Economic CrisisLecture9/10/12-Great Depression led to unemployment rates of up to 25%-Great Depression led to fascism in EuropeFinancial/ Economic Crises are ‘business as usual’-2001- dot.com bubble-1997-98-east Asia and Long Term Capital Management-LTCM led by 2 Nobel Prize winners in finance/economics-1989-90-Savings and Loan Crisis-$150 billion bailout-1987-Stock Market Crash-23% decline 10/19/87-Bubble mentality-East Asian economies were growing rapidly, population was productive money flowed into east Asia rapidly the economy grew very quickly, financial markets rose, stock market values rose, then it crashedLTCM-created by 2 people Nobel prize winners, financial experts and crashed after 3 yearsSavings and Loan-financed the growth of individual family homes-took in savings accountsStock Market Crash-1/4 of all its value lost in one dayHistorical Pattern-Kindleberger, Manias, Crashes and Panics-Crisis every 8.5 years from 1770-present-Basic Pattern: “Overleveraging”-Borrowing too much in pursuit of new profit opportunities-Creates self-reinforcing bubble-Crisis begins when bubble bursts-Impact of Financial Regulation and Deregulation-Bipartisan support for deregulation-Overleveraging-borrowing too much-idea that there’s a shift in financial expectations-Crisis occurs when people can’t pay back the money they borrow-The break in the pattern of a recession 8.5 years occurred after World War 2-As a result of the calamity of the GDP there was serious regulation put in place (financial reform through FDR new deal)-Deregulation started the pattern up again-Pattern of deregulation started to occur in the 1970’s-1998 the basic laws made by Glass and Steagle-the new deal law was overturnedClinton Economic Advisors on Financial Deregulation-2001 economic report of the President-“given the massive financial instability of the 1930’s, narrowing the range of banks’ activities was arguably important for that day and age. But those rulesWhat was Different This Time?-Subprime mortgage market and housing-“Bundling” and “securitizing” mortgages-Why it was supposed to reduce risk?-Role of rating agencies-Moody’s, Standard & Poors-Why it actually increased-Subprime market-higher risk-Bundling-buy a lot of mortgages from the bank and bring them together then sell it as a stock or a bond-Made to reduce risk to lenders-Rating agencies-evaluate risk and give grades-heart of the problem-rating agencies were using the concept of bundling mortgages and making high risk investments seem like low risk investments-When housing prices collapsed, people’s ownership in the house also collapsedImpact of Collapse of Household Wealth-creates macroeconomic “vicious cycle”-Households less willing/able to spend-Leads to: businesses less willing to invest to expand business-Leads to: less job creation-Leads to: markets are less buoyant-How to break a vicious cycle?-Government spend money-Stimulus programEconomics Really is About You-Nearly 70% of you and your families have experienced some hardships due to the financial crisis and recessionincome loss, job loss, loss of homes-More than 90% also know people in other families who have experienced hardshipsmore severe hardships when broaden circle out beyond one’s own family-overleveraging is what caused so much debt to be created-Mortgage backed security-buying something that has a high return but through financial markets it was perceived that the risk wasn’t so highWhat is an Economy?Economic OrganizationsHouseholdsBusinessesMarketsGovernmentsMoney and ExchangeHow do they interact?Combination of interactions defines an economyCapitalism and SocialismWhat is a Capitalist Economy?The US Market Economy (Colander p. 54; Meltzer p. 3)What is a socialist economy?“Socialism is based on individuals’ goodwill towards others…”(Colander p. 55)Alternative Perspectives on VideoMilton Friendman vs. Michael Harrington;Noam ChomskyAlternative Perspectives on EconomicsInstitutionalist, Radical, Feminist, Post Keynesian, Religious, Austrian (Colander, Preface for Students)The Reality is Mixed Economies: But What Mix? Morals and Science Again?Us as Market Economy but with:Large Government Spending on:Public Education; health care,; public pensions; militaryHow large is government spending as share of economy?Government interventions to stabilize economyGovernment regulations to prevent undesirable things that markets wont stopHow do we pay for government activities?Warren Buffet tax proposals: “Stop Coddling the Super Rich”Public Sector accounts for 35% of spending in the US EconomyGovernment Interventions/RegulationsInterventions/Regulations around:JobsSupporting job creationWhy Full Employment? (Pollin pp.7-9)Minimum wageRights to organize unionsFinancial MarketsLimits on speculative tradingEnvironmental ProtectionControlling greenhouse gas emissionsShould there be:Bank Bailouts?More money to reduce poverty?46 million in poverty; 15% highest in 52 yearsTwo Observations by Adam SmithAdam Smith as First Great EconomistConsidered himself a Moral PhilosopherStrong Supporter of both:Market EconomyMoral Foundation of SocietyAuthor of Wealth of Nations (1776) and Theory of Moral Sentiments(1759)“If you want bread, give me money”“Don’t give me bread because I need bread, give me bread because I will give you money”It is necessary for a market economy to operate to worship the powerful and the rich at the same time it is the universal cause of the corruption of our moral sentimentsBasics on Minimum WagesWhat is a minimum wage?Lowest amount of money an employer can legally pay an employeeWhat is a “Living Wage”?A minimum wage high enough to support a worker and his/her family at decent minimal standardCertainly Combines Questions of Science and MoralityIs the “Law of Unintended Consequences” at Work?Hurting people you are trying to helpThe Minimum Wage Over TimeNominal vs. Real Minimum WageMaking an adjustment for inflation and the cost of livingNominal value of minimum wage is 350% higher than 1968$1.60 in 1968; $7.25 todayReal value of minimum wage is 27% lower than where it was in 1968But Does Minimum Wage cause Unemployment?Law of Demand‘Raise the price of anything and demand will fall.’Colander: “The minimum wage hurts those who cannot find work a at the minimum wage but are willing to work and would have been hired at the market-determined wage,” (p114)“…All economists agree that the above analysis is