Presentation on theme: "The Financial Crisis: Whos to blame? Howard Davies Director, LSE HSE Cultural Centre, Moscow 14 December 2009."— Presentation transcript:
The Financial Crisis: Whos to blame? Howard Davies Director, LSE HSE Cultural Centre, Moscow 14 December 2009
Rolling Stone described Goldman Sachs as a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.
Who is most to blame for the current financial crisis? % Source: Thisismoney.co.uk, June 2009
economists - if anything needs fixing, its the sociology of the profession – Dani Rodrik (Harvard) business schools – the Guardian testosterone – Scientific American: risk-taking in an investment game with potential for real monetary pay-offs correlates positively with salivary testosterone levels and facial masculinity video games – Professor Susan Greenfield of Oxford human greed – Rowan Williams Jews Some suspects
Who blames the Jews for the financial crisis? Source: N Malhotra, Y Margalit: State of the Nation. Boston Review, May/ June 2009.
% blaming 49US banks 29Investment banks 29 Credit Rating Agencies 28 US regulators 25Hedge funds 23EU banks 6EU regulators ……and the answer? Views of Members of the European Parliament
…66% recommend deeper political union in Europe, as a key response to the crisis
Russians trust their government more than the British do.. What is your level of trust in the government to manage the financial situation? Average response, scale from 1.0 (no trust) to 10.0 (full trust). Source: WIN CRISIS INDEX, 3 rd Wave of the Worldwide Barometer of the Financial Crisis.
But the social impact is large Projected impact of the crisis on the poverty rate, percentage of people with income level below minimum subsistence, 2007-2009 Source: Russian Economic Report No. 19, World Bank.
The impact of the crisis on the long-term development objectives in Russia: dynamics of GDP level in Russia 2007-2020, (q1-2006=100) Source: World Bank Projections, Strategy 2020.
Russians are more confident in banks What is your level of trust in the stability of the banks? Average response, scale from 1.0 (no trust) to 10.0 (full trust). Source: WIN CRISIS INDEX, 3 rd Wave of the Worldwide Barometer of the Financial Crisis.
Source: Worldwide Barometer of the Financial Crisis – August 2009, BVA. Russia is one of the countries where level of optimism is above the average
Bank failures are caused by depositors who dont deposit enough money to cover the losses due to mismanagement. Dan Quayle
Act One:Subprime Act Two:Liquidity Act Three:Unravelling Act Four:Meltdown Act Five:Pumping The Credit Crisis: A Five-Act Shakespearian Tragedy
Real GDP % growth forecast, October 2008 Source: Financial Times European Economic Forecast.
Real GDP % growth forecast, July 2009 Source: Financial Times European Economic Forecast.
The IMF forecast a modest recovery next year Source: IMF World Economic Outlook Database, October 2009. Gross domestic product forecast (% change), constant prices, 2007-2014
But global unemployment is likely to continue to rise Unemployment (Million) and unemployment rate (%), 1999 - 2009 Source: ILO, Trends Econometric Models, December 2008.
global imbalances loose monetary policy, leading to mispricing of risk credit bubble excess leverage, facilitated by procyclical regulation, and regulatory arbitrage excess unmanaged growth of the financial sector, which magnified risks, rather than diversifying them What are the underlying causes?
Global current account imbalances grew rapidly from 2003 Estimates of account balances for selected countries ($ Billion), 1993-2007 Source: Datastream, FSA Calculations.
