from the end of bretton woods to the global financial crisis: 40 years of turbulence
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From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence. Risk Management Conference. Dr. Hugo Bänziger The European Association for Banking & Financial History 13.06.2014. Presentation Outline. 30 Years of Stability followed by 40 Years of Turmoil - PowerPoint PPT PresentationTRANSCRIPT
Dr. Hugo BänzigerThe European Association for Banking & Financial History13.06.2014
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of TurbulenceRisk Management Conference
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 2
1. 30 Years of Stability followed by 40 Years of Turmoil
2. The Business Model of Banks after Bretton Woods
3. The Forces which undid Bretton Woods
4. 1973 and its consequences
5. Early Days of Risk Management
6. The Derivatives Revolution, Value-at-Risk and Fair-Value Accounting
7. Latam Debt, Scandinavia, Tequila, Asia, Dot com bubble, Russian Default etc.
8. Risk Management matures …
9. … and fails in the Global Financial Crisis
10. Conclusions
Presentation Outline
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 3
30 Years of Stability followed by 40 Years of TurmoilDid Risk Management Make a Difference?
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 4
1. 30 Years of Stability followed by 40 Years of Turmoil
2. The Business Model of Banks after Bretton Woods
3. The Forces which undid Bretton Woods
4. 1973 and its consequences
5. Early Days of Risk Management
6. The Derivatives Revolution, Value-at-Risk and Fair-Value Accounting
7. Latam Debt, Scandinavia, Tequila, Asia, Dot com bubble, Russian Default
8. Risk Management matures …
9. … and fails in the Global Financial Crisis
10. Conclusions
Presentation Outline
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 5
March1933, Bank Holiday & Emergency Banking Act• Bank Recapitalisation & Resolution Power
March 1933, Securities Act• Regulation of primary market (underwriting)• Mandatory registration & prospectus,
transparency requirements
June 1933, Glass-Steagall Act • Separation of investment & commercial banks• Federal Deposit Insurance Corporation (FDIC)• Regulation Q & Large Exposure Limits• Regulatory Reporting & Supervision
June 1934, Securities & Exchange Act• Establishment of SEC, Regulation of secondary
trading (stocks, bonds) and Exchanges
June 1935, Banking Act (FED Reform)
The US Financial System after 1933Segregation, Deposit Insurance, Supervision & FED Reforms
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 6
Bretton Woods Conference in 1944 with 44 allied signatory countries
3 Pillars of Bretton Wood System• Free Trade (GATT, 1947 in Geneva)• Fixed Exchange Rates & Capital Controls (IMF)• Development & Recovery (IBRD, World Bank)
All currencies pegged to USD USD pegged to gold at $35.-/oz Pegs & capital controls were adjustable Adjustments for France, Germany and UK With international recovery, trade volume
increased faster than gold supply Gold pools after 1961 to defend USD peg US was the world’s central banker
The Bretton Woods SystemStable Exchange Rates, Bail-out Mechanism, USD as Gold substitute
source: Oono K, www.grips.ac.jp
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 7
Banks in Europe and AsiaEmerging from the Ashes of World War II
Germany & Japan were bankrupt after WW II. Banks were largely worthless
Inflation was rampant until the currency reform of 1948 and the pegging in 1949
Japan created the Keiretsu system to finance the reconstruction via BoJ
Germany used its Landesbanken Bank lending was the key instrument Cross-shareholdings and -directorship
limited risks of loan portfolio France nationalised banks in 1945 The UK saw a sharp contraction of its
economy after World War II Capital controls across Europe & Asia
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 8
The Banking Business Model 1945 to 1973Simple, stable and highly regulated
Banks were national and had few other assets than loans & cross-shareholdings
Deposit rates were regulated No interest or foreign-exchange risk Investment banks were partnerships Limited international capital mobility Sub-due level of IPOs & bond offerings Limited secondary trading – if any Tightly regulated risks on balance sheets Banks organised in branches & regions Every country supervised banks Business & risk management identical
