Dossier: Crack, Bubble, Pop! Speculations, Bubbles and Crashes. Seminar Course, Advanced Level. KTH 2013 Claes Sörstedt
Concepts Collapse – Clive Hennessey Consumption and Speculation – Marina Vila Financialization – Louis Bergis Money – Stavros Chrysovergis Profit Motive – Grzegorz Owczarczyk Quantification – Rasmus Westman Risk – Adrian Elizalde The Market – Valentina Reimer The New Economy –Jordan Lane Too Big To Fail – Jorge Pajares
Collapse / Bubbles
Clive Hennessey
Speculations, Bubbles and Collapses 22nd April 2013
Introduction to Bubbles The term ‘bubble’ is used to describe the economic occurrence of rapid increases in valuations of real property until they reach unsustainable levels and then decline. It is a phrase commonly used to describe when the property sector of an economy is increasing in demand and production. However, it is usually identified only in retrospect of a rapid economic growth, after the bubble has burst.
Stages of a Bubble Economic Bubbles always share the same phases and generally share the same reaction from the local population. They begin with a high demand but as the situation progresses, human greed and delusion set in and prices reach extreme highs. When demand is reached, the market rapidly drops and contraction or consolidation occurs to alleviate the surplus. The stages can be defined in the following order: 1. Displacement: A displacement occurs when investors get infatuated by a latest initiative, such as a reduction in interest rates or a sudden demand for an asset. 2. Boom: Once displacement occurs and there is a demand for the asset, more investors enter the market, resulting in a sudden boom. During the boom stage, the demand creates a lot of attention by the media, further advertising the sudden growth. Speculation occurs and the asset dramatically rises in price. Delusion and greed set in as prices reach a high. 3. Profit Taking: At this point, the awareness of the bubble sets in and the smart money observes the warning signs and sells out positions and take profits. Estimating the exact time when a bubble is due to collapse can be a difficult exercise and be high risk to one's financial condition. 4. Panic: Once supply surpasses demand and/or prices reach an excessively high point, interest in the asset reduces, causing the price of the asset to rapidly decrease. Investors and speculators are faced with financial decisions regarding the falling values of their holdings. The majority of the investors and speculators are forced to liquidate them at any price.
Causes of the Property Bubble Bubbles are created when there is a high demand for property. This may occur due to rise in population or an economy developing. When there is a shortage of housing, prices immediately increase as there is a greater demand. This encourages investors to enter the market in hope to gain profit. However, these investors require money to develop and buyers need the money to obtain the property. Therefore, banks and building institutions get involved by offering loans to potential investors and borrowers. Property Bubbles are developed by the over valuation of property due to low interest rates by the banks. By lowering interest rates, fluctuation within the property market occurs resulting in speculation. Banks take a higher risk by lending large sums of money to buyers with little or poor credit ratings. Generally, banks use the Loan to Value Ratio to work out the risk involved in a loan. Loan to Value Ratio is a term to represent the ratio of the first mortgage lien as a percentage of the total appraised value of real property. ie.
Loan
x 100
Value The higher the percentage, the greater the risk is for the lenders. Before the sudden growth in housing market, banks would only give high Loan to Value percentages to buyers that had a
high credit rating (high income and ability to repay the loan). However during the housing boom, banks offered high risk loans to borrowers with low credit scores, insufficient income, and poor loan repayment history. By lowering interest rates and giving out high risk loans, banks encouraged buyers to take out bigger mortgages for property. As demand increased, property prices kept rising and buyers were forced to take out larger loans. Investors engaged in risky financial transactions in an attempt to make profit from the market fluctuations. Developers were buying property and depending on the market to continue to rise to sell the property with a profit.
Collapse of Bubbles By encouraging more people to take out loans, banks began to increase their interest rate in hope to make a larger profit. However, rising interest rates and tightening credit standards can reduce the demand for large loans and result in a decline. Furthermore, during the growth in the property market, house prices are not backed by reality. When the demand for housing is reached there will be little interest in the housing market. Eventually, there is a decline in investment and properties devalue. These two factors will inevitably cause the housing bubble to burst.
Effects of the Collapse Due to the banks giving out high risk loans to borrowers with low credit scores, borrowers were faced with negative equity when the bubble burst. Borrowers fall into debt and are unable to repay loans when their mortgage becomes greater than the current value of property. This results in the banks taking ownership of property, ensuing in foreclosure. However, the market value of the property is now less than the amount owed and thus, banks can no longer meet their statutory capital requirements. The banks therefore need to raise further capital but, given the uncertainty around the true value of their assets, their stock is in too little demand for a general share issuance to be a viable option. This creates a knock on effect, starting with a banking crisis; as seen in both Spain and Ireland from 2008. Market participants that gained wealth due to the bubble, experience reduced wealth and limit spending and thus, further hindering economic growth. Due to the lack of demand for property, the majority of the building industry suddenly ceases their work, resulting in large scale unemployment.
Conclusion Speculative bubbles are inevitable in a free-market economy. Once there is a demand for a product, investors immediately seek interest in it. The damage of the collapse of the bubble depends on the amount of speculation during the boom stage. It can have a major impact on one’s economy such as the Global Financial Crisis in 2007, or it can have minimal impact as the market gradually reduces to the mean. Some institutions believe bubbles can be a positive occurrence as it shifts the demand to another sector. However, when there is such a great impact, as did the Global Financial Crisis 2007, it is hard to see a positive outcome from the burst of the bubble. Becoming familiar with the stages involved in bubble formation may help future economies to foresee the next one and avoid becoming an unwitting participant in it.
