A NEW WORLD A NEW WORLD

DISORDER ?DISORDER ?Causes and consequences of the globalCauses and consequences of the globalCauses and consequences of the global Causes and consequences of the global

financial crisisfinancial crisis

Professor Thomas Clarke UTS Centre for Corporate Governance

Dimensions

The “most serious financial crisis

since the Great Depression of the 1930s ”since the Great Depression of the 1930s.

The End of the Street?The End of the Street?

Early Tremors of the Financial Crisis

STOCK MARKET JITTERS: DOW JONES INDUSTRIAL AVERAGE, LAST 24 MONTHS(US dollars)(US dollars)

14,000

15,000

12,000

13,000

10,000

11,000

9 Aug 07: Credit crunch starts Sept 08: Collapse ofAIG Lehman Brothers

7 000

8,000

9,00031 Oct 07: Fed lowers rate to 4.5%

30 Jan 08: Fed lowers rates to 3.0%

AIG, Lehman Brothers,Washington Mutual, etc.

7,000

Nov

/06

Dec

/06

Jan/

07

Feb

/07

Mar

/07

Apr

il/07

May

/07

Jun/

07

Jul/0

7

Aug

/07

Sep

t/07

Oct

/07

Nov

/07

Dec

/07

Jan/

08

Feb

/08

Mar

/08

Apr

/08

May

/08

Jun/

08

Jul/0

8

Aug

/08

Sep

t/08

Oct

/08

No

v/08

Source: Bloomberg

Is this a Rollercoaster or a Financial System?Is this a Rollercoaster or a Financial System?

Synchronized SinkingSynchronized SinkingStock price changes over past year (Krugman 2008)

-5

0S&P 500 FTSE Nikkei Dow Jones Nasdaq

-15

-10

-25

-20

Per

cen

t

-35

-30

P

-45

-40

-50

Source: Bloomberg, Yahoo Finance

International Stock Markets in Free-Fall (past three months)(past three months)

FTSE 100FTSE 100

NIKKEI 225

Sept Oct Nov Sept Oct Nov

Dow Jones

Sept Oct Nov

Cumulative Financial Institution Failuresand Multiple Rescue Operations

This is what a run on the bank looks like..

Si th l tSixth largestbank in the US(assets $327 billion)billion)

Lehman Brothers 158 years old fourth largest investment bank on Wall StreetLehman Brothers 158 years old, fourth largest investment bank on Wall Street,Self-proclaimed ‘innovator in global finance.’

Australia’s Casualties of the Financial Crisis

(Formerly MFS)

Reactions to the Crisis(The behavioural theory of finance)

Finally, the global economic slowdown has prompted a re-evaluation and re-pricing of risk, in the jargon.

Or, to translate, investors have in the course of 14 months gone from the mad conviction that busts had been abolished to the fear that

everything's going bust.

Neither view was rational. But reason doesn't hold much sway atNeither view was rational. But reason doesn t hold much sway at market peaks, when the prevailing emotion is greed, and troughs –

when it's sauve qui peut.

Robert Peston BBC

Panic!Panic!

Fear!Fear!

Prayer!y

Ben BernankeChairmanUS Federal Reserve

Mervyn KingGovernor of theBank of England

Dominique Strauss-Kahn President of the IMF

ReflectionReflection

Elation! (Mistaken?)Elation! (Mistaken?)

Cool? (Medication?)Cool? (Medication?)

Despair!Despair!

Hope!Hope!

Nope!

“…this sucker is going down..” (The US economy..)

(If the $US700 billion Troubled Asset Relief Program (TARP) does not pass Congress)

PerhapsPerhaps..

Our objectives . which we believe these recommendations will achieve - are improvedtransparency and disclosure, better risk awareness and management, and stronger oversight.Collectively, these recommendations will mitigate systemic risk, help restore investorconfidence, and facilitate economic growth.

Wall Street Becomes a Tourist Attraction (Oct 2008)Wall Street Becomes a Tourist Attraction (Oct 2008)

déjà vu ?déjà vu ?

New York Stock Exchange on Black Thursday 1929New York Stock Exchange on Black Thursday 1929

The Future?The Future?

There is always a market..

