapter-01: Introduction-----------------------------------------------------------------------------09 Chapter-02: ----------------------------------------------------------------------------Chapter-03: ----------------------------------------------------------------------------Chapter-04: ----------------------------------------------------------------------------Chapter-05: ----------------------------------------------------------------------------Chapter-06: Conclusion----------------------------------------------------------------------------Reference------------------------------------------------------------------------------------------------26

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EXECUTIVE SUMMARY
Living in the developing part of the world, we need to exploit every possible opportunity to move towards advancement. In Bangladesh, the options for economic development have been being impeded by different social problems. One of the few problems that the government and the respective authority face to implement the planning is economic difference in the society. In addition when financial crisis gets add to the pain of these people Economic difference puts the strongest obstacle on way to a prosperous and developed nation. Having a worthwhile impact on the economic differences and vulnerable situation of the marginal people of the society, social security and welfare has become a major concern for every government around the world. On 16th December 1971, Bangladesh, a new country with a new hope got its identity on worlds map. The dream that led the whole nation to fight for its independence was a country free of economic oppression and social differences. The basic place to demonstrate the dream of a nation is its national budget and as a nation, our dream should be portrayed in the national budget. However, if we flashback to the budgets after independence, we can see that there was not enough allotment for social sector. In Bangladesh, social sectors are deprived of proper attention since the very beginning of its introduction in national budget. In our report, we tried to reveal the overall scenario of the social security and welfare sector of Bangladesh. At first, we introduced the term social security and welfare to the readers because we need to know the exact definition and coverage of the social security and welfare before implementing the plan regarding this sector. Then we showed the allotment for social security and welfare sector in different years in Bangladesh. Last of all, an unbiased comparison with India and Pakistan has been added to the report with a view to presenting a comparative position of Bangladesh in relative field. The study disclosed some important fact to us. We know that social security is one of the most significant parts of a developing or under-developed country. Since Bangladesh is recognized as a developing country (Finance minister A. M. Abdul Muhit mentioned Bangladesh as a developing country in his budget speech 2009-2010), we need to put more emphasis on social security and welfare sector. However, unfortunately, no government has given proper attention to this sector. Allocation for this important sector is still below 2% of GDP (constant price). Moreover, if we look at the percentage of total governmental expenditure that is being used for social security and welfare sector, then we see that a huge amount of money is spent every year for social security sector. But the fact that lies here is gigantic figure is deployed every year disaster management which is included in

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Social security and welfare. In addition, corruption and bureaucracy cost more than half of the allocated amount every year to implement the plan made by government. Our society is the power-station of our nation. If we can assure a standard life for every citizen of our country, then our beloved country will itself find out its way to long-cherished success. Here in this report, we mention the analysis based on numerical figures of budget from 1976-2010 but beyond the numerical figures our intention to do the best for our nation plays the most important role to achieve deserved goal of social security and welfare. Therefore, as long as we are concern about the budget allocations, we should also be aware of the proper implementation of the plan that we make to spend the allocated money.

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CHAPTER-01 INTRODUCTION
In this chapter, we tried to describe the origin of the report, objective of the report, the methodology, scope and limitations of the report.

I.

Origin of the Report

The BBA program under the department of finance offers a course named Economics of Money and Banking (F-305) which requires every group to submit a report on a specific topic determined by the course instructor. The report under the headline Financial Crisis, Causes and Remedies has been prepared to serve that purpose.

II.

Objectives of the Study

Several objectives to conduct the study are: 1. To study about the Financial Crisis. 2. To be informed about the Financial sectors of World Economy as well as economy of Bangladesh. 3. To learn how a financial crisis affect the economy of a country throughout the world. 4. To reveal the impact of financial crisis in Bangladesh. 5. To find out the Causes of different financial crisis throughout the world and its possible remedies. 6. To build a bridge between the theoretical & practical education of Economics of money and Banking.

III. Methodology To prepare this report we have used only secondary data. Different publications by Government of many countries as well as publications of different institutions which are working in the relevant field(s) were used to prepare the report. Process of collecting Secondary Data: Analysis of Global Financial crisis. Page 9 of 45

Analysis of the publications of different Financial institution of different countries of the world. Analysis of the articles published by different newspapers Analysis of the publications of World Bank

IV.

Limitations

We faced some usual constraints during the course of our preparation for the report. The major limitations are as follows: Lack of enough time: though we were given a month to prepare the report but the time was not enough for the volume of task we had to complete. Information is not available: The data required for sufficient analysis for preparing the report was not available. We could not get all the data from a single source. Here we should mention that even Ministry of Finance of Bangladesh could not provide all the data related to Financial crisis due to its poor collection and mismanagement of data. Busy working environment: The officials had sometimes been unable to provide information because of their huge routine work.

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CHAPTER-02 FINANCIAL CRISIS, RECESSION AND DEPRESSION

An American linguist, philosopher, cognitive scientist, and political activist Avram Noam
Chomsky (December 7, 1928, Age: 81) once commented on economic culture all through the world. According to him, under the regime of capitalism only god is secured from bankruptcy since he is not directly involved in monetary trade with human beings. In his speech, he emphasized on the importance of equal distribution of assets which in accordance of his understanding causes mismanagement in the economic environment. Relating the sagacious remark of Mr. Chomsky and practical examples, we can check out the most disastrous and fatal financial crisis, recession and depression. Before starting the through description of the concerned topic, we should put a birds eye view to some related terms to know what they mean by definition. FINANCIAL CRISIS: Financial Crisis refers to a situation in which the supply of money is outplayed by the demand for money. That indicates that liquidity is quickly evaporated because available money is withdrawn from banks (called a run), forcing banks either to sell other investments to make up for the shortfall or to collapse. The term FINANCIAL CRISIS is applied broadly to a variety of situations in which some financial institutions or assets suddenly lose a large part of their value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these panics. Other situations that are often called financial crises include stock market crashes and the bursting of other financial bubbles, currency crises, and sovereign defaults. Financial crises directly result in a loss of paper wealth; they do not directly result in changes in the real economy, may indirectly do so, notably if a recession or depression follows.

RECESSION: In economics, a RECESSION is a business cycle tapering force that generally acts as a catalyst to slowdown the economic Recessions can be easily understood by a significant decline in economic activity spread across the country, lasting more activities over a period of time. During than a few months, normally visible in real GDP growth, real recessions, many macroeconomic personal income, employment, industrial production, and wholesale-retail sales. indicators vary in a similar way.
-National Bureau of Economic Research Page 11 of 45 (NBER), USA

Production as measured by Gross Domestic Product (GDP), employment, investment spending, capacity utilization, household incomes, business profits and inflation all fall during recessions; while bankruptcies and the unemployment rate rise.

DEPRESSION: According to the theories of macro-economics, DEPRESSION is the result of long-term downturn in economic activity in one or more economies. In a brief, it can be held that depression is outcome of longer lasting recession. Generally, when a recession lasts for more than 3-4 months, then it is considered as Depression. In other words, depression is happened to take place when abnormal increases in unemployment, falls in the availability of credit, shrinking output and investment, numerous bankruptcies, reduced amounts of trade and commerce, as well as highly volatile relative currency value fluctuations, mostly devaluations. Price deflation, financial crisis and bank failures are also common elements of a depression. RELATIONSHIP AMONG FINANCIAL CRISIS, RECESSION AND DEPRESSION:
Financial crisis directly result in loss of paper wealth, they do not directly result in changes in the real economy.

INITIAL STAGE

FINANCIAL CRISIS

When impact on paper money turns to spread over the total economy

SECONDARY STAGE

RECESSION

A recession is defined to be a period of two quarters of negative GDP growth.

Recessionary circumstances lasting for more than four-five months

ACUTE STAGE

DEPRESSION

World economy is getting heated due to the consistent slow down in the economy.

