Demystifying Global Financial Crises: Prashant Patel
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Demystifying Global Financial Crises
Prashant Patel Smile Education 2008
Anatomy of a Typical Financial Crises • Hyman Minsky Model: identifies underlying economic model of a typical financial crises • Starts with Displacement • Displacement create profit opportunities • Opportunities draws firms and households…...boom is underway • Credit finances boom • Urge to Speculate leads to “feedback loop” • “Euphoria” leading to “overtrading” • “Monkey see monkey do” – leading to “mania” • Objects of speculation could vary • Swindlers and catchpenny schemes flourish • Mania spread across border • Smart guys / Insiders pull out • Speculators withdraw as specific signal precipitates • Revulsion – There is limited money to give limited exit at the top • Panic – feeds on itself just like speculation
Multiple Displacement backdrop • Asian crises leads to lower prices in Asia. Lower prices led to lower inflation and lower yield in developed markets and soon globally. • Shocked by Asian market collapse, Asian investors including central bankers kept transferring savings to US. This help even lesser yields in US. • Lower prices and lower credit rates led to unprecedented appetite to consume. • Meanwhile Asian deflation spread over to other asset classes like crude on back of Russia bust and debt challenges of Saudi Arabia • This was followed by LTCM collapse in Oct 1998 leading to further easing of liquidity. • Lower credit, lower yields and “innovation shock” led unprecedented capital spending on technology. Tech boom of 1998 to 2000 took off…but eventually collapsed under its own weight and scandals. Investors confidence hit lows. • Investors confidence was shattered further on back of historic terrorist attack on US – 9/11. • Low investor confidence prompted further rate cuts in US and quickly across the globe.
Massive Liquidity Injects Multiple Bubbles
Historic Profit Opportunities • Driven by huge liquidity and productivity US became nation of consumer. High consumption led to even higher income. • Lower credit found its way into housing markets. Home prices started rising above mean. Combination led to huge profit opportunities. • High US consumption fueled demand for cheaper Asian goods and services. Profit opportunities arose for firms and individuals in Asia. • Unprecedented demand for goods led to investment spending across emerging economies which eventually increased demand for commodities. • Soon positive feedback loop resulted in enormous profit opportunities in US housing, commodities and emerging markets. • Huge liquidity in developed markets also resulted in enormous private equity capital and structured product business
Productivity rise / Fed rate drop
Inflation decline / Credit cost decline
Feedback Loop
US Nation of : Import-Consume-Debt
Credit expansion & Object of Speculation • Sustained decline in interest rates across globe • Rise of structured products market and derivatives • Rise of Private equity and hedge funds • Five objects of speculation – five asset classes ranked from perceived safest to riskiest 1. Structured Products 2. Housing 3. Efficiency Capital – Hedge funds, Pvt. Equity 4. Commodities 5. Emerging markets
New Credit Factories
New Credit Models
Urge to Speculate : Nothing New About It!
US Housing Bubble
US Housing Bubble
Investment Demand mainly in Rest of the World
Commodity Prices Blast
Emerging Markets Boom – Like India
Historic Rise in Emerging market Indices
Seven Fold Rise
Revulsion & Panic •
House prices stops rising and Sub-prime defaults emerge in US
•
Specifics precipitates in terms of mortgage write-offs by Banks and Collapse of Bear Sterns, Lehman Brothers etc.
•
Structural finance industry quickly shows sign of panic
•
Soon Commodities and emerging market stopped rising and stampede to move on cash begins
Specifics Precipitates : Housing Starts Peak
Transmission of Sub-Prime Losses
Efficiency Capital Collapse
Commodity Stopped Rising
Stampede to move out of EM like India on…
-50%
Multiple Bubble Bust
Management of Crises • •
Let is Burn out…….No management: Evil of panic will work its own cure Lender of Last resort
“The Panic feeds on itself, as did speculation, until one or more of three things happen: 1. Prices fall so low that people are again tempted to move back into less liquid assets; 2. Trade is cut off by setting limits on price declines, shutting down exchanges or otherwise closing trading 3. A lender of last resort succeeds in convincing the market that money will be available in sufficient volume to meet the demand for cash” - Charles P. Kindleberger
Is It Different This Time?
