La crisi originata dai mutui subprime e molto altro sull’instabilità

finanziaria

prof. Giovanni FerriEconomia delle scelte finanziarie

e di portafoglioLezione 9

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This requires a paradigm shiftIn the last 15 years the international financial system lost its sense of gravity, like Willie Coyote … who helped it look up to the sky (and then fall)?

But then came the global financial crisis

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The Political Economy Cycle of Finance

Great Crash1929

1930sRe-Regulation

1970sDe-Regulation

1980sLatin American

Crises

1990sSystemic Crises

(Mexico-Asia-Japan)

1990s-2000sMega Bankruptcies

(LTCM, Enron, etc)

2007Subprime

Initial signalsof instability

Terminal partof the cycle

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Starting Point:-Low inflation

-Low unemployment

Positive Shocks:-deregulation

-Financial innovation-Capital inflows

-Low interest rates

Financial Sector:-Rising demand for credit

-Risk underestimation-Rising supply of credit

Financial Markets:-Rising asset prices

(shares & real estate)-Wealth increases-Debt increases

Real Economy:-Consumption rises-Investment raises

-Lower savings-Rising current account deficit

Boom:-Economy overheats

-Real and/or financial imbalances grow-Financial structure becomes fragile

Politicians & economiststheorize the beginning

of a new Era(e.g. New Economy)

Balance sheet channelLending channel

Financial accelerator(Bernanke-Gertler,’95)

Animal spirits(Akerlof-Shiller, ’09))

Global Imbalances(Bernanke ’07)

-Covered-Speculative

-Ponzi

The Great Moderation(Bernanke ’04)

The Minsky Model: Expansion

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Starting Point:-Rising interest rates

-Sudden change in expectations

Negative Shocks:-Capital flows away from more

speculative investment

Financial Sector:-Pessimistic evaluation of risk

-Lower demand for credit-Lower supply of credit (crunch)

Financial Markets:-Lowering asset prices

-Lowering wealth-Debt deflation

-Real debt increases

Real Economy:-Lower consumption-Lower investment

-Rising savings-Lower current account deficit

Burst:-Banking crisis (bank runs)

-Recession

Debt Spiral a la Fisher 1933

Deflationary Spiral

-Central Bank-Government-Regulation

Default of Ponzi units

The Minsky Model: Contraction

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Two spirals amplify subprime related losses.

Initial losses(e.g. mortgage default)

Fundingproblems

Lowerpositions

Prices divergefrom fundamentals

Highermargins

Largerlosses

Market Liquidity & Funding Liquidity

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Il credit channel nella crisi sub-prime - 1

CAUSE MACRO DELLA CRISI: 1-BALANCE SHEET CHANNELGreenspan + afflusso di capitali dall’Asia =

riduzione dei tassi d’interesse abbondante liquidità sul mercato.

1999 2000 2001 2002 2003 20040

1

2

3

4

5

6

7

8

99

FEDERAL FUNDS TARGET RATE (EP) : United StatesUS CONVENTIONAL FIXED MORTGAGES

0

1

2

3

4

5

6

7

8

99The Greenspan Fed

Source: Thomson Datastream

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Il credit channel nella crisi sub-prime - 2

CAUSE MACRO DELLA CRISI: 1-BALANCE SHEET CHANNELIl costo dei mutui diminuisce e la domanda di case

aumentaEsuberanza irrazionale: in 5 anni prezzo case

raddoppia!

1999 2000 2001 2002 2003 2004 2005 2006 2007 200880

100

120

140

160

180

200

220

S&P/CASE-SHILLER HOME PRICE INDEX - 20-CITY COMPOSITE : United States

80

100

120

140

160

180

200

220CASE-SHILLER COMPOSITE

Source: Thomson Datastream

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Il credit channel nella crisi sub-prime - 3

CAUSE MACRO DELLA CRISI: 2-BANK LENDING CHANNEL

TABELLA XXEmissioni e cartolarizzazioni di mutui in Usa dal 2001 al 2006

Anno EmissioniCartolariz-

zazioniRatio Emissioni

Cartolariz-zazioni

Ratio EmissioniCartolariz-

zazioniRatio Emissioni

Cartolariz-zazioni

Ratio

2001 $190,00 $87,10 46% $60,00 $11,40 19% $430,00 $142,20 33% $1.433,00 $1.087,00 76%2002 $231,00 $122,70 53% $68,00 $53,50 79% $576,00 $171,50 30% $1.898,00 $1.442,60 76%2003 $335,00 $195,00 58% $85,00 $74,10 87% $655,00 $237,50 36% $2.690,00 $2.130,90 79%2004 $540,00 $362,63 67% $200,00 $158,60 79% $515,00 $233,40 45% $1.345,00 $1.018,60 76%2005 $625,00 $465,00 74% $380,00 $332,30 87% $570,00 $280,70 49% $1.180,00 $964,80 82%2006 $600,00 $448,60 75% $400,00 $365,70 91% $480,00 $219,00 46% $1.040,00 $904,60 87%