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HOW A FINANCIAL CRISIS GETS STARTED: There are few important factors which encourage Recession and thus these are the clues of causes. Currency Crises It is a type of financial crisis and is often associated with a real economic crisis. Currency crisis, which is also called a balance-of-payments crisis, occurs when the value of a currency changes quickly, undermining its ability to serve as a medium of exchange or a store of value. Currency crises can be especially destructive to small open economies or bigger, but not sufficiently stable ones. Energy Crisis An energy crisis is any great bottleneck (or price rise) in the supply of energy resources to an economy. An energy crisis may be referred to as an oil crisis, petroleum crisis, energy shortage, electricity shortage or electricity crisis which can develop due to industrial actions like union organized strikes and government embargoes. The cause may be overconsumption, aging infrastructure, choke point disruption or bottlenecks at oil refineries and port facilities that restrict fuel supply. Under-Consumption According to under consumption theory, recessions and stagnation arise due to inadequate consumer demand relative to the amount produced. The concept of under consumption had been used repeatedly as part of the criticism of Say's Law until under consumption theory was largely replaced by Keynesian economics which points to a more complete explanation of the failure of aggregate demand to attain potential output, i.e., the level of production corresponding to full employment. Overproduction Overproduction refers to excess of supply over demand of products being offered to the market. This leads to lower prices and / or unsold goods. Overproduction is often attributed as due to previous overinvestment creation of excess productive capacity, which must then either lie idle (or under capacity), which is unprofitable, or produce an excess supply. The overproduction of commodities forces businesses to reduce production in order to clear inventories. Any reduction in production implies a reduction in employment which in turn, reduces consumption. As overproduction is the excess of production above consumption, this reduction in consumption worsens the problem. This creates a "feed-back loop" or "vicious cycle", whereby excess inventories force businesses to reduce production, thereby reducing employment, which in turn reduces the demand for the excess inventories.

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HOW A CRISIS CAN BE IDENTIFIED: Thus it is obvious that the natures and features of recession hide inside all these factors mentioned above. Lets discuss and discover something important about Recession. 1 Indicators of Recession

There are few informal indicators which tell us that it is the time of Recession in an economy. People Buying Fewer Products Decease In Factory Production Growing Unemployment Slump in Personal Income Unhealthy Stock Market

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Chapter-03 Financial Crisis: A Historical Review

Global Financial Crisis: Profile of Recessions and Depressions:
The statistics of financial crisis in between 1870 to 2009 are mentioned below:

Total number of recessions/depressions during period (100%) Number of recessions/depressions lasting < 2 years (13%)

=255 =33

Number of recessions/ Depression related to World War II =9 (4%) Others (83%) =213

Source = Paul Ormerod, The International Centre for Business Performance and Lean Leadership, Nottingham Business School In a climate of unprecedented turbulence, global energy markets followed the same extreme pattern as the world economy in general during 2008. Prices first rose to record highs as economic growth boomed in the first half of the year. Then they collapsed as the global economy abruptly reversed and plunged into recession in the wake of the financial crisis. But the year was also remarkable for another reason less dramatic but, arguably, just as profound in its implications for the long term. For the first time ever, according to the 2009 BP Statistical Review of World Energy, the developing world led by China leapfrogged OECD nations in the consumption of primary energy. At the launch of the Review in London today, BP chief executive Tony Hayward said: The centre of gravity of the global energy markets has tilted sharply and irreversibly towards the emerging nations of the world, especially China. This is not a temporary phenomenon but one that I believe will only increase still more over time. It will continue to affect prices and bring with it new challenges over economic growth, energy security and climate change. This shift will bring volatility in the short term, Hayward warned. But I have no doubt that the diversity and flexibility of modern energy markets will continue to ensure that energy supplies continue to reach consumers efficiently and without interruption. BP chief economist Christof Ruehl said that in spite of the dramatic gyrations in the world economy and energy prices, the Review data showed how well those markets had served energy security during the year. Allowing markets to continue to function freely and without interference remains key to managing the inevitable ups and downs in prices as we go forward, he said. Page 15 of 45

The Review reports remaining proved oil reserves of 1,258 billion barrels, excluding Canadian oil sands enough for 42 years at 2008 production rates. On the same basis, reserves of gas are sufficient for 60 years and coal for 122 years. Reflecting the extremes of the world economy across 2008 strong growth followed by sharp decline the Review shows that overall primary energy consumption nudged up just 1.4 per cent, the smallest rise since 2001. China alone accounted for almost three quarters of the rise, with most of the balance coming from the wider Asia-Pacific region. In the developed world, energy consumption fell by 1.3 per cent, with demand in the USA seeing the steepest single year decline since 1982, a drop of 2.8 per cent. In 2008 the average price of dated Brent crude oil rose to $97.26 a barrel 34 per cent up on the previous year and the seventh consecutive annual rise. However, the annual average masked huge variations across 2008. The price began the year at just below $100 a barrel, peaked at $144 in early July and fell dramatically to less than $40 at year-end the fall a consequence of higher OPEC production and rapid slow-downs in consumption in the second half. Over the year, global oil consumption fell by 0.6 per cent, or 420,000 barrels a day; the first decline since 1993 and the largest drop for 27 years. This included a steep fall in demand of 1.5 million barrels a day from the developed OECD countries their third consecutive year of decline and slower growth in demand (up just 1.1 million barrels a day) from outside the OECD. Despite overall lower demand, average oil production rose 0.4 per cent, or 380,000 barrels a day, driven largely by OPEC production increases. Despite cuts late in the year, average OPEC oil output actually rose by almost 1 million barrels a day, or 2.7 per cent. This all came from the Middle East with daily production from Saudi Arabia up 400,000 barrels and from Iraq up 280,000 barrels. Production outside OPEC recorded the steepest decline since 1992, falling by 1.4 per cent, or 601,000 barrels a day, with output from the OECD countries falling 4 per cent, or 750,000 barrels a day, driven by declines in North America and Europe. The single largest decline came from Mexico, where production fell 310,000 barrels a day. Russian production fell for the first time since 1998, by 90,000 barrels a day. UK oil production fell 94,000 barrels a day, or 6.3 per cent, to the lowest level for 30 years. Gas consumption grew by 2.5 per cent, below the 10-year average. Consumption in the USA grew by 0.6 per cent as spot prices remained well below oil prices. Elsewhere, only the Middle East saw above-average growth, driven by strong domestic demand. Oil-indexed gas prices in OECD Europe and Asia-Pacific rose more rapidly which, coupled with the recessionary impact, meant that consumption growth was below average. The largest incremental growth in world gas demand was from China, where consumption rose 15.8 per cent. The UKs gas consumption grew by 3 per cent, with gas now supplying 39.9 per cent of the UKs total primary energy well above the global average of 24.1 per cent. Globally, gas production rose 3.8 per cent, above the 10-year trend of 3 per cent. This was Page 16 of 45

driven strongly by the USA which recorded its highest ever annual increase in gas production as strong activity in the development of unconventional gas resources raised output by 7.5 per cent - 10 times the 10-year average growth rate. The second highest increment was from Qatar as pipeline exports to UAE increased. Production rose in Europe overall as increases in Denmark, Netherlands and Norway more than offset falls in the UK and Germany. For the sixth consecutive year coal remained the fastest growing fuel globally, even though its 3.1 per cent growth in consumption was below the 10-year trend. China, which accounts for fully 43 per cent of global coal demand, accounted for 85 per cent of this growth, with an increase of 6.8 per cent. Outside China however, global demand growth was weak, climbing only 0.6 per cent, reflecting the fact that coal prices in liberalized markets increased more than for any other fossil fuel. Coal use in the UK fell 7.6 per cent to the lowest level for a decade, in part due to fuel switching driven by CO2 prices in the EU emission trading scheme. Nuclear output fell for the second consecutive year, by 0.7 per cent, led by a 10 per cent decline in Japanese output as its largest power station remained shut after a 2007 earthquake. Hydroelectric output continued its recent strong performance with growth of 2.8 per cent, above the 10 year average for the fourth time in the past five years. However, again, all of the global increase could be accounted for by growth in China climbing by 20.3 per cent, nearly twice the countrys 10-year average rate. Hydroelectric generation outside China fell by 0.4 per cent. Renewable energy again grew strongly albeit from a low base, with wind and solar generating-capacity growing 29.9 per cent and 69 per cent respectively, both above their 10year average rate. The USAs wind power generating capacity grew by 49.5 per cent, overtaking Germany to have the largest installed wind generating capacity in the world. UK wind generating capacity grew 36.3 per cent to 3.3 GW; still, however, accounting for less than 3 per cent of global installed capacity.

