here we went again the financial crisis of...
TRANSCRIPT
![Page 1: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/1.jpg)
HERE WE WENT AGAIN:THE FINANCIAL CRISIS OF 2007
AN OVERVIEW OF CONTRIBUTING CONDITIONS, INSTITUTIONS, POLICIES AND BEHAVIOURS
A Public Policy Armchair Series Presentationby Hale RamseyApril 14, 2011Facilitated by:
Johnson-Shoyama School of Public PolicySaskatchewan Public Service Commission
April 2011 1The Financial Crisis of 2007
![Page 2: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/2.jpg)
PRESENTATION OVERVIEW
April 2011 The Financial Crisis of 2007 2
• Crisis chronology• Contributing factors• Financial reforms• Outlook
![Page 3: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/3.jpg)
KEY POLICIES AND EVENTS2000 – 2008
April 2011 The Financial Crisis of 2007 3
Source: IMF
![Page 4: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/4.jpg)
CRISIS CHRONOLOGYTHE HOUSING PRICE “TRIGGER”
April 2011 The Financial Crisis of 2007 4
-8
-6
-4
-2
0
2
4
6
0
50
100
150
200
250
300
350
1987 1990 1995 2000 2005 2010
U.S. Housing Prices
Case-ShillerNational House Price Index (SA)
Q/Q per cent change (rhs)
Peak2006:1
SEC Net Capital Rule Change
Black September
![Page 5: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/5.jpg)
CRISIS CHRONOLOGYOWNERS/INVESTORS “HERD” EFFECT
April 2011 The Financial Crisis of 2007 5
Source: The Economist3 February 2011
![Page 6: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/6.jpg)
CRISIS CHRONOLOGYHISTORICAL ANOMALY
April 2011 The Financial Crisis of 2007 6
Source: The Economist5 March 2011
![Page 7: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/7.jpg)
CRISIS CHRONOLOGYSUNSHINE STATES “UNDERWATER”
April 2011 The Financial Crisis of 2007 7
Source: The Economist, 23 October, 2010
![Page 8: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/8.jpg)
CRISIS CHRONOLOGYU.S. ECONOMY
April 2011 The Financial Crisis of 2007 8
• Key dates:
-1,200
-900
-600
-300
0
300
600
900
1,200
1,500
1,800
-8
-6
-4
-2
0
2
4
6
8
10
12
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
U.S. Macroeconomic Overview 2000:Q1 to 2010:Q4Per Cent S&P 500
S&P 500 (rhs) Unemployment
Federal FundsInflation
Real GDP
![Page 9: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/9.jpg)
CRISIS CHRONOLOGYU.S. EMPLOYMENT
April 2011 The Financial Crisis of 2007 9
U.S. Employment
0
30
60
90
120
150
1939 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 20100
5
10
15
20
25
Source: U.S. Bureau of Labour StatisticsCES Survey, http://www.bls.gov/data/#employmentFeb 21, 2011
Private
StateFederal
Total Government Share (rhs)
Millions Per Cent
Total Employment Change 2007-20102007 Level: 137.6 - private: 8.8 (-7.0%) + gov: 0.3 (+1.2%) = change: -7.7 (5.7%)2010 Level: 129.8
April 2011 9The Financial Crisis of 2007
![Page 10: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/10.jpg)
CRISIS CHRONOLOGYU.S. FISCAL POLICY RESPONSE
April 2011 The Financial Crisis of 2007 10
-110
-88
-66
-44
-22
0
22
44
66
88
110
-50
-40
-30
-20
-10
0
10
20
30
40
50
1930 1940 1950 1960 1970 1980 1990 2000 2010
U.S. Federal Fiscal Aggregates (% of GDP)
Source: U.S. Federal Budget FY2012
Revenue
Spending
Budget Balance
Public Debt (rhs)
2007
April 2011 10The Financial Crisis of 2007
![Page 11: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/11.jpg)
CRISIS CHRONOLOGYU.S. MONETARY POLICY RESPONSE
April 2011 The Financial Crisis of 2007 11
-3
-2
-1
0
1
2
3
-3
-2
-1
0
1
2
3
2003 2004 2005 2006 2007 2008 2009 2010
U.S. Treasury Securities
FRB Bank Notes
Policy ActionsSecurities from
failing institutions
Policy ActionsDeposits credited
to failing institutions
Source: U.S. Federal Reserve Board
US Federal Reserve Assets & LiabilitiesUS$ Trillions
Assets
Liabilities
April 2011 11The Financial Crisis of 2007
![Page 12: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/12.jpg)
U.S. FINANCIAL CRISIS →WORLD ECONOMY …
April 2011 The Financial Crisis of 2007 12April 2011 12The Financial Crisis of 2007
-10.0
-5.0
0.0
5.0
10.0
15.0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Real GDP Growth (%) - Selected OECD Countries
Canada, France, Germany, Greece, Iceland, Ireland, Italy, Japan, Mexico, Norway, Portugal, Spain, Sweden, Switzerland, United Kingdom, United States, Euro area, Total OECDSource: OECD
![Page 13: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/13.jpg)
… AND TO GOVERNMENTS
April 2011 The Financial Crisis of 2007 13April 2011 13The Financial Crisis of 2007
-40.0
-30.0
-20.0
-10.0
0.0
10.0
20.0
30.0
1993 1995 1997 1999 2001 2003 2005 2007 2009 2011
OECD General Government Financial Balances (% of GDP)
Australia, Canada, France, Germany, Greece, Iceland, Ireland, Italy, Japan, Norway, Portugal, Spain, United Kingdom, United States, Euro area, Total OECDSource: OECD
![Page 14: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/14.jpg)
April 2011 The Financial Crisis of 2007 14
CONTRIBUTING FACTORS
• Theory, Research and Applied Tools• U.S Cultural View of Housing• International Capital Flows• Macro-prudential Surveillance• Micro-prudential Institutions• Income Inequality?