Fonte: Ashcraft A. and T. Schuermann (2007)

Subprime Alt-A Jumbo Agency

I mutui Usa dalle banche al mercato

Il processo di disintermediazione

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Il credit channel nella crisi sub-prime - 4

CAUSE MACRO DELLA CRISI: 2-BANK LENDING CHANNEL

Fragilità delle investment banks: 25% delle passività o/n

Perché costano meno

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Il credit channel nella crisi sub-prime - 5CAUSE MACRO DELLA CRISI: 2-BALANCE SHEET CHANNEL- le famiglie dagli standard creditizi più bassi (subprime) iniziano ad andare in default i prezzi delle case scendono e la bolla scoppia;

- nello shadow banking system le modalità di raccolta fondi a breve termine si congelano

- gli spread aumentano (specie su commercial paper)

- Da 1/7 a 31/8/07 S&P riduce rating di 1544 titoli garantiti da mutui residenziali crollo fiducia nei rating

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Il credit channel nella crisi sub-prime - 6CAUSE MACRO DELLA CRISI: 2-BALANCE SHEET CHANNEL- dopo poco tempo anche il mercato dei CDO si congela- le SIV, a corto di liquidità, si rivolgono alle banche

LA CRISI SUBPRIME: AGOSTO 2007Default mutui subprime Funding liquidity* Mismatching di scadenze:rollover risk (mercato Abcp e altri prodotti strutturati);

margin risk (primary brokers alzano margin requirements);

redemption risk (deflusso di depositi). Intervento delle Banche centrali (iniezioni di liquidità)

* facilità con la quale è possibile raccogliere denaro per l’acquisto di un’attività tramite l’emissione di obbligazioni garantite dall’attività stessa.

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Il credit channel nella crisi sub-prime - 7LA CRISI SUBPRIME: DICEMBRE 2007Deleveraging Market liquidity* La Fed interviene con la Term Auction Facility (TAF): nuove linee di credito alle banche commerciali; ampia gamma di garanzie collaterali; no effetto stigma.

* facilità con la quale è possibile vendere un’attività senza che il suo prezzo subisca variazioni di rilievo.

LA CRISI SUBPRIME: MARZO 2008 Bear Stearns rischia il fallimento La Fed interviene su più fronti:- salva la banca d’affari concedendo un prestito a JP Morgan

- nuovi strumenti per fornire liquidità ai primary dealers

Perché Bear Stearns non poteva fallire? Too interconnected to fail

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Il credit channel nella crisi sub-prime - 8

LA CRISI SUBPRIME: SETTEMBRE 2008 Il mese che ha cambiato il capitalismo Usa (e non solo):

il fallimento di Lehman Bros. apre il vaso di Pandora dopo pochi giorni viene invece salvata l’assicurazione AIG

ma forse anche Lehman era too interconnected to fail la crisi contagia l’Europa e il resto del mondo

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Il credit channel nella crisi sub-prime - 9LA CRISI SUBPRIME: IL RISCHIO DI CONTROPARTEQuattro fasi della crisi: le banche non si prestano più … rischia di bloccarsi il sitema dei pagamenti

J F M A M J J A S O N D J F M A M J J A S O N0

1

2

3

4

5

66

US EURO$ DEP. 3 MTH (BID,LDN)-US TREASURY BILL 2ND MARKET 3 MONTH (RH Scale)

TED SPREAD (LIBOR 3M - TBILL 3M)

Source: Thomson Datastream

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As months pass, contagion extends to other markets Emerging are initially spared but decoupling is a pious illusion

Heat Map: developments in systemic asset classes

Fonte: IMF, GFSR, Aprile 2009

International Contagion

HEAT MAP

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World Recession; less pronounced in emerging economies.

The 2009/2010 Forecast

Fonte: IMF, GFSR, Aprile 2009

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The global financial crisis triggered by the subprime is non the first one but (perhaps) the last in a long series of crises appeared from the 1980s & intensified in the 1990s

Financial crises gradually aggravated hitting the periphery first and then move on to the center of the financial system re-regulation is needed

But to re-regulate well we need to understand past errors

While conflicts of interests (a key part of the pre-crisis deviations of finance) will need to be addressed with some form of separation, three theoretical errors have made stabilization interventions destabilizing:

i) erroneous risk pricing models;ii) wrong “evolutionary” view of the financial system;iii) “irresponsible” monetary policy by the Fed.

The crises behind the crisis & destabilizing policies

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- The benefits offered by financial markets through diversification have been exaggerated by underestimating systemic risk.