GREAT DEPRESSION, 1930 The Great Depression was the longest, most widespread, and deepest depression of the 20th century, and is used in the 21st century as an example of how far the world's economy can decline. It was a severe worldwide economic depression in the decade preceding World War II.

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Starting Point- Ending Point

Great Depression, 1930

3 Starting 4 October 29, The depression originated in the United Point 1929 (Tuesday) States, starting with the stock market crash of October 29, 1929 (known as Black Tuesday), but quickly spread to almost 5 Starting 6 Stock Market every country in the world. The timing of Incident Crash the Great Depression varied across nations, but in most countries it started in about 1929 8 Late 1930s or 7 Ended and lasted until the late 1930s or early early 1940s 1940s.Countries started to recover by the mid-1930s, but in many countries the negative effects of the Great Depression lasted until the start of World War II. Causal- effect Scenario of Great Depression

The stock market crash on October 29, 1929 set in motion a series of events that led to the Great Depression, but in fact, the American economy and global economy had been in turmoil six months prior to Black Tuesday, and a variety of factors before and after that fateful date in October caused and exacerbated the Great Depression. 1. False Sense of Prosperity before the Great Depression The idea of trickledown economics is that the more money you give rich people the more money poor people will get because the rich person would start a company with the money and hire poor people to work it. What happened instead was that rich people either kept all the money given to them or they started a company and instead bought a bunch of machines to work instead of people. Either way, it didnt work. Through this industrial revolution, the 1920s, known as The Roaring Twenties marked a time when America was over dependent on production, automobiles were the leading industry, and there was a great disparity between rich and poor. More than 60% of the population was living below poverty levels, while a mere 5% of the wealthiest people in America accounted for 33% of the income, and the richest 1% owned 40% of the nations wealth. This uneven distribution of wealth was mirrored in the unequal distribution of riches between industry and agriculture. 2. Global Crisis accelerating the Great Depression While America prospered during the 1920s, most of Europe, still reeling from the devastation of World War I, fell into economic decline. America soon became the worlds banker, and as Europe started defaulting on loans and buying less American products, the Great Depression spread.

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3. Speculation and over leverage just before the Great Depression This was when everyone wanted to have a part of the stock market but didnt have the money to. So they borrowed the money and bought overpriced stocks that were really worth nothing so they lost all their money. The people who lent them the money also lost because nobody could pay them back. This made lots of people lose everything they had to pay back for their borrowed money. With only loose stock market regulations in place before the Great Depression, investors were able speculate wildly, buying stocks on margin, needing only 10% of the price of a stock to be able to complete the purchase. Rampant speculation led to falsely high stock prices, and when the stock market began to tumble in the months leading up to the October 1929 crash, speculative investors couldnt make their margin calls, and a massive sell-off began. While the great rise in the stock market (from 181 points in early 1928 to 381 points in September 1929) was fueled by optimism and false hope, the plunge was flamed by stark fear. 4. Stock Market Crash of the Great Depression On September 3, 1929, the Dow Jones was at a high of 381 points, and on October 29, 1929, it had fallen to 41 points after a week of panic selling. The ensuing American economic collapse shook the world: World trade contracted, prices fell and governments faced financial crisis as the supply of American credit dried up. Many countries adopted an emergency response to the crisis by erecting trade barriers and tariffs, which worsened the crisis by further hindering global trade. 5. Bank Failures during the Great Depression The third cause of the Great Depression was bank closings. When all the investors couldnt pay the banks back they just had no money left and everyone lost all of their money they had in the bank. Everybody came to get their money though and when the banks didnt have it the people started breaking up the banks windows and furniture. Moreover, the stock market crashed, fearful that banks would fail, millions of Americans began to withdraw their money. Virtually overnight, they put thousands of banks in peril. The more money Americans withdrew, the more banks failed, and the more banks failed, the more money Americans withdrew. By 1933, more than 11,000 of the nations 25,000 banks had collapsed. 6. The Gold Standard during the Great Depression At the time of the Great Depression, America had a 100% gold standard for its money. This meant that all cash was backed by a government promise to redeem it in a specific amount of gold (at the time, one ounce of gold was redeemable for twenty dollars). Because the amount of money circulating in the economy is wholly dependent on the amount of gold available, Page 19 of 45

the money supply is very rigid. If people start to hoard money (see above) the money supply can drop drastically. As noted in the previous section on hoarding, this is not a problem as long as prices and wages drop instantly to reflect the lower amount of money circulating.

7. Lack of Available Credit during the Great Depression With massive draws on funds during the Great Depression, banks had no money to lend, and this lack of available credit led to a further worsening of economic conditions. 8. People Stopped Spending Money during the Great Depression Companies could make things really fast, so fast that there were too many products and not enough people to buy them. The companies kept on making a product that nobody was buying so they were still spending money on materials but not receiving any money from the product. Actually when the stock market crashed, and the banks failed, and unemployment levels reached higher and higher points, people understandably stopped spending money, which also deepened the economic crisis as demand for products and services ground to a halt. 9. High Unemployment Rates during the Great Depression When consumer spending plummeted during the Great Depression, unemployment rose, reaching its highest level in 1933, when 25% of the workforce was idle. 10. Dust Bowl during the Great Depression A drought that lasted from 1930 to 1936, known as the Dust Bowl, aggravated the problems of the Great Depression. More than a million acres of farmland were rendered useless because of severe drought and years of over farming, and hundreds of thousands of farmers joined the ranks of the unemployed. Primary Causes Behind The Great Depression There were multiple causes for the first downturn in 1929, including the structural weaknesses and specific events that turned it into a major depression and the way in which the downturn spread from country to country. Structural Factors (Emphasized by Historians) A. Massive Bank Failures B. The Stock Market Crash Monetary Factors (Emphasized by Economists) Page 20 of 45

A. Actions by the US Federal Reserve that contracted the money supply. B. Britain's decision to return to the Gold Standard at pre-World War I parities (US$4.86:1)