source: Du, L. (2014), C
ambridge Judge B
usiness School
Source: R. W. Goldsmith (1965), National Bureau of Economic Research
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 9
1. 30 Years of Stability followed by 40 Years of Turmoil
2. The Business Model of Banks after Bretton Woods
3. The Forces which undid Bretton Woods
4. 1973 and its consequences
5. Early Days of Risk Management
6. The Derivatives Revolution, Value-at-Risk and Fair-Value Accounting
7. Latam Debt, Scandinavia, Tequila, Asia, Dot com bubble, Russian Default
8. Risk Management matures …
9. … and fails in the Global Financial Crisis
10. Conclusions
Presentation Outline
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 10
New Developments in the 1960sReturn of Capitalist Dynamics
President Johnson’s ‘Big Society’ program & Vietnam War root cause of US inflation
EEC and Japan made currency convertible in 1958 and 1964 respectively
1963: Interest Equalisation Tax – large USD amounts build up outside US
1963: Italian Autostrade issues the first USD denominated Eurobond
To lower funding cost, US corporates re-discover Commercial Papers for ST debt
Banks counter by offering convenience accounts and Certificates of Deposits
1959: IBM offers computer service centers NYSE allows members to go public in 1970
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 11
The End of Bretton Woods1961 – 1971 From Stable to Floating Currencies 1960s see a negative US balance of payment,
the increase in international trade and the return of large international capital flows
1965: banks begin to establish large international loan-underwriting syndicates
Bretton Woods’ gold pools partially successful 1967: Sterling devaluation after run on £ 1968: US Congress repeals 25% gold covery
ratio for US Dollar 1968: France & other countries start to increase
holding of physical gold 1971: Nixon unilaterally closed the ‘gold window’
– gold convertability ends 1973: Japan & EEC let their currencies float The once stable asset classes of fixed income
(bonds) & foreign exchange become volatile Luckily, most banks still operate domestically
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 12
1. 30 Years of Stability followed by 40 Years of Turmoil
2. The Business Model of Banks after Bretton Woods
3. The Forces which undid Bretton Woods
4. 1973 and its consequences
5. Early Days of Risk Management
6. The Derivatives Revolution, Value-at-Risk and Fair-Value Accounting
7. Latam Debt, Scandinavia, Tequila, Asia, Dot com bubble, Russian Default
8. Risk Management matures …
9. … and fails in the Global Financial Crisis
10. Conclusions
Presentation Outline
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 13
1973 and its ConsequencesThe World becomes volatile
Black Scholes Model for valuation of options
Chicago Board of Options Exchange First Mobile Phone Call ATMs rolled out all over the US President Nixon resigns Yom Kippur War Oil Shock – Recessions return IBM S/370 and HP 9800 spread in
the banking industry Glass fibre optic cables invented It becomes possible to handle large
trading volumes
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 14
The Oil ShockImpact on Financial Markets
Because US oil production peaked around 1970, OPEC oil embargo lead to sharp re-pricing of oil & energy in 1973
The significantly increased $ proceeds flowed primarily to the interbank market and gave the City of London a boost
The $ liquidity needed to be invested – lending to Less Developed Countries
The flow provided the backbone for the significant growth in syndicate lending
Eurodollar bond market took off (CSFB) US Investment Banks expand to Europe New financial centers around the globe:
Frankfurt, Hong Kong, Singapore
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 15
Information Technology and CommunicationChanging the Dynamics of Banking
1981: IBM 5150 Personal Computer WordPerfect, Lotus 1-2-3, PowerPoint,
Access became widely used applications Rapid decline of processing cost 1977: 1st fibre optic cable in California 1986 SOFFEX (EUREX) 1st electronic
options & futures trading platform 1988: 1st trans-atlantic cable All banks invested heavily in technology IT systems followed accounting process;