The Scale of the PresentThe Scale of the Present

Financial Crisis and the

Significance of the

Rescue PackagesRescue Packages

Financial Institutions Heading For Trouble (2007)g ( )

Total Shareholder Return at 11 Financial Firms

S 2008Source: RiskMetrics April 2008

Bank Failures 2008

Bank Date Status Website

Fannie Mae 07 Sep Nationalised Fannie MaeFannie Mae 07 Sep Nationalised Fannie Mae

Freddie Mac 07 Sep Nationalised Freddie Mac

Lehman Bros 15 Sep Collapsed Lehman Brosp p

Merrill Lynch 15 Sep Taken over Merrill Lynch

AIG 16 Sep Part-nationalised AIG

HBOS 17 Sep Taken over HBOS

WaMu 25 Sep Collapsed and sold WaMu

Fortis 28 Sep Nationalised FortisFortis 28 Sep Nationalised Fortis

Bradford & Bingley 29 Sep Nationalised Bradford & Bingley

Wachovia 29 Sep Taken over Wachoviap

Glitnir 29 Sep Nationalised Glitnir

Hypo Real Estate 06 Oct Rescue package Hypo Real Estate

RBS 13 Oct Part-nationalised RBS

Lloyds TSB 13 Oct Part-nationalised Lloyds TSB(Source: BBC)

Eclipsing Other Financial Crisis Since the Great Depression

C i f Fi i l C iComparison of Financial Crises(Losses in billions of US dollars)

1200

1400

1600

30

35

40Other financials (left scale)

Bank losses (In billions of US dollars left scale)

Percent of GDP (right scale)

800

1000

1200

20

25

30

400

600

10

15

0

200

U S savings Japan banking Asia banking U S

0

5

Source: IMF Global Financial Stability Report: Financial Stress and Deleveraging, Washington: International Monetary Fund October 2008.

U.S. savingsand loan crisis

(1986-95)

Japan bankingcrisis (1990-99)

Asia bankingcrisis (1998-99)

U.S. subprime crisis(2007-present)

Losses So Far

Financial Sector Losses(In billions of U S dollars 2007:02 August 2008) Banks(In billions of U.S. dollars 2007:02 – August 2008)

700

MortgagesLoans/ Leveraged LoanOtherSIVs / conduitsTrading

700 Americas 700

800

Banks

Hedge funds/Other

Insurers

GSEs

500

600

700 TradingMonolines

400

500

600

Europe

Asia

500

600

700

200

300

400

200

300

400

200

300

400

0

100

Bank Writedowns by Type

0

100

Bank Writedowns by Region

0

100

Financial Sector Writedowns

Source: IMF Global Financial Stability Report: Financial Stress and Deleveraging, Washington: International Monetary Fund October 2008.

Reported write-downs reached $760 billion by end of September 2008, $580 billion of which were incurred by global banks

Critically weakened financial institutionsCritically weakened financial institutions

Market Capitalization and Equity Book Values of Select Financial Institutions

1000

1200

p q y(In billions of U.S. dollars)

800

1000

Market Capitalization end 2006

Total Common Equity end 2007

Current Market Capitalization

600

200

400

0

U.S. commercial banks U.S. broker dealers U.K. banks Euro area banks

Source: IMF Global Financial Stability Report: Financial Stress and Deleveraging, Washington: International Monetary Fund October 2008, table 1.28.

Collapsing share prices of US financial institutionsp g p

Scale of the International Rescue of Financial Institutions

Rescue Packages Compared to GDPRescue Packages Compared to GDP

Source: BBC

Will US Bail Out be Enough?Will US Bail-Out be Enough?

The Full US Bill for the Financial Crisis?

US$1.4 Trillion

Origins of the Crisis

Alan GreenspanChairman of the Federal ReserveChairman of the Federal Reserve

1987-2006

Alan Greenspan, the Federal Reserve chairman, with Treasury Secretar Robert E R bin left at a Ho se hearing in 1995Secretary Robert E. Rubin, left, at a House hearing in 1995.

Fed Chairman ThroughFour Administrations

“Not only have individual financial institutions become less vulnerable to shocks from underlying riskto shocks from underlying risk factors, but also the financial system as a whole has become more resilient ”resilient. — Alan Greenspan in 2004

Fannie Mae and Freddie Mac

Massive Growth of Mortgage Bond Market

The Sub-Prime

Mortgage Crisis

The Sub-Prime Contagion

The Growth of Sub-Prime Mortgages

Sub-prime Mortgage Lending

Source: BBC

Collapsing US House Prices: Negative Equity?p g g q y

Escalation of Distressed Debt

Escalating ForeclosuresEscalating Foreclosures

The End of the Neighbourhood?g

House Prices Fall and Foreclosures Rise

When the Music Stops…p

Source: BBC

Rescue of Main Street or Bail-Out of Wall Street?

Source: BBC

Adrian Cadbury

“I suggest that there are two aspects of what went wrong.

a) One was that in general risk was undervalued by the financiala) One was that in general risk was undervalued by the financial institutions.

b) The second was that the banks simply did not know where theirb) The second was that the banks simply did not know where their risks lay.

-Sub-prime mortgages were parcelled out by banks and sold through perhaps three or four levels ofsold through perhaps three or four levels of intermediary. -When house prices fell people handed in their keys. -The intermediaries found they were in the propertyThe intermediaries found they were in the property business which they could not finance and in turn each level went bust. -The banks found that they were ultimately responsible, y y p ,a contingent liability they were unaware of and had not provided for.