CONSUMPTION AND SPECULATION Marina Vila Reyes Crack, Bubble and Pop! KTH Kungliga Tekniska högskola
Taking a look the dictionary, you can define speculation as the action “to assume a business risk in hope of gain. Buying an asset with the intent of reselling it later at a higher price. The purpose of speculation is simply to buy low today and sell high tomorrow.”1 SPECULATING AS AN INVESTMENT. Exist the intelligent speculation as there is an intelligent investing. One of the most common aspect of the capitalism is speculate with everything. To speculate is neither illegal nor immoral for most people. The common dictionary define the topic as an investment in a risky business venture with the potential for large gains or losses. In fact, "the difference between investment and speculation is understood in a general way by nearly everyone, but when we try to formulate it precisely, we run into perplexing difficulties. In fact something can be said for the cynic's definition that an investment is a successful speculation and a speculation an unsuccessful investment."2 However, what may seem risky to somebody may not seem risky at all other people. There are many ways in which the speculation way is unintelligent. Of these the most frequents are for example to speculate when you think you are investing and risking more in speculation than you can afford to lose. Those who engage in speculation have no reason for buying the asset, other than resale at a later time Such speculation is quite common in most financial markets, futures markets are a particular favourites. But it is also a motive for those who have investments in fine art, baseball cards, coins, and real estate. THE PROPERTY SPECULATION. Many people probably think the meaning of property speculation is to get rich quickly buying some of the called BTL (Buy To Let) apartments. However, the real meaning is defined as “buying and selling or holding property in the same market without rendering any service in the way of distribution, storage and transportation on the belief that the capital value will increase”.3 Exist more than just economy amateur developers who speculate in the property. For example, a different kind of speculator we can find would be the “owners occupiers moving”, keeping their previous property, house or apartment, as a future investment. Another would be “ retired or at near retirement people” who continue holding more property than they actually need. By then, home ownership demand has two components: Home ownership Demand = Housing Demand + Speculative Demand. When the prices rise in the market, the speculative trends will fall away. When it becomes known that houses price inflation has stopped, because the owners do not want to hang on to their previous property, the speculative demand, one of the home ownership demand component, will evaporate and the price of the property will fall considerably. This happens in Spain by the 15 of June of 2012. It was the biggest and drastic fall since April 2009 (7,7%), being a new record on 2012. (1)
1 Defined by the Merriam-Webster online dictionary. 2 Noted by Benjamin Graham one of the greatest dean of security analysis. 3 Defined by Philip L. Carret. (1) Spanish struggle: The graph shows how drastically house prices have fallen in each region of Spain.
1
The prices of the property start to decrease considerably, specially in coastal areas, as a consequence of the huge speculative building boom along the Spanish coast, like Catalonia (14,9%). Other areas were affected as well like Madrid (14,2%). This depression had a detrimental impact, especially to those who were retired. Spain saw how the prices driven up during the construction and property speculation boom of 2005, and then came crashing down far further that the average reported falls4. URBAN SPECULATION. Another case of speculation is in the urban scale. Although the Article 47 of the Spanish constitution says that administrations should act to prevent speculation, since the 19th century the laws, like the Urban Agreement or the Urbanising Agen, have increasingly favoured speculation in Spain. Never in the history of Europe had there been such a devastating use of the territory as did this country. The construction rates have been five times higher than in the rest of the EU and in 20 years the number of houses has doubled, from 10 to 20 million. Spain has made current plans which will multiply by three the houses in the coast and which want to requalify over 10 billion square meters of land for another 20 million houses. But the worst point is that nowadays there are 3 million empty houses in the whole country, which is subject of a wild speculation. The main consequence of this urban and aggressive speculation has been some of the worst environmental problem, affecting hundreds of protected areas in the whole territory, systematically violating European laws, although mostly are approved for local authorities and often financed from the European Union. The overuse of resources has a devastating impact on climate change, affecting all the area of natural productivity. There is a proliferation of highly unsustainable models like the hundreds of golf camps in deserted areas, adding in this point the problem of the lack of water to maintain and treat this expensive areas. At the same time, there is a super-speculation in whole the coastal, being at the same time the most touristy, area of the country. There is an excessive construction of transport infrastructures with devastating impact and often enormous financing from the European Union. Nowadays Spain is located in the 3rd position as one of the countries with more number of infrastructures of the world after China and US. (2)
The urban speculation is source of the most severe social problems like inaccessible housing with lack of infrastructures and water resources. Exist as well constant abuses, frauds and difficulties to democratic participation linked with the radical decrease in quality of life and antisocial character of the new urban models, etc. It is the source of systematic destruction of the cultural heritage, affecting thousands of archaeological sites and buildings. Meanwhile, it is source of the most severe economic problems with over 20% of the economy and employment in construction industry, and a disappearing of alternative sources of productivity, being one of the first countries in the world with 20% degree of submerged economy in money laundering. The country situation is in the extreme consequence of the explosion of the “bubble� of urban speculation and current unemployment of 16% and with bad repercussion in tourism industry. Moreover, Spain is the direct source of generalised corruption that affects the system at all scales with an implantation of international Mafias.5 Spain needs some measures and alternative for economic growth as an immediate putting in practice plan that provide other form of productivity not based in this aggressive speculation, construction, abuses and destruction of the territory. 4 Extract of This is Money, finantial website, Spanish house price crash deepens, written by Lee Boyce. 15 June 2012. (2) Population in the coastal municipalities in Spain in 2001. 5 Report by the National Civil Coordinator in Defense of the Teriitory (CCDT). www.nosevende.org
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FINANCIALIZATION By Louis Bergis Speculations, Bubbles and Collapses
The financialization - the process by which financial institutions, markets, etc., increase in size and influence – is evocated as being equated with the 2007-2010 financial crisis and its consequences. What are the stakes of such a development?
FINANCIALIZATION ? - DEFINITION A strict definition of financialization could be the growing recourse to financing and in particular the indebtedness on the part of economic agents. The term is extending to: "the increasing dominance of the finance industry in the sum total of economic activity, of financial controllers in the management of corporations, of financial assets among total assets, of marketised securities and particularly equities among financial assets, of the stock market as a market for corporate control in determining corporate strategies, and of fluctuations in the stock market as a determinant of business cycles" (Dore 2002) Financialization refers to the increasing importance of financial markets, financial motives, financial institutions, and financial elites in the operation of the economy and its governing institutions, both at the national and international levels. (Gerald A. Epstein) Financialization is a process whereby financial markets, financial institutions and financial elites gain greater influence over economic policy and economic outcomes. Financialization transforms the functioning of economic system at both the macro and micro levels. (Thomas I. Palley) BRIEF HISTORY OF FINANCIALIZATION – CASE OF THE U.S.A. After the Great Depression, in order to prevent the dangers of a market without oversight, reforms where enacted such as the Banking Acts (1933 and 1935), the Glass-Steagall Act (1933), and the Security and Exchange Act (1934). In the 1970’s, with the oil crisis and the declining profit rate of the industry, the Flush with funds from the increased price of oil give rise to financialization. Although the oil crisis did produce significant wealth for oil producing countries at the expense many American firms, one unexpected side development took place that would further give rise to financialization. Flush with funds from the increased price of oil, producing countries began to put their so-called “petrodollars” in American and European Banks. Furthermore the U.S. monetary policy and the higher interest rates of the Federal Reserve accelerated it. From the 1980’s to the 2000’s the financialization keep growing without interruption. The deregulations 1990s – notably the Glass-Steagall Act in 1999 – enable the financial sector to realize ever greater profits.
By the mid-2000s, the peak years of financialization by most measures, financial profits accounted for a little over 40% of total U.S. business profits, nearly twice the postWorld War II average (Johnson, 2009).
