Credit Crunch-ed!

8/7/2019 Credit Crunch-ed!

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Crunch ed!A black swan eventA story of ambition&... greedinnovation&... destructioncompetition&... market failure

as told by Assoc Prof Toh Thian Ser,Nanyang Business School

[email protected]

Latest revision: 271008

Credit
mailto:[email protected]:[email protected]


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Credit Crisis Timeline (source: Wiki)2007June 7 : Bear Stearns , Bear Stearns informs investors in two of its funds, the HighGrade Structured Credit StrategiesEnhanced Leverage Fund and the HighGrade Structured CreditFund that it was halting redemptions.June 20 : Merrill Lynch seized $800 million in assets fromtwo Bear Stearns hedge fundsJuly 19 : Dow Jones Industrial Average closes above 14,000 forthe first time in its history.August : worldwide "credit crunch" as subprime mortgagebacked securities are discovered in portfolios of banks andhedge funds around the world, from BNP Paribas to Bank of

China. Many lenders stop offering home equity loans and"stated income" loans. Federal Reserve injects about $100Binto the money supply for banks to borrow at a low rate.September 14 : A run on the bank forms at the UnitedKingdom's Northern Rock bank
http://en.wikipedia.org/wiki/Bear_Stearnshttp://en.wikipedia.org/wiki/Merrill_Lynchhttp://en.wikipedia.org/wiki/Bear_Stearnshttp://en.wikipedia.org/wiki/Hedge_fundshttp://en.wikipedia.org/wiki/Dow_Jones_Industrial_Averagehttp://en.wikipedia.org/wiki/BNP_Paribashttp://en.wikipedia.org/wiki/Bank_of_Chinahttp://en.wikipedia.org/wiki/Bank_of_Chinahttp://en.wikipedia.org/wiki/Federal_Reservehttp://en.wikipedia.org/wiki/Bank_runhttp://en.wikipedia.org/wiki/United_Kingdomhttp://en.wikipedia.org/wiki/United_Kingdomhttp://en.wikipedia.org/wiki/Northern_Rockhttp://en.wikipedia.org/wiki/United_Kingdomhttp://en.wikipedia.org/wiki/United_Kingdomhttp://en.wikipedia.org/wiki/Bank_runhttp://en.wikipedia.org/wiki/Federal_Reservehttp://en.wikipedia.org/wiki/Bank_of_Chinahttp://en.wikipedia.org/wiki/Bank_of_Chinahttp://en.wikipedia.org/wiki/BNP_Paribashttp://en.wikipedia.org/wiki/Dow_Jones_Industrial_Averagehttp://en.wikipedia.org/wiki/Hedge_fundshttp://en.wikipedia.org/wiki/Bear_Stearnshttp://en.wikipedia.org/wiki/Merrill_Lynchhttp://en.wikipedia.org/wiki/Bear_Stearnshttp://en.wikipedia.org/wiki/Northern_Rock


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2008March 16 : Beginning of mergers. Bear Stearns acquiredby JPMorgan Chase , with Federal Reserve providing up to $30B to

