Financial Crises¶
Stage 1: Buildup¶
Credit boom & bust¶
- Boom
- Financial liberalization: Reduced restrictions
- Financial innovation: New financial product
- Bust
- Lenders may lack expertise and/or incentives to manage risk appropriately
Asset-price boom & post¶
Herding
Increased uncertainty¶
- Hard to obtain information
- Reduced lending
- Reduced economic activity
Stage 2: Banking Crisis¶
Stage 3: Debt Deflation¶
Underwater mortgage problem
Deflationary spiral: Deflation increase defaults, and that causes more deflation
Case Studies¶
Great Depression¶
Asian Tigers¶
Dot-Com Bubble¶
Tech bubble/Internet bubble
2008 Financial Bubble¶
- Housing prices
- Stock prices
Causes
- Failure for default prediction algorithms
- Used FICO (Fair Isaac Corporation) Score
- The models were trained on dataset where housing prices always increased
- Financial innovations
- Securitization: Process of building small loans (like mortgages) into standard debt securities
- CDO: Collateralized Debt Obligations
- CDS: Credit Default Swap
- Agency problems in mortgage markets
- Asymmetric information
- Credit-Rating Services