Diapositiva 1 - Asociación de Antiguos Alumnos del CEMFI

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Asociación de Antiguos Alumnos CEMFI Noviembre 2008
International financial crisis:
origins and implications
CEMFI 25th November 2008
Daniel Navia
Head Economist Financial Scenarios Unit
1
Risks were massively underestimated
Price of AAA Subprime MBS with AAA rating and US sovereing debt
100
100
2 yr. Treasury
Bill
regulators, etc. judged and
80
80
AAA subprime
MBS
price
60
60
assets as if economic
Nov-08
Oct-08
Sep-08
Aug-08
Jul-08
Jun-08
May-08
Apr-08
Mar-08
Feb-08
Jan-08
Dec-07
Nov-07
Oct-07
Sep-07
Aug-07
Jul-07
Jun-07
May-07
20
Apr-07
20
Mar-07
40
Feb-07
priced a wide variety of
cycles were irrelevant
40
Jan-07
Investor, rating agencies,
Source: JP Morgan
Subprime is only one aspect of risk underestimation, it
goes far beyond…
2
Delinquency by Vintage. Subprime
Months after origination
Source: IMF
Delinquency by Vintage. Prime
Months after origination
Source: IMF
Standards were overly lax in “prime” forms of credit
3
Default Probability Implicit in 5yr.CDS
40%
Investors assumed that
35%
banks would never fail…
US Banks
30%
resulting in ultra-low
25%
credit risk spreads
20%
15%
10%
5%
Europe Banks
Oct-08
Jul-08
Apr-08
Jan-08
Oct-07
Jul-07
Apr-07
Jan-07
Oct-06
Jul-06
Apr-06
Jan-06
Oct-05
Jul-05
Apr-05
Jan-05
Oct-04
Jul-04
Apr-04
Jan-04
0%
Source: Datastream, BBVA ERD
Bank funding in bond/securitization markets was way too
cheap
4
Liquidity was artificially abundant
G7: real monetary policy rates*
5%
5%
4%
4%
EMU and US: 10yr. Sovereign Debt Real Yield
10%
10%
3%
3%
2%
2%
1%
1%
0%
0%
2008
2006
2004
4
7%
2002
1984
6
2000
8
1998
Developed Monetary Base
1996
10
Emerging Reserves
1994
12
1992
14
1990
Global liquidity: Size and Composition (% World GDP)
8%
US
EMU
1988
* PPP weighted
9%
9%
1986
2008
4%
2007
4%
2006
5%
2005
5%
2004
6%
2003
6%
2002
-1%
2001
-1%
2000
7%
1999
0%
1998
0%
1997
8%
1996
1%
1995
1%
1994
2%
1993
2%
1992
3%
1991
3%
2
Source: Datastream, Robert Shiller, BBVA ERD
0
1999
2007
Low risk free rates…strong credit demand and search for
AAA yield
5
A large number of agents
engaged in risky origination
Investors in primary ABS issuance. 2006
3%
23%
25%
activities and risky maturity
transformation strategies,
capitalizing on strong demand
for AAA paper
Direct financing
49%
Banks
Source: BIS
SIVs
Pension Funds and Insurance Companies
SIV financing
Other through ABCP
Ultra-easy
financing of asset
growth
Risk underestimation and regulatory failure led to ultraeasy financing conditions for expansive credit policies
6
EMU: Euribor-OIS Spread
350
350
300
300
Today
Before Crisis (Aug-07)
250
250
200
200
150
150
100
100
50
50
0
0
1M
3M
6M
Liquidity risks were also
undervalued
Investors simply assumed that
deep and well-functioning
markets would always be
present
12M
Source: Bloomberg, BBVA ERD
Optimism about market ability to withstand stress meant
that risks of unwinding positions were ignored
7
Massive leverage ensued
Ratio Total Financial Assets to GDP: U.S.
2.5
Apalancamiento
y partidas fuera
de balance
2.0
Bancos comerciales y
entidades de ahorro y
préstamo
1.5
US financial system assets
increased by more than
60pp (over GDP) since 2000
It took 25 years to achieve
1.0
60pp before this cycle
0.5
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
0.0
Source: Federal Reserve, BBVA ERD
Positive interpretations of leverage were misguided: the
global financial system was on an unsustainable path
8
Massive leverage ensued
European banks: Assets over Tangible Equity
80
70
Excessive leverage is not
60
1999
limited to the US, European
2007
50
banks have played the game
40
too
Average 2007 = 34
30
Average 1999 = 26
20
10
0
Bank
1
Bank Bank Bank Bank
2
3
4
5
Bank Bank Bank
6
7
8
Bank
9
Bank Bank Bank
10
11
12
Accounting and regulatory differences complicated a
