Home > Financial Markets > Spotting a Financial Crisis

Spotting a Financial Crisis

November 30, 2017 Leave a comment Go to comments

Below is another great video from PunkFT. Financial crises start with significant increases in asset prices followed by a severe correction and a collapse. But with more debt and more credit the market is unstable and although they have never been higher the yields have never been lower.

Thanks to more and more debt driving yet more and more credit, making everything more and more unstable. Today, for example, markets have never been higher. Yields have never been lower.

The early warning signs
These economic crises are easy to spot and they follow a familiar pattern. The warning signs are:

1. A bank grows very quickly and issues poor quality loans against nominal yields. It uses leverage to do this and fails to be aside reserves for possible future losses.

2. Normally the share price of these banks would plummet but in fact the opposite happens – the share price is driven up. As the bank takes more and more risk to generate more return, the market gets giddy, and they drive up the share price.

3. We don’t learn from our mistakes. The Global Financial Crisis suggests that the economy is following the contours of typical recession but that it is more severe. Subsequently forecasters who have tried to make resemblance to post-war US recessions are “barking up the wrong tree” and are of the belief that conventional tools like expansionary fiscal policy, quantitative easing and bailouts are way to go. The real problem is that the global economy is badly leveraged and there is no quick fix without a transfer of wealth from creditors to debtors. Ken Rogoff (co-author of ‘This Time is Different’) suggests that the ‘Second Great Contraction’ is a more realistic description of the current crisis in the global economy. The “First Great Contraction” was the Great Depression of 1929 but the contraction applies not only to output and employment, as in a normal recession, but to debt and credit, and the deleveraging that typically takes many years to complete.

If everybody else is doing it and getting rich, why, the CEO asked himself, shouldn’t I? The real cause of banking failures and systemic collapse lies with ethics at the top. And human nature tells us that bad ethics drive out good ethics.

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