Financial Crises

Financial Crises

1. ERM Responses

   • Increasing Exposure
     • Exposure likely to increase as the economic cycle prolongs
   • Mitigating Exposure
     • Change products to meet newfound consumer tastes
     • Purchase swaps to reverse your investment position and reduce losses
     • Diversify portfolio
   • Avoiding Exposure
     • Sell business
     • Cut nonessential costs

2. Context

   • Types of Financial Crises
     • Currency crises
     • Sudden stops
     • Foreign and domestic debt crises
     • Banking crises
   • Importance
     • Prevent monetary losses from financial crises
       • Less likely of a company to go bankrupt
       • Higher income to finance new projects
     • Prepare accordingly
       • Adjust prices to meet new consumer's tastes
       • Change products to meet new demands (ex. sell essentials)
       • Sell to a different target market
       • Strengthen competitive advantage

3. Recent History of Financial Crises

   • LatAm sovereign debt crisis (1982)
     • Latin American countries continued to accumulate foreign debt and realized they will not be able to pay it off
   • Savings and loan crisis (1980s)
     • Institutions in the United States were lending long-term at fixed rates using short-term money
   • Stock market crash (1987)
     • Dow Jones lost 508 points (23% of its value)
   • Junk bond crash (1989)
     • Resulted in a significant United States recession
   • Asia crisis (1997)
     • Similar crisis to LatAm deb crisis
   • Tequila crisis (1994)
     • Massive interest rate crisis
   • Doctom bubble (1999)
     • Preceded by a bull rush into the technology and internet sector
   • Global Financial Crisis (2007)
     • Triggered from the crash of the housing market

4. Risk Analysis

   • Frequency
     • Looking at the past 40 years, there were 8 financial crises around the world
       • Doesn’t happen very often, but will eventually occur (Economic cycle: expansion, peak, recession, trough)
   • Severity
     • When a financial crisis occurs, the effects of it can put a massive toll on consumers
       • Lower disposable income
       • Higher unemployment rates
       • Unaffordable housing prices
       • Higher interest rates
       • Higher levels of credit and debt
   • Measuring Impact
     • Output
     • Happiness
     • Productivity
     • Stock Market Indices

5. Risk Identification

   • Asset Price Booms
     • Sharp increase in asset prices (bubbles)
       • Stock prices rise above fundamental levels
     • Mispricing
       • Microeconomic distortions
       • Investor irrationality
   • Credit Booms
     • Rapid increase in credit
       • Leverage buildup and greater risk-taking
       • Lower interest rates
     • Sharp increases in international financial flows
     • Financial liberalization and innovation
   • Asset Price and Credit Busts
     • Small shocks
       • Market freezes causing asset prices to exhibit rapid declines and downward spirals
       • Lack of short-term financing
     • Bank lending and investment decisions
       • Assets can no longer be used as collateral which decreases the ability to obtain further credit
       • Large price dislocations arising from fire sales causes financial intermediaries to hoard cash rather than invest