prof. ivo pezzuto's presentation of book "predictable and avoidable: lessons learned from...

Dr Ivo Pezzuto

Professor of Economics, Business Policy, and International Management

[email protected]

https://www.linkedin.com/in/drpezzutoivo

https://twitter.com/IvoPezzuto

Skype: i.pezzuto

Predictable and Avoidable: lessons learned from

the recent financial crises and how to help

prevent the next one

mailto:[email protected]

https://www.linkedin.com/in/drpezzutoivo

https://twitter.com/IvoPezzuto

Table of Contents

• Introduction

• Section 1: findings of the research and key lessons

learned from the crises

• Section 2: how to help prevent new systemic crises

and to create a more resilient financial system and a

new risk culture

© Copyright 2014 - Ivo Pezzuto – Predictable and Avoidable

Introduction: reasons behind the study


• To offer business students; academics; and industry

experts in the fields of finance, credit, risk management,

audit, corporate governance, economics, and regulation,

a truly independent and unbiased analysis of the

financial crises starting in 2007, and to contribute with

some original ideas and proposals to the debate about

the change needed in the banking and finance industries

and to supervisory frameworks, in order to enhance

regulatory mechanisms and to improve global financial

stability and sustainability.

• The study is the result of a two-year collaborative

research work undertaken by the author with the

precious support of prominent industry experts and

global thought leaders

Some of the organizations that have contributed

with their interviews to the study

Some of the thought Leaders

who have contributed to the book

Criteria for Selecting the Academic Thought

Leaders


• Scholars with prominent publications on risk

management, finance, economics, corporate governace,

regulation, CSR, and on the financial crises

• Seasoned academic career as full professor or

department chair

• Top ranking and/or award winning professorship in their

universities

• Willingness to openly express their opinion on the topics

of the study and independence of mind and spirit, without

the security of an anonymous interview

• Extensive industry advisory exposure and conference

lecturing

Criteria for Selecting the Industry Experts


• Seasoned “hands-on” expertise in the field of finance,

trading, economics, investment banking, risk

management, or board-level corporate governance of

financial institutions

• Willingness to openly express their opinion on the topics

of the study and independence of mind and spirit, without

the security of an anonymous interview

• Senior executive status or internationally recognized

financial and economic analysts with leading

organizations

• Speakers at international conferences on the topic of risk

management, finance, corporate governance, CRS,

financial regulation, financial crises, corporate cultures

• Authors of publications on the topics or contributor

Findings of the research and key lessons



• The root causes of the financial crisis were a

combination of multiple, complex, and highly interrelated

factors that build up over the years, which ultimately

resulted in the confidence and liquidity crisis

• Those factors, however, were originated by lax lending

standards and massive adverse selection; a badly

controlled expansion of innovative and "creative"

mortgage lending products and financial engineering

instruments/securitizations (Asset-Backed Securities -

ABS); excessive risk taking (and the transfer of risk of

the ABS to others through the sale of MBS and CDOs -

e.g. Originate-to-Distribute model);…………..




• …….a dramatic failure of financial firms’ corporate

governance, audit, risk management and regulatory

oversight; low interest rates; poorly rated assets classes

by rating agencies; conflicts of interest at all levels;

excessive and perverse executive and traders’

compensation schemes and incentives; a lightly

regulated and overleveraged shadow banking sector

(opaque, off-balance sheet operations on special

purpose vehicles - SPVs and SIVs, over-the-counter

derivatives' trading - e.g. CDS, RMBS, CDOs, CLOs,

structured finance and synthetic CDOs, and so on),

maturity mismatching for funding, and increased use of

methods helping to hide “tail-risks” (Pezzuto, 2008, 2010,

2013).



• The findings and the underlying assumptions reported in

my book of 2013 titled “Predictable and Avoidable” and in

my paper of 2008 titled “Miraculous Financial

Engineering or Toxic Finance?” have been confirmed in

January 2011 by the Final Report of the US Government

- Financial Crisis Inquiry Commission (FCIC, 2011).




