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OECD Breakfast series“Fixing Finance”Tuesday, October 13, 2009
8:30 a.m. - 10:00 a.m.
New America Foundation1899 L St NW, Suite 400Washington, DC 20036
Adrian Blundell-WignallDeputy Director, Financial & Enterprise Affairs
Causes of the Crisis
Macro •Global Imbalances•Reserve Currency•Asian & Other Exchange Rate
Arrangements•Liquidity: The Dam
OverflowingOct-2009
2
Fig. 1: US Monthly Trade Balance, Bilateral Comparisons
Source: Datastream, OECDOct-2009
-80000
-70000
-60000
-50000
-40000
-30000
-20000
-10000
0Ja
n-99
Aug
-99
Mar
-00
Oct
-00
May
-01
Dec
-01
Jul-0
2
Feb-
03
Sep-
03
Apr
-04
Nov
-04
Jun-
05
Jan-
06
Aug
-06
Mar
-07
Oct
-07
May
-08
Dec
-08
Jul-0
9
$m
TB with OPECTB with EECTB with JapTB with AsiaTB with NAFTAUS TB
3
Fig. 2: Chinese Exchange Rate Pressure
Source: Datastream, OECDOct-2009
-6.5
-4.5
-2.5
-0.5
1.5
3.5
5.5
7.5
9.5 yuan/$; %
dE/E-[σ(E)/σ(R)](dR/R)+[σ(E)/σ(i)](di)
Yuan/$Exch Rate Pressure 3m %chgImplied yuan/$
4
Fig. 3: US--China External Adjustment
Source: OECDOct-2009
C2 US external imbalance adjustment:RMB moves up, US Trade Bal. improvesChina to move growth towards higher domestic demand absorption (reduce saving-higher imports)US to move growth to lower domestic demand absorption (more saving: wealth effect and fiscal cuts)NB Real rates rise!!!!Highly unlikely to happen on current policy settings
C very dangerous for the long run.
B D ADEFICIT = AB
Global Adjustment
(1+r) (1+r*)C1
This gap permitted by RMBdistortion: ie expected long-run apprec.
5
Causes of the Crisis
Structural•Equity Culture in Banking•CDS/Derivatives/
Securitisation•Capital Arb./Tax Structuring•SEC rule change/LeverageOct-2009
6
Fig. 4: Structural/Regulatory Causes of the CrisisCREDIT CULTURE
BANKS POOL DEPOSITS, CREATE PRIVATE INFORMATION ON LENDERS TOOSMALL TO ACCESS THE CAPITAL MARKET, HOLD A BUFFER OF CAPITAL & LENDTO HOUSEHOLDS & SMALL & MEDIUM SIZE BUSINESSES
EQUITY CULTUREPUT OPTION FROM DEPOSITORS/UNLIMITED UPSIDE FOR EQUITY BOUNDEDAT ZERO ON THE DOWNSIDE=INCENTIVE TO TAKE ON MORE RISK: I.E.