![Page 15: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/15.jpg)
THEORY AND RESEARCHSEE NO EVIL, HEAR NO EVIL?
April 2011 The Financial Crisis of 2007 15
“Until very recently, the study of banking crises has typically focused on earlier historical experiences in advanced countries, mainly the banking panics before World War II, or else has focused on modern-day emerging market experiences. This dichotomy is perhaps shaped by the belief that for advanced economies, destabilizing, systemic, multi-country financial crises were a relic of the past. Of course, the recent global financial crisis emanating out of the United States and Europe has dashed this misconception, albeit at great social cost.”
Source: Banking Crises: An Equal Opportunity MenaceReinhart & Rogoff, December 17, 2008
April 2011 15The Financial Crisis of 2007
![Page 16: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/16.jpg)
CONTRIBUTING FACTOR: THEORYKEYNES ON THEORY IN POLICY
April 2011 The Financial Crisis of 2007 16
“Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back … the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest.”
John Maynard Keynes, The General Theory of Employment, Interest, and Money, 1936Concluding Notes, V, para. 2
![Page 17: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/17.jpg)
RATIONAL EXPECTATIONSHYPOTHESIS ORIGIN
April 2011 The Financial Crisis of 2007 17
• John Muth, 1961• alternative to adaptive expectations• linked peoples’ subjective expectations to mathematical expectations
• enabled policy analysis with “mathematical precision”
• dominant academic view in 1970s-80s• applied in public policies (1980s on)• The Economist, Wrong, INET, Nov 22, 2010
April 2011 17The Financial Crisis of 2007
![Page 18: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/18.jpg)
RATIONAL EXPECTATIONSPOPULAR INTERPRETATION & USE
April 2011 The Financial Crisis of 2007 18
Markets are:• always right
• market prices are best forecasts• always efficient
• efficient markets hypothesis• self-regulating
• regulation only imposed costs• self-correcting
• discretionary fiscal and monetary policies = inflation
April 2011 18The Financial Crisis of 2007
![Page 19: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/19.jpg)
RATIONAL EXPECTATIONSSECOND THOUGHTS
April 2011 The Financial Crisis of 2007 19
“We were all drinking the Kool-aid, Greenspan was tending bar, Bernanke and the academic establishment were supplying the liquor,”Ajay Kapur, Managing Director,Deutsche Bank, (2009 research report)
April 2011 19The Financial Crisis of 2007
“Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief.” Alan Greenspan, Oct 2008
![Page 20: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/20.jpg)
RATIONAL EXPECTATIONSA MORE MODERATE VIEW
April 2011 The Financial Crisis of 2007 20
“ … it is not difficult to sketch a theory of rational price speculation based on a microeconomic model of the housing market.” “Rational expectations provide a useful departure point for analyzing the implications of various alternative assumptions; it is the beginning not the end.”