THE OIL SHOCK 70s recession was a long and deep recession that is remembered primarily for its simultaneous rise in both the inflation rate and the unemployment rate - typically these two measures are expected to move in opposite directions. The 1970s was an era of fuel price increases, rising insurance rates, safety concerns, and emissions controls. The 1973 oil crisis caused a move towards smaller, fuel-efficient vehicles. 1973 Oil Crises was the time of Vietnam War and people of the developed nations were not only feeling the pangs of war but also in the economy. The oil prices quadrupled in that short time frame. It was also during those years that the developing world was spending too much money on national security and for the war. Summary of the Crisis Organization of Arab Petroleum Exporting Countries (OAPEC) declared it would limit or stop oil shipments to the United States and other countries if they supported Israel in the conflict. With the US actions seen as 1973 to 1975 (Duration 16 initiating the oil embargo, the long- Starting PointMonths) term possibility of embargo-related Ending Point Role of Arab Oil Embargo high oil prices, disrupted supply and Major Factor Political Pressure recession, created a strong rift within Concern Inflation Rate & Unemployment NATO; both European nations and Prime Effect Rate Japan sought to disassociate themselves from the US Middle East policy. Arab oil producers had also linked the end of the embargo with successful US efforts to create peace in the Middle East, which complicated the situation. To address these developments, the Nixon Administration began parallel negotiations with both Arab oil producers to end the embargo, and with Egypt, Syria, and Israel to arrange an Israeli pull back from the Sinai and the Golan Heights after the fighting stopped. By January 18, 1974, Secretary of State Henry Kissinger had negotiated an Israeli troop withdrawal from parts of the Sinai. The promise of a negotiated settlement between Israel and Syria was sufficient to convince Arab oil producers to lift the embargo in March 1974. By May, Israel agreed to withdraw from the Golan Heights. Causal- Effect Scenario 1. High Rise of Oil Price OPEAC forced the oil companies to increase payment drastically. The rise in the price of oil created dramatic effect on oil exporting nations, for the countries of the Middle East who had long been dominated by the industrial powers were seen to have acquired control of a vital commodity. The traditional flow of capital reversed as the oil exporting nations accumulated Page 21 of 45

vast wealth. Some of the income was dispensed in the form of aid to other underdeveloped nations whose economies had been caught between higher prices of oil and lower prices for their own export commodities and raw materials amid shrinking Western demand for their goods. 2. Oil Weapon In the political arena there was planned to play a smart game which caused hypertension round the globe. Then as the name of embargo there were cutbacks in oil production from the Arab states to select industrial governments of the world to pressure Israel during the fourth Arab-Israeli War in October 1973. These target industrial governments included the United States, Great Britain, Canada, Japan, and the Netherlands. In retrospect, the purpose of the embargo, as perceived by these target governments, was to sway their foreign policies concerning Israel towards a more pro-Arab position by threatening to cut off exports of Arab oil, and that in altering their policies the Arab states would respond by again allowing their purchase of more oil. The Arab states selected their target governments to emplace their embargo, mostly affecting the European Common Market countries and Japan with a eventual 25% oil cut in production. However, in all five cases there did not appear to be the dramatic change in policy making as envisioned by the Arab states. 3. Adverse Effects The embargo had a negative influence on the economy of developed through causing immediate demands to address the threats to energy security. On an international level, the price increases of petroleum disrupted market systems in changing competitive positions. At the macro level, economic problems consisted of both inflationary and deflationary impacts of domestic economies. The Arab embargo left many U.S companies searching for new ways to develop expensive oil, even in the elements of rugged terrain such as in hostile arctic environments. The problem that many of these companies faced is that finding oil and developing new oil fields are timely operations, and usually produce a time lag of 5 to 10 years between the planning process and significant oil production. 4. Economic Performance While the oil shock undoubtedly played a large part in the poor economic performance of the 1970s, many economists believed it has been assigned an exaggerated amount of blame for the decades poor economic performance. Inflation was rising unsustainably long before the oil shock, and the consensus among economists is that general wage and price control policies implemented in 1971 to mask inflation pressures exacerbated economic weakness before and after the oil shock by preventing the economy from adjusting to market forces. Action- Reaction

Alternative Sources Page 22 of 45

The energy crisis led to greater interest in renewable energy and spurred research in solar power and wind power. It also led to greater pressure to exploit North American oil sources, and increased the West's dependence on coal and nuclear power. This included increased interest in mass transit. In Australia, heating oil ceased being considered an appropriate winter heating fuel. Gas-conversion kits that let the heaters burn natural gas or propane were introduced. The Brazilian government implemented a very large project called "Prolcool" (pro-alcohol) that mixed ethanol with gasoline for automotive fuel. This project, which produces ethanol from sugar cane, continues, and has reduced oil imports and decreased the price of fuel. To supplement Israel's over-taxed power grid, Harry Zvi Tabor, the father of Israel's solar industry, developed the prototype for a solar water heater now used in over 90% of Israeli homes. Macro- economic Changes The crisis caused Japan's economy shifting from oil-intensive industries, and resulted in huge Japanese investments in industries such as electronics. The Japanese auto makers also took advantage of this embargo. After they realized what fuel costs were in the United States, they started producing small, more fuel efficient models, which began selling as an alternative to "gas-guzzling" American vehicles of the time. The Western nations' central banks decided to sharply cut interest rates to encourage growth, deciding that inflation was a secondary concern. Although this was the orthodox macroeconomic prescription at the time, the resulting stagflation surprised economists and central bankers, and the policy is now considered by some to have deepened and lengthened the adverse effects of the embargo. Attempted Measure The followings are the attempt of the policy makers to minimize the effect of oil crisis. a. Congress issued a 55mph speed limit on highways to level the situation. b. Daylight savings time was issued year round in an effort to reduce electrical use. These changes were made in hopes of preserving oil. c. Tax credits were offered to those who developed and used alternative sources for energy including solar and wind power d. Creating a stockpile of oil in case the country needed the military to carry it through a time of chaos. e. Voluntary cutback on the consumption of gasoline closing on Sunday. ASIAN CRISIS Although the Asian financial crisis is only one of many recent crises, it was particularly shocking because it happened at a time when most nations in this region were doing well. Growth rates were high, inflation was low, and government deficits were minimal. Just prior to the crisis, at the peak of euphoria around the early 1990s, many in the region were talking about the arrival of the Pacific Century. Though some signals were ominous, including Page 23 of 45

bubbles in real estate markets and rising trade deficits, these signs were generally dismissed as either unimportant or manageable. Starting Point- Ending Point The Asian financial crisis took place in 1997, which had an evolution that started mainly in the 90's in countries such as South Korea, Thailand, Indonesia and Malaysia. In this case, few predicted that a currency crisis could trigger a regional financial crisis, which then escalated into both an economic crisis and a political crisis.

Causal- Effect Scenario The fundamental cause of Asian financial crisis lies in the deficiency of their financial institutions and corporate governance.

1. Pre- crisis Conditon Here we acknowledge two main factors that were taking place prior this crisis. These were a lack of transparency, which made the investors and economical agents assume an Asian financial stability, and mislead structural and economic policies, which did not attempt to solve deficits in the balance of payments and debt tribulations.

2. Short- term Debt The giants of Asian countries experienced a rapid international debt boost, due to shorter payments dead line. Thus, the international debt of North Korea, for instance, increased from 31.699 million dollars in 1990 to 164.345 million at the end of 1996. Thailand increased from 28.088 million dollar debt to 90.622 million in the same period. The short-debt represented 31% of the total debt in 1990 for South Korea, yet in 1996 it represented 67% (world bank report). Most parts of this debt was involved in the private sector. Without a doubt, this shortterm debt represented one of the main reasons, which led to the financial crisis to occur.