STOCKHOLDERS AIM TO REDUCE THE RISK ADJ CLAIM OF CREDITORSON THE BANK & REALLOCATE WEALTH FROM CREDITORS TO STOCKHOLDERS
NEW INNOVATIONS & REGULATORY CHANGE ACCELERATE EQUITY CULTURE RISK TAKING
DERIVATIVES BIG ARBITRAGE OPPORTUNITIES SEC RULE CHANGE ON IB LEVERAGE GLASS-STEAGALL REMOVAL ●CREDIT DEF SWAP ●BASEL RULES ●CONSOLIDATED ENTITIES BASIS, IB's ●CAN MIX SECURITIES &
●TAX SYSTEM MOVE TO HIGHER EU LEVERAGE BANKING
STRUCTURED PRODUCTS NEW BUSINESS MODELS EXCESS COMPETITION EMERGES ●SECURITISATION: ORIGINATE TO DISTRIBUTE ●IN THE MARKET FOR CORPORATE CONTROL ●CONDUITS CDO's CSO's ●IN TAKING MARKET SHARE IN NEW GROWTH ●ON-B-SHEET STUCT. NOTES FUNDING BUSNNESSES ●CDS HEDGED ASSETS TO REDUCE CAPITAL
RISK CATEGORIES BEGIN TO RISE
CREDIT RISK RISING LEVERAGE ●EXCESS LEVERAGE ●COUNTERPARTY RISK OF FAILUREMARKET RISK GLOBAL ●EXPOSURE TO PRICING OF COMPLEX PRODUCTS FINANCIAL ●LIQUIDITY ISSUES CRISISCONTAGION RISK ●SECUITIES BUSINESSES CONTAMINATE SAFE COMMERCIAL BANKING ●CALL ON GROUP CAPITAL PUTS WHOLE INSTITUTION AT RISKOPERATIONAL RISKCORPORATE GOVERNANCE FAILURES
Oct-2009 7
Fig. 5: The Explosion of CDS Contracts
632 919 1,563 2,192 2,6883,779
5,442
8,422
12,430
17,096
26,006
34,423
45,465
62,173
54,612
38,564
0
500
1,000
1,500
2,000
2,500
3,000
3,500
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
1H01 2H01 1H02 2H02 1H03 2H03 1H04 2H04 1H05 2H05 1H06 2H06 1H07 2H07 1H08 2H08
Bil
lio
ns
of
US
do
llar
s
Notional amounts outstanding (LHS)
Gross market values (RHS)
Oct-2009 Source: BIS 8
Fig 6: Capital Regulations• Banks are desperately short of capital—Basel II
asks them to hold less.• Basel Pillar 1 does not penalise concentration
risk!!!! And relies on supervisors to do something in pillar 2!!
• Basel lets the regulated entities determine their own capital weights!!! & is pro-cyclical.
• Basel II does not allow for idiosyncratic or local risk (based on a single global risk factor).
• Weightings create regulatory arbitrage possibilities to raise leverage by off-balance sheet activity or CDS insurance to “de-risk” the balance sheets.
• A SIMPLE LEVERAGE RATIO IS SUPERIOR—BUT NOT ENOUGH (EXCESS RISK TAKING!).
Oct-2009 9
Fig 7: Citigroup & Capital Arbitrage• Securitized off-balance-sheet mortgages 0% capital
charge under Basel I, & 50% if on B/Sheet.• Arbitrage: what % of on and off-B/Sheet mortgages
allow the increased return now (from 2004) without causing a shortage of capital later on when Basel II became fully operational?
• 0.4*(50% On-B/Sheet Cap/wt.)+6%*(0% Off-B/Sheet)
=20% Basel II Equivalent Capital Requirement for Mortgages
• CITIGROUP end of 2007 10K filings show $313.5bn on balance sheet, $510.5bn off (VIE’s and retained interests in QSPE’s): i.e. about 38% on b/sheet and 62% off b/sheet.
• Citigroup had a further $733.7bn in QSPE’s, where the interests had been transferred away from Citigroup.
Oct-2009 10
Fig 8: Northern Rock CEO & UK Treasury Committee Evidence
• Mr Fallon: “Mr Applegarth, why was it decided a month after the first profit warning, as late as the end of July, to increase the dividend at the expense of the balance sheet?”
• Mr Applegarth: “Because we had just completed our Basel II two and a half year process and under that, and in consultation with the FSA, it meant that we had surplus capital and therefore that could be repatriated to shareholders through increasing the dividend.”
Oct-2009 11
Fig 9: The Hypo Bank Quote
• By purchasing CDS protection on its assets, which remain on its balance sheet, Hypo transfers the credit risk to someone else, and this is recognised in its Basel risk-weighted assets. (As long contracts can be renewed—no global financial crisis).