Rational Expectations, Steven M. Sheffrin, Cambridge Surveys of Economic Literature, 1983, p.170
April 2011 20The Financial Crisis of 2007
![Page 21: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/21.jpg)
THE “CLASSIC TEXTBOOK” MARKET FAILURES
April 2011 The Financial Crisis of 2007 21
• Imperfect competition• Public goods• Externalities• Informational asymmetries• Moral hazard • Principal-agent problem• Efficiency ≠ income equity
![Page 22: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/22.jpg)
CONTRIB. FACTOR: RESEARCHFINANCIAL CRISES ARE NOT RARE
April 2011 The Financial Crisis of 2007 22
Reinhart and Rogoff, 2008• study of crises from 1800 forward• “serial” crises in financial centers (U.K., U.S., and France)
• incidence similar in high- and middle-to-low-income countries
• close links with asset (house and stock) price cycles, financial market liberalization, degree of capital mobility
![Page 23: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/23.jpg)
HISTORICAL PRECEDENTSRECENT EXAMPLES
April 2011 The Financial Crisis of 2007 23
• 1977 – Spain• 1984 (start) – U.S. Savings and Loans • late 80s - early 90s – Nordic countries• 1992 (start) – Japan • 1994-5 – Mexico, Argentina• 1997-8 – Asia, Russia, Columbia• 2001 – Argentina• 2002 – Uruguay
Source: Banking Crises: An Equal Opportunity MenaceReinhart & Rogoff, December 17, 2008
![Page 24: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/24.jpg)
HISTORICAL PRECEDENTSPOST-1900
April 2011 The Financial Crisis of 2007 24
Source: Banking Crises: An Equal Opportunity MenaceReinhart & Rogoff, December 17, 2008
![Page 25: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/25.jpg)
CONTRIB. FACTOR: MODELSECONOMIC AND FINANCIAL NOT LINKED
April 2011 The Financial Crisis of 2007 25
• Macroeconomic standard:• DSGE (dynamic stochastic general equilibrium)
• Do not incorporate financial sector• Financial standard:
• VaR (value-at-risk)• Financial balance sheet focus• Micro focus, capture 1st round effects only
![Page 26: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/26.jpg)
MODELSCOMMON PROBLEMS
April 2011 The Financial Crisis of 2007 26
• All built on correlations• Increasing complexity => sensitivity• Distributions not normal, but used in practice
• Improbable events discounted to zero• Models developed using data from an era of low volatility and stable correlations
![Page 27: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/27.jpg)
CONTRIBUTING FACTOR:U.S. CULTURAL VIEW OF HOUSING
April 2011 The Financial Crisis of 2007 27
“Any discussion of housing policy in this country must begin with some recognition of the importance Americans attach to homeownership. Our society has taken steps to encourage homeownership. Tax incentives, mortgage insurance from the Federal Housing Administration, and other government policies all contributed to a long rise in the U.S. homeownership rate--from 45 percent in 1940 to a peak of 69 percent in 2004.”
Ben S. Bernanke, Chairman, Federal Reserve, Arlington, Virginia, October 25, 2010
![Page 28: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/28.jpg)
U.S. CULTURAL VIEW OF HOUSINGHISTORICAL HOME OWNERSHIP RATE
April 2011 The Financial Crisis of 2007 28
64.0
69.066.9
30
40
50
60
70
80
90
100
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
U.S. Home Ownership Rate
Source: U.S. Census Bureau
Decennial Annual
1994 2004
Federal Housing
Administration1934
Fannie Mae1938
Freddie Mac1970
![Page 29: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/29.jpg)
U.S CULTURAL VIEW OF HOUSINGTHE AMERICAN DREAM – ORIGINAL
April 2011 The Financial Crisis of 2007 29
“The American Dream is that dream of a land in which life should be better and richer and fuller for every man, with opportunity for each according to ability or achievement. … It is not a dream of motor cars and high wages merely, but a dream of social order in which each man and each woman shall be able to attain to the fullest stature of which they are innately capable, and be recognized by others for what they are, regardless of the fortuitous circumstances of birth or position.”
James Truslow Adams, Epic of America, 1931
![Page 30: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/30.jpg)
U.S. CULTURAL VIEW OF HOUSINGFISCAL POLICY SUPPORTS
April 2011 The Financial Crisis of 2007 30
Mortgage interest deductibility (MID)• Federal
• Second-largest “tax expenditure”• Employer health premiums largest
• Valued at $104.5 B (FY2011,OMB)• 26% tax savings (Hilber & Turner, 2010)
• States – varied applications• up to 9% tax savings
Capital gains exemption• Principal residence (first $250 K)
![Page 31: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/31.jpg)
U.S. CULTURAL VIEW OF HOUSINGFISCAL POLICY SUPPORTS
April 2011 The Financial Crisis of 2007 31
Stated policy objective: increase home ownership
Realized outcomes: (Hilber & Turner, 2010)• MID capitalized into house prices
• increased ownership rates for high income earners
• low income earner ownership unaffected, but face higher prices
• MID ineffective policy tool to increase home ownership, but does raise prices.
