The Financial Crisis SSE Homecoming 2012 10 04
Transcript of The Financial Crisis SSE Homecoming 2012 10 04
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THE F INANCIAL C RISIS
SSE and SIFR, October 4, 2012
Pehr Wissn
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Source: Schleifer 20092
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Page 3
THE S HADOW B ANKING S YSTEM
Regulatedcommercial banks
Regulatedcommercial banks
Shadow banks;Investmentbanks, SIV:s,hedgefunds. Partlyregulated or not regulated.
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A T RADITIONAL B ANK
BankBorrower
Lender
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THE TRADITIONAL BANK
Active in a local market. Keeps borrowing and lending on the Balance
sheet.
Capital Regulation. Deposit guarantees. Has a Lender of Last Resort.
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THE S HADOW B ANKING S YSTEM
A chain of transactions. Geographically diversified. Loan moved out of the traditional banking system
into the shadow banking system. Many different balance sheets involved.
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SBS - E XAMPLE
Lehmans keeps tranches of the CMO in their ownbalance sheet.
Lehmans funds the CMO over-night
Borrows interbank from Bear-Stearns and Citigroup Some tranches of the loan are sold to a Germanbank
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SBS THE G ERMAN B ANK .
Could increase its RoE by putting the CMO:s in aSIV.
Typically gave a liquidity line to the SIV.
Recieved a AAA-rating on a large part of the SIV. Funded the SIV by issuing ABCP.
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P OSITIVE ASPECTS OF THE SBS.
The local bank in Florida could concentrate onacquiring lending. Specialization. Good.
The financial sector grew very rapidly. Good?
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W HICH WERE THE PROBLEMS CREATED ?
Huge risks were built into the system in the form of:- Large liquidity risks- Very high leverage
- Counterparty risks.
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THE RISKS WERE NOT CLEARLY UNDERSTOOD . The rating agencies failed to properly assess the
risks in the structured products. The banks and other firms underestimated the
systemic risks. There were cultural and organizational problems
with respect to risk management in a number oflarger banks ( i.e. UBS, Citigroup, Merrill Lynch )
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C OUNTERPARTY RISKS .
Credit Default Swaps. Who had invested large amounts in CMO:s? How were the risks hedged off-balance sheet?
A very non-transparent system.
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LIQUIDITY RISKS .
There was excessive mis-matching in the system. Investment banks and SIV:s ran very mis-matched
books.
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P OSSIBLE EXPLANATIONS TO THE CRISIS
1. Pricing bubbles - housing2. Inadequate rules and regulations3. Macroeconomic imbalances
4. Inadequate risk controls in the private sector5. Institutional deficiencies6. The shadow banking system broke down
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1.P RICING BUBBLES
A bubble in the US housing market ( and UK andSpain )
Excess-liquidity in the markets
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2. I NADEQUATE RULES AND REGULATIONS
Too low capital requirementsGenerally too little capitalSpecifically, eg trading portfolios,
structured products Insufficient liquidity in the banks Inefficient regulatory system; too many
regulators Low transparency Assymetric regulation of different
institutions.
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3. M ACROECONOMIC IMBALANCES
Savings deficit in the US, surplus in China, India andoilproducing countries.
Long period with low interest rates and highliquidity
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4. I NADEQUATE RISK - CONTROL
Inefficient incentive systems ( bonuses ) Shareholder value Herd behaviour Inadequate risk control Procyclical leverage in financial sector Banks transaction driven
Corporate Governance problems? Moral hazard
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5. I NSTITUTIONAL FAILURES
Ginnie Mae and Fannie Mae Too many regulators Rating agencies
AIG
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THE RATING AGENCIES .
The Shadow Banking System was dependent onthe Rating Agencies.
The business model was problematic. Structured products were rated on the same scale
as normal credit. Correlations were most likely underestimated.
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CDO credit rating vs. Collateral rating (3,912 tranches)
0
50000000
100000000
150000000
200000000
250000000
AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC+ NR
CDO Rating
Collateral Rating
Source: Benmelech 200827
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6. T HE S HADOW B ANKING S YSTEM B ROKE
D OWN .
When the SIV:s collapsed it started a massive waveof forced selling.
Also, the banks had to honour their liquidityguarantees either by funding the SIV:s or byconsolidating them in their balance sheets.
Gave huge losses for the banks and started thedownward spiral.
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SEQUENCE OF EVENTS .
Increase in interest rates in the US. Sub-prime mortgages fell. Not considered a threat to systemic stability SIV:s failed ABCP-market disappeared. Hedge funds went under. Forced selling of assets.
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SEQUENCE OF EVENTS
Central bank lowered rates. All central banks liquidized the banking systems Central banks bought mortgage bonds and sold
Government bonds Bear Stearns went under Forced selling went on and on and on and on
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FROZEN INTERBANK MARKETS
When no banks borrow or lend with each other theall have to transact with the Central Bank.
The balance sheets of the Central Banks explode. This is what is meant by increasing the liquidity in
the system.
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International comparison between central banks'balance sheet totalsIndex, January 2007=100
50
100
150
200
250
300
350
400
jan 07 apr 07 jul 07 okt 07 jan 08 apr 08 jul 08 okt 08 jan 09
50
100
150
200
250
300
350
400ECB
Bank of EnglandFed
The Riksbank
Sources: The respective central banks 33
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Pehr Wissn Page 34Fall 2009
W HAT DID G OVERNMENT DO ?
Central banks increased liquidity. In some countries Government bought bad assets
from the banks Supplied equity to the banks ( US, UK and parts of
EU ) The Swedish Model .
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Pehr Wissn
THE E UROPEAN D EBT C RISIS
Often financial crisis are followed by soverign debtcrisis
Different stories in different countries : Ireland,Portugal, Greece, Spain, Italy, France.
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BUDGET DEFICITS FUNDED BY ISSUING BONDS
The various countries have issued bonds that havebeen sold to commercial banks and to the ECB
There are large losses on the holdings of thesebonds
Stress tests to determine the size of the losses