regional set-up with monthly closing of the bank’s books
IT systems were hardcoded, embedding data in processing instructions
Ln (C
ost p
er m
illio
n in
stru
ctio
ns)
DEC PDP-1:Mini computer
Apple II:Microcomputer
IBM PCCompaq Portable
1950 19601970
1980 1990
source: Morrison, Wilhelm 2004
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 16
Institutional InvestorsThe new owners of the bank’s liability side Mid 1950: the Mutual Funds industry
develops in the US (1970: AuM 48bn) Mid 1960: Funds reached Europe Mid 1960: Establishment of US Money
Market Funds (207 AuM 4.0 tr) Demographics in US & Europe force a re-
thinking of government run ‘Pay-As-You-Go’ pension systems
1972: 3-Pillar Retirement System in CH 1974: Employment Retirement Income
Security Act (EIRSA) 1992: UK Pension Scheme Act 2002: Hartz IV reform in Germany Total global deposits of $ 26tr vs. $ 80tr of
professionally managed funds Many of these institutional investors have
statutory return requirements
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 20120
50,000
100,000
150,000
200,000
250,000
300,000
Stock Market Capitalization Public Debt Securities
Private Debt Securities Bank Assets
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 17
International ExpansionBanks Become Global Absence of currency controls spurs free flow of
international capital National banks establish branches abroad Citibank has today 9’000 branches in 44 countries Santander makes only 13% of its profits in its home
market in Spain Anchor products are commercial loans and
consumer credit Merger wave begins (Citi, JPM, BofA, BNPP, RBS,
BoS, HSBC, BBVA, UniCredit etc) Rapid consolidation of US investment banks By 2000, ≈ 70 partnerships become 5 large
brokers/dealers: Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, Bear Sterns
Consolidated: Shearson, Dean Witter, Loeb, Kidder Peabody, Paine Webber, Hutton, White Weld, Salomon Brothers, First Boston
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 18
Deregulation – Animal Spirits RestoredThe end of the straight jacket 1958 / 1964: Abolishment of capital controls
in both EEC and Japan 1973: free floating of currencies 1980: Removal of regulation Q – restrictions
on deposit interest rates 1980: Removal of business restrictions for
Savings & Loan Associations 1984: Removal of barriers to interstate
banking 1986: ‘Big Bang’ in City of London 1992: Maastrich Treaty: 4 Liberties (Goods,
Capital, Labour, Services) 1999: Graham-Leach-Billey Act removes
Glass-Steagall separation 2006: European Directive on Services in
Internal Markets
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 19
1. 30 Years of Stability followed by 40 Years of Turmoil
2. The Business Model of Banks after Bretton Woods
3. The Forces which undid Bretton Woods
4. 1973 and its consequences
5. Early Days of Risk Management
6. The Derivatives Revolution, Value-at-Risk and Fair-Value Accounting
7. Latam Debt, Scandinavia, Tequila, Asia, Dot com bubble, Russian Default
8. Risk Management matures …
9. … and fails in the Global Financial Crisis
10. Conclusions
Presentation Outline
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 20
Establishment of new credit committees on board level
Joint liability for credit decisions Branch and regions managed by
trusted ex-pats with little credit authority
New HQ units for credit policies for main products (loans)
Matched funding strategies Market & settlement risk hidden
in accrual books 1974: Settlement risk became
visible with Herstatt Bank – not easy to settle across countries
Early Days in Risk ManagementEscalation to the Top
Source: S.Krisiloff 2012
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 21
The end of Bretton woods with free flow of capital and floating exchange rates made many central bank governors nervous
1971: a standing BIS committee was set up to assess the macro-economic impact
1975: following the collapse of Herstatt Bank, the BCBS was established, including for the first time bank-supervisors
When 1982 the Latin American Debt Crisis revealed the insufficient capital levels of US Money Center Banks, Congress raised capital standards and tightened supervision
FED Chairman Volcker went to the BCBS in 1983 to ask for equivalent international capital requirements (Japanese banks!)