![Page 32: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/32.jpg)
U.S. CULTURAL VIEW OF HOUSINGFINANCIAL MARKET INSTITUTIONS
April 2011 The Financial Crisis of 2007 32
• Federal Housing Administration (FHA, 1934)
• insures lenders against homeowner default
• sets minimum standards for insurable loans (ex: down payments)
• Government Sponsored Enterprises (GSEs)
• Fannie Mae (1938), Freddie Mac (1970)• Secondary mortgage market
![Page 33: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/33.jpg)
U.S. CULTURAL VIEW OF HOUSINGGOVERNMENT-SPONSORED ENTERPRISES
April 2011 The Financial Crisis of 2007 33
• GSEs – Fannie Mae, Freddie Mac• Private (shareholder) ownership• Public mandate (support housing finance)
• Exempt from state and local taxes, line of credit from U.S. Treasury (implicit government guarantee, low cost of funds)
![Page 34: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/34.jpg)
U.S. CULTURAL VIEW OF HOUSINGLEGISLATED HOUSING MARKET SUPPORT
April 2011 The Financial Crisis of 2007 34
• Community Reinvestment Act (CRA), • passed 1977; required banks to lend in local markets, predominantly minority areas; initially no explicit lending goals; modest regulator enforcement
• Clinton administration raised pressure on regulators to enforce CRA during 1990s
![Page 35: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/35.jpg)
U.S. CULTURAL VIEW OF HOUSINGLEGISLATED HOUSING MARKET SUPPORT
April 2011 The Financial Crisis of 2007 35
• 1992: Federal Housing Enterprise Safety and Soundness Act
• Directed Department of Housing and Urban Development (HUD) – develop affordable housing goals for Fannie, Freddie and monitor progress
• Mandated 42% of assets in 1995; 50% in 2000 (Clinton), 56% in 2004 (Bush)
• Support across political lines
![Page 36: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/36.jpg)
U.S. CULTURAL VIEW OF HOUSINGLEGISLATED HOUSING MARKET SUPPORT
April 2011 The Financial Crisis of 2007 36
Source: Financial Crisis Inquiry ReportJanuary 2011
![Page 37: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/37.jpg)
U.S. CULTURAL VIEW OF HOUSINGPOLITICAL SUPPORT - FHA
April 2011 The Financial Crisis of 2007 37
• Clinton administration reduced FHA qualifying down payment to 3% in 2000, raised max size of eligible mortgage for guarantee, halved premiums charged to borrowers.
• FHA criteria tended to be pro-cyclical during housing price run-up
![Page 38: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/38.jpg)
U.S. CULTURAL VIEW OF HOUSINGPOLITICAL SUPPORT - FHA
April 2011 The Financial Crisis of 2007 38
2006
0
2
4
6
8
10
12
14
16
18
0
100
200
300
400
500
600
700
800
1980 1985 1990 1995 2000 2005 2010
FHA Conforming Loan Limits - Fannie Mae
High-CostGeneralGrowth % (rhs)
Source: Fannie Mae
$Thousands Per Cent
![Page 39: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/39.jpg)
INVESTMENT/MARKETCHARACTERISTICS OF HOUSING
April 2011 The Financial Crisis of 2007 39
• Non-income producing asset• Indivisible• Depreciation rate about 1%/yr• Illiquid (vs stocks/bonds)• No short sale mechanism• Thinly-traded market• Subject to momentum• High transaction costs• High leverage (loan-to-value)April 2011 39The Financial Crisis of 2007
![Page 40: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/40.jpg)
HOUSING OWNER / INVESTORCHARACTERISTICS & BEHAVIOUR
April 2011 The Financial Crisis of 2007 40
• Perceive houses as safe asset• Emotional attachment• Focus on balance sheet• Poor cost accounting• Unwillingness to realize losses• Financial (il)literacy: subprime
April 2011 40The Financial Crisis of 2007
![Page 41: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/41.jpg)
CONTRIBUTING FACTOR:INTERNATIONAL CAPITAL FLOWS
April 2011 The Financial Crisis of 2007 41
• Free international capital flows associated with banking crises
• Post-WWII to 1970 period: restricted international flows + fixed exchange rates (Bretton-Woods)• Reduced period of banking crises
• Post-1970: free capital flows and flexible exchange rates – more crises
• Free markets argued to be best allocator of capital across borders
![Page 42: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/42.jpg)
INTERNATIONAL CAPITAL FLOWSFLOWS AND CRISES HISTORY
April 2011 The Financial Crisis of 2007 42
Source: Banking Crises: An Equal Opportunity MenaceReinhart & Rogoff, December 17, 2008
![Page 43: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/43.jpg)
INTERNATIONAL CAPITAL FLOWSDEFICITS: U.S. HH AND CURR. ACC.