Source: Bank of England, Speech of Charles Bean at the Annual Conference of the European Economic Association, 25 th Aug 2009. Monetary policy was loose, especially in the US Deviation of policy rates from Taylor rule (%), 2000-2009
Household debt as % of GDP, 1987-2007 Source: FSA, ONS, Federal Reserve, Eurodata, Datastream Household debt rose sharply
Case-Shiller Home Price Index (2000 Q1 = 100), Jan 1987 - 2005 Source: Silverlake, Case-Shiller Price Index. US house prices doubled in five years
Source: ECB, National Statistical Offices, IMF, EMF, Italian Ministry of Infrastructure, Morgan Stanley Research. House prices rose rapidly in much of Europe also Real house price changes over the last ten years (%), 1996-2006
Bank Balance Sheets expanded Source: Silverlake, Capital IQ. Large-cap banks aggregate assets rose to 43x tangible book equity
UK banks leverage grew sharply from 2003 onwards Source: Bank of England, Financial Stability Report, Issue 24, 28 October 2008. Major UK banks leverage ratio, %, 1998 - 2008 Note: Leverage ratio defined as total assets divided by total equity excluding minority interest. Excludes Nationwide due to lack of interim data.
Source: The Turner Review, March 2009. ABS – volumes outstanding, $ Billion, 1996 - 2007 As did the securitised credit market
Credit default swaps, $ Trillion, H2 2004 – H1 2008 And the outstanding credit default swaps Source: The Turner Review, March 2009.
Resecuritisation magnified credit creation SUPER SENIOR AAA AA A BBB Equity Capital Structure Containing Subprime Loans Subprime Mezzanine CDO Containing BBB Subprime Bonds 100% 28% 20% 11% 7% 0% 11% 7% 11% 8.6% 7% 100% 40% 0% CUMULATIVE LOSSES Source: Morgan Stanley.
Private Equity Leverage Multiples grew Source: Silverlake, Morgan Stanley, Capital IQ. Debt/EBITDA, 2002 - 2007 X
Growth in Hedge Fund Assets & Leverage accelerated Source: Silverlake, Through Q308 – HFR industry report; Q408 projections based on CS analysis.
This points to the need for monetary policy to focus more on - credit growth - financial intermediation, and - asset prices …with a stronger emphasis on the risk of financial instability
Weak regulation may not have been the main cause of the crisis, but it is important to reform it trust in markets, and in regulation, has been affected, which damages investment and economic growth the global system does not meet the needs of global markets
Trust Source: The Financial Trust Index. Average response on a scale from 1 to 5 to the question, How much do you trust…, where 1 means I do not trust at all and 5 means I trust completely.
Trust in financial markets, and government, has fallen Source: The Financial Trust Index. Average response to the question, How has your trust in some of these institutions changed in the last three months? Would you say your trust in…has 1) increased a lot; 2) increased a little; 3) decreased a little; 4) decreased a lot; or 5) has there been no change in your trust.
The crisis revealed problems with the existing regulatory architecture: Hopelessly complex global structure Lacking a central authority to drive co-operation and make changes happen US system balkanised and ineffective European system a fudge – neither truly European nor truly national No two national systems the same
Global Committee Structure - A Regulators View G-20 (Govts) Financial Stability Board WTO OECD (Govts) FATF (Money Laundering) IASB (Accounting IASC Bank for International Settlements (Central Banks) G-10 (Central Banks) CGFS CPSS Basel Committee (Banking) IOSCO (Securities) Joint Forum IAIS (Insurance ) Monitoring Group IAASB (Audit) PIOB IMF World Bank (Govts) IFIAR (Audit) Source: Adapted with permission from Sloan and Fitzpatrick in Chapter 13, The Structure of International Market Regulation, in Financial Markets and Exchanges Law, Oxford University Press, March 2007.
IOSCO Structure Presidents Committee Executive Committee Regional Committees Asia-Pacific Europe Interamerican Africa-Middle-East Emerging Markets Committee Working Groups Disclosure and Accounting (WG1) Secondary Markets (WG2) Market Intermediaries (WG3) Enforcement & Cooperation (WG4) Investment Management (WG5) Specific issue Task Forces Principles Implementation Committee SRO Consultative Committee Co-ordination Committee (with Basel and IAIS) Chairs Task Force Technical Committee Standing Committees Multinational Disclosure and Accounting (SC1) Secondary Markets (SC2) Market Intermediaries (SC3) Enforcement & Cooperation (SC4) Investment Management (SC5) Specific issue Task Forces E.g. CPSS-IOSCO Internet Task Force Source: Adapted with permission from Sloan and Fitzpatrick in Chapter 13, The Structure of International Market Regulation, in Financial Markets and Exchanges Law, Oxford University Press, March 2007.
