Transcript Past and future of financial markets

AUGUR stakeholder’s workshop, 17-18 November 2011
WP2: Financial markets
The transformation of international
financial markets 1971-2011-2030
Analysis and scenarios
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
Post WWII bank-centred financial crises
Germany, US
UK
Spain and Germany
Canada
United States
Norway
Australia
Finland and Sweden
UK
Japan
France
United States
United States, UK, Germany
Eurozone
1974
1974
1977
1983
1984
1987
1989
1991
1991
1992
1994
1998
2007
2011?
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
Transformation of financial markets
1971-2011-2030
• Globalisation of international financial market: new
institutions new products
• Creation of an international sovereign bond market
• Growth in total volume of assets traded relative to GDP (and
consequential changes in the size and composition of bank
balance sheets).
• Loss of sovereign status and then of quasi-sovereign status for
members of the Eurozone
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AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
Post-liberalisation growth of markets
• The ratio of forex trading to international trade in goods and
services plus long term investment rose from 2:1 to 80:1 today
• Overseas sales of US bonds rose from 3% of US GDP in 1970
to 200% in the early 2000s.
• Overseas sales of UK bonds rose from nil in 1970 to 1000% of
UK GDP in the early 2000s.
• The stock of assets traded in global markets exceeds 3 times
OECD GDP
• Banks’ balance sheets are now around 20 times greater,
relative to the given underlying gdp, than was the case in 1978.
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
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AUGUR stakeholder’s workshop, 17-18 November 2011
Growth in total volume of assets traded
relative to GDP
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AUGUR stakeholder’s workshop, 17-18 November 2011
Short Intermediation Chain
mortgage
households
deposits
mortgage bank
households
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AUGUR stakeholder’s workshop, 17-18 November 2011
Long Intermediation Chain
households
households
MMF shares
mortgage
money market fund
mortgage pool
Short-term
paper
MBS
ABS
ABS issuer
Repo
securities firm
commercial bank
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
Gross debt matters
• Netting impossible when assets and liabilities do not
match.
• Lehman Bros OTC CDS book had gross notional
value of $72bn, net $5.2bn
• AIG CDS book had notional value of $270bn,
actual losses $3bn – but collateral required against
gross figure.
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
Repos and Financial CP as Proportion of M2
(Source: US Federal Reserve)
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
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AUGUR stakeholder’s workshop, 17-18 November 2011
Overnight Repos and M2 (weekly data)
(Normalized to 1 on July 6th 1994. Source: Federal Reserve)
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
Short-term funding in the EU
Of the 90 banks covered by the recent European
Banking Authority stress tests, for example, need
to refinance €5,400bn of debt in the next two
years, equivalent to 45 per cent of European
Union gross domestic product.
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
Loss of sovereign status and then quasisovereign status for members of the Eurozone
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
Public debt to GDP %
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
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AUGUR stakeholder’s workshop, 17-18 November 2011
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
Quasi-sovereign status
• Taking Canada, Japan, the US, and the UK together, the
overseas proportion of public borrowing is around 12%.
• Taking Belgium, France, Germany, Greece, Ireland, Italy,
Portugal and Spain together, around 50% of public debt is
funded by foreign lenders.
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
Eurosystem and the repo market
Two serious errors:
first, the assignment of all eligible eurodenominated sovereign debt instruments issued by
the Eurozone central governments to the same
(highest) liquidity category.
second, the excessive increase in the
valuation haircut when the remaining maturity of
the collateral increases.
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
Moral hazard 2005?
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AUGUR stakeholder’s workshop, 17-18 November 2011
Turnover (lending plus borrowing)
in the euro interbank money market
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AUGUR stakeholder’s workshop, 17-18 November 2011
Share of euro-denominated euro
area central government bonds
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AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
Outstanding amounts (lending plus
borrowing) in European repo markets
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
Capital flight: claims of euro area members from netting of
Euro System cross-border payments. €bn at end 2010
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AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
Public or private debt
Banks did what they were encouraged to do
– bought sovereign euro debt.
Do markets care more about debt, or about
recession?
Where is the risk ultimately held? How
many extra links in the chain?
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
Scenarios
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AUGUR stakeholder’s workshop, 17-18 November 2011
Scenario One: Muddling through
• European finances dominated by austerity (whether
or not eurozone survives intact).
• Regulatory measures to increase bank capital and
liquidity result in a fall in bank lending, and some
growth of shadow banking.
• Continued austerity in the US, squeezed by
government financing concerns that are a function of
continued growth in balance of payments deficit.
• Eastern countries do not fully implement Basel III.
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
Scenario Two: bi-polar world
• US-China economic rapprochement results in higher growth in
US and sustained expansion in China and SE Asia.
• Within national jurisdictions (including the EU) there are new
measures introduced to limit the destabilising impact of wholesale
financial markets. These include pro-cyclical provisioning,
leverage collars, liquidity rules, and a variety of devices to
separate commercial banking from investment banking.
• These regulatory actions are not accompanied by any new
approach to macro-economic imbalances. The pressures of
international bond markets continue to exert deflationary
pressures on deficit countries. Continued EU austerity.
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
Scenario Three: regional balances
• Regional groupings emerge that seek to stabilise macro-financial
relationships within the region. These groupings comprise not just the EU
and NAFTA, but also new groupings in Asia and Australasia. The
international environment is characterised by negotiation between regional
groupings.
• Concerted macro-economic policy is accompanied by common measures to
limit instability generated by financial markets, notably by quantitative
controls on the expansion of wholesale funding (leverage collars and the
like) and by regulation of liquidity.
• Over the next 20 years the dollar remains the predominant international
currency, but the relative decline of the United States and the
regionalisation of the world economy, steadily weakens the dollar’s
position, resulting in destabilising swings in financial markets.
• There is a clear divergence of interest between East and West.
• Within the eurozone a single eurobond is established with a concerted
eurozone wide treasury function.
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR
AUGUR stakeholder’s workshop, 17-18 November 2011
Scenario Four: international management
• A World Financial Authority is established to regulate
financial markets. The WFA has treaty powers inherited from
the IMF, and an approach to regulation based on the structures
of the Financial Stability Board, i.e. bringing together
regulators, central banks and treasury departments.
• The WFA has wide ranging policy making powers and there
are agreed enforcement procedures mediated through national
jurisdictions.
• There is a concerted attempt to limit the cyclical instability
generated by wholesale financial markets, via a levy on noncore funding and tight leverage controls. International
imbalances are tackled by expansionary policies in surplus
countries.
• There are symmetric penalties in surplus and deficit countries.
DG Research and Innovation, CDMA building, 21 rue Champ de Mars, Brussels
AUGUR