April 2011 The Financial Crisis of 2007 43
• In early1990s:• U.S. current account deficit rises• Net household saving decreases
• becomes negative in late 1990s• General correlation (+) observed between current account deficit and household saving
• Question: internally or externally driven?
![Page 44: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/44.jpg)
INTERNATIONAL CAPITAL FLOWSU.S. HH SAVING AND CURRENT ACC.
April 2011 The Financial Crisis of 2007 44Source: IMF Performance in the Run-Up to the Financial and Economic CrisisIMF, January 10, 2011
![Page 45: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/45.jpg)
INTERNATIONAL CAPITAL FLOWSTHE U.S. “SPENDTHRIFT” VIEW
April 2011 The Financial Crisis of 2007 45
• Initial internal cause hypothesis:gov deficits + ↑HH consumption• should have caused lower $US and higher U.S. interest rates
• some decline in $US observed, but lower interest rates and more foreign lending occurred to finance U.S. current account deficit
![Page 46: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/46.jpg)
INTERNATIONAL CAPITAL FLOWSTHE EXTERNAL “SAVINGS GLUT” VIEW
April 2011 The Financial Crisis of 2007 46
• External “savings glut” hypothesis:• Bernanke, 2005• Developing countries saving (net goods exporters-China, oil exporters-Middle East, safe harbour in event of repeat financial crisis-Asia) – build-up of foreign exchange reserves
• Globally, savings = investment, so developing country CA surpluses must have developed country CA deficits
![Page 47: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/47.jpg)
CONTRIBUTING FACTORS I:CAPITAL FLOWS (“SAVINGS GLUT”)
April 2011 The Financial Crisis of 2007 47
Source: “When a flow becomes a flood”The Economist, print edition, January 22, 2009
![Page 48: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/48.jpg)
INTERNATIONAL CAPITAL FLOWSTHE EXTERNAL “SAVINGS GLUT” VIEW
April 2011 The Financial Crisis of 2007 48
• Foreigners willing to fund U.S. current account deficit – see U.S. as safe haven
• Money flows into U.S. – securities flow out
• Foreigners seek safety and returns above U.S. T-bill rates – creates demand for safe, high-return securities
• U.S. financial “alchemy” turns sub-prime mortgages into supply of high-yield, “A” rated MBS and CDOs
![Page 49: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/49.jpg)
CONTRIBUTING FACTOR:MACRO-PRUDENTIAL SURVEILLANCE
April 2011 The Financial Crisis of 2007 49
• IMF produces worldwide economic and financial system analysis• “surveillance” role
• From 2004-2007, IMF reports provided some risk indications (current account imbalances could lead to rapid decline in $US and recession)
• But, overall “banner” message (Apr/07) was one of “continued optimism within a benign global environment” (IEO, Jan 10, 2011, p5)
![Page 50: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/50.jpg)
MACRO-PRUDENTIAL SURVEILLANCEIMF ANALYSIS PRIOR TO CRISIS
April 2011 The Financial Crisis of 2007 50
• Confident that past decade of economic stability would continue
• Endorsed policies and financial practices that fostered rapid innovation and growth
• Reported that financial markets were sound and large financial institutions could weather any likely problem
• All would be proven wrongSource: IMF Performance in the Run-up to the Financial and Economic Crisis: IMF Surveillance in 2004-07Independent Evaluation Office of the International Monetary Fund, January 10, 2011
![Page 51: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/51.jpg)
MACRO-PRUDENTIAL SURVEILLANCEIMF ANALYSIS OF ITS FAILURES
April 2011 The Financial Crisis of 2007 51
• Main findings of IMF’s IEO:• “Groupthink” – cognitive bias among homogeneous, cohesive groups to consider issues only within a certain paradigm and not challenge its basic principles
• The paradigm? Market discipline, self-regulation, crises unlikely in advanced economies, sophisticated financial markets need little regulation
![Page 52: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/52.jpg)
MACRO-PRUDENTIAL SURVEILLANCEIMF ANALYSIS OF ITS FAILURES
April 2011 The Financial Crisis of 2007 52
• Disincentives to raise contrarian views or “speak truth to power”• Staff felt that strong contrarian views could “ruin one’s career”
• Conforming assessments not penalized, even if proven wrong
• Self-censorship became prevalent• “Silo operations”: staff tended not to share information or seek advice outside their units (“turf battles”)
![Page 53: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/53.jpg)
CONTRIBUTING FACTOR:MICRO-PRUDENTIAL INSTITUTIONS
April 2011 The Financial Crisis of 2007 53
• At the country level, legislative and regulatory institutions serve to provide prudence within and across markets and organizations (micro-prudential).