The financial sector has grown faster than real activity. The financialization of the economy has led to a considerable expansion of financial activity. In 2007 40% of the profits of the private sector in the United States was made by the banks, which employ only 5% of employees.. At the world scale, the development of international funding took place in the context of globalization but notably because of the development of the “petrodollars” following the increase in oil revenues of oil exporting countries. This abundance of liquidity that marked the second half of the 1970s was especially renewed in the 2000s.
OVERLEVERAGE AND DEVELOPMENT OF FINANCIAL DERIVATIVES Leverage represent the use of borrowed money to increase productio n volume, and thus sales and earnings. It is measured as the ratio of total debt to total assets. The greater the amount of debt, the greater the financial leverage.
Financialization has been grown as financial overlevarge (Occurs when a business is carrying too much debt, and is unable to pay interest payments from loans. Overleveraged companies are unable to pay their expenses because of over excessive costs). During the financial crisis of 2007–2009, the "excessive leverage" was blamed on different points. First, consumers borrowed large amounts of money - $2.6 trillion in the United States. In this case the borrowing was used to support consumption. Only people who borrowed for
investment, such as speculative house purchases or buying stocks, were using leverage in the financial sense. Moreover, financial institutions were highly levered. Lehman Brothers, for example, in its last annual financial statements, showed accounting leverage of 30.7 times ($691 billion in assets divided by $22 billion in stockholders’ equity).
As a related tool to overleverage, financial derivatives were developed. Financial derivatives are financial instruments, the price or value of which is derived from the price or value of another, underlying financial instrument. Those instruments, which initial purpose was hedging and risk management, has become widely traded financial assets in their own. The most common types of derivatives are futures contracts, swaps, and options. In the early 1990s, a number of central banks around the world began to survey the amount of derivative market activity, and report the results to the Bank for International Settlements. In the past few years, the number and types of financial derivatives have grown enormously. In November 2007, commenting on the financial crisis sparked by the sub-prime mortgage collapse in the United States, Doug Noland’s Credit Bubble Bulletin, on Asia Times Online, noted, « The scale of the Credit "insurance" problem is astounding. According to the Bank of International Settlements, the OTC market for Credit default swaps (CDS) jumped from $4.7 TN at the end of 2004 to $22.6 TN to end 2006. From the International Swaps and Derivatives Association we know that the total notional volume of credit derivatives jumped about 30% during the first half to $45.5 TN. And from the Comptroller of the Currency, total U.S. commercial bank Credit derivative positions ballooned from $492bn to begin 2003 to $11.8 TN as of this past June.... » A major unknown regarding derivatives is the actual amount of cash behind a transaction. A derivatives contract with a notional value of millions of dollars may actually only cost a few thousand dollars. For example, an interest rate swap might be based on exchanging the interest payments on $100 million in U.S. Treasury bonds at a fixed interest of 4.5 percent, for the floating interest rate of $100 million in credit card receivables. This contract would involve at least $4.5 million in interest payments, though the notional value may be reported as $100 million. However, the actual “cost” of the swap contract would be some small fraction of the minimal $4.5 million in interest payments. The difficulty of determining exactly how much this swap contract is worth when accounted for on a financial institution’s books is typical of the worries many experts and regulators have over the explosive growth of these types of instruments.
Economic effects Financial services (banking, insurance, investment...) has become a key industry in developed economies in which it represents a sizeable share of the GDP and an important source of employment. Those activities also played a key facilitator role to foster economic globalization. In the wake of the 2007-2010 financial crisis, a number of economists and others began to argue that Financial services had become too large a sector in the U.S. economy, with no real benefit to society accruing from the activities of increased financialization. Some, such as formerInternational Monetary Fund chief economist Simon Johnson even went so far as to argue that the increased power and influence of the financial services sector had fundamentally transformed the American polity, endangering representative democracy itself. In February 2009, white-collar criminologist and former senior financial regulator William K. Black listed the ways in which the financial sector harms the real economy. Black wrote, “The financial sector functions as the sharp canines that the predator state uses to rend the nation. In addition to siphoning off capital for its own benefit, the finance sector misallocates the remaining capital in ways that harm the real economy in order to reward already-rich financial elites harming the nation.” In testimony before the U.S. Congress in March 2009, former Federal Reserve Chairman “
Alan Greenspan has proclaimed himself "shocked" that "the self-interest of lending institutions to protect shareholders' equity" proved to be an illusion.... The ReaganThatcher model, which favored finance over domestic manufacturing, has collapsed. ... The mutually reinforcing rise of financialization and globalization broke the bond between American capitalism and America's interests... we should take a cue from Scandinavia's social capitalism, which is less manufacturing-centered than the German model. The Scandinavians have upgraded the skills and wages of their workers in the retail and service sectors -- the sectors that employ the majority of our own workforce. In consequence, fully employed impoverished workers, of which there are millions in the United States, do not exist in Scandinavia.
”
Consequences attributed to the financial market: Facilitating financial transfers between states, for example between the so-called Northern investors and southern recipients is double-edged. These FDI (foreign direct investment) are very volatile. A strong economy cannot rely only on foreign investment, particularly in areas of the world subject to internal or external pressures (civil war ...), investors may be required to withdraw their investments abruptly (for fear of losing their money) that would suddenly collapse the local economy, as the Argentine economic crisis (1999–2002) illustrated it. A problem of finance is the financial bubble. Investors in financial markets are leading to speculation that the strict sense means to conduct operations from assumptions about the evolution of the share price. The assumption of a rational market sets the principles of fundamental analysis, where the operator carefully studied the official reports of companies in recent years, its investment opportunities, development etc.. to determine if the share price will increase. But this partly
subjective behavior has meant there is the possibility that the predictions of the agents are selffulfilling: people will buy the shares they believe will rise, which rises. Here is the psychological phenomenon, the behavioral assumption of an irrational financial market. The agent doesn’t buy according to strict reflected economic evaluation forecasts. This is what Keynes compares with American beauty contest of the 1920’s in which entrants are asked to choose from a set of six photographs of women that are the "most beautiful." Those who picked the most popular face are then eligible for a prize. People make no judgment on the photo itself but reasoned on the most popular criteria. Investors might ignore the real foundations of the value of the company and anticipate how the market add value to the financial instrument. Current forms of financial markets development are particularly suitable for the practice of intuitive speculation which can be revealed dangerous.
Moreover, the financialization of the economy behind the so-called real economy reflects the creation of a market where the financial products are not directly related to the production, marketing and consumption activities. It is notably the case of the financial derivatives with the development of derivatives market and the creation of an economy derivated from the economic reality. It is different in the sense that it no longer relies on economic transactions but its effects on the economy is real. It can boost the economy has it can damage it. The scale of the risks are equated with the huge size of the financial markets and the excesses and abuses are likely to create major crises, such as the subprime crisis, and potentially systemic risk. On 15 February 2010, Adair Turner, head of Britain’s Financial Services Authority directly blamed financialization as a primary cause of the 2007–2010 financial crisis. In a speech before the Reserve Bank of India, Turner said that the Asian financial crisis of 199798 was similar to the 2008-2009 crisis in that “...both were rooted in, or at least followed after, sustained increases in the relative importance of financial activity relative to real non-financial economic activity, an increasing “financialisation” of the economy.”