• “Since October 2007, DEPFA has been a member of the Hypo Real Estate Group, and this transaction achieves a number of objectives for DEPFA, and the Group as a whole: DEPFA has reduced the amount of regulatory capital required to support the assets (which under current BIS rules are 100% risk weighted, though under Basel II this will reduce substantially), and at the same time has improved the return on equity and credit risk”
Oct-2009 12
Fig 10: The Tax Issue• The tax system encourages
securitisation.• Tax haven opaqueness allows capital
gains and income to be shifted in CDO creation
• Inequality of tax treatment of income and capital gains/losses causes CDS boom in synthetic CDO’s.
• Debt versus equity bias pushes up leverage—double dipping deductions.
Oct-2009 13
Fig. 11: The Tax Arbitrage in CDS
Source: , Samuel Eddins, OECD
Buy & Hold CDS premium +tax wedge Credit protectionInvestor (e.g. seller--broker in IB
Pension Fund)(Buys a synthetic (mark-to-market
CDO, Credit business trader)Protected) Pay credit loswses if defaults
Credit protection CDS premium=expected Credit Protectionbuyer losses only Seller
(mark to market (Synthetic bondbusiness trader) Pay loss if default occurs CDO issuer)
CDO in Caymans Broker can take Synthetic bondLow quality, with adv. of losses at creation with the broker.losses, that investor corp tax rate 35%. Mirrors cash flow ofcant take advantage Synthetic CDO. underlying bond.of (CGT 15% loss No capital outlay Insurance Co's& $3000 limit over gains). outlay, & gets a like AIG playingBut he pays CDS prem. return on the loss their role.plus tax wedge from the tax man.(to sleep easy) This is like an
infinite rate of return
Oct-2009 14
Fig. 12: Leverage Ratios Prior to the Crisis
0 5 10 15 20 25 30 35 40
US commercial banks
US investment banks
European banks
Hedge funds
Leverage ratio, year-end
2006
2007
Oct-2009 Source: Company reports
15
Fig. 13: The Explosion of Private Label Securitised Mortgages
Oct-2009 Source: BIS
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
16.00
18.00
20.00 %GDP Agency
Business Loans
Comm Mtgs
Con Credit
Home Mtgs
Home Equity & Oth
16
Causes of the CrisisCompetition
•Concentration issue.•New Businesses in
structured products.•Glass-Steagall removal &
corporate control.•Contagion risk.Oct-2009
17
Fig. 14: Concentration & Ratings
Source: Datastrean, OECDOct-2009
Top 50 rankCountry Top 4 Banks (by Assets) Assets Asset Mkt Share Credit RatingAustralia A$bn %National Australia Bank 657 24.6% AACommonwealth Bank of Australia 488 18.2% AAAustralia and New Zealand Banking 471 17.6% AAWestpac Banking Corporation 440 16.4% AATotal Top 4 2055 76.8%USA (bank only) $bnJP Morgan Chase 1,664 15% A+Bank of America 1,451 13% noCiti 1,165 11% noWells Fargo (incl. Wachovia) 1,100 10% AATotal Top 4 5,380 49%UK GBP bn.Royal Bank of Scotland Plc (The) 2402 18% noBarclays Bank Plc 2053 15% noHSBC Bank plc 1734 13% AA-Goldman Sachs International 896 7% noTotal Top 4 7084 52%Germany Euro bn.Deutsche Bank AG 2202 28% A+Commerzbank AG 625 8% noBayerische Hypo-und Vereinsbank AG 459 6% noLandesbank Baden-Wuerttemberg 448 6% AA+Total Top 4 47%France Euro bn.BNP Paribas 2076 29% AACrédit Agricole Group-Crédit Agricole 1784 25% AA-BPCE 1144 16% noSociété Générale 1130 12% AA-Total Top 4 6133 81% 18
Fig. 15: Notional & Delta Adj. Index Tranche Obligations, Structured Credit Notes
Source: Datastrean, OECDOct-2009
0
500
1000
1500
2000
2500
3000
Mar-07 Mar-08 Mar-09
$bnIndex Tranche Vols, Delta adj.($14.2trl. Cum.)