A new European Framework for Safeguarding Financial Stability Macro- prudential supervision Micro-prudential supervision Source: De Larosière Report, February 2009. Members of ECB/ESCB General Council (with alternates where necessary) European Systemic Risk Council (ESRC) (Chaired by President ECB) Chairs of EBA, EIA & ESA European Commission European System of Financial Supervision (ESFS) European Banking Authority (EBA) European Insurance Authority (EIA) European Securities Authority (ESA) National Banking Supervisors National Insurance Supervisors National Securities Supervisors ++ Information on micro-prudential developments Early risk warning
National Regulatory Structures Source: How Countries Supervise their Banks, Insurers and Securities Markets 2007: Central Bank Publications. 57 35 2 49 3 54 28 7 39 10 Other bank regulators Central banks as banking regulator Central bank as one pillar No Central Bank interest Non-Central Bank Central Bank
And there were a number of regulatory failures US Financial markets regulation was uncoordinated and overlapping - Promoted regulatory competition European Regulation also at fault: complex mix of European and national rules In the UK, weak FSA regulation of Northern Rock, and the Bank of England too distant from financial markets
More regulatory failures Key markets were unregulated –Non-bank private mortgage industry –Credit Default Swaps No exchange, central clearing or capital requirements Insurance industry in the US was lightly regulated –No federal regulator –Missed one-sided credit insurance & CDS risks taken on by AIG and others Basel II capital requirements were flawed –Allowed too much leverage, over-reliance on credit ratings, and didnt encompass liquidity –Pro-cyclical: as asset prices rose, banks seemed to need less capital
G20 Summits Reshaping the global financial and regulatory System Enhance corporate governance and risk management Strengthen prudential regulation, but with a managed transition to avoid exacerbating the downturn Regulate financial activities according to their economic substance and ensure regulation is consistent in all jurisdictions
Reshaping the global financial and regulatory system Financial Stability Board with standing committees Membership of FSB, Basel etc extended to BRICs and others Expanded coverage of regulation to include systemic hedge funds Tighter controls on offshore centres Tighter regulation of credit rating agencies More and better quality capital in the banking system Macro-prudential mechanism to respond to asset price bubbles Regulatory controls on bank remuneration G20 Summits
Poor risk management –excessive reliance on Value at Risk Models –herding behaviour –inadequate hedging Flawed capital allocation mechanisms –trading strategies under-capitalised Incentive structures which reward short-term risk-taking Weak corporate governance: boards ignorant of the risks management were taking on Failures in the financial firms themselves may have been even more important
Much of the past 30 years of macroeconomics was spectacularly useless at best, and positively harmful at worst Prof. Paul Krugman, Princeton The unfortunate uselessness of most state of the art academic monetary economics Prof. Willem Buiter, LSE The modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year Alan Greenspan And, finally, there are major problems with Economics – and efficient markets
The Global Financial Centres Index Financial CentreGFCI RankGFCI Rating London1790 New York2774 Hong Kong3729 Singapore4719 Shenzen5695 Zurich6676 Tokyo7674 Chicago8661 Geneva9660 Shanghai10655 Source: City of London Corporation, Global Financial Centres Index, Report - 6, September 2009.
Macro imbalances, loose monetary policy and financial innovation Rapid credit growth, asset price bubbles, overborrowing Global finance without global government Flawed assumptions about market efficiency and investor rationality Such a complex failure has many parents
The Financial Crisis: Whos to blame? Howard Davies Director, LSE HSE Cultural Centre, Moscow 14 December 2009