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Transcript
The Crisis of 2008 and the Future of Regulation Gerald P. Dwyer Federal Reserve Bank of Atlanta University of Carlos III, Madrid Disclaimer • These views are mine and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Housing Price Indices January 2000 to February 2009 200 Index value Case Shiller index OFHEO index 160 120 80 1/1/2000 4/9/2002 7/17/2004 Date 10/25/2006 2/1/2009 U.S. Mortgage Originations by Type 2001 through 2007 FHA / VA Conventional Prime Jumbo Alt A Subprime Home Equity Lines Trillion Dollars (U.S.) 4 3 2 1 0 2001 2002 2003 2004 Year Source: Inside Mortgage Finance 2005 2006 2007 U.S. Delinquencies by Loan Type First Quarter 1998 through Fourth Quarter 2008 30 Prime FRM Prime ARM Subprime FRM Subprime ARM 20 10 0 1/1/1998 10/1/2000 Note: Delinquent 90 days or more Source: Mortgage Bankers Association 7/2/2003 Date 4/1/2006 12/31/2008 Size of Financial Markets Source: Bank of England Stability Report, 10/2007 Story • A tiny part of securities markets has put asset markets around the world in a state of turmoil? • How can that be? Structured Finance • Mortgages are securitized – Residential Mortgage Backed Securities (RMBS) – Mortgages are pooled together and sold on the open market • Agency securities • Others • Can be divided into tranches • Tranching – Typical bond has all holders suffering losses proportionately – Structured financial instruments structure receipts of payments Two Securities from One AAA rated security Subprime mortgages Equity tranche of security Collateralized Debt Obligations • Take set of securities and restructure their payments – Corporate bonds – Residential mortgage backed securities (RMBS) CDO Deals Idiosyncratic and Traded over the Counter • A trust, generally in the Cayman Islands owns the assets backing the CDOs and distributes payments • Not standardized contracts • Over-collateralization and triggers – Can build up a reserve account for possible losses – Can be contingent on delinquencies and losses • Manager can be passive or active • Traded over the counter ABX Indices by Vintage 110 110 70 70 06-1 vintage 06-2 vintage 30 30 1/1/2006 8/31/2007 4/30/2009 AAA AA A BBB BBB- 80 1/1/2006 07-2 vintage 50 50 20 20 8/31/2007 Date 4/30/2009 80 07-1 vintage 1/1/2006 8/31/2007 4/30/2009 1/1/2006 8/31/2007 Date 4/30/2009 Securities and “Risk Sharing” • CDOs of ABS were purchased by entities all over the world • AAA rating made them seem like a fine purchase – AAA CDO is not a AAA corporate bond • CDO is based on a portfolio of loans • Behavior of cash flows in default is different – Ratings were conditioned on rising house prices • Mispricing of these CDOs may partly explain the earnings from creating so-called arbitrage CDOs LIBOR less OIS - 30 days January 1, 2006 to April 30, 2009 spread 300 200 100 0 1/2/2006 11/1/2006 9/1/2007 Date 6/30/2008 4/30/2009 LIBOR less OIS - 30 days January 1, 2006 to April 30, 2009 Run on money market funds spread 300 200 End of year 100 Northern Rock 0 1/2/2006 11/1/2006 9/1/2007 Date 6/30/2008 4/30/2009 LIBOR less OIS - 30 days January 1, 2006 to April 30, 2009 Run on money market funds spread 300 200 End of year Kindergarten day 100 Northern Rock 0 1/2/2006 11/1/2006 9/1/2007 Date 6/30/2008 4/30/2009 This Is Not All the Story • House prices rose in many other places than parts of U.S. – House prices have fallen substantially in Ireland, Spain and other countries – Nothing directly to do with subprime mortgages or CDOs • Widespread increases of leverage • Widespread increases of maturity transformation One Cause Source: http://library.thinkquest.org Another Possible Cause Who’s to Blame? • My personal estimate of proximate causes in order of importance • Fannie and Freddie’s purchases of subprime securities spurred on by Congress • Financial innovations – CDOs – Reduced the cost of risky activities – Not clear how much this is due to increased issuance of subprime loans • Private institutions took on more risk – Increased leverage – Increased maturity transformation Regulators to Blame? • Federal Reserve and low Fed Funds rate – Would have to establish that short rates were relatively low around the world, not just dollar rates • John Taylor claims this in talks and in his book – Would have to establish that low rates induced people to buy houses even though long rates were unaffected • Regulators – The combination of the developments caused the crisis – It’s easy to see this after the fact Financial Difficulties • It’s the truck you don’t see that runs you down Stability Source: http://img2.travelblog.org/Photos2/