The result was the Basel Accord on Capital (Basel I) in 1988
It introduced RWAs and min. Tier 1&2 ratios
The Basel Committee for Bank Supervision (BCBS)Central Bank Governors Take Notice
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 22
1. 30 Years of Stability followed by 40 Years of Turmoil
2. The Business Model of Banks after Bretton Woods
3. The Forces which undid Bretton Woods
4. 1973 and its consequences
5. Early Days of Risk Management
6. The Derivatives Revolution, Value-at-Risk and Fair-Value Accounting
7. Latam Debt, Scandinavia, Tequila, Asia, Dot com bubble, Russian Default
8. Risk Management matures …
9. … and fails in the Global Financial Crisis
10. Conclusions
Presentation Outline
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 23
Technology advances (PC), revolution in communication (fiber) and deregulation made global trading possible
Arbitrage on a global level provided big revenue opportunities
Derivatives highly profitable in 1990 (20bp for CS, 8bp for IRS)
Both investment and universal banks built large trading operations with thousands of live trades
By the end of the century, all asset classes were traded under FV and VaR
Financial Markets have become truly global. Indonesian bonds were sold to US investors, RMBS to European buyers
Derivatives essential to risk management
The Derivatives Revolution“Eventually, everything will become tradable” – Alan Wheat, CEO CSFB
Derivative financial instruments (notional amounts outstanding in billions of US dollars)
Source: G. Capelle-Blancard
2010
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 24
Traders developed VaR and FV simultaneously in order to calculate probability of loss in a portfolio at a given confidence level
VaR was calibrated with historical data or Monte-Carlo simulation
1989: VaR found quickly its way into management reporting (JPMorgan)
1996: the Basel Committee (BCBS) developed capital requirements for market risk based on VaR
1992: JPM began marketing Risk Metrics which was based on VaR for managing risks
1998: EU adopted CRD I which introduced VaR based min. capital requirements for market risk
2007: SEC required all banks to publish their VaR numbers in their annual report
In 2010, EU complemented VaR with SVaR+IDR
Short History of Value-at-Risk (VaR)Performs well for liquid markets but not in cliff events
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 25
Started with futures trading mid-1980s to calculate margin requirements
1986: Establishment of SOFFEX, 1st fully electronic exchange
In 1990, few banks (Bankers Trust, CSFP, GS, JPM) used Fair Value to account for their OTC Derivatives
1993: FAS 115 allowed banks to use Fair Value for equity and debt securities in trading books
FV allowed netting of positions (hedge) 1994: when $ yield curve turned, many banks
suffered significant losses These losses accelerated the use of FV 1994: credit default swaps – JPM, CSFP Market liquidity was not a criteria for FV
Short History of Fair Value AccountingThe Law of Unintended Consequences
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 26
The Unintended Consequence – Light Capital Treatment Traded Assets and respective Risk Weighted Assets
Trading RWA %Assets
RBS 2007 237bn N/A N/ARBS 2012 173bn 43bn 25%
Citibank 2007 538bn 109bn 20%Citibank 2012 321bn 41bn 13%
Deutsche Bank 2007 596bn 14bn 2%Deutsche Bank 2012 439bn 53bn 12%
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 27
1. 30 Years of Stability followed by 40 Years of Turmoil
2. The Business Model of Banks after Bretton Woods
3. The Forces which undid Bretton Woods
4. 1973 and its consequences
5. Early Days of Risk Management
6. The Derivatives Revolution, Value-at-Risk and Fair-Value Accounting
7. Latam Debt, Scandinavia, Tequila, Asia, Dot com bubble, Russian Crisis
8. Risk Management matures …
9. … and fails in the Global Financial Crisis
10. Conclusions
Presentation Outline
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 28
Latin American Debt CrisisThe Lost Decade
Many LatAm countries borrowed huge sums from international banks in 1970s
Cumulative debt growth rate: >20% p.a. Most spent on infrastructure & development 2nd oil shock made balance of payment massively
negative Tightening of monetary policy in US and Europe
increased interest rates sharply 1982: Mexico and Brazil defaulted 16 Latin countries re-scheduled Austerity programs induced recessions USA: banks could delay loss regognition for several
years until 1987 Bready Bonds: ≈1/3 of debt forgiven
source: J.A.Ocampo 2013, data from The World Bank and ECLAC
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 29
