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Transcript
The Financial Crisis Thadford Jackson Preface History is not yet written Ben Bernanke and the GD Those who do not know the past…. Better still, those who know the past can profit in the future Biographies of business titans illustrate… You will witness from 5 to 50 financial/economic troughs From households to global conglomerates! Preface Blame who you want, but the bottom line is all that counts History is a model that is only as good as it is useful…to what end? History is linear, though only by construction In fact, unfolding of events is simultaneous and beyond the scope of comprehension Preface A smart person learns from his own past; a wise person learns from others’ past. History is fascinating. History repeats. 1907 versus 2007 Preface Much of what we ‘know’ is wrong! Expertise is the realization of ignorance. Concentrate on the history of the doers, instead of on the history of the pundits, critics, or intellectuals Those who study history live on different planets from those who do not. Probably no better preparation (besides experience) than business history A note on mass media Media are intent on profit; sober assessment of the facts does not sell as well as finger-pointing and crucifixion As noted, scholarly assessments are incomplete at best The Story Bankers, or “Wall Street” types, are bad people (think ‘Jews’ and anti-Semitism) who: Intentionally loaned money to people who could not afford to repay Reaped private gains, then leaving losses to public Lied to, cheated, and stole from Main Street Should be in jail! The Story Republicans are greedy and corrupt people who are in bed with the bankers W., an oil man, slashed all regulations on banks which would have stopped the FC from ever happening Democrats are redistributionist fools who forced banks to loan money to minorities who could not afford the houses that they acquired…and democrats are in the pockets of the big banks, of course. Definitions Khan Academy on Credit Crisis Financial crisis Highly damaging, usually sudden, event associated with large decline in asset values Bubbles bursting Banking panics/runs Spillover to ‘real’ economy? Bubble Prolonged overvaluation of asset (class) from fundamental value Tulipmania, South Sea Bubble, Roaring Twenties, Tokyo real estate, Housing bubble Greater fool, extrapolation, herding Definitions Subprime mortgage Higher credit risk and higher returns Prime purchased by Fannie and Freddie Non-conforming Derivative Financial product that ‘derives’ value from other financial asset Option, future, forward, swap Can be combined to produced synthetic products CDOs, CDSs, synthetic CDOs Leverage Example of 100% equity stake versus 10% stake; i.e., leverage ratios of 0 versus 10 to 1 Definitions Commercial banks Funnels deposits to investors Investment banks Bank that does not take traditional deposits From G-S to G-L-B, firewall between banks and IBs All major banks had IB functions after G-L-B Goldman Sachs, Morgan Stanley, Merrill Lynch, Bear Stearns, Lehmann Brothers, Blackstone, Nomura Securities examples of long-time, pure IBs M&A, IPOs, advisory, wealth management, proprietary trading, private equity Definitions Hedge Funds Think mutual funds for sophisticated investors Sophisticated equals high net worth and familiar with complex financial products Pensions, endowments, high net worth individuals Can invest in wider variety of assets/asset classes and use more sophisticated strategies Vanilla hedge (130/30), global macro, event driven, arbitrage, directional 2/20 compensation contract with high watermark Leverage Definitions Originate-to-distribute model Used to be…bank loans money to homebuyer and keeps loan on its books (and services) for duration of loan O-to-D: Lender originates loan, sells loan to giant bank who securitizes loan and allows SPE to service loan Definitions ABS Investment the cash flows of which are reliant upon other assets MBS Represents a claim on the cash flows from mortgage loans through a process known as securitization Heart of the crisis RMBS v. CMBS 1. 2. 3. Credit cards, student loans, real estate loans, etc. SPV purchases/collects mortgages Pools mortgages Issues securities GSEs major players in MBS market, but not only ones Definitions More on MBS: Why? Liquidity thru standardization Cash for originators Diversification of finance sources Regulatory arbitrage: meet capital requirements easier Profitable About $15T outstanding Definitions CDOs ABS with multiple tranches of varying risk Water flows from senior to junior to equity Created by hedge funds, investment banks, banks $1.4T total issuance Definitions CDS Buyer makes regular payments to seller who will indemnify buyer in the event of credit event Credit event is defined in contract Failure to pay, repudiation, restructuring, etc. Swap that insures buyer against credit risk OTC derivative; opaque market Definitions Synthetic CDO CDO that references CDSs instead of assets such as ABS (RMBS, CMBS, etc.) Derivative of a derivative Sliced into tranches of various risk appetites much like a CDO CRA Moody’s, Standard & Poor's, Fitch Ratings Many investors required to invest in “investment grade” assets; no junk Higher credit rating entails lower risk, lower return Definitions Too Big to Fail Some institutions are so large that their failure would pose systemic risk Systemic risk is just what it sounds like Tom Brady (of Brady Bunch) is TBTF; Marsha is expendable Predatory lending Fraudulent origination practices? “Abusive” practices is more appropriate definition Definitions Deregulation ‘Decreasing’ number, scope, and enforcement of regulations I am not aware of any examples; perhaps regulatory consolidation led by VP Gore Promoting freedom in the market place Motor Carrier Act of 1980: deregulated assets that could be carried, routes open to carriers, price controls; result was more competition and price declines Airline Deregulation Act of 1978: price and entry controls relaxed; result in steady price declines Gramm-Leach-Bliley (Financial Services Modernization Act of 1999): Definitions Promoting freedom in the market place continued Gramm-Leach-Bliley (Financial Services Modernization Act of 1999): Repealed part of Glass-Steagall of 1933 Permitted consolidation of insurance, commercial banking, brokerages, and investment banking Improved efficiency of scale and thus reduced costs Thought important for global competitiveness of U.S. banks (bipartisan bill signed by WJC) NOTE: disallowed merger if party failed to satisfy CRA requirements Lack of new regulation; most common charge against republicans (during WJC presidency, though) Definitions GSE Fannie Mae, Freddie Mac Created by Congress to increase credit availability in home loan market Privately owned, but implicit guaranteed by Uncle Sam Bought up bulk of MBSs Incentivized to purchase MBSs issued to low-income borrowers Definitions Shadow banking system Those institutions that perform banking functions (liquidity and credit provision) but lacking in heavy regulation and deposit insurance Hedge funds, money market funds, SPVs, Repo market In 2008, roughly twice size of banking system; $20T versus $10T Definitions Maturity mismatch Banks typically borrow over short-term and lend over long-term Bank run Before deposit insurance, lost confidence in banks led people to rush banks to demand funds Fractional-reserve banking means that bank runs destroy banks FDIC stopped bank runs in U.S. Modern runs in repo market (which killed Lehmann Brothers), money market funds Country-wide runs (Greece) Definitions Commercial paper Day-to-day financing of almost all major firms reliant upon CP market Unsecured notes, 1 day to 9 month maturity Backbone of money market Sold at discount and usually backed by sponsoring bank Definitions Stimulus TARP Fiscal or monetary Equity injections into major banks and car companies Liquidity trap Zero percent interest rate environment that precludes FRB from lowering rates to stimulate economy
