Goff 2008 Financial Crisis Slides
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Transcript Goff 2008 Financial Crisis Slides
Getting to the Root of the Cause
MACROFINANCE CRASH OF 2008
Landmark Events in Crisis
Winter 2006-07
Real Estate Prices Fall
Summer 2007
Countrywide Mortgage in
distress
Fannie Mae, Freddie Mac in
distress
Summer-Fall 2007
British Lender Northern Rock
in bankruptcy
Spread between T-Bill and
LIBOR grows large
Recession begins
Spring 2008
Bear Stearns in distress
Summer 2008
Oil & other commodity prices
spike
September 2008
Lehman Bros. fails
AIG in distress
Parts of payments system
freezes; “Runs” on parts of
system
LIBOR; Commercial Paper
Wachovia (bank) in distress
Stock market plunges
Fed begins/expands unusual
interventions
Financial Stress Leading up to Sept 08
TED = T-Bill Rate – LIBOR (usually equal)
KCFSI = Kansas City Fed Financial Stress
Index
6
5
4
3
6
3.5
5
3.0
1
4
2.5
0
3
2.0
2
1.5
1
1.0
0
0.5
-1
0.0
-2
-0.5
2
-1
07M01
07M07
08M01
08M07
TED
09M01
09M07
KCFSI
90
92
94
96
98
00
TED (Libor -TB3)
02
04
06
KCFSI
08
Relative Size of Financial &
Macroeconomic Losses
Time Frame
Stock Market
Change (DIJA)
1907-08
Length
GDP Change
(Real)
Stock Change/
GDP Change
Highest
Unemp. Rate
-40%
13 months
-5%
8
8.00%
1919-20
-46%
15 months
-23%
2
11.30%
1929-33
-83%
43 months
-29%
3
25.20%
1937-38
-49%
15 months
-7%
7
19.10%
1946-48
-35%
21 months
-5%
7
4.00%
1973-75
-51%
25 months
-5%
10
9.00%
1978-82
-37%
48 months
-7%
5
10.80%
1987-88
-28%
5 months
>0%
NA
5.80%
2000-01
-18%
16 months
-1%
18
6.10%
2007-2009
-53%
16 months
-4%
13
10.10%
Key Questions
Cause/Effect
What was the gasoline, what was the match?
Responses
Get rid of gasoline?
Get rid of matches?
Store in safer places?
Answers
“The Gasoline” (Fuel)
Debt: very high amount relative to incomes/revenues
Includes but not limited to mortgage debt
Non-mortgage commercial loans a big part of the story
Amplified by “moral hazard”
Implied or explicit guarantees to banking/financial system
contributed to too much risk-taking, too much debt (TBTF)
“The Match” (Ignition)
Falling real estate prices & mortgage defaults beginning
in 2006-2007
Oil Price (and many other basic commodities) Spikes of
2008
Oil from $70/barrel to $145/barrel
Oil price spikes leading all but 1 post WWII recession
Income & Debt Constraints
Economy-wide Budget Constraint:
Income + Debt Value = Debt Payments + Consumption
Over the long run:
Debt Value = Debt Payment
“No Ponzi Game”
Consumption must be based on Income (not debt)
Debt at Root of Problem
Debt Growth (right-billions $); Debt/GDP (left)
4.0
60000
3.5
50000
3.0
40000
2.5
30000
Debt/GDP - left scale
2.0
20000
1.5
10000
U.S. Debt -- right scale
1.0
0
20
30
40
50
60
70
80
90
00
Mortgage Debt only Part of the Story,
Commercial Lending a Bigger Part
4.0
3.5
Total Debt/GDP
3.0
2.5
2.0
Non-house-govt/gdp
1.5
1.0
House-debt/gdp
0.5
Govt Debt/gdp
0.0
50
55
60
65
70
75
80
85
90
95
00
05
“Poster” Project for Commercial (nonmortgage) Debt (Artist Image)
$11 Billion City Center Project
Las Vegas – MGM Mirage
Bank Loan/Bond Funded
The Real Thing
Why So Much Attention on
Mortgage Debt?
Mortgage market was the first “on fire”
Many interpreted as “the cause”
Mortgage debt traded daily in markets
Quickly reflecting change in valuations
Info on this appearing by 2007
Commercial bank loans not traded in markets
Change in value reported slowly by banks over
time
Info on this not really appearing until into 2009
Causes of Debt/GDP Expansion:
Cheap Credit
9
8
7
6
5
1990-99
2003-07:7
4
3
2
1
0
Prime
AAA
BBB
Fed Funds
ComPaper
Causes of Cheap Credit:
Public Sector Backing of Debt
(Fannie Mae, Freddie Mac, and others)
9000
GSE Assets + Govt-MBS
(in Billions $)
8000
7000
6000
5000
4000
3000
2000
1000
90
92
94
96
98
00
02
04
06
08
Cheap Credit:
Foreign Investors Liked U.S.
.06
Capital Inflows Relative to GDP
.05
.04
U.S.
.03
.02
.01
.00
Euro Area
-.01
97 98 99 00 01 02 03 04 05 06 07 08 09
Causes of Cheap Credit:
Expansion of “Wholesale” Money Markets
Cheap Credit:
Wholesale Market Expansion
Cheap Credit:
Wholesale Market Expansion
Securitization, e.g. CDOs
Pooling mortgage (other debt) risk (CDOs, SPVs)
Credit Insurance
Transferring Risk (CDS)
Cheap Credit:
Fed Responsible?
20
16
Inflation Rate & Smoothed (HP Filter)
12
8
4
0
-4
-8
82 84 86 88 90 92 94 96 98 00 02 04 06 08
Limiting Future Problems?
Tradeoff: How to promote “sound” borrowing
and lending without promoting too much risk
taking
Tradeoff: How to provide insurance to system
(Fed) without promoting too much risk taking
Higher “Equity Standards” on loans
“Equity” = amount owners put in
Size-Risk Issues
Limit financial firm size?
Charge insurance fee based on size
More regulation or wiser regulation?
Code Fed Regulations already 200,000 pages; financial
regulation apx. 30,000