• U.S. financial market regulatory change began in early 1980s
• Several significant changes in the decade preceding the crisis
![Page 54: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/54.jpg)
MICRO-PRUDENTIAL INSTITUTIONSFINANCIAL MARKET REGULATION
April 2011 The Financial Crisis of 2007 54
• Nov 1999: Gramm-Leach-Billey Act• repeal of Glass-Steagall (1933) (p.55, FCIC)
• bank holdcos (Citigroup, JP Morgan, BofA) now in same areas as “Big 5” investment banks (Goldman Sachs, Morgan Stanley, Merrill Lynch, Bear Stearns, Lehman Bros.): securitization, OTC derivatives, insurance, stock & bond underwriting (p.56, FCIC)
![Page 55: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/55.jpg)
MICRO-PRUDENTIAL INSTITUTIONSFINANCIAL MARKET REGULATION
April 2011 The Financial Crisis of 2007 55
• Dec 2000: Commodity Futures Modernization Act (p.48 FCIC report)
• Deregulated OTC derivatives market, removed oversight by CFTC and SEC
• Large increase in market:• 2000: $3.2T (gross market value); $95.2T (notional)
• 2008: $20.3T (gross market value); $672.6T (notional)
• Derivatives positions used to lower capital requirements under Basel I, measured using VaR models (p,49 FCIC Report)
![Page 56: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/56.jpg)
MICRO-PRUDENTIAL INSTITUTIONSFINANCIAL MARKET REGULATION
April 2011 The Financial Crisis of 2007 56
• Apr 2004: SEC Net Capital Rule• EU (2002) required “Big 5” investment banks to have single regulator to operate in Europe (p.150, FCIC)
• Two existing options: Fed, OTS• “Big 5” proposed SEC option –proprietary VaR models to determine regulatory capital – reduced req’ts
• Not SEC area (investor protection, vssupervision), staff of 10 to 24
![Page 57: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/57.jpg)
MICRO-PRUDENTIAL INSTITUTIONSRATING AGENCIES
April 2011 The Financial Crisis of 2007 57
Provide credit quality:• information (aggregators, asym.info)• monitoring (costly for investors)• certification (in cap. req’ts, thresholds)Market structure: oligopoly (legal, SEC)• 10 U.S. NRSROs, 3 dominant firms
• price and market share competition• “issuer-pay”, “issuer-choice” market• conflict of interest potential – issuer can “ratings-shop”; rater can cut quality
![Page 58: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/58.jpg)
RMBS STRUCTURESUBPRIME AAA
April 2011 The Financial Crisis of 2007 58April 2011 58The Financial Crisis of 2007
![Page 59: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/59.jpg)
SECURITIZATION PROCESS
April 2011 The Financial Crisis of 2007 59April 2011 59The Financial Crisis of 2007
Source: US Federal Deposit Insurance Corporationhttp://www.fdic.gov/news/news/speeches/archives/2007/chairman/spapr1707.html
![Page 60: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/60.jpg)
MICRO-PRUDENTIAL INSTITUTIONSRATING AGENCIES
April 2011 The Financial Crisis of 2007 60April 2011 60The Financial Crisis of 2007
• “A” ratings crucial to investor acceptance of structured MBS, CDOs
• Investor acceptance crucial to rating agency revenue & profits
• Moody’s data: (FCIC Report, p.146)• 2000 – 33% total rev.; 26% profit• 2006 – 44% total rev.; 37% profit
• Quantity and value of issues increased• 2004 – 220 issues; $90B value• 2007 – 717 issues; 326B value
![Page 61: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/61.jpg)
MICRO-PRUDENTIAL INSTITUTIONSRATING AGENCIES
April 2011 The Financial Crisis of 2007 61April 2011 61The Financial Crisis of 2007
• Increase in agencies’ workload and revenue, no more staff or resources• lost staff to CDO firms (25% in 2005)• could not do “meaningful research”
• Model (joint probability) correlations for CDOs unavailable (short history)• MBS correlations used as proxies• added to view of CDOs as “safe”• uncritical investor acceptance
![Page 62: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/62.jpg)
MICRO-PRUDENTIAL INSTITUTIONSRATING AGENCIES
April 2011 The Financial Crisis of 2007 62April 2011 62The Financial Crisis of 2007
• Correlated decline in real estate values led to downgrades of MBS, CDOs• 2007: 20% of CDOs downgraded• 2008: 91% of CDOs downgraded• 3x ↑ in assumed model correlations
• MBS, CDO downgrades led to capital impairment in financial firms, leading to forced asset sales, feeding stock market decline … “cliff effect” (IMF)• self-perpetuating downward cycle
![Page 63: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/63.jpg)
MICRO-PRUDENTIAL INSTITUTIONSRATING AGENCIES
April 2011 The Financial Crisis of 2007 63April 2011 63The Financial Crisis of 2007
• Proposed reforms (IMF, Oct 2010)• remove regulatory rating references where “cliff effects” occur, make investors rely on own due diligence
• oversee raters same as banks• restrict “ratings shopping” (possibly assign raters to complex issues)
• Some voluntary movement from raters• unsolicited ratings
![Page 64: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/64.jpg)
MICRO-PRUDENTIAL INSTITUTIONSMARK-TO-MARKET ACCOUNTING
April 2011 The Financial Crisis of 2007 64
• Financial instruments valued at point-in-time market prices as opposed to book (historical) values or modeled (future) expected values• “Market is always right” POV• Works if markets are liquid and stable … • … but not if illiquid and volatile.
