Jones-Ch13

Jones-Ch13 - The Global Financial Crisis Overview Charles I...

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Unformatted text preview: The Global Financial Crisis: Overview Charles I. Jones * A Supplement to Macroeconomics (W.W. Norton, 2008) May 22, 2009 OVERVIEW In this chapter, we learn – the causes of the financial crisis that began in the summer of 2007 and where the economy currently stands. – how the current financial crisis compares to previous recessions and previous fi- nancial crises in the United States and around the world. – several important concepts in finance, including balance sheet and leverage . * Graduate School of Business, Stanford University. Preliminary — comments welcome. I am grateful to Jules van Binsbergen, Pierre-Olivier Gourinchas, Pete Klenow, James Kwak, Jack Repcheck, Josie Smith, and David Romer for helpful suggestions. 2 CHARLES I. JONES Wednesday is the type of day people will remember in quant-land for a very long time. Events that models only predicted would happen once in 10,000 years happened every day for three days. — Matthew Rothman, global head of quantitative equity strategies, Lehman Brothers, August 2007. 1 1. Introduction The financial crisis that started in the summer of 2007 and intensified in September 2008 has remade Wall Street. Financial giants such as Bear Stearns, Lehman Brothers, Merrill Lynch, AIG, Fannie Mae, Freddie Mac, and Citigroup have either disappeared or been rescued through large government bailouts. Goldman Sachs and Morgan Stanley converted to bank holding companies in late September, marking the end of an era for investment banking in the United States. While the U.S. economy initially appeared surprisingly resilient to the financial cri- sis, that is clearly no longer the case. The crisis that began on Wall Street migrated to Main Street. The National Bureau of Economic Research, the semi-official organization that dates recessions, determined that a recession began in December 2007. By April 2009, the unemployment rate had risen to 8.9%, up from its low of 4.4% before the re- cession. Forecasters expect this rate to rise to 10% or even higher in 2010, and it seems likely that this will go down in history as the worst recession since the Great Depression of the 1930s. This chapter provides an overview of these events and places them in their macroe- conomic context. We begin by documenting the macroeconomic shocks that have hit the economy in recent years. Next, we consider data on macroeconomic outcomes like inflation, unemployment, and GDP to document the performance of the economy to date. The chapter then studies how financial factors impact the economy. We introduce several important financial concepts, especially balance sheets and leverage. Clearly, 1 Quoted in Kaja Whitehouse, “One ’Quant’ Sees Shakeout For the Ages – ’10,000 Years”’ Wall Street Journal , August 11, 2007. THE GLOBAL FINANCIAL CRISIS: OVERVIEW May 22, 2009 3 there is a crisis among financial institutions tied to a decline in the value of their assets and the effect this has on their solvency in the presence of leverage. But the crisis hasand the effect this has on their solvency in the presence of leverage....
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This note was uploaded on 11/25/2010 for the course ECON 202 taught by Professor Angelatrimarchi during the Spring '10 term at Waterloo.

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Jones-Ch13 - The Global Financial Crisis Overview Charles I...

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