correct diagnosis…but the illness is essentially the same
9
Current situation: self-reinforcing process
5.0
US, EMU, Japan aggregate: GDP growth
5.0
Implicit volatility
4.0
4.0
3.0
120
300
110
275
100
250
90
225
3.0
2.0
1) Global
recession
2.0
1.0
80
2) Risk
aversion
200
Fixed income
70
1.0
175
60
150
50
125
40
0.0
100
VIX
30
0.0
75
20
25
Currency
N-08
S-08
J-08
0
M-08
J-08
N-07
S-07
J-07
M-07
J-07
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
0
M-08
-1.0
M-07
-1.0
50
10
Interbank markets: 3 month rates
Spread (3M LIBOR -3M Monetary policy expectations)
US, EMU, Switzerland and UK: troubled bank assets*(us$bn)
Accumulated
350
25000
350
Bear
Sterns
300
20000
4) Banking
stress
15000
10000
3) Liquidity
tensions
300
Lehman
Brothers
250
250
200
200
150
150
EEUU
100
100
50
Nov-08
Sep-08
Oct-08
Jul-08
Jun-08
Jan-08
0
Apr-08
May-08
Assets of banks: 1) failed; 2) acquired; 3) receiving public capital as
part of rescue programs
0
Feb-08
Mar-08
Nov08
Oct-07
Oct08
Nov-07
Dec-07
Sep08
Sep-07
Aug08
Aug-07
Jul-08
Jun-07
Jul-07
Jun08
Apr-07
May-07
Mar- Apr-08 May08
08
Jan-07
Dec- Jan-08 Feb07
08
50
UEM
Feb-07
Mar-07
0
Aug-08
5000
10
Current situation: what can be done?
1) Global recession
- Use fiscal policy liberally
√ (but not enough in some European countries)
- Commit to persistently low official rates
√
2) Risk aversion
- Flexible attitude: trial and error
√ (but not enough in some European countries)
3) Liquidity tensions
- Full central bank liquidity in short-term maturities
- Revitalize medium-term funding markets
√
√ … key short-term challenge
4) Banking stress
- Public assumption of crisis costs via capital injections
√
- Re-estructuring and re-regulatinng the global financial system
NO… key
medium-term
challenge
11
Medium-term trends: protracted deleveraging
Ratio Total Financial Assets to GDP: U.S.
2.5
Leveraged & OffBalance Sheet
Finance
2.0
1.5
Calibrated
Commercial
banks + S&Ls
on balance
1.0
0.5
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
0.0
Source: Federal Reserve, BBVA ERD
Delicate equilibrium between avoiding short-term impact
and delaying necessary cleaning of balance sheets
12
Medium-term trends: risk aversion to persist
Calibrated CDS premia
80%
3.5%
Calibrated
70%
3.0%
LGD (left scale)
40
35
60%
2.5%
5yr.Default Prob.
(right scale)
50%
30
2.0%
40%
Calibrated
45
Before the crisis
1.5%
30%
25
20
15
1.0%
20%
Before the crisis
10
0.5%
10%
0%
0.0%
Before the crisis
Calibrated
5
0
Before the crisis
Calibrated
Source: BBVA ERD
Expect higher credit risk premia across the board…and
higher financing costs for non-financial corporates too
13
Medium-term trends: liquidity premia to persist
12 month EURIBOR components
6.0
October 2008
5.5
5.0
Before crisis
Liquidity +
credit risk
premium
4.5
4.0
3.5
Forecast
December
2009
3.0
2.5
2.0
Monetary
policy
expectation
(OIS)
1.5
1.0
0.5
0.0
Before crisis
October 2008
Forecast december 2009
Interbank market rates will be persistently higher relative
to monetary policy expectations
14
Medium-term trends: financing needs to become
key in market evaluation of agents
5-yr sovereign CDS and current account
over GDP
220
Ireland
Country CDS (y-axis)
A difficult financing
environment will weigh on the
prospects of countries/firms with
large external financing needs
Greece
170
Italy
Austria
Slovenia
120
Spain
Portugal
Belgium
France
Cost and term conditions to
Netherlands
70
Finland
Germany
worsen substantially
20
Current account (x-axis)
-30
-20
-15
-10
-5
0
5
10
Source: Datastream, Bloomberg
Strong market pressure on firms/countries to grow without
relying on external credit
15
International financial crisis:
origins and implications
CEMFI 25th November 2008
Daniel Navia
Head Economist Financial Scenarios Unit
16

Diapositiva 1 - Asociación de Antiguos Alumnos del CEMFI

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