The Credit Crunch and its Consequences

Howard DaviesDirector, LSE

Moscow

17th November 2008

Act One: Subprime

Case-Schiller Home Price Index 2000-2008

0

50

100

150

200

Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q3 Q4 Q1 Q2

2000 2001 2002 2003 2004 2005 2006 2007 2008

Year & Quarter

Ind

ex

Source: Wikipedia

Mortgage Origination by Product (%)

0102030405060708090

100

2001 2002 2003 2004 2005 2006 9m 2007

Prime Subprime Alt-A

Notes:

1. Total mortgage origination excludes seconds and home equity lines of credit

2. For relative growth versus 2001, 2007 annualized based on 9 months of date

Recent ABX BBB Price HistoryPrice

Source: Markit Partners

Resecuritisation

BBB

A

AA

AAA

Residual/Equity

SUPER SENIOR

AAA

AAA

AA

A

BBB

Equity

Capital Structure Containing Subprime Loans

Subprime Mezzanine CDO Containing BBB Subprime Bonds

100%

28%

20%

11%

7%

0%

11%7%

11%

8.6%

7%

100%

40%

0%

CUMULATIVE LOSSES

Act Two: Liquidity

Sources: Bloomberg and Bank calculations

Act Three: Unravelling

-Bear Stearns, Indymac, Wa mu

-HBOS, RBS

-Fortis, Dexia etc.

Act Four: Meltdown

Act Five: Pumping

Act One: Subprime

Act Two: Liquidity

Act Three: Unravelling

Act Four: Meltdown

Act Five: Pumping

The Credit Crisis: A Five-Act Tragedy

EU Growth Rates: IMF Forecasts

-2

0

2

4

6

8

10

Germany France Russia UK

2007

2008

2009

Source: www.ft.com

Five Ways

1. Legitimacy – why Luxembourg and not China?

Global Committee Structure - A Regulator’s View

G-7(Gov’ts)

Financial Stability Forum

WTOOECD

(Gov’ts)

FATF (Money Laundering) IASB

(Accounting IASC

Bank for International Settlements

(Central Banks)

G-10(Central Banks)

CGFS CPSS

Basel(Banking)

IOSCO(Securities)

Joint Forum

IAIS

(Insurance)

Monitoring Group

IAASB(Audit)

PIOB

IMFWorld Bank

(Gov’ts)

IFIAR(Audit)

Source: Adapted with permission from Sloan and Fitzpatrick in Chapter 13, The Structure of International Market Regulation, in Financial Markets and Exchanges Law, Oxford University Press, March 2007

Five Ways

2. Simpler, co-ordinated mechanisms which better reflect the shape of today’s markets

National Regulatory Structures

Tripartite Dual 'Twin Peaks' Unified regulator

Source: How Countries Supervise their Banks, Insurers and Securities Markets 2007: Central Bank Publications

57

35

2

493

54

28

739

10

Other bank regulators

Central banks as banking regulator

Central bank as one pillar

No Central Bank interest

Non-Central Bank

Central Bank

Five Ways

3. Speed: Basel 2 took a decade

Five Ways

4. Stronger links between macroeconomic surveillance and regulation

• A new G (G12)

• Standing group of Finance Ministers

Five Ways

5. Political leadership

Five ways to fix our Financial Architecture

1. Legitimacy – why Luxembourg and not China?

2. Simpler, co-ordinated mechanisms which better reflect the shape of today’s markets

3. Speed: Basel 2 took a decade4. Stronger links between macroeconomic

surveillance and regulation5. Political leadership

“ Bank failures are caused by depositors who don’t deposit enough money to cover the losses due to mismanagement”.

Dan Quayle

The Credit Crunch and its Consequences

Howard DaviesDirector, LSE

Moscow

17th November 2008