This preview shows page 1. Sign up to view the full content.
Unformatted text preview: After the Fall After
(a.k.a. “The Current Banking Crisis and the Role of Financial Regulation”) the
The Washington Campus West Virginia University College of Business and Economics November 16, 2009 Marc E. Lackritz Where Were You in 1989? Where President George H.W. Bush sworn in; World Series Between Oakland A’s and San World Francisco Giants Francisco Loma Prieta Earthquake, Disrupted World Loma Series BUT MORE IMPORTANTLY: BUT Fall of the Berlin Wall Collapse of Soviet Union “The End of History”, by Francis Fukuyama 2009: The Triumph of Democratic Capitalism? Capitalism? U.S. GDP at about $15 Trillion; Federal Support for Economy at about $5 Federal Trillion: Trillion TARP -$700 TARP FNMA, FrMac, AIG 570 FNMA, Card, Auto, Small Biz 1,000 Card, Stimulus Package 787 Stimulus MBS -1,450 MBS Treasury Bonds 300 300 TOTAL $4,807 B ! How Did We Get Here? How China: China: “Socialism with Market Characteristics” – our biggest creditor our U.S.: “Democratic Capitalism with U.S.: Socialist Characteristics” Socialist Convergence, Dynamic Evolution, or A Convergence, Changing of Global Leadership?? Changing How Could This Have Happened?? A Crisis Without a Narrative Crisis Conservatives/Republicans: Conservatives/Republicans: Blame is all on government – ineptitude, all negligence, bad policies (but weren’t they but negligence,
in charge during the relevant time?) in Liberals/Democrats: Liberals/Democrats: Blame is all on all market and absence of government as absence a result of “deregulation” (but didn’t they but result
support “deregulation” politically?) support Politics, Cynicism, and Manipulation Manipulation They’re both right, to some extent; But if one side’s “solution” is “more But market, less government”, and the other side’s is “more government”, there’s not a whole lot of “common ground! ground! THE TRUTH: We all got it wrong! We all Whither Thou Goest, Adam Smith?? Smith?? “Free Market Model” Assumptions: People Act Rationally . . . WRONG! People Act Independently . WRONG! We Have Perfect Info . . . . WRONG! The “rational markets theory” has taken a pretty The big hit; big The “behavioralists” are now riding high; The comforting illusion of precision – adios to The quants, financial engineers, “confidence intervals” intervals” Anatomy of a Bubble Anatomy From 1988 to ’06, long term interest From rates dropped from 9% to under 5%; dropped The Credit Market exploded from $2.3T The exploded in ’90 to $12.9T in ’07, an unsustainable CAGR of 11%; CAGR Mortgage Debt Doubled from ’01 to ’07, Mortgage Doubled as Americans borrowed more than in previous 225 years combined! previous Anatomy of a Bubble (cont.) Anatomy Sub-prime mortgages went from 2% of Sub-prime 2% all mortgages in ’00 to 28% in ’06; 28% 2/28 or 3/27 Adjustable Rate Mortgages 2/28 went from 53% of all mortgages in ’99 53% to 93% in ’06; 93% Median Home Price doubles from ’00 to Median doubles ’06, while median household real income drops by 2% in same period! drops 2006: The Chickens Come Home to Roost; 2006: Credit Went to Increasingly Marginal Credit Borrowers, and “Teaser Rates” Spiked Borrowers,
Subprime Defaults by Vintage year
18 16 14 12 CDR_1m 10 8 6 4 2 0 0 4 8 12 16 20 24 28 32 36 40 44 48 52 56 60 Age 2000
Source: BlackRock 2001 2002 2003 2004 2005 2006 2007 POP! POP! Evolution of a Crisis Evolution
Bear Stearns Hedge Funds Long on MBS Fail; MBS 8/07 – Securitization Markets Seize, Credit 8/07 Markets Freeze; Markets 9/07 – Fed starts easing interest rates; Fed 9/07 12/07 – U. S., Global Economy enter Recession; Recession; 1/08 – Fed slashes interest rates; $150 1/08 billion stimulus in tax rebates enacted; enacted; 3/08 – Bear Stearns collapses; bought by JP 3/08 Morgan; Morgan; 7/07 – 7/07 Evolution of a Crisis (cont.) Evolution
“Black September” ’08:
Fannie Mae, Freddie Mac taken over by Feds; Lehman Bros. files bankruptcy; Merrill Lynch bought by Bank of America; Goldman, Morgan Stanley become Ban Holding Goldman, Cos.; Cos.; Government takes over AIG; Reserve Money Market Fund “Breaks the Reserve Buck”; Treasury ensures all money market funds; funds Washington Mutual fails (bought by JP Washington Morgan); Morgan); Evolution of a Crisis (cont.) Evolution
TARP enacted ($700 Billion); Fed leads global rate cut, creates new liquidity programs (TALF, TSLF, etc.); Stock market begins serious sellselloff. Auto company aid; Treasury helps B of A to close Merrill deal; of $787 Billion Stimulus Package; TARP reform; TARP “Shock and Awe” – Fed, Treasury support of markets increases to $5 trillion! $5 12/08 – 2/09 – 2/09 3/09 – 3/09 Fall, 2009 Fall, Unemployment rate hits 10.2%; home resale data level off, improve; economic data show some improvement; TODAY: Recovery, or double dip recession? Future inflation? Future of the dollar?? A Year of Vanishing Wealth Year
2008 Bank losses between $2-4 Trillion; Stock Market Losses over $7 Trillion; U.S. Wealth Losses > $11 Trillion 7.2 million jobs lost since Dec., ’07 Global Financial Assets Dropped by $50 Trillion, almost 1 year of Global GDP! Home Price Index Dropped by 38% nationally since July ‘06 Causes of Crisis Causes Interest Rates Were Too Low for Too Long (Global Interest imbalances or New Expectations?); imbalances Public Policy Favored Home Ownership; Lenders Pushed Sub-prime and Exotic Loans with Lenders Lower Standards; Lower Securitization/structured finance re-cycled capital, Securitization/structured increased leverage; Asymmetrical Rewards to Bankers Encouraged Asymmetrical Too Much Risk; Too Human Behavior is Flawed (Overly Optimistic; Act Human in Herds); in No one saw the extreme leverage/interconnections No in the system; in Interest Rates Were Too Low for Too Long
An Extended Period of Monetary Accommodation (With Negative Real Rates!) Stimulated Too Much Debt!
2-Year Real Rates and Fed Funds Fed Funds 2Year Real Rates Source: Bloomberg, Federal Reserve Real 2-Year rates: 2-Year Treasury minus rate of growth of personal consumption expenditures Public Policy Favored Home Ownership Ownership Tax Policy Mortgage Interest Deductibility Capital Gains Exclusion up to $500K Mortgage Financing FNMA, Freddie Mac chartered to support housing finance (guarantees, mortgage purchases, securitization) FHA, GNMA support low, moderate income home ownership Public Policy Favored Home Ownership (cont.) Ownership CRA enacted in 1977 to stop “redlining”; Home ownership steady at 64% until ’95; ’95 – CRA “strengthened”; more scrutiny of banks; FNMA, Freddie Mac can securitize subprime loans; ’95 – Mortgage requirements eased; 3% down payments ’96 – HUD gave FNMA, Freddie Mac target of 42% of mortgages to below median borrowers; to 50% in ’00; 52% in ‘05 Public Policy Favored Home Ownership (cont.) Ownership ’97 – First securitization of CRA sub-prime loans; $385 million by Bear Stearns, First Union Capital Markets; guaranteed by Freddie Mac; followed by $1.9 billion of CRA mortgages backed by FNMA, Freddie Mac; # of mortgages to low- and moderate income families increased by 80% Home ownership level increased to 69% Lenders Pushed Sub-Prime and Exotic Loans and Sub-prime loans increased from 2% of all Sub-prime 2% mortgages in 2000 to 28% in 2006; mortgages % of sub-prime mortgages that were exotic of 2/28 or 3/27 ARM’s went from 53% in ’99 to 93% in ’06; 93% % of sub-prime mortgages that were “low of doc” went from 23% in ’00 to 43% in ’06; doc” Sources: Federal Reserve; Washington Post; Campaign for America’s Future. New Asset Classes and Derivatives Grew Dramatically Derivatives
Assets in Hedge Funds $ Bils Growth in Global OTC Derivatives
$ Bils 450000 1600 1400 1200 1000 800 600 400 200 0 1995 12x 23x 400000 350000 300000 250000 200000 150000 100000 50000
2006 0 1995 2006 The market created a “structuring machine” which was fed by mortgage/credit product. The supply was met by demand; buyers didn’t request, nor did regulators require transparency of products, markets, or balance sheets.