The US FCIC (FCIC, 2011, pp. xvii – xxviii) in its final report

confirmed the following points:

• “We conclude that this financial crisis was avoidable;

• We conclude dramatic failures of corporate governance

and risk management at many systematically important

financial institutions were a key cause of this crisis;

• We conclude a combination of excessive borrowing, risky

investments, and lack of transparency put the financial

system on a collision course with crisis;

• We conclude the government was ill prepared for this

crisis, and its inconsistent response added to the

uncertainty and panic in the financial markets;”…….




The FCICI (FCIC, 2011, pp. xvii – xxviii) in its final report

confirmed the following points (continues….):

• “We conclude there was a systematic breakdown in

accountability and ethics;

• We conclude collapsing mortgage-lending standards and

the mortgage securitization pipeline lit and spread the

flame of contagion and crisis;

• We conclude over-the-counter OTC derivatives

contributed significantly to this crisis;

• We conclude the failure of credit rating agencies were

essential cogs in the wheel of financial destruction.”




Since 2009, big banks in the U.S. and Europe have paid at

least $128 billion to regulators (but a significant portion of

the fines and settlements paid have been tax-deductible as

a business expense), according to data compiled by the

Wall Street Journal, Reuters, and The Huffington Post for

issues tied to the housing collapse and other financial

misdeeds, including aiding and abetting money laundering

and tax evasion (Short, Gongloff, 2014).




On September 15th, 2008 the financial services firm

Lehman Brothers filed for Chapter 11 bankruptcy protection

mainly due to the eroding confidence in the valuation of its

assets by the repo counterparties who decided to drain

their liquidity supply thus leaving the investment bank

insolvent (Pezzuto, 2013; US Bankruptcy Court Southern

District of New York – Examiners’ report, 2010, pp. 2-14).




That dramatic event and other ones in the industry, which

followed the burst of three interconnected bubbles (e.g. US

housing bubble, mortgage lending bubble, and shadow

banking bubble), generated a liquidity conflagration in the

wholesale banking market (and writedowns) which, in

conjunction with massive credit ratings' downgrades and

investors' panic selling, have led to Wall Street’ biggest

crisis since the Great Depression (Pezzuto, 2013).



learned from the crises: three bubbles




Subprime Mortgage Market Growth and Share of Total Mortgage Market

Source: Inside Mortgage Finance (2007)



0

50

100

150

200

250

1900

1912

1925

1938

1951

1964

1977

1990

2003

An

nu

al

CP

I

No

min

al

Ho

me

Pri

ce

In

de

x

Source: Robert J. Shiller, Irrational Exuberance, 2nd. Edition, Princeton University Press, 2005, 2009

Nominal Home Price Index versus Annual CPI

Nominal Home Price Index Annual CPI

0

5

10

15

20

25

30

35

40

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59

Perc

en

t o

f o

rig

inal

bala

nce

in d

elin

qu

en

cy

Months from origination

2007

2006

2005

2004

2003



learned from the crises: delinquency rates

…everybody is happy!


…the burst of the bubbles and the property

market crash




As hundreds of billions in mortgage-backed securities went

bad, banks became suspicious of one another's

undisclosed potential credit losses and preferred to reduce

their exposure in the interbank markets. This withdrawal

caused the increase of interbank interest rates, spreads,

and credit default swaps, and massive credit crunch and

liquidity shortage. The bail-outs has had a sizable impact

on the countries’ sovereign debts (shifting the burden of the

risk generated by the burst of the three bubbles, the

meltdown of the financial sector, and the consequent 'Great

Recession' to the sovereign debt)


…from private debt to public debt!


…the spill-over effect of the financial

crisis and the ‘Great Recession’




The huge increase in sovereign debts and/or deficits has

triggered over the years additional crises (e.g. tail risk) or

fiscal challenges. This became quite evident in Europe in

2010 with the Euro Zone Debt Crisis in the peripheral

countries due to high sovereign debts, deficits, long

recession and slow GDP growth, lack of structural reforms

(pension, welfare, labor market, bureaucracy,

lobbies/corporatism, education, tax system, industrial

policy, and properly capitalized banks), lack of a single

crisis resolution mechanism; current account imbalances,

and in some countries, housing bubbles/high private debt

(Pezzuto, 2008; 2010).