Notional
19
Fig. 16: Notional & Delta Adj. Index Tranche Obligations, Structured Credit Notes: Main Issuers
Source: Datastrean, OECDOct-2009
0
500
1000
1500
2000
2500
3000
3500
4000
4500 $bnCum. Issuance Index Tranches by Bank
20
Fig. 17: Notional & RW Issuance: Collateralised Synthetic Obligations
Source: Datastrean, OECDOct-2009
0
100
200
300
400
500
600
700
800
900
Mar-07 Mar-08 Mar-09
$bnTot Issuance CSO's, Risk-wtd($3.4trillion cum.)
Notional
21
Fig. 18: Collateralised Synthetic Obligations: Main Issuers
Source: Datastrean, OECDOct-2009
0
100
200
300
400
500
600
700
800
900 $bn Cum. Issuance RW CSO by Bank
22
Fig. 19: USA Takeovers As Glass-Steagall Abolition Approaches
Source: Thomson, OECDOct-2009
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.5019
90
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Rank
ing
valu
e (in
cl.
net
debt
of t
arge
t) in
per
cen
t of
GD
P
Banks' acquisitions of financial companies: United States
Portfolio mgm. & other
Insurance
Investment banking
Commercial banking
NationsBank Corp,Charlotte,NC acquires BankAmerica Corp on 30-Sep-98, deal value = U$ 61,633 mill, .7 pct of United States GDP
Chase Manhattan Corp,NY acquires JP Morgan & Co Inc on 31-Dec-00, deal value = U$ 33,555 mill, .34 pct of United States GDP
Norwest Corp,Minneapolis,MN acquires Wells Fargo,San Francisco,CA on 02-Nov-98, deal value = U$ 34,353 mill, .39 pct of United States GDP
JPMorgan Chase & Co acquires Bank One Corp,Chicago,IL on 01-Jul-04, deal value = U$ 58,663 mill, .49 pct of United States GDP
Bank of America Corp acquires FleetBoston Financial Corp,MA on 01-Apr-04, deal value = U$ 49,261 mill, .42 pct of United States GDP
23
Fig. 20: Europe Takeovers
Source: Thomson OECDOct-2009
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.6019
90
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Rank
ing
valu
e (in
cl.
net
debt
of t
arge
t) in
per
cen
t of
GD
P
Banks' acquisitions of financial companies: Euro area
Portfolio mgm. & other
Insurance
Investment banking
Commercial banking
Banca Intesa SpA acquires SanPaolo IMI SpA on 01-Jan-07, deal value = U$ 37,624 mill, .31 pct of Euro area GDP
Deutsche Bank AG acquires Bankers Trust New York Corp on 04-Jun-99, deal value = U$ 9,082 mill, .14 pct of Euro area GDP
Credit Agricole acquires Credit Lyonnais SA on 27-May-03, deal value = U$ 16,243 mill, .19 pct of Euro area GDP
Unicredito Italiano SpA acquires Capitalia SpA on 01-Oct-07, deal value = U$ 29,528 mill, .24 pct of Euro area GDP
Unicredito Italiano SpA acquires Bayerische Hypo- und Vereins on 23-Nov-05, deal value = U$ 18,256 mill, .19 pct of Euro area GDP
24
Fig. 21: Australia Takeovers
Source: Thomson OECDOct-2009
0.00
0.50
1.00
1.50
2.00
2.5019
90
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Rank
ing
valu
e (in
cl.