![Page 65: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/65.jpg)
MICRO-PRUDENTIAL INSTITUTIONSMARK-TO-MARKET ACCOUNTING
April 2011 The Financial Crisis of 2007 65
• Can add to pro-cyclicality in volatile or illiquid markets – “cliff effect”• Effects recognized during crisis (Sep 2008) FASB Statement No. 157, Fair Value Measurements clarification
• Illiquid market rule change (Apr 2009) FASB Staff Position FAS 157-e rule change on determining if a market is illiquid
![Page 66: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/66.jpg)
MARK-TO-MARKET ACCOUNTINGPOST-CRISIS OBSERVATIONS
April 2011 The Financial Crisis of 2007 66
“… at times, marking securities at market prices “creates situations where you have to go out and raise physical capital in order to cover losses that as a practical matter were never really there.”
Financial Crisis Inquiry Report, p.227
![Page 67: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/67.jpg)
MARK-TO-MARKET ACCOUNTINGPOST-CRISIS OBSERVATIONS
April 2011 The Financial Crisis of 2007 67
“Mark-to-market conventions forced lower valuations, which in turn led to fire sales of assets and a self-fulfilling vicious circle of lower valuations, higher volatilities, and larger haircuts.”
Global Financial Stability Report, IMF, October 2010, p.63
![Page 68: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/68.jpg)
MARK-TO-MARKET ACCOUNTINGPOST-CRISIS EVENTS
April 2011 The Financial Crisis of 2007 68
• Some evidence of “rule-skirting”• Lehman Bros. used purchase/repurchase agreements near quarter-end MtM to show reduced leverage (“Repo 105”)
• Lehman auditors, Ernst and Young facing fraud lawsuit
![Page 69: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/69.jpg)
CONTRIBUTING FACTOR:INCOME INEQUALITY?
April 2011 The Financial Crisis of 2007 69
• Correlation between bank failures (financial crises), income inequality, financial (de)regulation and income inequality in U.S. history.
David Moss, Harvard Business School, August 2010
“The study of income inequality--its causes, its consequences, and its potential policy implications--has a long history in economics, although it has not always had a high profile among researchers and policymakers.”
Alan Greenspan, Jackson Hole, Wyoming, August 28, 1998
![Page 70: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/70.jpg)
INCOME INEQUALITYREGULATION & BANK FAILURE LINK?
April 2011 The Financial Crisis of 2007 70
![Page 71: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/71.jpg)
INCOME INEQUALITYINCOME TAX LINK?
April 2011 The Financial Crisis of 2007 71
0
500,000
1,000,000
1,500,000
2,000,000
2,500,000
0
20
40
60
80
100
120
1916 1921 1931 1941 1951 1961 1971 1981 1991 2001 2011
U.S. Federal Top Marginal Tax Rates& Income Share of Top 0.01% of Income Earners
Income Tax
Capital Gains
Income Threshold
Income Share of Top 0.01%(scaled to 1916=100)
![Page 72: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/72.jpg)
COUNTING THE COSTSMORE THAN JUST “BAILOUTS”
April 2011 The Financial Crisis of 2007 72
• Costs of financial crises tend to focus on direct bank bailout costs (government expense)
• Ignores effects on government revenue and consequent deficits/debt
• Also, economic and social costs
April 2011 72The Financial Crisis of 2007
![Page 73: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/73.jpg)
April 2011 The Financial Crisis of 2007 73
GOVERNMENT REVENUEDECLINES …
Source: Banking Crises: An Equal Opportunity MenaceReinhart & Rogoff, December 17, 2008
![Page 74: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/74.jpg)
April 2011 The Financial Crisis of 2007 74
… AND GOVERNMENT DEBTRISES
Source: Banking Crises: An Equal Opportunity MenaceReinhart & Rogoff, December 17, 2008
![Page 75: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/75.jpg)
LOOKING FORWARDHOW LONG TO RECOVER?