May Be Not!
God Bless
Prashant Patel Smile Education 2008
Anatomy of a Typical Financial Crises • Hyman Minsky Model: identifies underlying economic model of a typical financial crises • Starts with Displacement • Displacement create profit opportunities • Opportunities draws firms and households…...boom is underway • Credit finances boom • Urge to Speculate leads to “feedback loop” • “Euphoria” leading to “overtrading” • “Monkey see monkey do” – leading to “mania” • Objects of speculation could vary • Swindlers and catchpenny schemes flourish • Mania spread across border • Smart guys / Insiders pull out • Speculators withdraw as specific signal precipitates • Revulsion – There is limited money to give limited exit at the top • Panic – feeds on itself just like speculation
Multiple Displacement backdrop • Asian crises leads to lower prices in Asia. Lower prices led to lower inflation and lower yield in developed markets and soon globally. • Shocked by Asian market collapse, Asian investors including central bankers kept transferring savings to US. This help even lesser yields in US. • Lower prices and lower credit rates led to unprecedented appetite to consume. • Meanwhile Asian deflation spread over to other asset classes like crude on back of Russia bust and debt challenges of Saudi Arabia • This was followed by LTCM collapse in Oct 1998 leading to further easing of liquidity. • Lower credit, lower yields and “innovation shock” led unprecedented capital spending on technology. Tech boom of 1998 to 2000 took off…but eventually collapsed under its own weight and scandals. Investors confidence hit lows. • Investors confidence was shattered further on back of historic terrorist attack on US – 9/11. • Low investor confidence prompted further rate cuts in US and quickly across the globe.
Massive Liquidity Injects Multiple Bubbles
Historic Profit Opportunities • Driven by huge liquidity and productivity US became nation of consumer. High consumption led to even higher income. • Lower credit found its way into housing markets. Home prices started rising above mean. Combination led to huge profit opportunities. • High US consumption fueled demand for cheaper Asian goods and services. Profit opportunities arose for firms and individuals in Asia. • Unprecedented demand for goods led to investment spending across emerging economies which eventually increased demand for commodities. • Soon positive feedback loop resulted in enormous profit opportunities in US housing, commodities and emerging markets. • Huge liquidity in developed markets also resulted in enormous private equity capital and structured product business
Productivity rise / Fed rate drop
Inflation decline / Credit cost decline
Feedback Loop
US Nation of : Import-Consume-Debt
Credit expansion & Object of Speculation • Sustained decline in interest rates across globe • Rise of structured products market and derivatives • Rise of Private equity and hedge funds • Five objects of speculation – five asset classes ranked from perceived safest to riskiest 1. Structured Products 2. Housing 3. Efficiency Capital – Hedge funds, Pvt. Equity 4. Commodities 5. Emerging markets
New Credit Factories
New Credit Models
Urge to Speculate : Nothing New About It!
US Housing Bubble
US Housing Bubble
Investment Demand mainly in Rest of the World
Commodity Prices Blast
Emerging Markets Boom – Like India
Historic Rise in Emerging market Indices
Seven Fold Rise
Revulsion & Panic •
House prices stops rising and Sub-prime defaults emerge in US
•
Specifics precipitates in terms of mortgage write-offs by Banks and Collapse of Bear Sterns, Lehman Brothers etc.
•
Structural finance industry quickly shows sign of panic
•
Soon Commodities and emerging market stopped rising and stampede to move on cash begins
Specifics Precipitates : Housing Starts Peak
Transmission of Sub-Prime Losses
Efficiency Capital Collapse
Commodity Stopped Rising
Stampede to move out of EM like India on…
-50%
Multiple Bubble Bust
Management of Crises • •
Let is Burn out…….No management: Evil of panic will work its own cure Lender of Last resort
“The Panic feeds on itself, as did speculation, until one or more of three things happen: 1. Prices fall so low that people are again tempted to move back into less liquid assets; 2. Trade is cut off by setting limits on price declines, shutting down exchanges or otherwise closing trading 3. A lender of last resort succeeds in convincing the market that money will be available in sufficient volume to meet the demand for cash” - Charles P. Kindleberger
Is It Different This Time?
May Be Not!
God Bless
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