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Reflections by an economist on the lessons from the crisis for capital adequacy and accounting principles Jesper Berg - 2009 1. A buffer for bad years ” Now Joseph was thirty years old when he came before Pharaoh, king of Egypt. And Joseph went out from before the face of Pharaoh and went through all the land of Egypt. Now in the seven good years the earth gave fruit in masses. And Joseph got together all the food of those seven years, and made a store of food in the towns: the produce of the fields round every town was stored up in the town. So he got together a store of grain like the sand of the sea; so great a store that after a time he gave up measuring it, for it might not be measured..” Source: Old Testament Gênesis 41. 2. Outline Turner and de Larosiere From Modigliani and Miller and onwards Four lessons to be remembered Procyclicality, liquidity and the liability side 3. Policy messages Capital requirements up Shift relative taxation Assets at mark-to-market/Fair value Liabilities at Max (Nominal value, mark-tomarket) Alternative valuations in notes Transparent cyclical buffers Tightening implemented in years of plenty 4. Turner and de Larosiere 5. Do the MM-Proposition apply to banks ”Yes and no” Source: M. Miller, J. of Banking and Finance, 1995. 6. The difference between going and gone Selected items from failed banks, mill. kr. EBH Bank 1. half 2009 Writedowns Result 2008 1105 -1470 Loans outstanding 3349 Own Funds 1476 Source: Finansiel Stabilitet FIONIA -2200 -1300 Roskilde Bank 1. half 2009 1. half 2009 2. half 2008 1945 1362 3503 -1901 -1115 -3501 17000 17839 20457 -79 2857 -1028 7. Years of plenty and years of famine LOAN LOSS PROVISIONS, PER CENT OF LOANS Denmark Sw eden Norw ay Finland 3.1 2.5 1.5 1.5 0.6 1.1 2.0 1.6 2.3 2.7 3.3 3.2 0.5 0.5 0.7 0.5 0.6 0.5 0.3 0.4 1.2 4.0 7.6 6.3 0.2 0.3 0.3 0.4 0.5 1.3 2.0 2.6 2.3 4.3 2.5 1.6 0.6 0.5 0.5 0.6 0.6 0.7 0.7 0.7 0.6 1.7 5.8 5.6 Average 1982-90 ............................................ 1.8 Average 1982-93 ............................................ 2.1 0.6 1.9 1.1 1.5 0.6 1.5 1982 1993 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 ................................................................ ................................................................. ................................................................. ................................................................ ................................................................ ................................................................ ................................................................ ................................................................ ................................................................ ................................................................ ................................................................ ................................................................ 8. SIV and conduits or the danger of a liquidity guarantee Assets ABCP Liabilities Assets Shares Liabilities Home loans Money Market Mutual Fund ABCP ABCP SIV/Conduit Liquidity guaranty OK! Ratings Agency Bank OK! (non-balance sheet) 9. The game is skewed HOW OFTEN IS SIV AND CONDUITS M ENTIONED IN FINANCIAL STABILITY REPORTS Financial Stability Report SIV Conduit IM F spring 2007 .............................................. IM F aut umn 2007 ........................................... 0 26 0 30 ECB spring 2007 ............................................ ECB aut umn 2007 ........................................... 0 28 0 26 Bank of England spring 2007 ....................... Bank of England aut umn 2007 ..................... 0 33 0 21 BIS annual report spring 2007 ...................... BIS annual report spring 2008 ...................... 0 5 0 3 Source: Financial St abilit y Report s. 10. The ostrich strategy People and governments have never learned anything from history, or acted on principles deduced from it . Source: Hegel, as quoted in "History of the 80s, vol. I, An examination of the banking crisis of the 1980s and early 1990s", Federal Deposit Insurance Corporation, 1997. 11. Procyclicality, liquidity and liability side the ”The large bike blade”. Source: Expressions used when Bjarne Riis during the Tour de France in 1996 gave his competitors rear by running a high gear up the hill. Bjarne Riis has subsequently indicated that he was drugged. 12. Policy messages Capital requirements up Shift relative taxation Assets at mark-to-market/Fair value Liabilities at Max (Nominal value, mark-tomarket) Alternative valuations in notes Transparent cyclical buffers Tightening implemented in years of plenty 13. Concluding observation To understand the world is like peeling an onion. Each time, removing a layer, you discover a new layer and occasionally you weep. Source: An analyst philosophy of life.