the financial crisis of 2008: causes and consequences j. peter ferderer macalester college 21...
Post on 15-Jan-2016
218 views
TRANSCRIPT
![Page 1: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/1.jpg)
The Financial Crisis of 2008: Causes and Consequences
J. Peter FerdererMacalester College
21 October 2008
![Page 2: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/2.jpg)
Outline
• A Chronology of the Collapse
• Eight Causes
• Maturity Mismatch and Leverage
• Another Great Depression?
• Q & A
![Page 3: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/3.jpg)
Parallels to Natural Phenomena
Source: The Economist
![Page 4: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/4.jpg)
Parallels to Natural Phenomena
Source: The Economist
![Page 5: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/5.jpg)
Parallels to Children’s Stories
Source: The Economist
![Page 6: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/6.jpg)
![Page 7: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/7.jpg)
Bank Failures start in Europe
• German and French Special Investment Vehicles (SIVs) unable to rollover commercial paper and close funds (August 2007)
• U.K. experiences first bank run in more than a century (9/19/2007
![Page 8: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/8.jpg)
14 March 2008: The First Investment Bank Collapses
- JPMorgan Chase takes over Bear Stearns
- Bear’s mortgage book might contain “whopping further losses” (The Economist)
- The Fed makes $30 billion loans to I-banks as well as regulated banks - a significant shift in policy
![Page 9: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/9.jpg)
13 July 2008Federal Government Takes over
Freddie and Fannie Mac
- Fannie and Freddie own or guarantee $5.2 trillion in mortgage debt
![Page 10: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/10.jpg)
16 September 2008: When things went from bad to worse
- Lehman Brothers – Wall Street’s 4th largest Investment Bank – collapses
- Barclay’s and Bank of America step away
- U.S. Treasury lets Lehman go
- Counterparty risk spikes as Lehman files for bankruptcy
![Page 11: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/11.jpg)
17 September 2008:Size Matters
- American International Group (A.I.G.) fails due to credit-default swaps.
- The government takes control of the company
![Page 12: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/12.jpg)
24 September 2008: And then there were None
- Goldman Sachs and Morgan Stanley convert into bank holding companies
- Mitsubishi UFJ buys 20% of Morgan
- Warren Buffett injects $5 billion into Goldman
![Page 13: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/13.jpg)
September 25: The Biggest Bank Failure in History
- Regulators seize Washington Mutual, the country’s
largest savings and loan institution and sell most of its operations to JPMorgan Chase.
- More than $300 billion in assets (Continental Illinois, had $40 billion when it toppled in 1984).
![Page 14: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/14.jpg)
3 October 2008 Bailout Bill Passes
• $750 billion ($2,500 per American)
• Initially created to buy “toxic” assets off financial institution balance sheets
• $250 used to buy ownership positions in banks.
![Page 15: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/15.jpg)
The Magnitude of the Problem
• Estimated worldwide losses on debt: $1.4 trillion (IMF)
• $760 billion written down by banks, insurance companies, hedge funds and others
• Cost of average systemic banking crisis in OECD counties over the past few decades: 16% of GDP
• Cost of the U.S. bailout so far: $760 billion (7% of GDP)
![Page 16: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/16.jpg)
The Housing Boom and Bust
![Page 17: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/17.jpg)
Explanation #1Asymmetric Monetary Policy
- Too much borrowing
- Too much short-term borrowing
![Page 18: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/18.jpg)
Explanation #2:The Savings Glut in the ROW
Rest of the World United States
Loanable Funds
Loanable Funds
r rSROW
IROW
r*
S
I
I0S0S0I0
NCOROW>0 NCOUS<0
r*
S1 I1
![Page 19: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/19.jpg)
Explanation #3 Democraticisation of Home Ownership
- Community Reinvestment Act of 1977
- Fannie Mae and Freddie Mac (Government- sponsored mortgage buyers) were encouraged to guarantee a wider range of loans in the 1990s.
- Tax deductibility of mortgage interest payments
![Page 20: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/20.jpg)
Explanation #3 Democraticisation of Home Ownership
61
62
63
64
65
66
67
68
69
1994 1996 1998 2000 2002 2004 2006 2008
U.S. Homeownership Rates
![Page 21: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/21.jpg)
Explanation #4 The Great Moderation
Source: Dallas Federal Reserve Economic Letters (September 2007)
![Page 22: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/22.jpg)
Explanation 5 Erosion of Lending Standards
• Adjustable Rate Mortgages (ARMs)
• No-documentation mortgages
• No down payments
• NINJA mortgages (“No income, no job or no assets”)
![Page 23: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/23.jpg)
The Default Decision
$80,000
$100,000
$20,000
$90,000
$10,000
What does home owner do it they need cash due to loss of job or medical emergency?
$100,000
$100,000
$0- $10,000
20 Percent Down Nothing Down
Home Value
Mortgage
Equity
$90,000
Suppose the market price of homes falls
![Page 24: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/24.jpg)
Mortgage Defaults
![Page 25: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/25.jpg)
Explanation #6Innovation – New Financial Instruments
- New instruments allow risk spreading
- Options
- Interest-rate and credit-default swaps
- Securitization (Collateralized Debt obligations, CDO)
![Page 26: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/26.jpg)
Securitization
Source: The Economist
![Page 27: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/27.jpg)
Credit-Default Swaps
Source: The Economist
$20,000 per person
A.I.G.
![Page 28: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/28.jpg)
Explanation #6Innovation – New Financial Instruments
1. Upside to greater risk spreading
- The cost of capital falls- Credit is “democratized” - The system is more resilient to shocks
2. Downside
- Large counterparty risk - Difficult for regulators to keep track of firm exposure (A.I.G.)