RESOURCES
Financialization and the World Economy, Gerald Epstein Financialization: What it is and Why it Matters, Thomas I. Palley's Financialization and the Global Economy, Engelbert Stockhammer The Financialization of Capital and the Crisis, Monthly Review, April 2008
Speculations, Bubbles and Collapses -Profit Motive KTH Stockholm 2013 Grzegorz Owczarczyk The special relation of the profit and mot motive in understanding social and economic behaviours engage directly “rational choice theory”. This theory maintains that our choices are determined by maximization of benefits and minimize of loses. This theory speared to be useful tool for analysing the financial crisis in 2008. In a brief applied to mentioned phenomenon we can describe the origins of crisis by actions of the banks and financial institutions in order to maximize their profits. On the other the actions of the banks speared to be immoral since it caused a lot of people losing their jobs and homes. Outraged groups criticized banks for their behaviour. The financial crisis is interesting situation where critics and analyse is a field of intersection of many disciplines involving economy ,science (rational choice theory ) , philosophy (in general and morality ,mathematics (game theory) and others. Each mentioned area is full of controversies and open problems. In this essay I shall analyse this problems and indicate the interrelation of the answers for each problem each other and relation to it for more general or practical question. First, it is important to distinguish the scientific question (posing the question of the sort “ How the world is” ) and moral questions (“How we should act in the world” ). As we can see , In second type of question we also use the word “World” . Form this follows that the answers for the first sort of question are determining the answerers for second type of questions. Furthermore financial crisis problems are involving questions which in the same time are related to science and morality. In theory and in order to do the analysis is beneficial to separate such questions and Problems but in practice and life the question that we are posing have scientific and moral component which is inseparable. The same apply for the financial crisis. In next paragraph I shall analyse scientific question according to “Rational Choice Theory” which will be named now RCT. DOES RTC is tautology ? It has been proposed that RTC has no informative value and is tautology. Tautology is a sentence which is true by definition or meaning of the words. The example of tautology can be following sentence: “Everything that is white is white”. This kind of sentence are independent from empirical data and can’t be rejected by experiments or observations. On the other hand RCT states: “that all our choices are determined by maximization of our profits” which seems be empirical generalization of observations. We shall note that people take different decisions in the similar conditions since they differ with knowledge and intellectual skills. So the theory maintains that people(or institutions) take a decisions which SEEMS to them most beneficial. Someone can be wrong about that what is most beneficial for him but still rationality is hold since the rationality is property of choice not action in objective manner. Therefore we include also all insane decision since they are taken with conviction of the maximal profit. By this condition we open application of RCT for all sort of decision even most not-rational since the responsibility is based on intellectual equipment of the decision taker. But then RCT can’t be also rejected by any kind of experiments since any decision is automatically counted as “rational”. One could argue that even though that all decisions being made are automatically counted “as rational – in terms of RCT” but if we would ask the decision maker about his true intention we could confirm the RCT. But this would be wrong scientific methodology – we don’t ask what people are saying about their decisions we ask what are decisions or choices itself. People can’t realize correctly their true motives and they can’t answer properly why they make the decision that they actually did. They can justify the decision that has been made but this is made after the decision is made and is not directly related to real mechanism of the decision. Therefore RCT is actually saying nothing about the world. If we consider altruistic behaviours in terms of RCT then one could argue that altruistic behaviours are made in order to satisfied internal needs of an individual. But again “internal needs” it is not good scientific notion since its connection to empirical data is
vague. This does not mean that RCT is essential false but needs to be formulated in a different manner since on the other hand we know that vast majority of decision of individuals and banks is made in order to maximize their profits. How problem of morality is associated with financial crisis. We can define moral-depended action as action which is goal is not only benefit but more general concept like good or evil. We can make moral positive action that will be not optimal for our profits. We can also make moral negative action that will be also not optimal for our profits ( this is the case for example if we dedicate our resources for damage someone else property). There is also possible that we can make an action that can me moral neutral but optimal for profits. If we are helping for example homeless people but we are being paid for that this moral neutral action. Actions of the banks and financial institutions can be described as morally negative since they act in order to maximize their profits but they also act for detriment for most part of society. But this consideration also open new question and bringing back the RCT into the scene. We can maintain that most of the people don’t steal because it is not moral. From RCT point of view one can argue people don’t steal because it is not beneficial. If one is stealing something then there is a chance that he will land in a jail and possible loses are fair much greater than profits. We shall observe that in a poorer societies the crime prevalence is bigger which can be accounted for RCT since the benefits of stealing something are greater in poorer societies and decrease a little possible loses from possibility of being in a Jail. This indicate that our actions have both moral and profit-oriented component. In other words I think we don’t only acts in order to maximize our profits but vast majority of our actions can be explained but such motives -but worth to underline that not all and also moral and scientific component can’t be separated. We can distinguish also immediate-profits and long-term profits. One action may seem as a truly moral but sometimes can labelled as RTC with long term profit. If we consider .the situation that company pays relatively big salaries for their workers we could label this action as a moral since this is not optimal for profits of the company. But on the other hand we should realize that if the workers are better paid they are better motivated to make their work better and consequently increase the profits of the company. Capitalist proponents often argue that selfish motivation is actually good because society is getting richer and richer and in fact everyone benefits from that. The mathematical game theory is studying theoretical situation and is looking for optimal strategy (most beneficial) if such exist. In some cases it the optimal strategy can be in the same time selfish and act for income for the group. But such consideration are theoretical and have to be carefully applied for real life. We can consider following example. There are two passengers that their baggage was lost. Airlines ask them to indicate the value of the lost baggage. Airlines say to the passengers: You can indicate value of your baggage form 1$ up to 100$. The passengers will indicate separately and will don’t know what indication did other passenger. There is also another rule: If you will indicate less then other passenger you will get +2$ to the value that you have indicated (as a reward for being honest) and other passenger will get the value that you have indicated. If you indicate the same you’ll will get the value that you have indicated. So if we would be a passenger we could make following reasoning: 1. I can indicate 99$ and my partner will indicate 100$ , there fore I will get 101$ (optimal profit). 2. Other passenger can make the similar reasoning ( Can indicate 99$ ) so I am going to get only 99$. If I will indicate 98$ I am going to get 100$ (optimal profit ) We assume that other passenger can reason like we. 3. Other passenger will make reasoning (2.) So he’ll indicate 98$. I can indicate 97$ so I will get 98$ (instead of 97$) 4. . Other passenger will make reason 3.... 5. Other passenger will make refining 4.... ….... Till we reach 3$ So from game theory most optimal solution is to indicate 2$ !. Selfish strategy is not always optimal. We could indicate 100$ at the beginning. This theoretical consideration indicating the problems involved in intersection of economy and morality. Most expert can argue that financial crisis is born by immoral behaviour of the banks and institutions focused on their short or more or less long benefits. It is obvious that we should refine our financial institution
by providing some regulations but theoretical investigation determining mechanics of the decision of individuals and institution can tell us how to shape this regulation in order to be more appropriate for the nature of the mechanism of society. It is important to realize that no matter how elegant theory such RCT may seem not every action of every man can me described as only profit oriented.