3. Consequence Of The Fixed Exchange Rate Many investors found the Asian market attractive, because they did not have the risk of losing investment in the conversion of one currency to the other due to the fixed exchange rate system. But, once the crisis occurred the Asian central banks no longer had reserves to keep the currency fixed. The only option that these countries could use was to let the Page 24 of 45

exchange rate float. However, if the currency stops being fixed the investors might decide to invest somewhere else. This is, because they are no longer gaining from the fixed exchange rate. This situation will imply other problems for the banks, because they would not have the funds that they desperately need. 4. Financial Chain Rapid growth led to capital inflows from foreign investors who wished to profit from future growth, increased borrowing by domestic firms who believed their investments would continue to be profitable, and rising imports for domestic consumers who believed their rapid income growth would continue indefinitely. The mere slowing of this growth in 1996 led to the sudden slowing of capital inflows in countries where central banks tried to maintain onesided pegged exchange rates against their major trading partners. As a result, surpluses in the balance of payments suddenly turned to deficits, and though central banks tried to create the illusion of stability, speculators quickly figured out that they were running out of foreign currency reserves, forcing catastrophic devaluations that burst the bubble. Afterwards, repayment problems, capital flight, and higher import costs pushed many firms towards insolvency and forced banks to tighten credit. 5. Inefficiency Of The Financial System With high domestic savings rates and easy access to foreign capital, there was little incentive to invest wisely. Banks lent because of firm connections or government pressure, not on the basis of a prudent examination of project payoff. Growth was extensive, not intensive, and thus was not sustainable. Like all pyramid schemes, it ultimately collapsed, taking many nave foreign investors with it. 6. Globalization as a Triggering Factor As a result of accelerated globalization and worldwide integration, competition for export markets has become much fiercer since the 1990s. The rapidly globalizing international finance system is conducive for this purpose. Many Pacific nations suddenly became more exposed to an increasingly competitive global environment, and have been forced by events to become more sensitive and responsive to external changes. These external changes include changes in other nations foreign exchange rates, changes in their competitiveness relative to that of other nations in a particular product or a particular factor price, changes in other nations policies on FDI, trade, capital markets, et cetera. As globalization goes wider and deeper, domestic events often have global implications, especially to nations with more openness. Thus, because the exposure of Vietnam, Laos and China is less than Thailand, these nations are less affected by the financial crisis. I. Action- Reaction Four Main Proposals Page 25 of 45

The four proposals are: tax for outflow of shot-term capital, a fixed spread for the financial institutions that will apply only in the short term, a dirty exchange rate that will apply only the short term as well and an improvement of financial transparency. Role of IMF a) Acquisition of Capital With strong encouragement of the IMF and World Bank, many Asian countries followed a three-pronged strategy for attracting foreign capital: liberalization of the financial sector (i.e. elimination of restrictions on capital flows); maintenance of high domestic interest rates in order to suck in portfolio investment and bank capital; and pegging of the national currency to the dollar to reassure foreign investors against currency risk. b) Ineffective Utilization In retrospect, these countries exemplified the perils of "fast-track capitalism." Foreign capital entered in the form of short-term loans to banks and enterprises, but this speculative investment capital never found its way into the real economy of domestic manufacturing or agriculturelow-yield sectors that would provide a decent rate of return only after a long gestation period. Instead, the capital was invested into high-yield sectors with a quick turnaround time, such as the stock market, consumer financing and, in particular, real estate. c) Critical Situation Commercial banks and finance companies soon found they were horribly overinvested in these high-yield and high-risk sectors. Meanwhile, real estate and foreign portfolio investors and banks that had loaned to domestic entities discovered that their customers were carrying a load of non-performing loans (i.e. loans that produced no income). With a worsening balance of trade, the countries' capacities to repay the debts incurred by the private sector became very cloudy. The worsening balance of trade struck fear in the hearts of investors, who recognized the pattern as similar to that which happened in Mexico in 1994. d) Rise of Crisis By early 1997 many investors and speculators concluded it was time to get out before currency devaluation ruined their investments. The ensuing devaluation resulted in a catastrophic combination of skyrocketing import bills, spiraling costs of servicing the foreign debt of the private sector, heightened interest rates spiking economic activity, and a chain reaction of bankruptcies. The Southeast Asian miracle had come to a screeching stop. e) Step for Recovery Page 26 of 45

Despite the failure of IMF policies in Asia, it has moved to revise its articles of association to include within its jurisdiction the liberalization of capital movement within its member countries. Currently, the Fund has the formal authority to monitor and supervise financial flows that are connected with trade in goods and services, exchange rate movements, and credit flows and debt servicing. This latest proposal would extend its formal authority to monitoring and supervising of financial flows connected with direct and portfolio investment. The main lesson to be learned from the Asian financial crisis, critics of the IMF contend, is that there is an urgent need to reverse current practices and re-regulate global capital flows. Yet the IMF is demanding that there be even less controls over currency movements by denying governments the right to ultimate control over capital movement. f) Sensible Financing China is one of these newly-arrived heavyweight players in the global export competition. China suddenly exhibited an explosive export capacity after ten years of economic reform and decentralization, and it also devalued its currency in 1995, further improving its export edge over other nations. The other Pacific Asian nations were complacent in their success, however, and were slow to realize how dramatically their world was changing. Had their financial systems and corporate governance been flexible and sensitive enough, less controlled by governments but more responsive to changes in the world markets, then these nations might have swiftly escalated their export composition by restructuring their industries, and gradually adjusted their exchange rates in response to changes in their foreign currency reserves. But instead, they followed a dollar-pegging policy, and responded to external changes slowly in upgrading their exports. The worsening foreign reserves eventually alarmed the prospective foreign investors, and attracted speculators who realized that the situation was not sustainable.

SUBPRIME MORTGAGE CRISIS ORIGINS AND CAUSES OF THE CRISIS At the recent Reserve Bank of Australia conference on the current financial turmoil the paper by Adrian Blundell-Wignall and Paul Atkinson explained the current financial crisis as being caused at two levels: by global macro policies affecting liquidity and by a very poor regulatory framework that, far from acting as a second line of defense, actually contributed to the crisis in important ways. 2 The policies affecting liquidity created a situation like a dam overfilled with flooding water. Interest rates at one per cent in the United States and zero percent in Japan, China's fixed exchange rate, the accumulation of reserve sin Sovereign Wealth Funds, all helped to fill the liquidity reservoir ton overflowing. The overflow got the asset bubbles and excess leverage under way. But the faults in the dam namely the regulatory system started from about 2004 to direct the water more forcefully into some very specific areas: mortgage securitization and off-balance sheet activity. The pressure became so great that that the dam finally broke and the damage has already been enormous. Page 27 of 45

This paper summarizes the main findings of the Reserve Bank paper and extends it through focusing on the policy discussion and comments received. 2004 IS CRITICAL IN THINKING ABOUT CAUSALITY: The crisis originated from the distortions and incentives created by past policy actions. When economists talk about causality they usually have some notion of erogeneity in mind; that relatively independent factors changed and caused endogenous things to happen in this case the biggest financial crisis since the Great Depression. The crisis itself was not independent, but originated from the distortions and incentives created by past policy actions.

Many of the reforms underway focus on securitization, credit rating agencies, poor risk modeling and underwriting standards, as well as corporate governance lapses, amongst others, as though they were causal in the above sense. But for the most part these are only aspects of the financial system that accommodated a new banking business model in its drive to benefit from the incentives that had been created over time, and were unleashed by timespecific catalysts. The rapid acceleration in RMBS from 2004 suggests these factors were not causal in the erogeneity sense that would require that they had been subject to independent behavioral changes. For example, rating agency practices would be causal if in 2004 agencies developed new inferior practices that triggered events; in fact they were only accommodating banks drive for profit as the banking system responded to other exogenous factors. In 2004 four time specific factors came into play. (1) the Bush Administration American Dream 3 zero equity mortgage proposals became operative, helping low-income families to obtain mortgages; (2) the then regulator of Fannie Mae and Freddie Mac, the Office of Federal Housing Enterprise Oversight (OFHEO), imposed greater capital requirements and balance sheet controls on those two government sponsored mortgage securitization monoliths, opening the way for banks to move in on their ``patch'' with plenty of low income Page 28 of 45

mortgages coming on stream; (3) the Basel II accord on international bank regulation was published and opened an arbitrage opportunity for banks that caused them to accelerate offbalance-sheet activity; and (4) the SEC agreed to allow investment banks (IBs) voluntarily to benefit from regulation changes to manage their risk using capital calculations under the consolidated supervised entities program. (Prior to 2004broker dealers were supervised by stringent rules allowing a 15:1 debt to debt equity ratio. Under the new scheme investment banks could agree voluntarily to SEC consolidated oversight (not just broker dealer activities), but with less stringent rules that allowed them to increase their leverage ratio towards 40:1 in some cases.) The combination of these four changes in 2004 caused the banks to accelerate off-balance sheet mortgage securitization as a key avenue to drive the revenue and the share price of banks. There was not much objection at the Reserve Bank conference to the idea that low interest rates and related policies (like American Dream was neither a factor, nor that higher leverage in investment banks and multi-layered regulation in the US is problematic, of which the Fannie and Freddie controls were but one symptom. WHY WAS MORTGAGE PRONOUNCED IN THE USA? SECURITIZATION IN SUBPRIME MORE