net
debt
of t
arge
t) in
per
cen
t of
GD
P
Banks' acquisitions of financial companies: Australia
Portfolio mgm. & other
Insurance
Investment banking
Commercial banking
Westpac Banking Corp acquires St George Bank Ltd on 17-Nov-08, deal value = U$ 17,933 mill, 1.58 pct of Australia GDP
National Australia Bank Ltd acquires MLC Ltd(Lend Lease Corp Ltd) on 30-Jun-00, deal value = U$ 2,726 mill, .68 pct of Australia GDP
St George Bank Ltd acquires Advance Bank Australia Ltd on 24-Jan-97, deal value = U$ 2,224 mill, .53 pct of Australia GDP
Commonwealth Bank of Australia acquires Colonial Ltd on 13-Jun-00, deal value = U$ 5,906 mill, 1.47 pct of Australia GDP
National Australia Bank Ltd acquires Michigan National Corp on 02-Nov-95, deal value = U$ 1,713 mill, .48 pct of Australia GDP
25
Exit Strategy Issues
Forbearance & Time
•Losses & Writedowns.•Recapitalisation.•Coordination May Not Mean
Simultaneity.Oct-2009
26
Fig 22: The 5 Policy Steps• Emergency measures in monetary policy,
central bank loans and public guarantees.• The need to deal with impaired assets both
on and off bank balance sheets.• The need to recapitalise banks to get credit
and other forms of financial intermediation moving again to avert a credit crunch.
• The eventual necessity to exit from emergency measures, and government loans and guarantees.
• Decisions about the longer-run shape of the future global financial system.
Oct-2009 27
Fig. 23: Losses, Capital Rebuilding 2009 Mid Year
Oct-2009 Source: Bloomberg
1099.1 1025.2
264.4157.6
237.9
118.2
0
200400
600800
10001200
1400
1600
Writedown & loss
Capital raised
USD
bill
ion
GlobalGovernment sponsored entities (U.S.)
Insurers
Banks & brokers
607.5 495.8
204.8121.1
237.9
118.2
0
200
400
600
800
1000
1200
1400
1600
Writedown & loss
Capital raised
USD
bill
ion
USAGovernment sponsored entities (U.S.)
Insurers
Banks & brokers
432.2 419.9
54.8 33.7
0
200
400
600
800
1000
1200
1400
1600
Writedown & loss Capital raised
USD
bill
ion
EuropeInsurers
Banks & brokers
33.5 90.61.5 0
0
200
400
600
800
1000
1200
1400
1600
Writedown & loss Capital raised
USD
bill
ion
Asia
Insurers
Banks & brokers
28
Fig. 24: USA (19 SCAP Banks) Losses, Capital Raised
Oct-2009 Source: OECD, Company reports
Q2 2009 Q4 2010(billions US dollars) est.
Capital Q2 2009 853.8
Assets Q2 2009 11547.4
Leverage Ratio 13.5 Balance Sheet Writedow ns 573.3 Further Losses F/cast (3.5% Assets) 404.2 Capital Raised 476.3 0
Shortfall B/sheet 97 501.2
Off B/Sheet Exposures VIE's now consolidated onto B/Sheet (end 2008) 120.6 VIE Outstanding (Q2 2009 unconsolidated) 796.3 Unconsolidated VIE max Loss exposure 317.3 QSPE Outstanding end 2008 3326.5 QSPE Loss exposure 80.7
Potential New Losses On & Off B/Sheet 802.2 Plus B/sheet shortfall to date 97 899.2 Less Pot. earnings ($173bn) est. 1.5% p.a. assets 1 1/2 yrs259.8 Potential capital needs end 2010 639.3
Memo: 3.5 yrs of earning @ 1.5% Assets to restore pre-crisis leverage after 201029
Fig. 25: Europe (Loss Banks) Losses, Capital Raisings, & Scenarios
Oct-2009 Source: OECD, Company reports and Bloomberg