Quantification, by Rasmus Westman
The quality of life measured by (neo-liberal taste and‌) quantitative techniques.
In short quantification is about presenting observations of human behaviour and experience through sets of numbers, obtained by counting and measuring. The quantitative researcher gathers data and draw conclusions from statistics. The use of quantification in economy is regarded as a part of social sciences. In the area of social sciences quantification is an integral part of both economics and psychology. In both fields data is gathered and presented through different statistical techniques of representation, which then are used to interpret and draw conclusions from. However in the field of psychology there is an ongoing debate about the differences of quantitative methods to qualitative ones. In many areas of science using either qualitative or quantitative ways of research is not at all an controversial question. But in the area of social science debates often occur whether one is more appropriate to use than another. As this debate about how the two would differ has not yet found an end, both are regarded as relevant ways of doing research. But while some researchers do combine both qualitative and quantitative methods, others stick to one of them as if it was a deep ideological question. In 1978 SQAB: the Society for the Quantitative Analysis of Behaviour, was founded. The organisation is operating in the field of mathematical psychology and holds a meeting every year where various topics and methods of quantitative analysis of behaviour is discussed. The society aims to make the quantitative ways of analysing human behaviour the dominant approach to behaviour analysis and learning in general. One often discussed topic is that of behavioural economics, in which the effects of social, cognitive and emotional on economical decisions are studied. By combining
psychology with economic, putting the subject of psychological research in a situation such as dealing with the market or other economical phenomenas, a deeper understanding of how economies react and develop is hoped to be achieved. While qualitative research gather non-numerical data to explain or develop a theory, quantitative research uses statistical, mathematical or computational techniques to create numerical models or theories about something. Qualitative methods might be interviews, case-studies and different ways of doing observation. On the other hand the quantitative methods are much more specific, and demand a more strict definition of what the gathered data actually tells. Often a very large amount of data is needed in order of making the research material as strong as possible. To help handling the large amount of data, softwares are often used as tools of organising and presenting the material. The PSPP, R or IBM SPSS software packages are three of the most popular of its kind. Quantitative research and its results has become a popular way of trying to predict the movements of economy. If the economist can predict how the stock market will change, or as example what countries to expect as a factor in future development of global economy, then big wins can be made. Of course you will always need to make the prediction and act upon it before everyone else does so, so the value doesn’t fall. Quantitative hedge funds and trading strategy indices are often used as ways of dealing with the competition among actors on the stock market. By developing complicated models and algorithms in an attempt of cracking the rapid and often unexpected changes of the finance world, economics are trying to get an advantage in knowing where to invest next, to make the big-money. Quantitative research is also used a lot to make arguments for economical and political decisions and paths to make. If definitions of quality of life can be made using statistics, then that makes it easier to make an argument for whatever decision can cause that statistics. The most commonly used quality of life index is perhaps the per capita GDP index. Since that which is supposed to be valued is of a quite unobservable kind, a proxy variable will replace it. In the case of GDP the definition of standard of living is replaced with an economical method of measuring a the market value of a countries goods and services produced during a specific period of time. It is of course easy to argue that this might actually not be the best way of measuring a countries actual standards. But it is perhaps easier to use and combine with the field of economy than a more qualitative research would be. Other indices that attempts to define the quality of life among the people in an economy, is for example: the Big Mac index, which uses hamburgers as a variable that is the same in every country all over the world. There is also the HDI index, which is trying to give a more complete image of the actual prosperity of a nation. Apart from taking the national GDP into account, the HDI also use expected length of the inhabitants lives and the level of education among the people. Critique is aimed at how the HDI index is regarded as quite easy to manipulate in order to create a false image of the actual standards of a country. Another method, but still quantitative, of measuring something as intangible as quality of life, is to ask a question and for the subject to rate the answer on a specific scale. It might be a happiness scale or perhaps a how healthy do you usually feel scale.
This way of measuring quality of life doesn’t replace the actual definition of quality with something else, but is maybe not one hundred percent reliable anyways. One example of this way of measuring and presenting information that can put different countries in relation to each other, to help us get a picture of the differences is the “index of economic freedom”. This index is created annually by the Heritage Foundation and The Wall Street Journal. The index is ranking the economical freedom of countries (defined by the ideals of very liberal ideology) based on statistics gathered from organizations like the IMF. One argument against quantitative measurements as method to define living standards is the lack of arguments for the actual purpose of the investigation, and its selected way rating achieved statistics. The quantitative methods only focus on numbers indicating a very specific relationship between a most superficial perspective on different countries financial situations. What the numbers actually mean; why, for instance, economical growth is to be achieved is not at all presented in the research. It seems like an obvious goal to achieve, since the higher statistics, the higher ratings on the “quality of life” scale, but the actual reason of heading for growth as a goal is not at all presented or debated in quantitative research methods. …
RISK
two different meanings Risk means expose someone or something valued to danger harm or loss. During many years in the economic market this meaning was different. For decades the financial system was stable. The crisis starts when in the 1980’s the government of the United States starts a deregulation of saving and loan companies allowing them to speculate or do risky investments with their depositors money. At the same time technology emerges in the world being able to calculate millions of variation and separating reality of fiction. They had created so many possibilities that it became difficult to detect the risks an investment was exposed. The banks started a speculative circuit where there was no apparent risk. They created a consumist society encouraging the people to consume. It was based in banks giving credits and people spending money. But it was a time bomb system which became gradually more risky until it blew up making the rich richer and the poor poorer. The infected assets were spread around the world generating the most powerful crisis ever.