One question raised at the Reserve Bank conference was this: if all this is true about the Basel global bank regulation, then why was this activity so much stronger in the US than elsewhere? There are many reasons for this, all of them to do with policy. First, the Bush Administration American Dream policy that tried to spread home ownership to lower income groups through zero equity lending greatly facilitated generation of the mortgage raw materials. Second, mortgage interest for home owners is deductible in the US. Third, the 1986 tax reform act included the Real Estate Mortgage Investment Conduit (REMIC) rules which can issue multiple-class pass through securities without an entity-level tax. This greatly enhanced the attractiveness of mortgage securitization. Fourth, the 1997 tax change substantially exempting homes from capital gains tax (which did not apply to financial assets like stocks). Fifth, the Fannie/Freddie capital restrictions from 2004, which saw banks move into the vacuum that was left. Sixth, the greater overall dominance of the investment banking culture in the USA which was a key feature of the new business model. The incentives created by these factors, when combined with the features of Basel I and the transition to Basel II and the SEC rule changes in 2004, proved to be too strong a temptation for the bank business model to ignore. Most of the early disasters in the crisis occurred where investment banks were involved either separately or as a part of a diversified financial institution: Bear Stearns, MerrilLynch, Lehmans, Citi, UBS and AIG (via its investment bank subsidiary AIG Financial Products that had CDS losses on a massive scale), were all prominent in this respect. The push to keep fee income from securitization of (low-capital-charge) mortgages as a key source of earnings growth necessitated moving further and further into low quality mortgages, and the issuance of RMBS based on them, that would prove increasingly toxic in the levered vehicles and bank balance sheets into which they were thrust. Other countries, Page 29 of 45

such as Switzerlands, Germanys and the UKs, investment banks took up similar activities often to keep market share, or because the incentive to improve returns by gaming the Basel process was too strong. But many countries would be drawn into the crisis in other ways as their banks expanded off-balance-sheet activity, rapidly expanded use of wholesale funding to anticipate more profitable mortgages under Basel II (see Northern Rock below), invested in the products created, copied strategies in efforts to hold market share, or became involved as counterparties with banks at risk (for example in credit default swap transactions).

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Chapter-04 Behind the Scene

The search for causes is closely connected to the question of how to avoid a future depression, and so the political and policy viewpoints of scholars are mixed into the analysis of historic events. The even larger question is whether it was largely a failure on the part of free markets or largely a failure on the part of government efforts to regulate interest rates, curtail widespread bank failures, and control the money supply. Those who believe in a large role for the state in the economy believe it was mostly a failure of the free markets and those who believe in free markets believe it was mostly a failure of government that compounded the problem. According to Keynesian economics and Institutional economists The reasons generated from under consumption and over-investment (causing an economic bubble), malfeasance by bankers and industrialists, or incompetence by government officials. The consensus viewpoint is that there was a large-scale loss of confidence that led to a sudden reduction in consumption and investment spending. Once panic and deflation set in, many people believed they could make more money by keeping clear of the markets as prices dropped lower and a given amount of money bought ever more goods, exacerbating the drop in demand. According to Keynesian economics and Institutional economists There are the monetarists, who believe that the Great Depression started as an ordinary recession, but that significant policy mistakes by monetary authorities (especially the Federal Reserve), caused a shrinking of the money supply which greatly exacerbated the economic situation, causing a recession to descend into the Great Depression. Related to this explanation are those who point to debt deflation causing those who borrow to owe ever more in real terms. Action- Reaction 1. The smoot-Hawley tariff: In 1988, the Council of Economic Advisors proclaimed that the Smoot Hawley Tariff Act was "probably one of the most damaging pieces of legislation ever signed in the United States." The act was passed in June of 1930 and increased tariffs to a tax of 50 percent on goods imported into the United States. Since this occurred after the onset of the Depression, it's hard to see how it could have caused it. However, since the real effect of the increased tariffs was to increase prices and increase price rigidity, it is easy to see how the Act could have exacerbated the Depression. Enacting the tariff was exactly the wrong thing to do and about 1,000 economists signed a petition begging Congress not to pass it. Eventually, 60 other countries passed retaliatory tariffs in response. Page 31 of 45

1. The Federal Reserve Board The Fed was ostensibly created to prevent bank panics and Depressions. Is it possible that the Fed was actually responsible for the Depression? The answer is a qualified no. The Fed took several actions that, in retrospect, were quite bad. The first thing it did was to inflate the money supply by about 60% during the 1920's. If the Fed had been a little more careful in expanding the money supply, it might have prevented the artificial Stock market boom and subsequent crash. Second, there are indications that the economy was starting to cool off on its own in early 1929, thus making the interest rate hike in TBD completely unnecessary and avoiding the subsequent crash. The third mistake the Fed made was in early 1931. The Fed raised interest rates, exactly the wrong thing to do during a contraction. Ironically, the country's gold stock was increasing at this point all on its own, so doing nothing would have increased the money supply and helped the recovery. Critics Review The Federal Reserve began expressing concern in early 1928 and at that time began a policy of monetary restriction in an effort to stem the stock market advance. This policy continued through May 1929. The monetary restriction was carried out by selling $405 million in government securities and raising the discount rate in three stages from 3.5 percent to 5 percent at all Federal Reserve banks. Besides, the monetary expansion of 1927 is considered by many economists to be an important factor in setting off the U.S. stock market advances of the late 1920s. But a further irony is the fact that the very existence of the Federal Reserve caused banks to wait for the central bank to act and not turn to the solutions they had devised in the face of the banking crises of the nineteenth century. Even with all that bungling, it is not clear that we can lay responsibility for the Great Depression at the feet of the Fed.

2. Gold Standard Issue From about 1921, Britain had started a slow economic recovery from the war and the subsequent slump. But in April 1925 the Conservative Chancellor, Winston Churchill, on advice from the Bank of England, restored the Pound Sterling to the gold standard at its prewar exchange rate of 4.86 US dollars. This made the pound convertible to its value in gold, but at a level that made British exports more expensive on world markets. The economic recovery was immediately slowed. To offset the effects of the high exchange rate, the export industries tried to cut costs by lowering workers' wages, provoking the General Strike of May 1926. The industrial areas spent the rest of the 1920s in recession, and these industries received little investment or modernization. Throughout the 1920s unemployment stayed at a steady one million. 3. New Financial System

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The US government commenced with several measures designed to resurrect the financial system. (i) (ii) The establishment of the Reconstruction Finance Corporation which set about funneling large sums of liquidity to banks and other intermediaries; The Securities Exchange Act of 1934 which established margin requirements for bank loans used to purchase stocks and bonds and increased information requirements to potential investors; and The GlassSteagal Act which strictly separated commercial banking and investment banking.