![Page 29: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/29.jpg)
Explanation #7Innovation – Off the Balance Sheet
Solution: Basel Accord I (1988) mandates that banks must hold $0.08 in capital for every $1.00 in assets
Impact on Banks: Reduces their ability to increase profits through leverage
Bank Response: Create “Structured Investment Vehicles” (Basel capital requirements for credit linesto SIVs are less than 8%.)
Problem: Loan defaults expose banks to insolvency
![Page 30: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/30.jpg)
Explanation #8Deregulation
![Page 31: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/31.jpg)
The Old Model
$
mortgages
Commercial Banks SaversBorrowers
Investment BanksBonds
Stocks
Savings & Loans
Business loans
Savings Account
Demand Deposits
Bonds Stocks
$ $
$
$ $
![Page 32: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/32.jpg)
The New Modelfunds
mortgages
Commercial Banks
SaversBorrowers
funds
deposits
InvestmentBanks
mortgages
structured products
Structured products (“Collateralized Debt Obligations”) are portfolios of mortgages, split into tranches.
- Diversification (regional)- Heterogeneous risk appetites (“Super Senior” v. “toxic waste”)
Pension Funds
Hedge Funds
Structured Investment Vehicles (SIVs)
![Page 33: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/33.jpg)
Three Problems with the SIVs
• Maturity Miss-match (long-term assets funded by short-term liabilities) exposes them to funding and liquidity risk
• Excessive Leverage to Increase returns makes the system more fragile
• Liquidity Problems spill over to sponsoring Commercial and Investment Banks
![Page 34: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/34.jpg)
Structured Investment Vehicles
Risk perceived to be low
![Page 35: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/35.jpg)
Commercial Paper Outstanding
Source: Brunnermeier (2008)
![Page 36: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/36.jpg)
Problems Rolling over ABCP
Liquidity injections by
Central Banks
BNP Paribus closes funds
Bear Stearns
fails
Lehman Brothers
fails
![Page 37: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/37.jpg)
Leverage and Amplification
![Page 38: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/38.jpg)
Leverage Example
Assets Liabilities
Financial Intermediary
Securities: $100
Debt: $90
Equity: $10
L = A/(A-L)
= 100/(100-90)= 10
Financial firm manages its balance sheet to maintain constant leverage
![Page 39: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/39.jpg)
Event: Security Prices rise by 1%
Assets Liabilities
Financial Intermediary
Securities: $101
Debt: $90
Equity: $11
L = A/(A-L)
= 101/(101-90)
= 9.18
How must firm react to keep leverage at 10?Issue more debt and buy more securities
![Page 40: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/40.jpg)
Event: Security Prices rise by 1%
Assets Liabilities
Financial Intermediary
Securities: $110
Debt: $99
Equity: $11
L = A/(A-L)
= 110/(110-99)
= 10
Thus a $1 rise in the price of securities leads to a $9 increase in debt and security purchases
![Page 41: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/41.jpg)
Event: Security Prices fall by 1%
Assets Liabilities
Financial Intermediary
Securities: $110
Debt: $99
Equity: $11
L = A/(A-L)
= 109/(109-99)
= 10.9
How must firm react to keep leverage at 10?
$109 $10
Sell $9 of securities and pay off $9 in debtRole of Mark-to-Market
![Page 42: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/42.jpg)
Balance sheet after assets sold
Assets Liabilities
Financial Intermediary
Securities: $100
Debt: $90
Equity: $10
L = A/(A-L)
= 100/(100-90)= 10
![Page 43: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/43.jpg)
Implication: Positive feedback loops and amplification
- Contagion across balance sheets
rising/falling asset prices
Stronger/weaker balance sheets
![Page 44: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/44.jpg)
The Cost of Making Markets Liquid
The average credit spread of the 15 largest credit derivative dealers (ABN Amro, Bank of America, BNP Paribas, Barclays Bank, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs Group, HSBC, Lehman Brothers, JP Morgan, Merrill Lynch, Morgan Stanley, UBS, and Wachovia.)
![Page 45: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/45.jpg)
Another Great Depression?
Source: The Economist
![Page 46: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/46.jpg)
Cartoon
![Page 47: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/47.jpg)
Spillovers
The Economist
![Page 48: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/48.jpg)
Fed Policy
The Economist
![Page 49: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/49.jpg)
Reason for Optimism: Size of Government
Y = C + I + G + (EX – IM)
![Page 50: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/50.jpg)
No External Constraint
Y2K9/11
![Page 51: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/51.jpg)
Conclusion
![Page 52: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/52.jpg)
Competing Views
Financial Market Efficiency
Eugene Fama
Financial Market Instability
Hyman Minsky
![Page 53: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/53.jpg)
Financial Market Efficiency• Freer (deregulated) financial markets produce
superior outcomes.• Unencumbered capital flows to its most
productive use, boosting growth and economic welfare. (tech. boom)
• Innovations that spread risk more widely (e.g., credit default swaps) reduce the cost of capital, “democratize credit” and make the system more resilient to shocks.
![Page 54: The Financial Crisis of 2008: Causes and Consequences J. Peter Ferderer Macalester College 21 October 2008](https://reader035.vdocuments.mx/reader035/viewer/2022062322/56649d815503460f94a66d11/html5/thumbnails/54.jpg)
Financial Instability
• Periods of stability lead to excess and eventual crisis.
• Stability encourages greater leverage and ambitious debt structures (e.g., reliance on short-term funding).
• Financial innovation allows banks to avoid regulatory hurdles (capital requirements and off-balance sheet vehicles).