They appeared two types of risky investments, the ones the banks did and the ones the population did. Particulars decided to speculate with the money because banks gave credit. They bought houses at a low price hoping their value would increase and sell them at a higher price. The loans that the bank gave they could not be returned in a whole life, were called risky mortgages or subprimes. They became financial packages which people from Wall Street speculated with them and won money even though the particulars could not return the loan. They sold the mortgages to the investment banks who combined them with other mortgages (like car loans, student loans, commercial mortgages‌) to create CDO, which are complex packages. These packages apparently solvent were infected by the subprimes. Another aspect involved are the rating agencies. They are in charge of qualifying how risky are some financial products giving a grade that shows the quality of the product. The problem is that agencies are private and are paid by their own clients, the banks. For example Lehman Brothers, Enron and many other companies were rated AAA (maximum grade, solid investment and most likely that debt obligation will be honoured) days before they bankrupt. CDO were qualified with AAA with no liability allowing investors sell them at a very high price. The system created was based in the risky investments, they started doing riskier loans as they had higher profits with higher risks. Furthermore, the employees were offered high premiums if they sold high risky products. When the crisis arrives and the housing bubble explodes the system collapses. Banks stop giving loans and people cannot sell and pay the mortgage. Banks keep their homes in compensation while they have to continue paying the mortgage. The prices of housing decrease considerably as banks cannot give credit and people do not have money to buy them. Powerful banks go bankrupt and receive loads of money from the state to rescue them and stabilize the system. They get stronger as smaller companies do not receive money. Even though, banks still do not give credit because they are just passing through the crisis. In consequence many middle and little enterprises go bankrupt, have to shut down and fire people that the government has to pay unemployment. The economic funds of the state also finish having to take public money from schools, hospitals and services. The big economic groups have become stronger than there were due to the constant loans of money the governments gave them. The political ambit has been corrupted and people who caused the crisis have gone away with the fortunes they earned with the derivative products. Moreover the CEO’s of the companies who drove their firms to bankruptcy were relocated or received huge offsets after they resigned by the executive board of the company. The responsible politicians who allowed and helped to deregulate the market have
not suffered any consequence. To make it worse, those who criticised their decisions have not shown any attitude to change the economic system when they governed and have surrounded by the same economic counsellors that instituted the crisis. Many countries lend each other money to keep on going their infrastructures and public services, it is called public debt. The penalization of the loan depends in the reliability of the country, if their incomes are stable they will be able to borrow money paying a little fee. The difference is called the risky premium. The higher the country risk the higher the risk premium and the interest rates on the debt. Nowadays it also exists bonus or assets of every country that can be bought. Is politically accepted that in the markets allow to sell something even though you don’t have it presupposing it will decrease and sell it. The risky capital funds or hedgefunds can influence in the economy of a country with fear. They are doing it with the bonus of a country hopping their economy goes bad and win money.
In conclusion, risk does not have the same meaning for everyone. A system has been created: big economic groups can risk their companies to win a lot of money without paying the bad consequences. The more money the customers lose the more money big financial companies make. They have enough power to avoid prison or any other criminal liability. In the other hand, medium class has been really affected by the risky speculations, there are less jobs, less money, lower salaries, less public services... There is no risk if investors banks, rating agencies and politics are in the same team.
Seculations, Bubbles and Collapses Seminar_KTH Stockholm Spring Term 2013 Teacher: Claes Sörstedt Essay: The Market Valentina Reimer MA // Arts Academy Stuttgart Defnition A market is an actual or nominal place where forces of demand and supply operate, and where buyers and sellers interact (directly or through intermediaries) to trade goods, services, contracts or instruments, for money or barter.
The market for a particular item is made up of existing and potential customers who need it and have the ability and willingness to pay for it. Markets include mechanisms or means for (1) determining price of the traded item, (2) communicating the price information, (3) facilitating deals and transactions, and (4) efecting distribution. It can be said that a market is the process by which the prices of goods and services are established. A trade can occur between one single buyer and one single seller, but to have a competitive market it takes at least three persons. Todays markets understood in formal economic theory rely on much larger numbers of both buyers and sellers. But there can be also imperfect markets like monopolys, which means only one single seller and multiple buyers or monopsony with a single buyer and mutliple sellers. Defnition Market economy Markt economy is an economic system that regulates the allocation of fairly decision and trading right of private property on resources. Its working decentral and is coordinated by market prices. Market ecconomy should run under laissez-faire policies, which means it is a free market. It is "free" in the sense that the government makes no attempt to intervene through taxes, subsidies, minimum wages, price ceilings, etc. Market prices may be distorted by a seller or sellers with monopoly power, or a buyer with monopsony power. Such price distortions can have an adverse efect on market participant's welfare and reduce the efciency of market outcomes. The invisible hand The scottish moral philosopher Adam Smith described the market, in his book „The Wealth of Nations“ as a fnancial incentive and penalty mechanism working system. Selfsh behaviour of every single human spezialized economic activity is coordinated to lead to satisfy the needs of every single person. This theory was he titled by the system of the „Invisible Hand“.
It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.
Adam Smith (5 June 1723 OS – 17 July 1790) was a Scottish moral philosopher and a pioneer of political economy.
http://www.youtube.com/watch?v=ulyVXa-u4wE
Real estate market The real estate market is a part of the housing industry. It assumes the commercial exploitation to fnance of the proceeds other than that entrepreneurial proft also the development and managment of residential property. The real estate market can be understood as the market of locations. In this sense is every part of the earth's surface a property. The property market of locations distinguishs itself from the market of movables especially by following characteristics: The market of movables expects a mobility of supply to work, while the housing market depends on the mobility of demand and also on the creation of market transparency. In times of economical boom the supply's competition plays a bigger role in the movables market while the demand's competition declines. However the real estate market is afected by an ecomonical upturn through an increasing of demand's competition. In the market of movables the sellers defne the prices and it is up to the buyers decision if they want to buy under the afected conditions. In the real estate market sellers suggest prices to bargain and the buyer which aford the highest price wins the competition. The market of movables is able to answer fast to demand's changes , while the real estate market can react only with time-lags.
To understand the mechanisms of a real estate market, we have to recognize that this market is particular characteized by permanent and ever-changing spatial ofers distribution. Composed through its nonunion market circumstances and its non-transparency, it evokes automatically transparency orginating indutries. Realtors and real estate internet portals play today an important role in the global housing market.
Financial crisis in the USA and real estate market The reasons that leads to the fnancial crisis are controvers discussed in science and market studies. But experts are sure that beyond the policy of low interest rates the real estate industry was one of the determinant for the access and extent of the crisis. The crisis were preceded by a worldwide long period of low average interest rates. The Federal Reserve System conducted a policy of low interest rates, after the market rates decreased to stimulate the US economy. Concerning the low interest rate level the low level income could aford private residential homes. Encouraged by the low Federal Funds Rate and the goverment the US banks assigned foating rate credits to debtors with more moderate solvency. The risk of an advance in rate belonged to the debtors which most of them didn't knew. Coincident to the rising demand the housing market prices increased and in therewith their value of loan security. The banks used
this progress to sell additional credits to the debtors and also customers with bad solvency received credits. If the real estate prices increase the debts in case of insolvency can be paied by selling the real estate to a higher market value. The banks were secured by rising prices and debtors believed in the possibilty to sell their houses in case of need to higher prices. This development leads to a revival of the buliding industry and consumer demand and the housebuliding investements achieved a record value. All these occurrences trailed behind a whole string of confusing and unvisible fnacial mechanism and bigger speculations . To raise the necessary funds for the new credits, big credit claims were documented. The loaner banks sold the payment claims of the mortgage credits together with their credit risks documented to global investors like other banks, hedgefonds and insurance companies. The whole thing became so widespread that it was nearly impossible to be inexplicable.