(iii)

4. Innovative Theory Irving Fisher proposed that the predominant factor leading to the Great Depression was overindebtedness and deflation. Fisher tied loose credit to over-indebtedness, which fueled speculation and asset bubbles. He then outlined 9 factors interacting with one another under conditions of debt and deflation to create the mechanics of boom to bust. (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) Debt liquidation and distress selling Contraction of the money supply as bank loans are paid off A fall in the level of asset prices A still greater fall in the net worth of business, precipitating bankruptcies A fall in profits A reduction in output, in trade and in employment. Pessimism and loss of confidence Hoarding of money A fall in nominal interest rates and a rise in deflation adjusted interest rates.

Performance of US Economy Particulars Banks in operation Prime interest rate Volume of stocks sold (NYSE) Privately earned income Personal and corporate savings 1929 25,568 5.03% 1.1 B $45.5B $15.3B 1933 14,771 0.63% 0.65 B $23.9B $2.3B

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Chapter-05 Bangladesh Chapter Analysis

There is a saying that when America sneezes, the world gets flu. This is evident, as the American financial crisis has spread throughout the world. America can come out of this crisis, but countries with weaker economies like Bangladesh will suffer heavily. Bangladesh is affected by what transpires in international markets and economies of leading countries. Most of them are experiencing slowdown in growth. Bangladesh is most likely to be adversely affected sooner or later. In the industrialized countries, manufacturers are not making money, the retailer is not making money and the consumer is complaining because they are paying more. An unprecedented plunge in the confidence of consumers is being experienced in these countries. The global slowdown in the leading economies is likely to create adverse effects in these cases. RMG Exports Linked to this recession in industrial countries, global demand has fallen and the pace of expansion of exports has reduced considerably. The growth rate of developing country exports in dollar terms has fallen from 42 percent in the first quarter of 2008 to 7.5 percent in the third quarter. Exports have declined by 4 percent during the three months of August-October 2008, suggesting bleak prospects for the expansion of exports in 2009. From Bangladesh, about 75% of the exported garments and knitwear go to the US and Europe, but this is likely to fall because there will be no demand in those countries.

Aid- flow for FDI Although the financial crisis began in the world's richest nation, there is good reason to worry about how it will affect the world's developing country like Bangladesh. Bangladesh needs foreign direct investment (FDI) up to 28% of GDP every year to reduce poverty in the country, and this aid usually provided by the developed countries. Development process may slow down considerably because aid from the G-7 countries expected to be less.

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After each previous financial crisis in a donor country since 1970, the country's aid has declined.

Remittances from workers Furthermore, The Middle East has not been immune from the crisis and stocks fell there too. Labor laws in some Middle East countries have changed to the detriment of foreign workers. It is likely that remittances will be less because there will be job cuts. Remittances during the last financial year stood at almost $7 billion. 25% was from industrialized countries and 75% from the Middle East.

Bangladesh fights back fallout good

Bangladesh figures in a group of countries that are emerging from the shocks of global economic crisis better than the developed world. The research report released on December 4 says Bangladesh has performed "broadly in line with expectations". Bangladesh is one of the 11 countries that have a high potential of becoming a leading economy in the 21st century along with Brazil, Russia, India and China (BRICs). Brazil, China, Indonesia and even Bangladesh have shown less vulnerability to the crisis. A. Introduction & Implementation of BASEL II In the last few decades banks were becoming increasingly international in their operations, there was a need for a uniform regime to set minimum levels of capital that banks must hold across the developed countries. The Bank for International Settlements, based in Basel in Switzerland, was the body charged with establishing a framework for setting a minimum level of capital each bank should have to hold. Basel II came into effect in the European Union on 1 January 2007 under the Capital Requirements Directive (CRD) and all lenders covered by the CRD will have to implement it from the beginning of 2008. In summary, Basel II works not only to align regulatory capital more closely with risk but to promote a more sophisticated approach to risk management and to create a 'risk culture' inside lenders, whereby the organization, and senior management in particular, understand risk and remain alert to risk as a core issue. As lenders begin to gear up for its introduction, they are discovering just how substantial a change the move to Basel II really is. All lenders covered by the CRD will be required to have fully implemented Basel II from the beginning of 2008.

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Structure of Basel II

Basel II consists of 3 'pillars' which enshrine the key principles of the new regime. Collectively, they go well beyond the mechanistic calculation of minimum capital levels set by Basel I, allowing lenders to use their own models to calculate regulatory capital while seeking to ensure that lenders establish a culture with risk management at the heart of the organisation up to the highest managerial level. Pillar 1 Sets out the mechanism for calculating minimum regulatory capital. Under Basel I this calculation related only to credit risk, with a calculation for market risk added in 1996. Basel II adds a further charge to allow for operational risk.

Pillar 2

Meant to identify risk factors not captured in Pillar 1, giving regulators discretion to adjust the regulatory capital requirement against that calculated under Pillar 1. For most lenders, the Pillar 2 process is expected to result in a higher regulatory capital requirement than calculated under Pillar 1. Pillar 2 requires banks to think about the whole spectrum of risks they might face including those not captured at all in Pillar 1 such as interest rate risk.

Pillar 3

Designed to increase the transparency of lenders' risk profile by requiring them to give details of their risk management and risk distributions. Information is likely to be released through the normal mandatory financial statements lenders are required to publish or through lenders' websites.

a.

Businesses Started During a Recession

Here are some interesting facts as taken from a recent USA Today article:

16 out of the 30 corporations that make up the current Dow Jones Industrial Average started during a recession Walt Disney Corporation began during the recession in 1923-24. Hewlett-Packard Corporation began in 1938 during the Great Depression. Microsoft Corporation began during the 1975 recession.

This USA Today also notes that in the recession of the early 90s, 25% of downsized executives over 40 started their own companies. It makes you think that, perhaps, recession is a natural way to clean house and restart the economy anew, even though it is very painful.

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b.

Why Recession is a Good Time to Start a Small Business

Many people spend years tinkering with a product in their garage. Others spend time drawing out ideas for a special service in their home office. However, they hold down full-time jobs and never have time to go ahead with their inventions. During a recession, if their job status changes, it may be just the time to go forward with their inventions and ideas. Here are some reasons that a recession may be a good time to start a small business. 1. Your competitors are weakened. Because of the recession, your competitors are not only weakened but perhaps even closing up and selling out. Maybe some owners are retiring. All are tightening their belts. There may be a niche for you to slip into if a hole is developing in the marketplace. 2. Is your product or service viable in a good or bad economy? Just because there may be a market niche for your product or service doesnt mean you can just stick any product in it. A flawed idea never works in the long-term. You need to do extensive market research to find out if your product or service is needed in both good and bad economies because the economy will eventually recover. 3. Most things are cheaper. Prices often drop during a recession. This is called deflation. Office space is cheaper because it is plentiful, although starting your small business in a recession out of a home office may be the best idea. You may be able to find good sales on everything from office furniture to office supplies. If you need to hire personnel, you may find you can hire talented people for lower wages. 4. Buy what you need at auction.If you want to try to get what you need to start your business really cheap, try buying it at auction. There are usually lots of auctions during recessions. You might even be able to get fleets of vehicles, large machinery or restaurant equipment, or other usually expensive large items at rock bottom prices if you try going to auctions. 5. Be frugal. If you are starting a business during a recession, you are starting with a very limited budget. Chances are, you dont have access to angel investors or venture capitalists. You may have access to funds from your family or friends since, in a recession, they may not be investing in the stock market or other financial instruments. Be frugal with the funds you have or obtain. Cut your budget, then cut it again. You will have to track your expenditures carefully. You should pay close attention to your cash flow and budgets. Be prepared to operate under Spartan conditions. 6. Negotiate better terms with your suppliers. During a recession, credit is tight or virtually non-existent. Suppliers are likely to give a company good terms under these conditions.

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Chapter-06 Policy Implications

Lessons from the Great Depression of the 1930s would be useful in overcoming the current recession but the forces and requirements of globalization need to be taken into consideration when conceiving and formulating policies aimed at ending it. So global economic policies need to designed and implemented by individual nations, sub-regional, regional and world bodies with due consideration of forces and requirements of globalization and with a view to setting goals on desired employment a productivity levels, growth rates, etc, which should be in line with the existing endowments and capacities of each nation, sub-region or region.