In the Eurozone, in spite of a relatively anemic

growth/stagnation and very low inflation, the Sovereign

Debt as a percentage of GDP in 2013 was above 90%

versus the 60% rule of the Maastricht Treaty. In the USA in

2013 an emerging threat was the "Sequester, Fiscal Cliff,

and Debt Ceiling” while inflation was below target, the

economy was improving, and the S&P 500 index was

reaching new records (overvalued). The Sovereign Debt as

a percentage of GDP in the USA in 2013 was almost

doubled from approximately 60% of 2007 to approximately

110% of 2013 (Pezzuto, 2013). Even, the Fed's Balance

Sheet, thanks to the quantitative easing (“QE”) programs,

has increased to $4.4 trillion at the end of June 2014—five

times its pre-crisis size (Labonte, 2014). © Copyright 2014 - Ivo Pezzuto – Predictable and Avoidable

…the Euro zone Debt Crisis



learned from the crises: the new regulation

On July 21, 2010 a new comprehensive, high-level

regulation was signed into law in the USA (the Dodd-Frank

Wall Street Reform and Consumer Protection Act)

aiming to introduce a sweeping overhaul of US banking

rules and to help prevent the recurrence of a crisis similar

to the one of 2007 – 2009 or even worse




Even in Europe since 2010 regulators have introduced new

risk governance frameworks, regulations and compliance

rules (e.g. Basel III; Capital Requirements Directive -

CRD IV; Capital Requirements Regulation – CRR;

European Market Infrastructure Regulation – EMIR;

Mortgage Credit Directive 2014/17/EU; Markets in

Financial Instruments Directive - MIFID II and the

Markets in Financial Instruments Regulation - MiFIR;

Financial Transaction Tax – FTT; the European General

Data Protection Regulation; and Target 2-Securities –

T2-S, etc.) in order to enhance risk mitigation techniques,

to make the financial system more efficient, transparent,

and resilient to financial and economic shocks, and to

strengthen the protection of investors. © Copyright 2014 - Ivo Pezzuto – Predictable and Avoidable



The new regulation has improved risk governance and

supervisory authorities’ oversight, however, some scholars

and commentators believe that the new alleged

comprehensive and forward-looking regulation will not be

able to prevent the recurrence of other financial and

economic crises in the future. Some analysts even argue

that overregulating the financial services industry will

eventually lead to more complexity, bureaucracy,

fragmentation, and discretionary decisions. They also claim

that the overload of rules will also generate higher

operating costs and advisory fees for financial firms, more

ex-post supervisory controls for authorities, and more

“political” interference in the financial markets (e.g.

revolving doors, lobbying activity, power networks). © Copyright 2014 - Ivo Pezzuto – Predictable and Avoidable



(1) Is the new financial regulation able to help prevent the

recurrence of systemic crises and other bail-outs (rescue with

taxpayers’ money)?

(2) Have financial firms managed to strengthen their risk

culture, transparency, corporate governance's accountability,

and the risk appetite frameworks of their organizations?

(3) Are the record civil settlements so far reached between

major banks, the Department of Justice, the Securities and

Exchange Commission, and states’ attorneys-general,

adequate deterrents to help prevent future wrongdoings,

financial fraud charges, and to hold banks effectively

accountable for triggering financial crises?


How to help prevent new systemic crises and

to create a more resilient financial system and

a new risk culture


• Reducing conflicts of interest and “revolving doors”

• Making corporate governance more involved and

accountable for firm-wide risk management

• Risk-based and long-term oriented objectives/compensation

• Develop a stronger risk culture in financial firms

• ‘Bail-in regime’ and claw-backs in case of bank failures and

Crisis Resolution Schemes funded by financial institutions.

