Sources of Systemic Risk

Philippe Jorion

PAAMCO and

University of California at Irvine

© 2017 P.Jorion

Source: Bordo et al (2000) and Laeven (2012)

0

5

10

15

20

25

30

35

40

1880-89

1890-99

1900-09

1910-19

1920-29

1930-39

1940-49

1950-59

1960-69

1970-79

1980-89

1990-99

2000-09

Number of Banking and Currency Crises

Banking Crises Currency Crises

(21-Country Group)

Start InstitutionsDate Country Closed or Rescued Reason % GDP $ bn1977 Spain 53 banks Recession 6 $101988 United States 1400 S&Ls, 1300 banks Property loans 3 $1801991 Sweden 5 banks Property loans 4 $151994 Venezuela 22 banks Bad loans 15 $111995 Mexico 20 banks Devaluation, lending 19 $811997 Japan 61 institutions Stock market, property 24 $9601997 South Korea 303 institutions, 9 banks Devaluation 31 $1001997 Indonesia 83 banks Devaluation 55 $831997 Thailand 59 institutions Devaluation, property 44 $491997 Malaysia 29 institutions, 2 banks Devaluation 16 $141998 China 4 state banks Bad loans 18 $3211998 Russia 720 banks Devaluation 6 $152000 Turkey 21 banks Devaluation 31 $542000 Argentina 70 institutions Devaluation 32 $46

Average: 22 $138

Cost Systemic Banking Crises: 1970-2002

Source: Bordo et al (2000) and Laeven (2012)

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,00019

9519

9619

9719

9819

9920

0020

0120

0220

0320

0420

0520

0620

0720

0820

0920

10

Value  of  U.S.  Residential  Real  Estate($  Billions)

Source:  Flow  of  Funds,  Household  real  estate  at  market  value  (series  LM155035005)

$7,000b

0%

10%

20%

30%

40%

50%

60%19

70

1975

1980

1985

1990

1995

2000

2005

2010

2015

$0

$100

$200

$300

$400

$500

Sovereign  Defaults

Amount  in  Default  (US$b)

Fraction  of  Countries  in  Default

Fraction  of  CountriesDebt  ($b)

Source:  Bank  of  Canada,  CRAG  sovereign  database

Unwinding Monetary Policy

Source: Bonis, Ihrig, and Wei (2017), “The Effect of the Federal Reserve's Securities Holdings on Longer-term Interest Rates,” FEDS

“Greenspan sees another taper tantrum once rates rise” (May 2015)

Unwinding this… should lead to this

Arbitrary Enforcement

● Over 2011-2015, legal costs imposed on banks amounted to $370 billion

● Sep 2016: D.of Justice requests $14 billion in penalties from Deutsche Bank (80% of its market capitalization)

Source: CCP Research Foundation

Fischer Black’s View

Source: Black (1995), “Hedging, speculation, and systemic risk,” Journal of Derivatives

Industry

Counterparty effect

Firm B: Creditorof firm A Cascading

counterparty effect

Common Shock

Industry A Industry B

Firm A:Files for

bankruptcyrivals

Source: Jorion and Zhang (2009), “Credit contagion from counterparty risk,” Journal of Finance

Counterparty Risk

Counterparty Risk: Eurozone 2009

Source: BIS, Claims of reporting banks

Bank Claims on Claims on Claims onEquity Greece Portugal Spain

(Billions EUR) (Dec 08) (Sep 09) (Sep 09) (Sep 09)France 268 51 24 134Germany 145 29 32 164Greece 25 . 0 0Italy 196 6 5 21Netherlands 94 8 8 86Portugal 28 7 . 20Spain 202 1 60 . Switzerland 94 44 2 10United Kingdom 327 8 17 82United States 11 4 36Foreign Claims 206 196 787Gov't Debt 291 154 579

Positive Steps for Counterparty Risk

● Bank capital has gone up sharply● Greater transparency:

» regulatory stress tests for banks» wider use of centralized clearing (but?)

● Regulators now have more information on network effects» ECB analysis of interbank exposures suggests

the banking system should be more resilient (“European Lehman Moment would not cause a Lehman Moment”)

Source: Huser et al (2017), “The systemic implications of bail-in: a multi-layered network approach,” ECB

Sources of Systemic Risk

● Governments» Real estate/property» Fixed exchange rates» Sovereign default risk» Uncertainty in monetary policy» Arbitrary enforcement

● Counterparty/network effects