Japanese Asset Bubble 1986When Japanese Banks Bought the Rockefeller Center
Unrestricted money & credit supply – BoJ cut ST rates from 5% (1986) to 2.5% (1989)
Export boom made corporates cash rich – subdue demand for commercial loans. Stock market boom lowered cost of capital
Deposit rich banks pushed into mortgages & margin lending
Price peaks in 1988/1990 Two lost decades of economic growth Sanyo Sec., Yamaichi Sec., LT Credit Bank &
Nippon Credit Bank rescued by government Wave of mergers created the big banking
conglomerates of today Tax payer’s bill: ¥ 9.3 tr (USD 91bn)
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 30
S&L lent their deposits long-term fixed Interest rate increase by FED to curb
inflation caused big banking book losses In 1976, S&L controlled 80% of $ 700bn
mortgage market 1980: deregulation allowed Thrifts to
expand commercial & consumer banking but without adequate oversight
Thrifts grew 56% from 1980 – 1983 by financing speculative malls & property developments
1989: Resolution Trust Corporation RTC resolved 747 S&L to 1995 Losses: USD 160bn (tax payers 120bn)
Savings & Loan Associations 1980 – 19951/3 of 3’240 Thrifts failed
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 31
Rapid expansion of lending due to sharp increase of short term debt in banks
Property prices peak in 1991 Bubble bursts in 1991 - 1992 Loan loss provisions 1990 - 1993:
Sweden 4.5%, Finland 3.4%, Denmark 3.0%, Norway 2.7%
1991: Governments had to guarantee all deposits
Nordbanken & Gotabanken nationalized Governments created bad banks which
took over distressed debt for equity GDP dropped by 5% 1990 - 1993 Unemployment rate on new 6% plateau
Scandinavian Financial Crisis 1991-92Well-fare State Re-designed
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 32
North American Free Trade Agreement entered in effect January 1, 1994
NAFTA accounts for 21% of world GDP Mexico entered NAFTA with overvalued Peso In anticipation, government and consumer
spending increased rapidly – all debt financed For political reasons, government kept interest
rates low (election year) As investors started to sell Tesobonos, central
bank reserves got depleted December 1994: Peso devaluation USA steps in with a $ 50bn stabilisation
package Three largest Mexican banks went bust and
were sold (Citibank, BBVA, Santander) Mexico recovered quickly due to low debt
levels
The Tequila Crisis 1994NAFTA – To Good to be True
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 33
Based on strong economic performance, pegged currencies attracted a significant USD short-term money & portfolio investments
Most was invested long-term in real estate, projects or infra-structure
Crony capitalism syphoned off a large portion of these funds. This mis-allocation of investments was one of the root causes. Investments produced no cash flows for servicing debt
Mid 1997, investors wanted to get out When governments could not defend the peg,
currencies crashed. Cut off from access to finance, GDP dropped. In Thailand & Indonesia banks collapsed.
IMF intervened with package of $ 40bn Korea’s bank had a bad debt problem HK, Singapore & Taiwan were able to defended
their peg
Asian Debt Crisis 1997 - 1998The Curse of Portfolio Investments
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 34
Overvalued exchange rate & the large fiscal deficit under Yeltsin at the core of the crisis
In March 1998, the Russian government faced difficulties in placing Ruble denominated debt with Russian banks and investors
Government debt was placed abroad where it was picked up due to high coupon rates
IMF granted a package of $ 22bn to stablize market and swap short-term GKO to long-term Eurobonds
Yeltsin decided to keep the $ peg in July In August, investors started to flee. Stock
market crashed, Ruble plummeted by 75% 17 August, Ruble devaluation & moratorium Inkombank, Oneximbank, Tokobank closed Massive capital outflows, inflation at 85%
Russian Crisis 1998When the Ruble turned to Rubble
Graph source: Morrison, Wilhelm 2004
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 35
Low level of $ rates provided start ups with easy access to capital
Investors were looking for higher yielding assets to compensate low yielding treasuries
Internet became available to wider public in 1990. By 2002, almost all US schools had access to internet
Netscape browser 1995: amazon.com, 1998: Google AOL merger with Time Warner Jan 2000 FED increased $ rates 6x in early 2000 10th of March 2000, bubble burst with
NASDAQ at 5’408.60 points 2000 – 2002: $ 5tr in market value destroyed But 48% of dot.com companies survived There was no bank financing
Dot Com BubbleLearning the wrong lesson?