No more Bail-out

• Improved industry-wide systemic risk monitoring, stress

testing, and scenario analysis

• Separate trading from retail/commercial banking

• Assure adequate capital, liquidity, leverage ratios



a new risk culture


• Downsize shadow banking and improve transparency

• Make credit rating agencies more accountable

• Higher “skin in the game” requirements for securitization

• Avoid vicious circles between sovereign debt and

financial firms’ risk and implicit or explicit subsidies and

guarantees

• CROs, Compliance Officers, and Audit more connected

to top management, strategic decisions, and boards

• Harmonization of global regulation to avoid regulatory

arbitrages

• More press and media independence to guarantee a

more transparent and fair economic and political analysis



a new risk culture


• Structural reforms and fiscal consolidation plans in

countries with long-lasting structural problems, slow GDP

growth rates and high public debt and deficits as a

percentage of GDP

• Reduced inequality and income distribution to improve

consumption and economic growth

• Simplification of financial regulation and stronger

coherence with the real root causes of the financial crisis

in order to make it more effective and relevant

• Donations to parties and political leaders should be fully

transparent in order to reduce ‘secret’ lobbystic

pressures on political leaders



a new risk culture


• Individual criminal charges and industry bans for financial

misdeeds

• Enhanced early warning analytics (predictive analytics)

on systemic risks and in particular on the risk of

aggressive non-conventional monetary policies, inflated

asset classes, deregulations, geo-political risks,

externalities, and global imbalances

• Tighter control on the impact of loose policy exceptions

of financial regulation and currency wars

• Tighter control on emerging risks, bubbles, systemic

shocks, and potential boom-bust scenarios

Christine Lagarde, the managing director of

the International Monetary Fund, made the

following remark at the annual IMF and World

Bank meeting in Washington on October 12,

2014:


With regards to the disconnect

between economics and

markets, there is “too little

economic risk-taking (e.g.

capital expenditures and

lending), and too much

financial risk-taking.”

……….a short video on Shadow Banking

http://www.ft.com/intl/cms/s/0/89

7bf21a-52dd-11e4-9221-

00144feab7de.html?ftcamp=crm

/email/20141014/nbe/Companie

sBySector/product#axzz3G1DX

1tUF


References

• Labonte, M. (2014). Monetary Policy and the Federal

Reserve: Current Policy and Conditions. (US)

Congressional Research Service. RL30354. Retrieved

from http://tinyurl.com/m42zu8m

• Pezzuto, I. (2008). Miraculous Financial Engineering or

Toxic Finance? The Genesis of the U.S. Subprime

Mortgage Loans Crisis and its Consequences on the

Global Financial Markets and Real Economy. SMC

University Working Paper Series 2008. Retrieved from

http://tinyurl.com/7nwjwg7


http://tinyurl.com/m42zu8m

















References

• Pezzuto, I. (2010). Miraculous Financial Engineering or

Legacy Assets (Chapter 16) in Kolb, R.W. Lessons from

the Financial Crisis. Causes, Consequences, and Our

Economic Future. John Wiley & Sons, Inc.

• Pezzuto, I. (2013). Predictable and Avoidable: Repairing

Economic Dislocation and Preventing the Recurrence of

Crisis. Gower Publishing Limited.


References

• Short, K.; Gongloff, M. (2010, September 9). $128 Billion

In Bank Fines, In 1 Chart. The Huffington Post. Retrieved

from http://tinyurl.com/q3g7gqc

• The Financial Crisis Inquiry Commission (FCIC) (2011).

The Financial Crisis Inquiry Report. The US Government

Printing Office. Retrieved from http://fcic.gov/report

• US Bankruptcy Court Southern District of New York –

Examiner’s report (2010). Lehman Brothers Holdings Inc.

Chapter 11 Case No 08‐13555 (JMP). Report of Anton R.

