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Transcript
The Financial Crisis 2009 Steinar Holden Økonomisk institutt, UiO http://folk.uio.no/sholden/ ECON 4325 Outline Macroeconomic imbalances Weaknesses in financial markets Weaknesses in regulation What happened? Historical experiences Some lessons 2009 Securitization Predicted growth in world GDP, given at different points in time 7 6 5 7 Anslag oktober Anslag november Anslag januar 2009 Anslag mars 2009 6 5 4 3 3 2 2 1 1 0 0 -1 -1 -2 -2 -3 -3 -4 -4 Verden Industriland Fremvoksende økonomier 2009 4 (IMF) Amplification mechanisms 2009 Background - macroeconomics Macroeconomic imbalances Fairly high economic growth at world level, yet low inflation partly due to cheap imports from low-cost countries Central banks set low interest rates in 20022005 Economic growth and low interest rates High growth in asset values ”Search for yield” 2009 High saving in China, Japan, Germany and oil exporting countries High borrowing in the U.S, UK, Spain, etc House prices 2009 Background – financial markets Extensive changes in financial markets last 20-30 years Advantages Easier to borrow, better funding of investments Broader spectre of assets, diversification Increased efficiency and profitability 2009 Institutional changes (e.g. hedge funds, private equity funds) Deregulation – removal of artificial barriers Technology – increased access to information, communication, computer power, financial innovation Strong profit motives and incentive based remuneration Securitization Pension funds hold AAA rated assets due to restriction by charter Hedge fund focus on more risky pieces Banks hold ”equity tranch” to ensure monitoring But: most of risk stayed within banking sector (although spread across the world) banks held leveraged AAA assets – tail risk 2009 Diversified portfolios formed on basis of mortgages, corporate bonds and other assets Portfolios are sliced into tranches, sold to investors with different appetites for risk Securitization – bad reasons Supply Demand Naiveté – risk underestimated due to past low correlation among regional housing markets Search for yield – accept tail risk 2009 Regulatory arbitrage – Basel I required banks to hold capital of at least 8 percent of loans on balance sheets, but requirements were lower for SIVs (structured investment vehicles, i.e. off balance sheet entities created by banks) Rating arbitrage – transfer assets to SIVs and issue AAA rated papers rather than A- rated papers Subprime –mortgages in the US Mortgages to household with weak financial background: NINJA – No Income, No Job or Assets Often provided by agents paid on provision Simplified credit evaluation Often based on information from borrower Teaser rates and ”piggyback” mortgages to avoid initial down payment USA Subprime Percent of mortgages, stock 2009 Short term funding and leveraging (low equity shares) Investors prefer assets with shorth maturity Most investment projects and mortgages have long maturities Leads to ”maturity mismatch” for banks Increased reliance on extensive short-term borrowing Lower equity ratios to increase return on equity Earn 1 USD on loan of 100 USD 10 % equity => 10 % return on equity; 5 % equity => 20 % return on equity 2009 Provides liquidity Discipline device for banks Rating agencies and credit default swaps CDS AAA rating important for sale of CDOs Highly profitable business for rating agencies Risk was underestimated Rating ”at the edge”, i.e. as ”risky as possible” Insurance: Credit Default Swaps CDS Extensive reinsurance to other companies Insufficient capital – monoline insurers had only 1 percent of amount at risk Possible to buy CDS without having underlying asset 2009 Higher fees for structural products Background – incentives in the financial sector Not only new, unknown risk, but also Incentive based remuneration, bonus for upside, but no punishment for downside Measuring return relative to risk lead to search for other possibilities Tail risk – win something 9 out of 10, loose a lot 1 out of 10 Herd behaviour – don’t do worse than others 2009 Low price on risk ”Old, well known” risk, e.g. borrow in foreign currency Background – weaknesses in the regulation Large parts of financial markets without capital requirements and supervision Holes in the regulation ”off-balance-sheet” Coordination problems and several regulatory authorities Insufficient transparency Procyclical regulation Good times: asset prices up => equity share up => lend more => asset prices up Reverse in bad times 2009 Half of the US credit market, including investment banks (because no depositors) House prices in the US, annual growth rates 1988 - 2008. 20 Case-Shiller indeks for 10 byområder 15 10 Prosent 5 Case-Shiller nasjonal indeks 2009 0 -5 -10 -15 -20 88 90 92 94 96 98 00 02 04 06 08 Source: Reuters EcoWin Årsvekst i 4. kvartal 2008 for 10 byområder: -19,2 prosent Kilde: Reuters EcoWin 16 Difference 3-month money market rates and policy rates 1. januar 2008 – 2. februar 2009. Prosentpoeng 3,5 USA 3,0 2009 Prosentpoeng 2,5 2,0 1,5 Norge Eurosonen 1,0 0,5 0,0 jan. 08 -0,5 Kilde: Reuters EcoWin apr. 08 jul. 08 okt. 08 jan. 09 Credit default swaps 2009 Amplification mechanisms Loss on bad loans, and fear of new losses Liquidity crisis Banks more reluctant to lend to other banks Difficult to obtain short term funding Banks must sell assets => asset prices fall Lower asset prices increase loss => sell more Asset markets become illiquid Solvency problems Downgrading of securities and institutions Procyclical behaviour and regulation 2009 2009 The financial crisis leads to a recession Financial crisis leads to lower investment and lower consumption, so that GDP falls Demand falls Risk increases More difficult to finance investment projects, consumption and trade credits Investments, cars, durables, manufacturing products severly hit Recession involves real losses that amplifies financial crisis Banks take losses, and must reduce lending Firms have lower equity and lower sales, more uncertainty, becomes less credit worthy 2009 Historical experiences of financial crises after 1945 Reinhart og Rogoff, NBER Average change from top to bottom Longlasting reduction in asset prices Fall in output and employment Unemployment increases by 7 percent over four years GDP falls by 9 percent over two years Public debt increases Average increase is 86 percent (not a good measure, as it depends on initial debt) 2009 House prices fall by 35 percent over six years Stock prices fall by 55 percent over 3 ½ years Some lessons for the regulation of financial markets More emphasis on stability and less on competition Market discipline must improve Raw leverage caps, not only risk adjusted Credit rating agencies Insentives in financial institutions Liquidity regulation and better liquidity provision 2009 Supervision and regulation of all activity which involves system risk Better information and transparency Make regulation less procyclical Lessons – economic policy Fiscal policy tighter in good times Global imbalances reduced International cooperation improved 2009 Monetary policy must reflect concern for financial stability