Tiburon Systemic Risk Presentation

8/8/2019 Tiburon Systemic Risk Presentation

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I. What is Systemic Risk?

Risk that impacts the entire financial sector and real economy through cascading,

contagion and chain-reaction effects.

Central Bank contracts liquidity

Large private firm fails

Natural disaster

Terrorist attack

Risks that individual firms cannot necessarily protect themselves against.

The financial crisis of September, 2008 featured many examples of systemic risk,

including bank runs and illiquidity of asset classes.

Tiburon Capital Management LLC


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I. Causes of this Ongoing Financial Crisis Two Views

The Market Did It

Crisis was due to forces emanating from the market economy which the government did not control,either because it did not have the power to do so, or chose not to.

The Systemic Risk was a market failure that can be dealt with via government actions.

International market forces beyond governmental authority were at work.

World savings abroad drove down interest rates, concurrently, mortgage rates.

Failure of regulators to intervene in Lehmans failure.

The Government Did It

Crisis was due to forces emanating from the government.

Government actions caused, prolonged and worsened the crisis. Limiting governmental power is

essential to minimize Systemic Risk.

Excessive monetary easing by the Fed.

Low interest rates led to a housing boom.

Fannie and Freddie exacerbated matters, supporting the mortgage backed market, purchasing more higher risk

mortgages.

Regulatory misperception that the seize up in the money markets was liquidity related, rather thancounterparty related.

Points succinctly made by Professor John Taylor of Stanford, Jekyll Island speech May 12,2009



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I. Causes Real House Prices vs 10 Year Treasuries



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I. Causes - Fed Funds Rate Last US Recession to Present

Source: Bloomberg



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I. Our Conclusions What Low Interest Rates Wrought

World

Awash in

Investment

Capital

Wall Street

Challenged

to Create

Higher

Yielding

Investment

Grade Paper

Rating

Agencies

Provide

Ratings on

Untested

Product

Investors

Buy with

Decreasing

Scrutiny

History with auto-

backed paper.

Deluge of new

ratings requests

drives significant

new revenues for

ratings agencies.

Rating agencys

moral hazard.

Wall Street

responds to

demand with over-

collateralized asset

backed securities.

Single loan default

histories suggest

adequate coverage.

Pervasive low

interest rates

continues cycle.

Less and less

scrutiny by all

parties as demand

escalates,

underlying asset

values increase.

Incentives driveeach part of chain

to work as

aggressively as

possible to book

new business to

meet demand.

Low interests rates

drive down yield on

IG paper.

Enormous demand

for high grade

investment assets.

Why Was There No Attempt to Quell this Burgeoning Asset Bubble By Raising Rates?



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I. Our Conclusions

Market risks are not Systemic Risk.

Mistakes in markets are made, corrections occur without systemic shock.

Government actions, in part, converted market risks to systemic risk.

Low interest rates forced global investors to reach for yield.

The match that lit the fire.

Wall Street innovation in asset-backed securities with implied AAA rating

met the need.

Low interest rates led to low cost mortgages, driving up home prices.

Low delinquency and foreclosure rates comforted rating agencies,

underwriters and investors.

Demand for paper, low interest rates, skyrocketing home prices drove an

extraordinary vicious cycle leading to declining standards and documentation.



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II. Systemic Risks Markets Worry About

Deficits and Growing Debt of the Federal Government Large percentage of GDP that is federal debt in excess of 40%?

CBO projects debt will be 89% of GDP by 2019.

No stimulus from this deficit.

Is excessive tax or excessive inflation the solution?

How can private enterprise compete for capital versus sovereigns crowding out effect.

Feds Balance Sheet Questionable whether additional asset purchases will forestall inflation.

Fed Market Interventions

Fed intervention into operations of private business firms.

Is it proper purview to intrude on employee compensation matters, priority of debt holders in restructurings, etc?