The economical decrease in 2005, the shrinking growth rate of labor productivity, especially of the construction industry and the increasing Federal Funds Rate triggered a chain of reactions. Low-income debtors couldn't aford the raising credit rates of their variable interest anymore and were forced to sell their houses. Due to the progressive housing sales real estate prices went down. The falling value of real estate conditioned unsafe credit claims. Banks and investors sufered under the insolvency of customers. The payment- defaults of subprime-credits attained the highest level of yesteryear. The deterioration and the fear from buyers of further loss of capital leads zu a investment decrease and declined the equity of banks. The banks were forced to shed a multiple of assets to low prices, which introduced an implosion of the fnancial system.
THE NEW ECONOMY “WE WILL DANCE WHEN OUR LAWS COMMAND US TO DANCE, and we will feast when our hearts desire to feast. Do we ask the white man, ‘Do as the Indian does?’ It is a strict law that bids us dance. It is a strict law that bids us distribute our property among our friends and neighbors. It is a good law. Let the white man observe his law; we shall observe ours. And now, if you come to forbid us dance, be gone. If not, you will be welcome to us.” Chief O’wax̱ a̱laga̱lis of the Kwagu’ł
WHAT IS IT? To think that the NEW ECONOMY is over is like somebody in London in 1830 saying the entire industrial revolution is over because some textile manufacturers in Manchester went broke.
Alvin Toffler
The New Economy is a term to describe the result of the transition from a manufacturingbased economy to a service-based economy.
It is difficult to say as to when this change happened. It has been a gradual but steady change that has increased almost violently in the past decades. This definition explores the question...is new always better?
Inflation hasn’t ruined everything. A dime can still be used as a screwdriver. H Jackson Brown Jr
W H E N DID THIS HAPPEN? THE TRANSITION TO A KNOWLEDGE BASED ECONOMY
It is difficult to pinpoint exactly when the
life were affected by these changes. At home
transition to a knowledge based economy
television was universalised, changing the
occurred, however by tracing the social
way families interact at home. International
change and economic ramifications of the
travel became accessible with commercial
last century, one year stands out.
jet aviation providing the means to shorten distances
between
geographies.
The
1956 was the first year in US history when the
birth control pill challenged traditional
number of white collar workers outnumbered
understandings
blue collar factory workers.
relationships.
This may appear to be a quite under whelming
Within
observation, however this shift represented
transformation was intense with myriad shifts
the dawn of new way of life - a new civilisation.
in women, gender and civil rights.
social
of
and
gender
and
political
sexual
climates,
It was at this time that the world started to experiment with a new model for civilisation
It seems technology is the easy part of the
based on a new economy.
transformation - changing social patterns and institutions remains the real challenge.
The next five years were filled with fantastic technological developments. All layers of
IS THIS THE ONLY SYSTEM?
The global financial crisis was a wake up call for the world. After years of bubbles brewing and speculation, the full fragility of the economic system was exposed.
In this definition essay I would like to go extend the traditional definition of NEW ECONOMY to explore alternative systems.
I will introduce three different models of economic systems - gift, local and circular economies. Although given different names, they share multiple origins and relationships.
ALTERNATIVES TO THE NEW ECONOMY ALTERNATIVE DEFINITIONS AND SYSTEMS
GIFT A gift economy, gift culture or gift exchange is a mode of exchange where valuables are given without an explicit agreement for immediate or future rewards.
LOCAL A local economy is a system that encourages local prosperity through the purchasing of locally produced goods and services over those produced farther away.
CIRCULAR A circular economy is a based on a circular flows of materials, adhering to natural principles.
GIFT Gift cultures are adaptations not to scarcity but to abundance. They arise in populations that do not have significant material-scarcity problems with survival goods. We can observe gift cultures in action among aboriginal cultures living in ecozones with mild climates and abundant food. We can also observe them in certain strata of our own society, especially in show business and among the very wealthy.
In gift cultures, social status is determined not by what you control but by what you give away. Thus the potlatch.
Eric Steven Raymond. The Hacker Milieu as Gift Culture
POTLATCH A potlatch is a gift-giving festival and primary economic system practiced by indigenous peoples of the Pacific Northwest Coast of Canada and United States.
The word comes from the Chinook Jargon, meaning “to give away” or “a gift”; originally from the Nuu-chah-nulth word “p̓ačik”, to make a ceremonial gift in a potlatch.
The potlatch, as an overarching term, is quite general, since some cultures have many words in their language for various specific types of gatherings. Nonetheless, the main purpose has been and still is the redistribution of wealth procured by families.
LOCAL Jane Jacobs proposed that the health of local economies be measured by the number of dollars of local economic activity they generate for every dollar of goods they import.
Diverse local economies are good at meeting local needs, and tend to add as much value as possible before exporting goods and services. They keep money circulating in the community, stimulating the economy and creating new economic niches. They pursue strategies of resource efficiency and use waste as resource. They are made up of mixeduse,
economically
diverse
human-scale
neighborhoods. Jacobs, J. Cities and the wealth of Nations
[ C S A ] CSA consists of a community of individuals who pledge support to a farm operation so that the farmland becomes, either legally or spiritually, the community’s farm, with the growers and consumers providing mutual support and sharing the risks and benefits of food production. Typically, members or “share-holders” of the farm or garden pledge in advance to cover the anticipated costs of the farm operation and farmer’s salary. In return, they receive shares in the farm’s bounty throughout the growing season, as well as satisfaction gained from reconnecting to the land and participating directly in food production. DeMuth, S. 1993. Community Supported Agriculture (CSA): An Annotated Bibliography and Resource Guide, USDA, National Agricultural Library.
CIRCULAR A circular economy seeks to rebuild capital, whether this is financial, manufactured, human, social or natural. This ensures enhanced flows of goods and services.
Put simply, industrial processes and the lifestyles that feed on it consume energy and commodities i.e. deplete finite reserves to create products whose fate is, in the vast majority of cases, to end up in landfill.