Valukas Examiner. Volume 2 of 9. Retrieved from

http://tinyurl.com/cf2f9dd


http://tinyurl.com/q3g7gqc









http://fcic.gov/report














http://www.ictfworld.org/page/Prague2014Symposium

http://www.ashgate.com/isbn/9781409454458

http://www.eiu.com/industry/article/981340082/world-

finance-bookshelf-december-2013/2013-12-13

http://blog.iese.edu/antonioargandona/2013/12/13/dos-

escritos-sobre-la-crisis-economica-y-

financiera/#sthash.XX2QCLOr.dpbs

https://www.linkedin.com/pulse/article/20140730142213-

2250863-author-analyst-keynote-speaker-

lecturer?trk=prof-post

References


http://www.ictfworld.org/page/Prague2014Symposium

http://www.ashgate.com/isbn/9781409454458

http://www.eiu.com/industry/article/981340082/world-finance-bookshelf-december-2013/2013-12-13













http://blog.iese.edu/antonioargandona/2013/12/13/dos-escritos-sobre-la-crisis-economica-y-financiera/sthash.XX2QCLOr.dpbs















https://www.linkedin.com/pulse/article/20140730142213-2250863-author-analyst-keynote-speaker-lecturer?trk=prof-post















About the Author


About the Author

Catholic University of the Sacred Heart, Milan (Italy)

Adjunct Professor of Strategy, Innovation Management, International Business,

Multinational Management and Entrepreneurship. Since 2010

Member of ICRIM (International Center of Research in International Management),

Milan, (Italy). Since 2010

MIP Business School of Politecnico, Milan, (Italy)

Visiting Senior Lecturer and Guest Lecturer (seminars/MBA modules). Since 2007

ISTUD Business School, Baveno/Milan (Italy)

Senior Lecturer of Economics and Strategic Management (MBA modules/Executive

Education seminars). Since 2004

Economics and Scenario Analyst Commentator at CNBC Europe , London (UK)

Author of papers, articles, journal publications, book chapters and books, analyst

(industry and scenario), keynote speaker, and executive education trainer

Former senior executive in Europe at leading multinational corporations in

diversified industries (FIAT, American Express, Accenture, Citibank, Diners Club)


2007 – 2012 Swiss Management Center University, Zurich (Switzerland)

Degree: Doctor of Business Administration

2008 - 2008 ISTUD Business School, Milan (Italy)

Degree: Executive Development Program

2004 – 2005 SDA Bocconi School of Management, Milan (Italy)

Degree: MBA in General Management .

2003 – 2004 SDA Bocconi School of Management, Milan (Italy)

Degree: Master in Economics and Management (CEGA)

2000 – 2000 SDA Bocconi School of Management & CFMT, Milan (Italy)

Degree: Senior Executive Program in General Management

1999 – 2000 Accenture Center for Professional Education, Chicago (U.S.A.)

Degree: Experienced Executive Development Program

1985 – 1989 New York University Stern School of Business, N.Y.C. (U.S.A.)

Degree: Bachelor of Science in Business Administration

About the Author


Publications

Miraculous Financial Engineering or Toxic Finance? (2008)

Predictable and Avoidable: What’s Next? (2014)


Reviews

Predictable and Avoidable: Repairing Economic

Dislocation and Preventing the Recurrence of Crisis. By

Ivo Pezzuto. Gower; 438 pages

‘This insightful book written by Ivo Pezzuto, a professor of business

administration and a renowned expert on the global financial crisis, gives

an unbiased and fulsome analysis of the 2007 financial crisis and the

global economic dislocation that followed. Mr Pezzuto brings his work to

life by augmenting its technicalities with personal interviews with industry

experts and by interspersing his take on the mechanisms that contributed

to the crisis with its cultural, ethical and human impact. By exposing the

causes of the crisis, and putting forward ideas about the changes needed

in the banking and finance industry and in the regulatory structures

governing them, the author has written a valuable work of interest to

academics, industry experts and students alike.’

World: Finance bookshelf,

December 2013 © Copyright 2014 - Ivo Pezzuto – Predictable and Avoidable

Reviews

Predictable and Avoidable

‘Research Essential’ !

Predictable and Avoidable has been classified as ‘Research Essential’ by

Baker & Taylor YBP Library Services.