I think a sound rule is that, if you do not understand the business youare getting into, don’t get in!"

Financialisation of the Global Economy

Financialisation of the International EconomyFinancialisation of the International Economy

Competing definitions of ‘financialisation’ include:Competing definitions of financialisation include:

• the ascendancy of ‘shareholder value’ as a mode of corporate governance;

• the growing dominance of capital market financial systems over bank-based financial systems;

• the increasing political and economic power of a particular class grouping: the rentier• the increasing political and economic power of a particular class grouping: the rentier class for some (Hilferding 1985);

• the explosion of financial trading with a myriad of new financial instruments;

• the “pattern of accumulation in which profit making occurs increasingly through financial channels rather than through trade and commodity production’ (Krippner 2005);

• the increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of the domestic and international economies (Epstein 2005).

US Finance Overtakes Manufacturing

Proliferation of Exotic Financial SecuritiesProliferation of Exotic Financial Securities

ABS = asset-backed securitiesS asse bac ed secu es

CDO = collateralized debt obligation

CLO = collateralized loan obligation

CMBS = commercial mortgage backed securitiesCMBS = commercial mortgage-backed securities

MBS = mortgage-backed securities.

The Future Becomes Financial Instruments

Explosion of Derivatives

The Age of Derivatives

Financialisation Relative to GDP

Financialisation of the US EconomyFinancialisation of the US Economy

Financial Services Trade Balance

Securitisation Issuance Based on Originating Country or Region

Global Hedge FundsGlobal Hedge Funds

Private Debt in US and AustraliaPrivate Debt in US and Australia

Collapsing Value of Mortgage Bonds

Growing Bank Liabilities 2007

Regaining a sense of reality…?

As the Archbishop of Canterbury argued recently,

“Trading the debts of others without accountability has been the motor of astronomical financial gain for many in recent years…

The crisis exposes the element of basic unreality in the situation –the truth that almost unimaginable wealth has been generated by equally unimaginable levels of fiction, paper transactions with no concrete outcome beyond profit for tradersconcrete outcome beyond profit for traders..

The biggest challenge in the present crisis is whether we can recover some sense of the connection between money and materialrecover some sense of the connection between money and material reality – the production of specific things, the achievement of recognisable human goals that have something to do with a shared sense of what is good for the human community in the widest g ysense.” (The Spectator 27 September 2008).

The Consequences

Would You Lend A$1 Trillion Dollars to this Man?Would You Lend A$1 Trillion Dollars to this Man?

Henry Paulson US Treasury Secretary

The Emergency Economic Stabilisation Bill 2008The Emergency Economic Stabilisation Bill 2008

Th E E i St bili ti A t 2008 th i d th US• The Emergency Economic Stabilisation Act 2008 authorised the US Treasurer Henry Paulson to spend up to $700 billion purchasing distressed assets, particularly mortgage-backed securities from the banks. The p rposed of the act as to p rchase the to ic assets ass ring the orth ofpurposed of the act was to purchase the toxic assets, assuring the worth of the bank’s remaining assets, and restoring the confidence of the market.

• Objections: the idea that taxpayers should bail out Wall Street; the ambiguity of objectives and lack of oversight of the new agency responsible for buying assets; the prospect of over-paying for bad assets giving the

i d i i fi i l fi i df llexecutives and investors in financial firms a windfall at taxpayers expense; and a conviction that any purchase should be of preferred stock in the banks, avoiding the problem of valuing complex assets, and offering a

t d f t l d th ibilit f i ifi t t fgreater degree of control and the possibility of a more significant return from the exercise (Stiglitz 2008; Krugman 2008).

Emergency Economic Stabilisation Act 2008

The Emergency Economic Stabilisation Act 2008The Emergency Economic Stabilisation Act 2008

• Immediate access to $250 billion following that a further $100 billion can be• Immediate access to $250 billion, following that a further $100 billion can be authorised by the President, with Congress confirming the last $350 billion.

• Transparency details were required for each transaction, and a set ofTransparency details were required for each transaction, and a set of oversight mechanisms involving a Financial Oversight Board, Congressional Oversight Panel, and Special Inspector General of the program.

Th T i d t bt i th i ht t h ti t k• The Treasurer was required to obtain the right to purchase non-voting stock in companies that participated in the sale of assets giving the government an equity interest in the companies.

• The Treasury was required to maximise assistance to homeowners facing foreclosure.

• Finally companies participating in the scheme were prohibited from offering executives incentives to take excessive risks, to offer golden parachutes to executives, and were given the right to clawback senior executive bonuses if they were later found to be based on inaccurate data.y

European Action Plan…?