Q2 2009 Q4 2010(billions US dollars) (Est)Capital end 2008 1155.1Assets end 2008 33736.1Leverage ratio 29.2 Balance Sheet Write Downs 391 Capital Raised 400 Loss Forecast IMF: EU UK 2009Q2-2010Q4 1027.2 Shortfall B/sheet -8.9 1018.3
Capital to get to the lower US leverage ratioCapital Required for leverage ratio of 13.5 (USA) 2499.0Extral Capital to match US by 2010 1343.9Capital Needs for new losses & to catch USA 2362.2Off Balance Sheet ExposuresTot. Eur. issuance of CSO's to 2007Q1-09Q2 3433.6Off Bal sheet exposure to conduits/losses UNKNOWN UNKNOWNLess pot earnings est 1% assets ($337bn) for 1 1/2 years 506.0Potential capital needs ignoring conduits after 2010 1856.1Memo: Or 6 years of underlying earnings per annum @ 1% pa on assets after 2010
30
Fig. 26: Fannie and Fredddie vs Private Label Mortgage Securitisation
Oct-2009 Source: BIS
0
10
20
30
40
50
60
% of Mtgs
30% Cap. rise
B-sheet ConstraintsFed Mtg Pools % Tot Mtgs
RMBS ABS Issuers
31
Fig. 27: US Bank Intermediation (Bank Loans + ABS), GDP & Real Consumption
Source: Datastream, OECDOct-2009
-10
-5
0
5
10
15
20
25 %paNominal GDPBank Loans+ABSReal Consumption
32
Fig. 28: US Bank Intermediation versus GDP % Change & US House Prices % Change
Source: Datastream, OECDOct-2009
-10
-5
0
5
10
15
Mar
-81
Jun-
82
Sep-
83
Jan-
85
Apr
-86
Jul-8
7
Oct
-88
Jan-
90
Apr
-91
Jul-9
2
Oct
-93
Jan-
95
Apr
-96
Jul-9
7
Oct
-98
Jan-
00
Apr
-01
Jul-0
2
Oct
-03
Jan-
05
Apr
-06
Jul-0
7
Oct
-08
Jan-
10
Bank Loans+ABS% less GDP%
House Price Index %
33
Exit Strategy Issues
Policy Withdrawal•Fiscal & monetary.•Guarantees and loans.•Coordination May Not Mean
Simultaneity.
Oct-2009 34
Fig. 29: Two Routes to Deleveraging
Source: OECDOct-2009
EQUITY %
A11%
B
6% GDP %
The Saving RouteTo Deleveraging The Inflation Route
To Deleveraging
35
Fig. 30: Fiscal Deficit Projections
Source: OECDOct-2009
2007 2008 2009 2010(per cent of nominal GDP)
United StatesFinancial balance -2.9 -5.8 -10.2 -11.9Gross financial liabilities 62.9 71.9 88.1 100.0
JapanFinancial balance -2.5 -2.6 -6.8 -8.4Gross financial liabilities 167.1 172.1 186.2 197.3
Euro areaFinancial balance -0.7 -1.8 -5.4 -7.0Gross financial liabilities 71.2 71.0 77.7 84.4
OECDFinancial balance -1.4 -3.0 -7.2 -8.7Gross financial liabilities 74.5 78.8 90.6 99.9
36
Fig. 31: Support Packages For Financial Sector
Source: OECD, IMFOct-2009
Purch. of assets Cen. Bank Supp. Liq. Provisionand lending by prov. With Trsy & other supp. by TOTAL Up-front
Capital inject. Treasury backing central bank (a) Guarantees(b) A+B+C+D+E Govt. Fin. (c) (A) (B) (C) (D) (E)
OECD membersAustralia 0 0.7 0 0 n.a. 0.7 0.7Germany 3.8 0.4 0 0 18 22.2 3.7Ireland 5.3 0 0 0 257 263 5.3Japan 2.4 11.3 0 1.2 7.3 22.1 0.8(f)Netherlands 3.4 2.8 0 0 33.7 39.8 6.2South Korea 2.7 5.4 0 0.3 13.8 22.2 0.8(g)Spain 0 4.6 0 0 18.3 22.8 4.6Switzerland 1.1 0 0 10.9 0 12.1 1.1United Kingdom 3.9 13.8 12.9 0 51.2 81.8 20.2(i)United States 3.9 1.3 1.1 42.1 31.3 79.6 6.3(j)
37
Exit Strategy Issues
New Fault-lines Already Emerging
•Asia versus the crisis countries.