‘In this new Gower book, Professor Dr Ivo Pezzuto offers an independent

and unbiased analysis of the financial crises and one of the first fully

considered expositions of the financial, governance and regulatory reforms

needed for the future. With personal interviews involving selected global

thought leaders and industry experts, the book exposes the root causes

and demonstrates that the crisis we have seen was predictable and should

have been avoidable, and that a recurrence can be avoided, but only if

lessons are learned and the right action taken in relation to the banking

and finance industries and to supervisory frameworks and regulatory

mechanisms.’


Reviews

Dr. Antonio Argandoña, Emeritus Professor of IESE

Business School, Spain

‘A complete and detailed explanation of the financial crisis. There are

many popular descriptions of the current financial crisis. There are also

many more or less detailed and rigorous analyses of the causes,

consequences and solutions of the crisis. But when the student, the

teacher or the researcher needs a complete analysis, which includes all

the alternative explanations, a deep presentation of the consequences of

the crisis and an accurate study of the policies that have been adopted,

the number of available books is very limited. Dr Ivo Pezzuto’s Predictable

and Avoidable is one of those rare books that deal with this complex

subject in an affordable and complete way.’


Reviews

The book has been classified as 'Relevant Money Laundering and

Fraud Title' by the IMLPO (The Institute of Money Laundering

Prevention Officers) - the networking organisation for the UK's anti-

money laundering and financial crime prevention community.

In 2014 the book has been short-listed by The Chartered Management

Institute (CMI) for the “Management Book of the Year” Award. The

CMI in association with the British Library aim to celebrate the best of

management books published or distributed in the UK, from the most

inspiring to the most useful.

Predictable and Avoidable

‘Relevant Money Laundering and Fraud Title'


Reviews

‘Dr Pezzuto’s far-reaching and insightful book on the causes of and

cures for the financial meltdown of the late 2000s is a must read for

anyone who holds a position of trust. In particular, his comprehensive

table on the “Summary of Causes of the Financial Crisis and Actionable

Risk Mitigation Plans” is unparalleled in both form and function.’

John H. Nugent, School of Management, Texas Woman’s

University, USA

‘This exquisite book sheds a light on the facts that led to the biggest

financial crises since the Great Depression. Dr Pezzuto provides the

opportunity to understand the extreme risk taking, the excessive power

of the banks and the regulation failure. By using fact based evidences,

he proves that the biggest financial turbulence of this generation was

preventable.’

Daniela Milanese, journalist, Agência Estado, Brazil


Reviews

‘This book impressively fits a number of puzzle pieces of crisis analysis

right into a comprehensive structure of ethics and values that will be

necessary to shape a world without too much “pollution”, and it shows

that through the financial crisis also such a thing as “financial pollution“

became apparent. Highly recommendable at a specifically personal

level for leaders of all ranks.’

Peter H. Hoffmann, CEO, Evolta - Evolving Executive Careers /

Consulting and Development, and Prof. em. SMCU, Austria

‘This remarkable and insightful book shows the reader what really went

wrong, and why, in the global financial crisis. A fact-based and unbiased

perspective, robustly coupled with analytical insights, “connects the

dots” of all the events that led to the financial meltdown and its

aftermath. Based on the author’s own deductive reasoning, his

extensive research and his seasoned managerial experience, the book

is enriched with valuable “thought-leaders” insights on the crisis and

sound proposals for improved financial regulation.’

Asghar Aghili Dehkordi, Strategic Plans and Development Manager

at LG Electronics, Iran


Reviews

‘An excellent analysis of the causes of the recent financial crisis. Written

for a wide audience, this timely contribution educates the reader on the

main causes and effects of the recent financial crisis. It is an accurate

and comprehensive treatment of facts that led to the meltdown,

substantiated by the overwhelming evidence of various warnings that

went unheeded, and corroborated by inspiring interviews with academic

and industry experts. Predictable and Avoidable does not limit itself to a

sterile a-posteriori criticism, but describes concrete actions to take to

prevent the occurrence of similar catastrophic events in the future. A

must read!’

Fabio Mercurio, Head of Derivatives Research, Bloomberg LP, New

York, and Adjunct Professor, New York University, USA


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