us & eu linkages: how did they contribute to the crisis?

The current banking crisis (EU and US linkages)Dr Stephen Kinsella, UL | stephenkinsella.netSummer School Lecture, August 19th, 2009

3 Ideas.

History of regulation matters most in explaining crisis.

1/3

US/EU Linkages much stronger

than in previous crises, very bad

thing.

2/3

Implementation of regulation will not

be effective enough to

mitigate crisis of 2020’s.

3/3

But before all that...

Where are we now?

[US/EU GDP per capita, 1990-2007]

See http://research.stlouisfed.org/fred2/series/M2?cid=29

http://research.stlouisfed.org/fred2/graph/?s[1][id]=EXUSEU

Oh Dear. How did this happen?.

History of regulation matters most in explaining crisis.

1/3

History

See ft.com, http://ec.europa.eu/index_en.htm for details

Current vs proposed regulatory changes

EU


EU

US


US/EU Linkages much stronger

than in previous crises, very bad

thing.

2/3

Chapter 2The Financial Services Industry Has Undergone Dramatic Changes

Page 45 GAO-05-61 Financial Regulation

Figure 2: International Debt Securities, 1987-2004

The financial services industry—firms, markets, and products—have been an integral part of the globalization trend. At present, firms have a greater capacity and increased regulatory freedom to cross borders, creating markets that either eliminate or substantially reduce the effect of national boundaries. U.S.-owned financial services firms have increased their international activities, and a significant number of foreign-owned financial services companies are operating within the United States. In banking, for example, Citibank has substantial and growing retail banking activities in Germany and ING Direct, a Dutch-owned company, has a large deposit base in the United States. In the securities sector, in 2003 U.S. investors held $2.5 trillion of foreign securities, and foreign holdings of U.S. securities other than U.S. Treasury securities rose to $3.4 trillion. In the insurance sector, a significant portion of U.S. insurers and the U.S. market are now foreign controlled. In 2001, 142 U.S. life insurers were foreign-owned, up from 69 in 1995. And, according to the International Insurance Institute, from 1991 to 1999, sales by foreign-owned property-casualty insurers doing business in the United States grew by 62.8 percent.

Deregulation and technological change have facilitated globalization. Barriers that once limited international financial transactions have been substantially reduced or removed, and greater computing power and better

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

200420032002200120001999199819971996199519941993199219911990198919881987

Dollars in billions

Source: Bank for International Settlements.

See http://www.ecb.int/stats/services/latest/html/index.en.html



Figure 3: Share of Assets in Each Sector Controlled by 10 Largest Firms, 1996-2002

605550454035302520

65

105

15

0

Source: TowerGroup.

Property/casualty insurance

Life insurance

Commercial banks

Securities firms

Savings institutions

Percent

1996 1997 1998 1999 2000 2001 2002

Increased Market concentration by financial sector

Large financial institutions have consolidated by merging with or acquiring other companies in the same line of business.

Next Slide Shows Merger Activity among

banks, 1990-2004



Figure 4: Merger Activity among Banking Organizations, January 1990-June 2004

1990-1995 1996 1997 1998 1999 2002 200420012000

CiticorpEuropean American BankUniversal Bank, N.A.

First Interstate BancorpWells Fargo & CompanyNorwest Holding Company

Wells Fargo & Company Wells Fargo& Company

Source: GAO.

J.P. MorganChase & Co.

American National

American National Bank and Trust Company of ChicagoBanc OneFirst CommerceFirst ChicagoNBD Bancorp

First Chicago NBDFirst Chicago NBD

Bank One

Bank One

Chase ManhattanJ.P. Morgan & Co.

Chemical BankingManufacturers Hanover

J.P. Morgan Chase & Co.

Chemical BankingChase Manhattan

United States National Bank of Oregon

Mercantile Bancorporation

First Bank SystemU.S. Bancorp

U.S. Bancorp

FirstarU.S. Bancorp

Firstar

CitigroupCitigroup

Maryland National Bank

BankAmerica

Boatmen's National Bank of St. Louis

Continental BankSecurity Pacific Bancorporation Northwest

C & S/Sovran

Barnett Banks

BankAmerica

NationsBankNationsBank

Bank ofAmerica

NatWest Bank National Association

BancBoston HoldingsBay Banks

Fleet Financial GroupBank of New EnglandShawmutSummit BancorpUJB Financial

BankBoston

FleetBoston Financial

FleetBoston FinancialFleet Financial Group

Fleet Financial Group

Summit

BankAmerica

NationsBank

NCNB National Bank of Florida

Philadelphia National Bank

Central Fidelity National Bank

First Fidelity

Signet

Wachovia

First UnionFirst Union

Wachovia

Wachovia

First Union

Meridian BankCorestates Financial Corestates Financial

Corestates Financial

[Linkages matter]

Implementation of regulation will not

be effective enough to

mitigate crisis of 2020’s.

3/3

[Minsky]

Minsky Moments

Idea: Credit markets will breed their own reversal

Minsky Moments1. How?

1. Cheap interest rates lead to increased lending.

2. This leads to increases in leverage (Loan/Deposit ratio).

3. Perverse incentives breed dodgy lending via financial innovations (Junk bonds/CDOS/etc) ensues.

4. Something changes, dodgy loans default, banks fail, unless they get bailed out by Big Bank/Big Govt.

Minsky cycle

Five stages in Minsky’s model of the credit cycle:

1. displacement,

2. boom,

3. euphoria,

4. profit taking, and

5. panic.

Leverage Cycles

In a crisis, collateral rates matter

In 2006, average leverage was 16:1

Meaning: buyers paid down only $150 billion and borrowed the other $2.35 trillion.

See “The Leverage Cycle by John Geanakoplos”, http://cowles.econ.yale.edu/P/cd/d17a/d1715.pdf

Crises?

The current banking crisis (EU and US linkages)Dr Stephen Kinsella, UL | stephenkinsella.netSummer School Lecture, August 19th, 2009

us & eu linkages: how did they contribute to the crisis?

Education