AIG why bail out all creditors and allow equity to remain outstanding? Costs all borne by taxpayers.

Bear Stearns, Fannie and Freddie - bondholders paid, GM , Lehman, Chrysler - bondholder impaired.

Many actions reverse previous modus operandi and perhaps rule of law .

Runs and Liquidity

Runs can begin at troubled institutions but spread to healthy ones.

Runs can be set off by otherwise healthy institutions counterparty exposure to an unhealthy one.



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II. Systemic Risks Markets Worry About

To Big to Fail Systematically Important Firms

The knowledge or suspicion that a firm is too big to fail changes the behavior of a firm and its

creditors because of moral hazard.

Incentive to take more risks in an attempt to increase potential profits, since there will be less

downside if those risks turn out badly.

Leverage

Cycle of leveraging up in good times and de-leveraging promptly, forcibly, in bad times, is exacerbates

systemic risk.

Payment, Settlement and Clearing Systems

Derivatives and other over-the-counter contracts not processed promptly, nor represented with

adequate paperwork support.

Vulnerability to counter-party risk

Limited transparency

Asset Bubbles We argue low interest rates were the catalyst for the run up of assets post 2004. Policies that call

for lower interest rates can cause another asset bubble. This is within regulators control.

Tampering with rates seems to ultimately magnify the asset boom/bust cycle rather than moderate

it.



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III. Lessening Systemic Risk to Lower Probability of a Future Crisis

Stop the Projected Systemically Risky Budget Deficits.

Exit from the extraordinary monetary policy actions, and end the bailout mentality that

is taking the federal government further and further into the operations of businessesand threatens the rule of law.

Government Should Establish Clear and Consistent Rules.

Stop changing them during the game, and enforce them. The rules do not have to be

perfect, but the rule of law is essential.

Cease the Bailout Mentality. It will be necessary to let some firms fail. One way to

wean the system from bailout presumptions would be for the government to try tostop chain reactions by helping the innocent bystander rather by rescuing the one

who gambled and lost. This is a principle that was used to end the bailout mentality

of the IMF in 2003 and it helped stop the bout of emerging market crises that

began in the 1990s.

Specific, Delineated Regulator Responsibilities. Rather than form any additional

regulatory bodies, insist that the current ones become articulate in financialinstruments, their use and their risks and share data with each other.



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IV. Whats Wrong with Dodd-Frank Financial Legislation

Overreaching . The bill adds regulations and rules about many activities that had little ornothing to do with the crisis.

Consumer Financial Protection bureau to be housed at the Fed that is supposed toprotect consumers from fraud and other abusive financial practices. Yet it is notapparent that many consumers were victimized during the financial boom years.

The bill gives the Fed authority to limit interchange or swipe fees that merchants payfor each debit-card transaction Why?

Price controls are undesirable, and this is what the Fed should be attuned to?

SEC authority to empower stockholders to run their own candidates for corporate

boards of directors improves corporate governance?

Expanded Authority of Regulators that Didnt Act Once Already.

The Fed could have tightened the monetary base and interest rates as the crisis wasdeveloping, but chose not to do so.

The SEC and various Federal Reserve banks-especially the New York Fed- had theauthority to stop questionable lending practices and increase liquidity requirements.

Additional governmental discretionary power over banks, without clear rules for banks. Financial Stability Oversight Council, a nine-member panel drawn from the Fed, SEC, and other

government agencies.



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IV. Whats Wrong with Dodd-Frank Financial Legislation

Banks Can Still Count Risky Assets as Capital. Insufficient capital relative to bank assets was

an important cause of the financial crisis.

Silent on Freddie and Fannie.

In 2008 they held over half of all mortgages, and almost all the subprime mortgages.

They have absorbed an even larger fraction of the relatively few mortgages written after

2008.

Potential Unintended Consequences. Many proposals in the bill will have highly uncertain

impacts on the economy.


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Tiburon Systemic Risk Presentation