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 36
1. 30 Years of Stability followed by 40 Years of Turmoil
2. The Business Model of Banks after Bretton Woods
3. The Forces which undid Bretton Woods
4. 1973 and its consequences
5. Early Days of Risk Management
6. The Derivatives Revolution, Value-at-Risk and Fair-Value Accounting
7. Latam Debt, Scandinavia, Tequila, Asia, Dot com bubble, Russian Crisis
8. Risk Management matures …
9. … and fails in the Global Financial Crisis
10. Conclusions
Presentation Outline
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 37
Value-at-Risk captured the risk of a portfolio Economic Capital attempted to capture the
risk of the entire enterprise Risk calculated with various comfort levels:
99%, 99.5% or 99.8% Computer runs took easily an entire night Concept developed on trading floors Popularized by JPM’s Risk Metrics 1992 Used to allocate capital in some firms – often
against stiff resistance Key challenge: availability & quality of data
• Loss-Given-Default not retrievable• Probability of Default of banks?• Operational loss data spotty• With a high degree of accuracy, we calculated
garbage
Risk Management MaturesEconomic Capital Concept
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 38
Dedicated Risk Managers are first found on the trading floors managing single books
Concept appears first time in GE Capital which is known for its six-sigma concept
With Sarbanes-Oxley it quickly spreads to the manufacturing industry in the US
Mid 1990: James Lam from GE Capital the world’s first CRO?
McKinsey, Oliver Wyman and other consultants advocate for independent risk organisations as early as 1993
Role of Risk Management? First or 2nd line of defence?
Risk systems independent or fully integrated? Centralized or decentralized organisation? Role of Risk in Capital Management?
Risk Management Matures IIRisk Management Divisions
Amy Brinkley, CRO BofA
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 39
1997: Core Principles on Supervision (3 Lines of Defence)
1999 – 2004: Basel II Process• 2 Consultation Papers• 2 Impact Studies
Based on Economic Capital concept Advanced Approach based on internal models
and data Let to significant capital savings in Europe FDIC objected; not implemented in the USA National discretions; home – host issues Model x model x model = unknown unknowns
Regulation Becomes GlobalSupervisory Principles and Basel II
RWA = 12.5*K*EAD
K = LGD * N [(1 - R)^-0.5 * G (PD) + (R / (1 - R))^0.5 * G (0.999)] - PD * LGD] * (1 - 1.5 x b(PD))^ (-1) × (1 + (M - 2.5) * b (PD))
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 40
1. 30 Years of Stability followed by 40 Years of Turmoil
2. The Business Model of Banks after Bretton Woods
3. The Forces which undid Bretton Woods
4. 1973 and its consequences
5. Early Days of Risk Management
6. The Derivatives Revolution, Value-at-Risk and Fair-Value Accounting
7. Latam Debt, Scandinavia, Tequila, Asia, Dot com bubble, Russian Crisis
8. Risk Management matures …
9. … and fails in the Great Financial Crisis
10. Conclusions
Presentation Outline
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 413 June 2013
0
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1st 3-year LTRO loan by ECB
“Whatever it takes” speech by
ECB’s Draghi
Phase 1:Private sector debt bubble implodes
as US housing market collapses
Sources: Bloomberg, DB Research
3m Euribor – 3m Eonia swap rate, in bps (lhs)Itraxx Euro XO generic, 5y spread, in bps (lhs)
VIX implied volatility index S&P 500, % (rhs)
IKB warning
and bailout
Fed rate cuts
Fed approves takeover of Bear Stearns by JPM
Phase 3:Sovereign debt crisis
Phase 2:Unprecedented
intervention transfers risk to public sector
Takeover of AIG & Merrill Lynch, Lehman files for Chapter 11
UK bank capital injections
Hypo Real Estate rescue
Fortisstate support announced
US bank stress-test
results
S&P cuts Greece
rating to junk
Greece reveals budget deficit numbers
EU bank stress-test
results
EU/IMF announce €110 bn bailout for Greece and €750 bn EFSF
Japan earthquake
US downgraded, growth slowdown, EMU crisis focus
shifts to Italy
06/07 12/07 06/08 12/08 06/09 12/09 06/10 12/10 06/11 12/11 06/12 12/12100
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Cyprus bailout deal
PPChart;1;210;Excel84-F5-C8-1D-DF-EF-9D-77-36-BD-9D-E6-2E-38-26-3E
Global Financial CrisisSystemic shocks, high volatility & unprecedented policy interventions
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 42