•The broken dam refilling anew with liquidity before it is fixed.
•Asset prices bouncing strongly.Oct-2009 38
Fig. 32: China: Money vs Domestic Credit, Opposite of OECD Countries
Source: Datastream, OECDOct-2009
0.00
5.00
10.00
15.00
20.00
25.00
30.00
Jan/99Jan/00Jan/01Jan/02Jan/03Jan/04Jan/05Jan/06Jan/07Jan/08Jan/09Jan/10Jan/11
M2
Dom Credit(Contrib)
Forex Reserves(Contrib)
%yoy
39
Fig. 33: China: IP, FAI, Real M2 Exports
Source: Datastream, OECDOct-2009
-40
-20
0
20
40
60
80
100
2.00
6.00
10.00
14.00
18.00
22.00
26.00
30.00
Jan/99 May/00 Sep/01 Jan/03 May/04 Sep/05 Jan/07 May/08 Sep/09 Jan/11
Exports(RHS)Indust Prod.(3ma)Real M2Fixed Asset Inv.(RHS)
% yoy % yoy
40
Fig. 34: Global Forex Reserves & China Stock Market
Source: Datastream, OECDOct-2009
-5.00
0.00
5.00
10.00
15.00
20.00
25.00
30.00
35.00
40.00
-75.00
-25.00
25.00
75.00
125.00
Dec
-96
Sep-
97
Jun-
98
Mar
-99
Dec
-99
Sep-
00
Jun-
01
Mar
-02
Dec
-02
Sep-
03
Jun-
04
Mar
-05
Dec
-05
Sep-
06
Jun-
07
Mar
-08
Dec
-08
Sep-
09
Jun-
10
%% China Stock Market
Global Reserves $'s
41
Fig. 35: Stock Markets: Better EM Fundamentals?
Source: Datastream, OECDOct-2009
0.8
1.8
2.8
3.8
4.8
5.8
Mar/03 Jun/04 Sep/05 Jan/07 Apr/08 Jul/09 Oct/10
Japan
EU
USA
China
Korea
Aust
INDEX
42
Fig. 36: Dividend Yield vs Cash
Source: Datastream, OECDOct-2009
-9
-7
-5
-3
-1
1
3
% Points
USAAust.JapEUUKChina
43
Exit Strategy Issues
Defining What the Future Global
Financial System Should Look Like.
Oct-2009 44
Fig 37: What IS & IS Not Being Addressed• Is addressed: ●capital rules—the FSB & G20 are on the right track. ●compensation—but it is a symptom only . ●accounting, clearing, back office.• Is NOT addressed: ●“Too big to fail” & the implicit ‘puts’ & the ‘equity
culture’. ●Contagion risk & corporate structure—what banks should
do. ●Corporate governance reform to align shareholder &
management interest more generally than compensation. ●The structure of competition in banking conducive to a
credit culture. ●The structure & governance of regulatory agencies to
avoid overlap & conflicts. ●Tax reform to remove incentives to structuring.
Oct-2009 45
Fig 38: Equity Culture, & Competition vs Prudence
• Equity culture—the creditor-versus-equity-owner put in banking—asymmetric upside; & the CEO shareholder asymmetry of interests.
• “Too big to fail” is a huge problem—the government implicit put that ensures that risk is mispriced.
• “Too big to fail” problems come out of M&A & growth via structured products helped by commercial banks owing investment banking/securities businesses with massive leverage on of off the balance sheet.