- Starting from the base model - e.s. the Capital Asset Pricing Model - the assumption is made that sovereign risk is uncorrelated (orthogonal) to private risks.

- Through this it is possible deriving the CAPM fundamental formula:

ERi = r + βi(ERm – r)

where ERi is the equilibrium expected return on risky asset i, r is the risk free rate (approximated by the return on government securities), ERm

is the equilibrium expected return on the diversified portfolio and βi = cov(Ri , Rm)/var(Rm).

- The fallacy of this assumption of orthogonality of risks has become evident when governments had to intervene to salvage the banks in danger: the spreads on bank CDS lowered while those on sovereign CDS raised (following fig. 1) risk pricing models need be revised.

1. Erroneous risk pricing models

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Ballooning sovereign CDSThe financial-sovereign spread visibly lowers after Lehman

1. Erroneous risk pricing models

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The evolutionary view postulated that financial markets be more efficient than banks at managing risks, so that banks should move from the old model (lend & keep the loans, OTH) to the new model (lend & sell the loans, via securitization, OTD).

Banks’ role as certifiers of loan quality was neglected but that role was there only with OTH not with OTD granting loans to sell them rather then to keep them endangered banks’ incentives to perform in depth screening & monitoring of the borrowers, so that lending standards rapidly deteriorated.

And the evaluation of the creditworthiness of the loans underlying securitizations fell back on the rating agencies who founded such evaluation on past historical default rates, but these were based on OTH and, thus, the agencies systematically gave overly optimistic ratings.

2. Wrong “evolutionary” view of the financial system

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Il credit channel nella crisi sub-prime - 10

Da “originate to hold” a “originate to distribute”

SIV

$$$

debt debt

InvestitoriBancheFamiglie –

Imprese

debt

Agenzie di ratingTrue Sale

MortgageBrokers

ScreeningMonitoring

LE CAUSE MICRO: MORAL HAZARD & ADVERSE SELECTION

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For too long we had a “crossed-eye” theory of finance: Market theory based on complete markets & perfect

information; Financial intermediary theory based on asymmetric

information & delegated monitoring.

When, with liberalization, financial markets became dominating banks’ practice and even regulatory principles (e.g. IAS, Basel 2) moved toward financial market type activities while weakening banks’ credit function we applied to banks the theory which if adequate to financial markets is inappropriate to banks

It’s wrong subordinating banks to financial markets (and also the opposite would be a mistake) we need to build on the banks-markets complementarity (Allen & Gale, 2000).

2. Wrong “evolutionary” view of the financial system

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- The mix became explosive when the two previous mistakes – making lenders irresponsible – were compounded with the third: a monetary policy focused only on consumer price inflation which systematically ignored the enormous global imbalances that were cumulating: the US current account deficit rose from 1.5% of GDP in 1995 to beyond 6% in 2005-06.

- As a counterpart of the external imbalance US households took on excessive debt – rising from 71% of GDP in 2000 to 100% in 2007 – mostly against real estate (betting on its continuous appreciation) something that became a nightmare when house prices started falling.

3. “Irresponsible” monetary policy by the Fed

US DOLLAR REAL EFFECTIVE EXCHANGE RATE AND CURRENT ACCOUNT DEFICIT

-7.0

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.01995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

80.0

85.0

90.0

95.0

100.0

105.0

110.0

115.0

CURRENT ACCOUNT/GDP (%; left axis) REAL EFFECTIVE EXCHANGE RATE (right axis)

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Moreover, perhaps the great moderation of inflation of the last 15 years depends more on globalization (with production being relocated to lower cost of labor countries) than on the Central Banks’ credibility and the rigor of their monetary policies

It is useful to recall that:i) during the first globalization of the 1800s developed countries experienced a drop in their price level – 1.4% per year between 1865 and 1900 in the US – and not simply a lower increase in prices, i.e. a moderation of inflation

ii) then the international monetary system, based on the gold standard, ruled out discretionary monetary policy

i) & ii) together lead to doubt that, effectively, the discretionary monetary policies of the main Central Banks have been fundamental to lower inflation in the recent phase

3. “Irresponsible” monetary policy by the Fed

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We need to enlarge the focus of monetary policy with Central Banks not merely aiming at inflation while big imbalances grow

This takes us back to the mistakes made by the Fed who kept too low interest rates for too long while the US were cumulating their external debt

Furthermore, salvaging the LTCM hedge fund (in 1998) and lowering rates decidedly after the burst of the new economy bubble (in 2000), the Fed had heightened moral hazard for financial intermediaries, to the point that pundits described a kind of “Greenspan put”, i.e. an option with which if things went well they cashed in the profits and if things went awry the Fed would come to their rescue lowering interest rates

All in all, those stabilization policies were destabilizing because they were founded on theoretical mistakes

3. “Irresponsible” monetary policy by the Fed