MEAFA Forum on the Financial Crisis, 2nd April 2009

Introductory Remarks

Graeme Dean

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Forum Overview:Examining the global financial crisis several forum speakers (including MEAFA members and other invited scholars from The University of Sydney) will cover many aspects of the crisis, responding to questions such as: what the crisis says at a technical level concerning finance theory and practice; what part accounting reforms have played; what individual behavioural forces are at work; what sociological problems have been revealed in the business and wider communities; what role US and other house prices have played; who are the winners and losers; how corporate, banking and regulatory sectors of society should respond; what ever happened in the US to cause all this and what will happen next; and whether markets will learn from the casualties or will it all happen again soon enough?

MEAFA Forum on the Financial Crisis

cont’d This brief introduction to the crisis is influenced, perhaps overly, by the thoughts of the contemporary financial critics and commentators, Nicholas Taleb who in his 2007 The Black Swan, forecast the problems Fannie Mae would face; and Robert Shiller in his Irrational Exuberance. Both take issue with the paucity of the financial press in discussing financial issues.

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Regarding academic and finance practitioners Taleb was especially critical of what he (as a student of Mandelbrot’s chaos theory and fractals analyses) saw as the inherent weaknesses of the Gaussian 'bell curve' notion evident in many financial models which are under current scrutiny worldwide. It will be interesting to hear what the finance specialists and others might have to say about such concerns. It is hoped that this forum will identify systemic lessons from this ongoing crisis.

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notoriously lax and fraudulent lending [e.g., no doc loans, etc],  excess leverage [generally – gearing levels, credit cards, etc], the creation of complex and risky investments through

securitization and derivatives [CDOs squared, CDSs, etc], the global distribution of such instruments across rapidly growing

unregulated and opaque markets lacking a proper infrastructure for clearing mechanisms and price discovery [thus counterparties became more intertwined],

faulty ratings [by recognised ratings agencies making the assessment of whether assets had uncorrelated risks nigh impossible], and

the absence of appropriate risk management and valuation processes at many financial institutions [faulty modelling that, arguably, failed to stress test for significant downside risk].

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1. The apparent conflict regarding government regulation in a so-called market economy. Is the incongruous resort to market manipulations through bailout mechanisms a repeat of FDR’s ‘New Deal’ tactics? And will it be any more successful? Conundrum: Seemingly, ex post attempts (to mitigate the outcomes of the market's excesses) is fine, but to put a potential brake on an 'out of control' market (before it crashes) is (arguably) an anathema - anti free market. Contemplate whether the 'innovative', the so-called synthetic, products (CDOs, CDOs squared, etc and related CDSs) designed by the financial engineering 'masters of the universe' are similar (in principle) to (say) medical products - and hence should they have been subject to regulatory controlled stress testing. What is unique about a financial product? Is this why ‘genius failed’ in 1998 at LTCM?

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2. 2. Conundrum:Conundrum: The corporation good guy - bad guy. What The corporation good guy - bad guy. What role did the corporation (with its inherent structural role did the corporation (with its inherent structural financial and operational complexities as well as risk financial and operational complexities as well as risk minimisation benefits) play in this regard? – consider, for minimisation benefits) play in this regard? – consider, for example, the (or the lack of) information flows (and hence example, the (or the lack of) information flows (and hence controls by the AIG parent company) related to the controls by the AIG parent company) related to the operational and financial activities of AIG’s subsidiaries operational and financial activities of AIG’s subsidiaries worldwide - especially regarding the London Structured worldwide - especially regarding the London Structured Products division which created the infamous CDSs (on a Products division which created the infamous CDSs (on a scale apparently unimaginable), with their now notorious scale apparently unimaginable), with their now notorious

short term bonus incentives.short term bonus incentives.

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3. Conundrum: Whilst many regard it appropriate for the US Government to bail out the largest finance houses (with first the US$25 billion direct payout and then the additional indirect funds received as counterparties through the ad-hoc bailout schemes, such as AIG’s US$200 billion bailouts), there has been an outcry from some at suggestions that the executives bonuses should in some way be 'clawed back' - even though without the government bailouts those executives would be lining up in the queue with other creditors of failed financial houses like AIG. Whilst I do not view this a priority issue – it is till a conundrum.

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cont’d

A unique teaching focus has been handed to academics on a golden platter. Surely for academics the up-side of the crisis is that it creates a setting in which virtually every aspect of the conventional business setting is contestable. As educators we should be able to draw upon current events (particularly something as massive as the global financial crisis) in classroom discussions.  We have an opportunity not only for engaging students but also potentially for some (stronger) synergies to develop between teaching and research activities.