April 2011 The Financial Crisis of 2007 75
Reinhart and Rogoff (2008) present estimates for 18 post-WWII antecedent banking crises in advanced economies
April 2011 75The Financial Crisis of 2007
VariablePeak-to-Trough
ChangeDuration of Downturn
Per Cent Years
House Prices (real) - 35.5 6.0Equity Prices (real) - 55.9 3.4Unemployment Rate * + 7.0 4.8GDP (real, per capita) - 9.3 1.9
* Trough-to-peak
![Page 76: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/76.jpg)
LOOKING FORWARDFINANCIAL REFORMS
April 2011 The Financial Crisis of 2007 76
• Dodd-Frank Act (July 21, 2010)• regulator consolidation• systemic risk evaluator• liquidation authority
• Basel III (Dec 19, 2009 proposed)• higher capital requirements• greater liquidity requirements• central clearing of derivatives
• IMF capital controls (Apr 5, 2011)• “policies to manage [capital] inflows”
![Page 77: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/77.jpg)
LOOKING FORWARDBARRIERS TO REFORM
April 2011 The Financial Crisis of 2007 77
• Regulatory implementation hurdles• governments face budget constraints• political discussion often “binary”
• Regulations’ success can lead to removal of regulation (seen as no longer needed)
• Regulation effectiveness metric of static economic efficiency at odds with dynamic risk-taking and with income distribution
April 2011 77The Financial Crisis of 2007
![Page 78: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/78.jpg)
LOOKING FORWARDWILL IT WORK?
April 2011 The Financial Crisis of 2007 78
• Will current reforms prevent future financial crises?• Given past experience: No.
• Recent crisis has the hallmarks of many past crises: capital mobility, financial market liberalization, asset price inflation
• Past attempts at controls have failed• Memories fade, not inherited: “next time, it will be different”
April 2011 78The Financial Crisis of 2007
![Page 79: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/79.jpg)
QUESTIONS, COMMENTS?
April 2011 The Financial Crisis of 2007 79
![Page 80: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/80.jpg)
MAJOR REFERENCES
April 2011 The Financial Crisis of 2007 80
Financial Crisis Inquiry Commission. The Financial Crisis Inquiry Report, Final Report Of The National Commission On The Causes Of The Financial And Economic Crisis In The United States, Official Government Edition. January 2011
Hilber, Christian A. L. and Turner, Tracey M. The Mortgage Interest Deduction and its Impact on Homeownership Decisions. August 12, 2010, draft.
International Monetary Fund. Recent Experiences in Managing Capital Inflows—Cross-Cutting Themes and Possible Policy Framework. February 14, 2011
International Monetary Fund, Independent Evaluation Office. IMF Performance in the Run-Up to the Financial and Economic Crisis: Bilateral Surveillance of the United States, Background Paper. December 9, 2010
International Monetary Fund, Independent Evaluation Office. IMF Performance in the Run-Up to the Financial and Economic Crisis: IMF Surveillance in 2004-07. January 10, 2011
International Monetary Fund. Global Financial Stability Report. October, 2010
Rajan, Raghuram G. Fault Lines: How Hidden Fractures Still Threaten The World Economy
Reinhart , Carmen M. and Rogoff, Kenneth S. The Aftermath of Banking Crises. December 19, 2008, draft.
Reinhart , Carmen M. and Rogoff, Kenneth S. Banking Crises: An Equal Opportunity Menace. December 17, 2008.
April 2011 80The Financial Crisis of 2007
![Page 81: HERE WE WENT AGAIN THE FINANCIAL CRISIS OF 2007users.accesscomm.ca/.../Material/FinCrisisPres-JSSPP.pdf · 2018. 3. 15. · Ben S. Bernanke, Chairman, Federal Reserve, Arlington,](https://reader036.vdocuments.site/reader036/viewer/2022063018/5fdd5d9b08b09d599516d51e/html5/thumbnails/81.jpg)
MAJOR REFERENCES
April 2011 The Financial Crisis of 2007 81
Sheffrin, Steven M. Rational Expectations. Cambridge Surveys of Economic Literature. 1983.
Greenspan, Alan. The Crisis. April 15, 2010.
Moss, David. Comments on Bank Failure/Regulation/Inequality Chart. August 2010.
Piketty, Thomas and Saez, Emmanuel. Income Inequality in the United States, 1913–1998. The Quarterly Journal of Economics. February 2003.
U.S. Internal Revenue Service. U.S. Individual Income Tax: Personal Exemptions and Lowest and Highest Bracket Tax Rates, and Tax Base for Regular Tax. http://www.irs.gov/taxstats/article/0,,id=115033,00.html (Tables 23, 24)
United States Federal Budget , FY2011
The Economist. Various Issues.
April 2011 81The Financial Crisis of 2007