cover possible Bear Stearn losses.May 6 : UBS AG Swiss bank announces losses & plans to cut 5,500jobs by the middle of 2009September 7 : Federal takeover of Fannie Mae and FreddieMac which owned or guaranteed about half of the U.S.'s $12trillion mortgage market.September 14 : Merrill Lynch sold to Bank of AmericaSeptember 15 : Lehman Brothers files for bankruptcy protectionSeptember 17 : The US Federal Reserve loans $85 billionto American International Group (AIG) to avoid bankruptcy.September 19 : Paulsons financial rescue plan unveiled after avolatile week in stock and debt markets.September 25 : Washington Mutual seized by the Federal DepositInsurance Corporation ; its banking assets sold to JPMorganChase for $1.9bn.
http://en.wikipedia.org/wiki/Bear_Stearnshttp://en.wikipedia.org/wiki/JPMorgan_Chasehttp://en.wikipedia.org/wiki/UBS_AGhttp://en.wikipedia.org/wiki/Federal_takeover_of_Fannie_Mae_and_Freddie_Machttp://en.wikipedia.org/wiki/Federal_takeover_of_Fannie_Mae_and_Freddie_Machttp://en.wikipedia.org/wiki/Merrill_Lynchhttp://en.wikipedia.org/wiki/Bank_of_Americahttp://en.wikipedia.org/wiki/Lehman_Brothershttp://en.wikipedia.org/wiki/AIGhttp://en.wikipedia.org/wiki/Proposed_bailout_of_U.S._financial_system_(2008)http://en.wikipedia.org/wiki/Washington_Mutualhttp://en.wikipedia.org/wiki/Federal_Deposit_Insurance_Corporationhttp://en.wikipedia.org/wiki/Federal_Deposit_Insurance_Corporationhttp://en.wikipedia.org/wiki/JP_MorganChasehttp://en.wikipedia.org/wiki/JP_MorganChasehttp://en.wikipedia.org/wiki/JP_MorganChasehttp://en.wikipedia.org/wiki/Federal_Deposit_Insurance_Corporationhttp://en.wikipedia.org/wiki/Federal_Deposit_Insurance_Corporationhttp://en.wikipedia.org/wiki/Washington_Mutualhttp://en.wikipedia.org/wiki/Proposed_bailout_of_U.S._financial_system_(2008)http://en.wikipedia.org/wiki/AIGhttp://en.wikipedia.org/wiki/Lehman_Brothershttp://en.wikipedia.org/wiki/Bank_of_Americahttp://en.wikipedia.org/wiki/Merrill_Lynchhttp://en.wikipedia.org/wiki/Federal_takeover_of_Fannie_Mae_and_Freddie_Machttp://en.wikipedia.org/wiki/Federal_takeover_of_Fannie_Mae_and_Freddie_Machttp://en.wikipedia.org/wiki/UBS_AGhttp://en.wikipedia.org/wiki/JPMorgan_Chasehttp://en.wikipedia.org/wiki/Bear_Stearnshttp://en.wikipedia.org/wiki/JP_MorganChase


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2008October 3, 2008 : U.S. Congress passes Paulsons US$700 bn rescueplan. Marktomarket rules on toxic mortgagerelated investmentseased.October 6 : Beignning of massive government guarantees. Danishgovernment announces plan to guarantee all banking deposits andsome interbank loans.October 6 : BNP Paribas agrees to takeover Fortis from the Belgiangovernment for 14.5 billion.October 6 : Iceland nationalizes its banks.October 11 : G7 launch coordinated action to prevent the credit crisisfrom throwing the world into depression.October 20: Government support action spreads worldwide to

China, India, Korea, Gulf, Eastern Europe.


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"Panics do not destroy capital; they

merely reveal the extent to which it hasbeen previously destroyed by itsbetrayal into hopelessly unproductiveworks.

Mr John Mills,Article read before the Manchester Statistical Society,December 11, 1867, on Credit Cycles and the Origin of Commercial Panics as quoted in Financial crises andperiods of industrial and commercial depression,Burton, T. E. (1931, first published 1902). New York andLondon: D. Appleton & Co


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Competing financial authorities, Web, ITAccelerators

Investment

Banks

The Players

Corporates

Hedge fundsMutual Funds

Pension funds

City councils

IndividualsRatings agencies

ISDA

Audit firms

Lawyers

Insurancecompanies

Banks

Beneficiaries

or victimsThe Stars

Support:

Validators

IT firms


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Alan Greenspan, Chairman,Federal Reserve Board,

19872006


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Post WWII


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It is hard for us, without being flippant, to even see a scenariowithin any kind of realm of reason that would see us losing one dollarin any of those transactions. Joseph J. Cassano, former head of financial products division, AIG, Aug.2007.J P Morgan approached him & asked AIG to launch CDS contracts.


10/37Source: Fortune 30.9.08


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Netting vsNotional(gross) value


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What we have found over theyears in the marketplace is

that derivatives have been anextraordinarily useful vehicle

to transfer risk from those whoshouldnt be taking it to those

who are willing to and arecapable of doing so.

Alan Greenspan, 2003,SenateBanking Committee hearing


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Wachovia and Citigroup sue $50 millionhedge fund located in the ChannelIslands.

Dispute: Two $10 million credit default swapscovering some CDOs.

Observation: These banks put their faith in aLilliputian fund (in an inaccessible jurisdiction) thatwas risking 40% of its capital for just two CDS.Can anyone imagine that Citi would, say, insure itsheadquarters building with a thinly capitalized,

unregulated, offshore entity?

Fortune Magazine, updated 30 Sept 2008


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US Foreclosure Heat Map (Oct 2008)

Foreclosure Rate: filings per XXX householdsSource: Hotpads.com


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FI Liquidity trap


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Ted Spread 2008 (source: Bloomberg)

FI Liquidity trapMidSept

Liquidity

trapeasing?


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As of Sept. 9, 57 companies had defaulted on

$45.3 billion of debt for the year (2008),according to S&P RatingsDirect, up from 22companies defaulting in all of 2007. Of the 57,45 are outside the financial industry.

