La crisi originata dai mutui subprime e molto altro sullinstabilità finanziaria prof. Giovanni Ferri Economia delle scelte finanziarie e di portafoglio Lezione 9

2 This requires a paradigm shift In 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

3 The Political Economy Cycle of Finance Great Crash s Re-Regulation 1970s De-Regulation 1980s Latin American Crises 1990s Systemic Crises (Mexico-Asia-Japan) 1990s-2000s Mega Bankruptcies (LTCM, Enron, etc) 2007 Subprime Initial signals of instability Terminal part of the cycle

4 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 & economists theorize the beginning of a new Era (e.g. New Economy) Balance sheet channel Lending 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

5 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

6 Two spirals amplify subprime related losses. Initial losses (e.g. mortgage default) Funding problems Lower positions Prices diverge from fundamentals Higher margins Larger losses Market Liquidity & Funding Liquidity

7 Il credit channel nella crisi sub-prime - 1 CAUSE MACRO DELLA CRISI: 1-BALANCE SHEET CHANNEL Greenspan + afflusso di capitali dallAsia = riduzione dei tassi dinteresse abbondante liquidità sul mercato.

8 Il credit channel nella crisi sub-prime - 2 CAUSE MACRO DELLA CRISI: 1-BALANCE SHEET CHANNEL Il costo dei mutui diminuisce e la domanda di case aumenta Esuberanza irrazionale: in 5 anni prezzo case raddoppia!

9 Il credit channel nella crisi sub-prime - 3 CAUSE MACRO DELLA CRISI: 2-BANK LENDING CHANNEL I mutui Usa dalle banche al mercato Il processo di disintermediazione

10 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

11 Il credit channel nella crisi sub-prime - 5 CAUSE 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

12 Il credit channel nella crisi sub-prime - 6 CAUSE 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 2007 Default 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 lacquisto di unattività tramite lemissione di obbligazioni garantite dallattività stessa.

13 Il credit channel nella crisi sub-prime - 7 LA CRISI SUBPRIME: DICEMBRE 2007 Deleveraging 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 unattività 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 daffari concedendo un prestito a JP Morgan - nuovi strumenti per fornire liquidità ai primary dealers Perché Bear Stearns non poteva fallire? Too interconnected to fail

14 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 lassicurazione AIG ma forse anche Lehman era too interconnected to fail la crisi contagia lEuropa e il resto del mondo

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

16 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

17 World Recession; less pronounced in emerging economies. The 2009/2010 Forecast Fonte: IMF, GFSR, Aprile 2009

18 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

19 - 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: ER i = r + β i (ER m – r) where ER i is the equilibrium expected return on risky asset i, r is the risk free rate (approximated by the return on government securities), ER m is the equilibrium expected return on the diversified portfolio and β i = cov(R i, R m )/var(R m ). - 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

20 Ballooning sovereign CDS The financial-sovereign spread visibly lowers after Lehman 1. Erroneous risk pricing models

21 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

22 Il credit channel nella crisi sub-prime - 10 Da originate to hold a originate to distribute SIV $ $$ debt InvestitoriBanche Famiglie – Imprese debt Agenzie di rating True Sale Mortgage Brokers Screening Monitoring LE CAUSE MICRO: MORAL HAZARD & ADVERSE SELECTION

23 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 Its 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

24 - 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 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

25 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

26 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