Reflationary measures should be employed by nations to increase aggregate demand in their economies with a view to reducing unemployment. It can be executed through printing of money or through public sector borrowing (government borrowing from the private sector). Leaders of individual nations should know the difference between what can be done with foreign earnings and what can be done with their local currencies and how the two are related. It is improper to tie, for instance, provision of adequate money for a project that can be executed with local resources, to foreign earnings. Where dams for irrigation, roads for transportation and buildings for schools and hospitals are mainly made with local resources (rocks, sand, cement, etc) found in a given nation, local currencies can be printed to buy these resources. This policy would increase economic activities and reduce poverty among people through the multiplier effect. It will also provide the infrastructure required for boosting productivity. Foreign earnings should be used for foreign goods and services and in line with the priorities of the moment. Financial aids and assistance given to the poor and less developed nations by the developed ones should not be curtailed as doing this will further reduce global demand for goods in services and subsequently exacerbate global recession. Additional sources of revenue other than taxes should be identified and used to supplement government revenue. Asking people to pay more taxes or pay new ones reduces their disposable incomes and leads to a further fall in demand.

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Chapter-07 Conclusion
Financial Crisis is one of the most important issues around the world. In Bangladesh, its impact has caught attentions. In twenty first century, as a nation it is our responsibility to ensure proper economic security for all the citizens. Government of Bangladesh has been trying to ensure proper security for the common people. A proper planning should be made on this regard. The government has taken all possible steps to secure the interest of people from the thunder of financial crisis around the world.

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APPENDIX

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POINT OF DIFFERENCE Based on the GDP

Major Prey

FINANCIAL CRISIS When a nation/ Country faces crisis in its monetary control and supply-demand management. It does not directly have any impact on GDP. Financial institutions like Banks, Insurance organizations etc.

RECESSION A recession is an economic downturn that causes decline in GDP less than 10 percent.

Economy of a specific country/ nation and partially other countries will get negative change in the economy due to the impasse caused by the recession.

DEPRESSION A depression is any economic downturn where real GDP declines by more than 10 percent. Responsible country (ies) and all other related economies (Countries) are affected due to the fatal impact of economic crisis.

Put impact on paper money.

9.2 9.3 Major Recessions in United Kingdom

Name

Dates

Duration

GDP Reduction

Root Causes

1919-21 Depression

1919-1921

~3 years

10.9% 1919 The end of the First World 6.0% 1920 War 8.1% 1921 0.7% 1930 US Depression. Reducing 5.1% 1931 demand for UK exports, also high interest rate defending the gold standard. 1973 oil crisis

Great Depression

1930-1931

~2years

Mid 1970s 1973-75 Recession Early 1980s 1980-82 Recession

2 years 3.9% (6 out of 9 3.37% Qtr) ~2 years 5.8% (6 - 7 Qtr)

Early 1990s 1990-92 Recession

~2 years 2.5% (5 Qtr)

Cause possibly monetarist government policies to reduce inflation? US savings and loan crisis leading to the Early 1990s recession.

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Late-2000s Recession

2008-09

6 Qtrs so far, from Q2 2008 (~May)

6.0% to Sep-09 Forecasts 6.2%

end Financial crisis of 20072009 ~5-

Name 1919-21 Depression Great Depression Mid 1970s Recession

Other Data Deflation ~10% in 1921, and ~14% in 1922.

UK came off gold standard Sept 1931. 3-5% deflation pa. UK much less affected than US. Took 14 quarters for GDP to recover to that at start of recession

Early 1980s Company earnings decline 35%. Unemployment rises 124% from 5.3% of Recession the working population in Aug 1979 to 11.9% in 1984[7] Took 13 quarters for GDP to recover to that at start of 1980. Early 1990s Company earnings decline 25%. Peak budget deficit ~8% of GDP. Recession Unemployment rises 55% from 6.9% of the working population in 1990 to 10.7% in 1993 Took 13 quarters for GDP to recover to that at start of recession Late-2000s Manufacturing output down 7% by end 2008. Unemployment 2.8M at Recession beginning 2010 CBI forecast manufacturing output to drop 10% in 2009. Unemployment forecast to rise to 3.0M (9.4%) in 2010.It has been the longest recession since the war. It has affected lots of parts of the country including banks and investment firms. Longest recession to hit post-war Britain.

9.4

Major Recessions in USA

Name

Date

Duration

Time since Unemployment previous Peak Recession

GDP Decline

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190204 Recession

Sep Aug 1904 May June 1908

1902 1 year 1 year 16.2% 11 months 9 months 1907 1 year 2 years 29.2% 1 month 9 months 1910 1 year 14.7% 7 months

17.1%

Panic of 1907

31.0%

Panic of Jan 19101911 Jan 1912

2 years

10.6%

Recession of Jan 19131914 Dec 1914

1913 1 year 1 year 11 months

25.9%

19.8%

Post-World War recession

Aug 1918 7 months March 1919

3 years 24.5% 8 months

14.1%

Depression of Jan 192021 July 1921

1920 1 year 10 months 6 months 1923 1 year 2 years 2 months

38.1%

32.7%

192324 recession 192627 recession

May June 1924 Oct Nov 1927

25.4%

22.7%

1926 1 year 2 years 12.2% 1 month 3 months

10.0%

Name 190204 Recession

Root Causes Though not severe, this downturn lasted for nearly two years and saw a distinct decline in the national product. Industrial and commercial production both declined, albeit fairly modestly. The recession came about a year after a 1901 stock crash. of A run on Knickerbocker Trust Company deposits on October 22, 1907, set Page 43 of 45

Panic1

1907

events in motion that would lead to a severe monetary contraction. The fallout from the panic led to Congress creating the Federal Reserve System.

Panic of This was a mild but lengthy recession. The national product grew by less than 1%, and commercial activity and industrial activity declined. The 19101911 period was also marked by deflation. Recession of Productions and real income declined during this period and were not offset until the start of World War I increased demand. Incidentally, the Federal 19131914 Reserve Act was signed during this recession, creating the Federal Reserve System, the culmination of a sequence of events following the Panic of 1907. Severe hyperinflation in Europe took place over production in North Post-World War I America. This was a brief but very sharp recession and was caused by the end of wartime production, along with an influx of labor from returning recession troops. This in turn caused high unemployment. Depression of The 1921 recession began a mere 10 months after the post-World War I recession, as the economy continued working through the shift to a 192021 peacetime economy. The recession was short but extremely painful. The year 1920 was the single most deflationary year in American History; production, however, did not fall as much as might be expected from the deflation. GNP may have declined between 2.5 and 7 percent, even as wholesale prices declined by 36.8%. The economy had a strong recovery following the recession. From the depression of 192021 until the Great Depression, an era dubbed the Roaring Twenties, the economy was generally expanding. Industrial production declined in 192324, but on the whole this was a mild recession. This was an unusual and mild recession, thought to be caused largely because Henry Ford closed production in his factories for six months to switch from production of the Model T to the Model A. Charles P. Kindleberger says the period from 1925 to the start of the Great Depression is best thought of as a boom, and this minor recession just proof that the boom "was not general, uninterrupted or extensive".

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REFERENCE
Persons Md. Mukhlesur Rahman Lecturer, Department of Finance, University of Dhaka Pallabi Siddiqua. Lecturer and Course Instructor, F-101 (Business Communication) Department of Finance, University of Dhaka

Books The Economics of Money, Banking and Financial Markets Frederic S. Mishkin Basic Business Communication, 10th Edition by R.V.Lasiker & M.E.Flatley

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