(While not a bankruptcy, a default sets off

clear alarm bells about a company's fiscalhealth.)

.... Roughly 70% of nonfinancial companiescarry a noninvestment or junk credit rating.S&P projects that the threeyear cumulative

default rate between 2008 and 2010 amongnonfinancial firms with poor credit will rise to23.2%, the worst on record since 1981.

Source: BusinessWeek 3Oct2008


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Free markets didbreak down," hetestified. "That,

as I said, shockedme. I still do notfully understandwhat happened."

Former Federal Reserve Chairman Alan Greenspan giving his testimony at Capitol Hillin Washington, Thursday, Oct. 23, 2008, before the House Oversight and GovernmentReform Committee hearing on the roll of the federal government in the financialmarkets.

Greenspan shocked at failure of free markets
http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/10/24/BUI513N8QM.DTLhttp://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/10/24/BUI513N8QM.DTLhttp://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/10/24/BUI513N8QM.DTL


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U.S. auto sales tumbled 27 percent in Septemberfrom year ago


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July/Aug 2007: KB DeutscheIndustriebank, Sachsen LB(Saxony State Bank) andBayernLB (Bavaria State Bank).Sept 2007: Northern Rocknationalised

Sept 28, 2008: More nationalisations

Across the Atlantic


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Oct 7 9 Icelands bankruptcyKaupthing nationalised, Glitnir & Landsbanki in receivership &taken over by Govt.

Icelands banking assets amounted to about nine times its

gross domestic product and its current account deficit hasbillowed to 16 per cent of GDP last year. UK freezes Icelandsassets.

European banks nursing likely losses of $74bn; the Germans

have lost $22bn. already


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Oct 8: UK announces 500 bn bankrescue & recapitalisation plan

Oct 13: France & Germany agree to leadEurozone with a similar plan first real

move on regional basis; avoids EU collapse.

Oct 11, 2008: Royal Bank of

Scotland rescued by UK Govt 20bn. HBOS, Lloyds, Barclays to follow

250bn loan guarantees200bn shortterm loans

50bn recapitalisation

The key:Faith in government

Total Europeancommitment: over 1

trillion

Total globalrescue cost

est: US$4trillion


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Oct 9 2007:Dow14164

Oct 10, 2008


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Crisis Evolution

Subprime

Commercial paper

Investment Banks

Banks across the Globe

Emerging countries

The really shocking thing,however, is the way thecrisis is spreading to

emerging marketscountries like Russia, Koreaand Brazil. Paul Krugman, Nobel Laureate,NYT, 26Oct08


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EmergingMarketswhich froze at least

for a while for weekending Oct 10

Austria (exposure toE. Europe)

BrazilIcelandIndonesiaRussiaPeru

Countries with Reserves but hitby private borrowing.

Argentina (nationalised thecountrys top 10 private pensionfunds, with $30 billion in assets)

IcelandKazakhstanPakistanUkraine

Countries tottering onbankruptcy?

S. KoreaRussiaPolandBrazil


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Loans by Banks from Developed Countries to

Emerging Economies (as pc of domestic GDP)

Austria 85pcSwitzerland 50pcSweden 25pcUK 24pcSpain 23pcUS figure 4pc

The foreign debt Russiasoligarchs ($530bn) hassurpassed the countrysforeign reserves. Some $47bnhas to be repaid over the nexttwo months .

Sources: Morgan Stanley, Daily Telegraph, 26 Oct 2008

2001


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2008$700 bn

Troubled AssetRecovery Plan(including bankrecapitalization)

2008$85bn+35bnAIG

2008$200 bnFannie &Freddie

1989

$293.8 bnSavings &Loan

2008$30 bnBear Stearns

2008$25bnAutos

post9/11$18.6bnAirlines

1980$3.9bnChrysler

1975$9.4 bnNY City

US Govt.bailoutsin 2008 dollarsSource: ProPublico

Total world govtsupport exceedsUS$ 4.0 trillion


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``Things are getting worse, they are not gettingbetter...

There's an increased risk of a multiyeareconomic stagnation in the U.S....

We have a whole set of emerging marketeconomies in trouble. Even a few of them goingbust may cause systemic trouble...

During the Great Depression, output in the U.S.fell by more than 20 percent, I don't believethat's going to be the case.''

(source: Roubinis Blog, 24Oct08)

Nouriel RoubiniDr Doom


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Reregulation:Is this the endof financial

globalization?

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Credit Crunch-ed!