The Epicenter of the Global Financial CrisisUS Mortgage Market
Total size: USD 13.1tr1 Community Reinvestment Act Lending: USD
4.5tr % of prime mortgages in Freddie Mac &
Fannie Mae:• 1990: 80%• 1999: 45%• 2007: 15%
Around USD 2.0tr of aggregated losses during the Global Financial Crisis
Taxpayers paid $ 0.5tr, investors $ 1.5tr
1 Data a/o Q32012 from The US Federal Reserve BankSource: Schiller-Case
00 01 02 03 04 05 06 07 08 99 10 11 120
50
100
150
200
250
Schiller-Case US House Price Index
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 43
The Epicenter of the Global Financial CrisisSecondary Triggers
0
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US Asset-Backed Securities Issuancein USD mn
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600,000
800,000
1,000,000
1,200,000
1,400,000
European Structured Finance Issuancein USD mn
19971998
19992000
20012002
20032004
20052006
20072008
20092010
20112012
2013*0
5001,0001,5002,0002,5003,0003,5004,0004,500
Outstanding Money Market Instrumentsin USD bn
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 44
The Epicenter of the Global Financial CrisisLeverage
Evolution of Liabilities of MFIs1998 – 2012, Euro-Area, in EUR bn
Evolution of Assets of MFIs1998 – 2012, Euro-Area, in EUR bn
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 45
The Global Financial CrisisShort Narrative Trading & Investment Portfolios key revenue
generators for EU and US banks Collapse of US housing market spilled into
ABS market Any bank with open ABS positions suffered
big losses Liquidity dried up. First LT debt, then Money
Markets, then trading positions Large central bank interventions necessary
as early as July 2007; large expansion of their balance sheets
Bail-outs in 9 & 10/2008 for US & EU banks Quantitative easing as early as 3/2009 Sovereign debt crisis in Europe after 2/2011 EU banks unable to fund in both $ and EUR,
LTR necessary
Source: E
CB
data
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 46
1. 30 Years of Stability followed by 40 Years of Turmoil
2. The Business Model of Banks after Bretton Woods
3. The Forces which undid Bretton Woods
4. 1973 and its consequences
5. Early Days of Risk Management
6. The Derivatives Revolution, Value-at-Risk and Fair-Value Accounting
7. Latam Debt, Scandinavia, Tequila, Asia, Dot com bubble, Russian Crisis
8. Risk Management matures …
9. … and fails in the Great Financial Crisis
10. Conclusions
Presentation Outline
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 47
The Global Financial CrisisCulmination of 40 Years of Instability Key drivers for GFC
• Asset-Liability Mismatch• Large Leverage• Banks became investors• Insufficient transparency• Lack of governance• Total failure of risk management
Regulation not up to date• Basel II focussed on credit risk• Liquidity rules were outdated• Insufficient capital for market risk• Increased leverage not addressed
Crisis Accelerators• Global Interconnectivity of Banks• Fair Value triggered fire sales• Complexity overpowered management• Lack of capital market discipline
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 48
The Global Financial CrisisOpen items to address Main losers of GFC were investors
• Insurance, pension plans and mutual funds havel each 1/3 of global USD 80tr AuM. How to protect society’s safety net for rainy days and old age?
Market Structure of the Financial System• The pipes & pipelines to be utilities: payment
systems, clearing & settlement do not need to be part of the private, risk taking sector
• Markets to be accessible for everyone at the same price and liquidity
• Trading to move back to exchanges Proper representation of values
• Capital market discipline requires a high level of transparency – way beyond what bank do today
• Fair Value only for truly liquide instruments approved by supervisory authorities
Simplify Corporate Governance• Checks & Balances; CEO-CFO-CRO one ticket
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 49
From the End of Bretton Woods to the Global Financial Crisis: 40 Years of Turbulence · Dr. Hugo Bänziger · 13.06.2014 · 50
AppendixLiquidity inFinancialMarkets
Mar-05
Aug-05
Jan-06
Jun-06
Nov-06Apr-
07
Sep-07
Feb-08
Jul-08
Dec-08
May-09Oct-
09
Mar-10
Aug-10
Jan-11
Jun-11
Nov-11Apr-
12
Sep-12
Feb-13
0
0.2
0.4
0.6
0.8
1
1.2
1.4
CHN IDN JPN KOR MYS PHL SGPTHA
%
2003 2004 2005 2006 2007 2008 2009 2010 2011 20120
50
100
150
200
250
300
350
400
450%
NYSE Turnover Asian Bond Turnover