Unfit to Survive Wall Streets Darwinian Lessons New America Foundation Washington, DC. December 17,...

Unfit to Survive

Wall Street’s Darwinian Lessons

New America Foundation

Washington, DC. December 17, 2008

Leo M. TilmanPresident, L.M.Tilman & Co.

Adjunct Faculty, Columbia University

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The Challenge

Macroeconomic Forces

Low Return Environment Bretton Woods II Imbalances

US Housing & DeficitsMonetary Policies

Financial Instruments

DerivativesCDOs

ABCP & SIVsSubprime MBS

Financial Institutions

Investment BanksCommercial Banks

Hedge FundsSWFs & Pension Plans

Intellectual Paradigm

Accounting EarningsFinancial Disclosures

Credit RatingsEquity Market Valuations

The Challenge: Complexity + Risk + Deficient Lens

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Secular forces (globalization, disintermediation, informational availability, greater market efficiency, alternative investments, deregulation, financial convergence, derivatives and increasingly complex financial products)

Period-specific forces (Bretton Woods II, global savings glut, disinflation exporting)

Cyclical factors (monetary policies, interest rates, yield curves, default rates)

Source: Mitchell (2003), OECD, Oliver Wyman analysis

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-5%

0%

5%

10%

15%

20%

25%

30%

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81

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86

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91

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96

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01

20

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GDP Growth Inflation Rate Returns on Gov't Bonds

The Great Moderation

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FeesCompress

SecularForces

Funding Advantages Decrease

SecularForces

Greater Liquidity &Funding Risks

More Complex &Opaque Investments

Risk Exposures Increase

Compensation forRisk Declines

Vicious Circle

CyclicalForces

Period-SpecificForces

Static Business Models

AlternativeInvestments

More Leverage & Risk

The Culmination: 2007-2008 Financial Crisis

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Risk Aversionand

Deleveraging

ExogenousCatalyst

Illiquidity:

Prices Decline On Thin Trading

Margin Callsand

Forced Liquidations

Contagion:Other Assets Are Sold

Across Markets

Inability to Borrow:

Haircuts Increase,

Lenders Shrink Balance Sheets

More Price Declines and

Margin Calls

Deleveraging of Modern Financial Crises

Vicious Circle

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The “Greed and Complacency” Narrative

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The “Greed and Complacency” Narrative

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The “Greed and Complacency” Narrative

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“Greed and Complacency” Financial Darwinism

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“Greed and Complacency” Financial Darwinism

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Strategic Vision and Systemic Knowledge (or lack thereof)

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The Blue Ocean Strategy

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Financial Industry– Acquire new kind of strategic vision– Redesign their business models– Make risk management the framework for executive decisions– Position for sustainable and real value creation that benefits all stakeholders

Risk-Based Transparency– Business model- and risk-focused regulation

What is a breakdown of economic performance by revenue sources? What are the risks taken on in the process – by revenue sources and in total?

– Systemic effects and fair value accounting

Economic Dynamism – A system conducive of discovery, development, financing and production of viable

commercial innovations

Economic Policy

A Unique Opportunity

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