The current model is unquestionably linear, and from the following diagram, it is quite clear that it is bound to reach its own limits:
[ D f D ] Design for disassembly is a strategy that considers the need to disassemble products for repair, refurbishment or recycling. Will a product need to be repaired? Which parts will need replacement? Who will repair it? How can the experience be simple and intuitive? Can the product be reclaimed, refurbished, and resold? If it must be discarded, how can we facilitate its disassembly into easily recyclable components?
By responding to questions like these, the design for disassembly method increases the effectiveness of a product both during and after its first life. Afterlife: An essential Guide to Design for Disassembly, by Alex Diener (1)
The new exchange systems we are exploring blur the boundary between the monetary and nonmonetary realsms and therfore the standard definiton on the ‘economy’.
Ultimately, what economics attempts to measure, underneath money, is the totality of all that human beings make and do for each other.
That we should even attempt to measure this at all is quite odd. Eisenstein, C. (2011). Sacred economics : money, gift, & society in the age of transition. Berkeley, Calif: Evolver Editions.
RESOURCES Eisenstein, C. (2011). Sacred economics : money, gift, & society in the age of transition. Berkeley, Calif: Evolver Editions.
Afterlife: An essential Guide to Design for Disassembly, by Alex Diener
DeMuth, S. 1993. Community Supported Agriculture (CSA): An Annotated Bibliography and Resource Guide, USDA, National Agricultural Library.
Raymond, E. (2001). The hacker milieu as gift culture. Future Positive.
TOO BIG TO FAIL by Jorge Pajares WHAT DOES IT MEAN? The “too big to fail” theory was developed during the 80s, and according to Andrew Ross it sustains that some financial institutions are so big that their crash would also cause the failure of the whole system. This would forze public institutions to help or even rescue them.
IS IT TRUE? WE ALREADY KNOW... The bubble our system was supported by exploded in 2008 when Lehman Brothers broke down. The amount of assets that Lehman was dealing with was that big that a 5% variation of its value would be enough to overcome the actual value of the company.
HOW DID WE GET HERE? -Traditionally, banks didn’t lend their money to everyone, they used to take care of it because it was its money. -Currenty, the commercial banks (lenders) dont’t care anymore about who they are lending their money to because it is not their money anymore. Mortgages, loans... they are all sold to third parties. -Investment banks created CDOs (Collaterized Debt Obligations) with the different loans they bought to commercial banks, paying rating agencies to value them, so then they could sell them to investors. -Many of the CDOs that Lehman and other investment banks created had a AAA rate, the highest one, just a few days before the whole system went down.
AFTER LEHMAN’S BREAK DOWN... ALL THE MARKET WAS SATURATED OF ASSETS, SO THEIR PRICE WENT DOWN. Investment banks, commercial banks, investors, speculators, etc. they all asked AIG (who worked as a huge insurance company for invesments) to cover their losses. Not only in the United States...WORLDWIDE!!
WHAT DID AIG DO? -Investors could assure their assets, but speculators could also bet against those investments. -This way, when the market went down, AIG had to pay them all, it was not possible. -It was then proven that many CEOs and executives from both commercial and investment banks were betting against the financial products they were selling to their customers. 1
WHAT HAPPENED NEXT? -AIG received a 85 billion dollars bailout so it could pay investors (like investment banks), part of this money went to the executives who had bet against their clients. -Some investment banks like Merril Lynch were bought by commercial banks. -Others, like Goldman Sachs and Morgan Stanley turned into commercial banks,but also had to be bailout later. Almost the whole executive board of many banks was replaced, but they received millions of dollars in indemnifications.
SO IN THE END... Those who were too big, are now even bigger. Assets have been displaced and concentrated. The value of the assents of the five largest banks is 8.5 trillion of dollars (56% of US GDP) against the 6.0 trillion of 2008 (43% of GDP)
BUT NOT ONLY COMPANIES CAN BE TOO BIG... HENRY PAULSON, ex-CEO of Goldman Sachs, and Secretary of Treasure during 2006-2009. To become Secretary he had to sell his participations in Goldman, he won 600 million dollars with this operation. MARIO DRAGHI, ex-vicepresident of Goldman Sachs in Europe and former CEO of ECB. Goldman helped the greek goverment to hide the results of the deficit while Draghi was in charge.
THE CURRENT SITUATION Since 2009, the Financial Stability Board tries to analize the financial system and publishes a list with those financial institutions that are considered too big. But we are still wondering about what we can do to avoid this companies to keep growing without threating the whole system. The answer is not clear. Many think that the only way is to forze these instituions to be divided into smaller ones, another option is to tax size, others think that they can still keep growing as they are regulated and forzed to have enough safety funds in case they fail. This last one seems to be the path chosen in the last years. What seems to be clear is that bailout is no longer an option for these institutions, it doesn’t solve the problems. There could be a day when no public institution can handle the size of this companies in case they go down.
THE SPANISH CASE In the list made every year by the Financial Stability Board we can find financial 2
instituions from almost everywhere in the world, two of them are the spanish banks Banco Santander and BBVA. In the Banks Stress Test conducted in 2010 to the European Banks, Banco Santander was ranked the strongest one. HOW IS IT POSSIBLE THAT A SPANISH BANK IS THE STRONGEST IN EUROPE CONSIDERING HOW IS THE CRISIS AFECTING SPAIN? Because it is too big... Around 35% of the bussiness of the bank is in Central and South America, less affected by the crisis.
WHAT HAPPENED WITH SMALL BANKS IN SPAIN? Small local banks, called Cajas, which main shareholders were local goverments, were really affected by their toxic assets. During the last 10 years local governments asked these banks to finance the construction of new infrastructures, public spaces, housing, great buildings signed by Star Architects, etc. with a money that it just never existed. But the executive boards of these banks were mainly chosen by politicians, either left or right ideology, labor unions, etc. everyone wanted a piece of the cake and at the same time jobs were being created with this construction works, so there was no one who opposed. When the bubble collapsed, no one wanted to take responsibility either knew what to do with them. Five of these banks failed the Stress Test, so one decision was made...
LET’S MERGE THEM, MAKE THEM BIG!!! A new bank, called Bankia, was made merging many of this small banks. Rodrigo Rato, ex-minister of Economics of Spain and ex-CEO of the IMF was named CEO of the bank to recover the trust of investors. The new bank went out to the market, anyone could invest and buy assents.
2 YEARS LATER...THE BANK HAD TO BE NATIONALIZED The value of the assets was not real, the bank was unsusteinable. Thousands of people have lost the money they invested. Rodrigo Rato is currently facing jail for its management.
REFERENCES www.financialstabilityboard.org www.bloomberg.com www.expansion.com www.wikipedia.org www.forbes.com www.intereconomia.com Book: Too big to fail by Andrew Ross Film: Too big to fail Film: Inside Job Documentary: Salvados
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