3500 Securitization on Steroids Securitization Gross Issuance ($ billions) 3000 2500 CDOs CMBS ABS 2000 1500 1000 500 0 MBS 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: Lehman Brothers Fixed-Income Research; Thomson Financial; Bondware; IMF; BlackRock Compensation Structures For Bankers Encouraged Too Much Risk Too Wall Street Partnerships all became publicly held corporations in past 30 years; Bankers were “playing” with “Other People’s Money”; “Heads,” They Won; “Tails,” Shareholders Lost; Leverage ratios of Broker Dealers Grew to 35 to 1, and some even higher; Human Behavior is Flawed Human We are overly optimistic (irrationally exuberant!); We act in “herds”; We’re emotional as well as rational; Mathematical Models Don’t Capture The Complexity of Human Behavior; “Fat tails” abound! No Regulator Saw the Extreme Leverage or Heightened Risk Leverage
No “systemic” regulator; V.A.R. models, like “high tech” boats, are useless in a “tsunami”; Interconnections publicly “denied” by officials – were they “blinded” by ideology or lack of data? Financial Services Regulation Financial
“Intelligent Design” or “Evolution”?
1. 2. 2. 3. 3. 4. 5. 6. 6. 7. Banks – Fed, OCC, FDIC, States Banks Credit Unions – NCUA Credit Thrifts – OTS, FDIC, States Broker-Dealers – SEC, FINRA, States Futures Commission Merchants – CFTC, SEC Futures Insurance – States, Dept. of Labor Industrial Loan Companies (a.k.a. “non-bank Industrial banks”) – Fed, FDIC, States banks”) Five Gaps and An Opportunity Five No Systemic Regulator; Too Much Opacity, Leverage; No Formal Resolution Authority; No Fiduciary Duty, Oversight for Mortgage No Brokers; Brokers; Much Consumer Confusion and Misinformation; information; REFORM!!! REFORM!!! The Administration’s Proposal or. . . Locked in the Amber of Yesterday Yesterday Systemic Regulator – The Fed??? More Transparency and Regulation of Derivatives . . . But how, without “strangling the baby in the crib”??? Formal Resolution Authority . . . A “nobrainer”; A Consumer Financial Protection Agency – The Worst Idea in a long time (we don’t have enough federal agencies??? ) A Better Way to Go Better Use Technology, don’t argue about agency jurisdictions; Align Incentives for Capital Requirements, Compensation, Too-Big-To-Fail, etc. that kick in automatically (like automatic fiscal stabilizers); Fiduciary duty, reg oversight of financial product brokers; Increase transparency wherever possible; The Objectives of Public Policy The Maintain Financial Market Stability; Avoid Systemic Risk Avoid Moral Hazard – don’t reward bad behavior, but protect the innocent Encourage Economic Growth Maintain Fiscal Discipline Improve Transparency, Risk Management Transparency --“Sunshine is the best disinfectant” Optimize Leverage – Real Capital Standards (Sell and Buy Sides) Going Forward Going Have We Reached Bottom? (Yes) What Lessons Have We Learned? Markets Aren’t Always Rational, Because People Aren’t; Mathematical Models May be Elegant, but they’re not always right; It’s Dangerous Out There; Be Careful. How Can I Protect Myself and My Family? Why Did I Choose to go to Business School? Is It Ever “Different This Time”? (NO!) Is This a Great Country, or What? ...
View Full Document
This note was uploaded on 10/16/2010 for the course B&E BADM 613 taught by Professor Dawley during the Spring '10 term at WVU.
- Spring '10