• Australian banks are in the top 20. Why? A clue here. They had Basel, the same Credit Rating Agencies, & access to securitisation & derivatives. Their success must have been due to something else—Less equity culture.Oct-2009
46
Fig 39: Why Is Australia Better Placed??• Twin Peaks regulatory structure: APRA, ASIC. The RBA
focus on monetary policy & stability of the payments system.
• Hence macro policy without conflict of interest: Budget surplus, and high interest rates. Plenty of room to ease.
• 4 Pillars: Stable, medium-sized oligopolies that did not compete excessively in securities. 80% of the market does not fear competition in the market for corporate control, which is conducive to a “credit culture”.
• Australian banks take deposits and lend as the main focus of their business—they look for profitable lending opportunities, rather than structuring notes and CSO/CDOs.
• Macquarie: our one big IB introduced a Non-Operating Holding Company Structure (NOHC) in 2007. Reduces contagion risk amongst affiliates.Oct-2009
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Fig. 40: Comparative Bank Structures
Source: Datastream, OECDOct-2009
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
80.0 % B of AmCitiBarclaysUBSDeutscheWestpac
48
Fig. 41: $70.6bn Payments to AIG Counterparties ($45.7bn to EU!): Sept. 16 to 31 December 2008
(billions of US dollars) Collateral postings Payments to securities As a share of
Institution for credit default swaps* lending counterpaties** Total capital*** at end-2008
Goldman Sachs 8.1 4.8 12.9 29.1%Societe Generale 11.0 0.9 11.9 28.9%Deutsche Bank 5.4 6.4 11.9 37.4%Barclays 1.5 7.0 8.5 20.0%Merrill Lynch 4.9 1.9 6.8 77.4%Bank of America 0.7 4.5 5.2 9.1%UBS 3.3 1.7 5.0 25.2%BNP Paribas … 4.9 4.9 8.3%HSBC 0.2 3.3 3.5 5.3%[memo: Bank of America after its merger with Merrill Lynch] 12.0 [18.1%]
*Direct payments from AIG through end-2008 plus payments by Maiden Lane III, a financing entity
established by AIG and the New York Federal Reserve Bank to purchase underlying securities.
**September 18-December 12, 2008.
***Common equity net of goodwill; net of all intangible assets for Merrill Lynch and HSBC.
Oct-2009 Source: Fed, US Treasury
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Fig. 42: Non-operating Holding Company NOHC
Source: OECD
NOHC, Non-
operating parent.
External funding, eg equity
capital.
Commercial
Bank, external funding,
trading etc
Broker/Dlr. equity
sales,IPO's, etc
Wealth mananage
ment, private
clients, etc
Insurance, general,
life, reinsurane
Invest. Banking, position taking,
securities business
Oct-2009 50
Fig 43: Competition Policies• Open market buying of toxic assets is least distortive.• Stable oligopolies that don’t compete excessively in the
securities and derivatives businesses.• Foreign acquisition of domestic weak banks fosters better
competition without disturbing the local structure.• Selling asset of failed firm in pieces enhances competition.• Temporary nationalisation is better than a megamerger.• Promote entry with competitive mergers of smaller healthy
banks—e.g. regionals—in overbanked jurisdictions. They are ready to lend and competition will force recapitalised banks to lend.
• Foster removal of regulatory barriers to entry in the loan market: fine grained credit rating information on consumers and small businesses.
• NOHC structures to foster transparency, competition, and regulatory ease.Oct-2009
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Fig 44: Corporate Governance
• Independent directors: strengthen fit and proper person test to cover competence, technical expertise. Risk management skills; formal separation of CEO and Chair; term limit on board membership.
• Risk officer role with access to the board (with special employment terms--CEO doesn’t fire or set salary).
• Fiduciary responsibility of directors: clarified tying duties to single affiliate in the case of complex firms.
• Remuneration: board reform helps, and tax incentives provide teeth.
Oct-2009 52