Would You Lend A$1.2 Trillion Dollars to this Man?

Gordon Brown UK Prime Minister

UK Government $1.2 Trillion Dollar Rescue Plan

Source: BBC

US Federal Government Capital Investments in US Banks October 2008

The Cost of the UK RescueThe Cost of the UK Rescue

European Union summit in Brussels

British Prime Minister Gordon Brown (left) and European CCommission President José Manuel Barroso at this week's

Regulation of International Financial MarketsRegulation of International Financial Markets

• Transparencya spa e cy

• Capital Adequacy

• Corporate Governance

• Prudential Regulation

• Risk Management

G7 Finance Ministers Meet in WashingtonG7 Finance Ministers Meet in Washington

Deposit Insurance (Before)Deposit Insurance (Before)

OECD 2008

Deposit Insurance (After)Deposit Insurance (After)

Would you like to be interviewed by this man?

Rep. Henry A. Waxman (D-Calif.) seeks to learn if banks are using taxpayer dollars to pay bonuses to their executives.

Richard Fuld CEO Lehman BrothersBefore Congressional Committee 5 October 2008

Henry Taking Aim AgainHenry Taking Aim Again

Rep. Henry A. Waxman, Democrat of California, on the committee investigating hedge funds.

Hedge Fund DirectorsHedge Fund Directors

Five prominent leaders of giant hedge funds testified before Congress on Thursday. From left, George Soros, James Simons, John A. Paulson, Philip A. Falcone and Kenneth C. Griffin.

Emerging Multi-Polar World ?g g

The Indian prime minister, Manmohan Singh, left, with President Nicolas Sarkozy of France, center, and the European Commission president Jose Manuel Barroso in Beijing for European/Asia Summit 25 October 2005

G20 SummitG20 Summit

A New Bretton Woods?A New Bretton Woods?

July 1944: The U.S. delegation to the Bretton Woods conference in New Hampshire, the multi-nation confab that set up the international banking-and-finance protocols and institutions that still exist today

Getting Used to the New Multi Polar WorldGetting Used to the New Multi-Polar World

G20 AnalysisG20 Analysis

G20 summit are comprehensive and based on a sober analysis of the f h i icauses of the crisis:

• Weak underwriting standards, d i k t ti•unsound risk management practices,

•increasingly complex and opaque financial products, •and consequent excessive leverage •combined to create vulnerabilities in the system•combined to create vulnerabilities in the system.

Policy-makers regulators and supervisors in some advanced countries:Policy-makers, regulators and supervisors, in some advanced countries:

•did not adequately appreciate and address the risks building up in financial markets,markets, •keep pace with financial innovation, •or take into account the systemic ramifications of domestic regulatory actions.”

G20 RecommendationsG20 Recommendations

• The commitments to strengthening transparency and accountability• The commitments to strengthening transparency and accountability, enhancing regulation, promoting integrity in financial markets, reinforcing cooperation and reforming international financial institutions, represents an ambitious agenda. , p g

• These commitments and the diplomatic process that has delivered them suggest that an important consequence of the financial crisis is gg p qa defining move towards a multi-polar world, with a new economic order in which global regulation of international business and global market oversight will be accepted as the basis for market stability and integrityand integrity,

• With executive incentives aligned to prevent excessive risk taking, and reward sustainable business developmentand reward sustainable business development.

Corporate Governance? Boards of US Banks

Costs of the Financial CrisisCosts of the Financial Crisis

• 20 million unemployed

• Insecurity for hundreds of millions dependent on superannuationsupe a uat o

• Undermining of other industry sectors – property, g y p p ymanufacturing and services

• Lost opportunities for innovation and sustainability investments

The US Auto Industry Comes to WashingtonThe US Auto Industry Comes to Washington

Ford, Chrysler and General Motors CEOs

The end of the US auto I d t ?Industry?(45% fall in Sales in 2008)Sales in 2008)

Never Again…?

From NASDAQ Bubble (1997-2000)

Total market value: NASDAQ. 11% annual growth derived from pre-bubble valuation (peak occurred March 10, 2000, when the NASDAQ traded as high as 5132.52 and closed the day at 5048.62)

Source: Janszen (2008)

To US Real Estate Bubble (2001 2007)To US Real Estate Bubble (2001-2007)

Total market value: Real estate. Actual market value from “Federal Reserve Flow of Funds o a a e a ue ea es a e c ua a e a ue o ede a ese e o o u dsAccounts of the United States.” Historical trend from Robert J. Schiller, Irrational Exuberance.

Source: Janszen (2008)

The Next Bubble?Alternative Energy and Infrastructure?

Total market value: Alternative energy and infrastructure

Source: Janszen (2008)

Total market value: Alternative energy and infrastructure. Estimated fictitious value of next bubble compared with previous bubbles