Structured Finance and the Global Financial Crisis.
-
date post
20-Dec-2015 -
Category
Documents
-
view
220 -
download
2
Transcript of Structured Finance and the Global Financial Crisis.
Structured Finance and the Structured Finance and the Global Financial CrisisGlobal Financial Crisis
Feb 23, 2009Feb 23, 2009 Arjun Jayadev Assumption CollegeArjun Jayadev Assumption College22
Which Crisis?Which Crisis?
During the second half of the war, there was During the second half of the war, there was an explosion of easy credit, driven by capital an explosion of easy credit, driven by capital from abroad.from abroad.
This resulted in lavish displays of wealth — This resulted in lavish displays of wealth — and opulent living was seen, especially in New and opulent living was seen, especially in New York. York.
Housing prices soared during the war. Housing prices soared during the war. But when credit tightened afterward– collapse But when credit tightened afterward– collapse
of real estate bubble and generalized crisisof real estate bubble and generalized crisis
Feb 23, 2009Feb 23, 2009 Arjun Jayadev Assumption CollegeArjun Jayadev Assumption College33
Feb 23, 2009Feb 23, 2009 Arjun Jayadev Assumption CollegeArjun Jayadev Assumption College44
Structural Adjustment in the US after 1970
Decline in Real Wages
Hollowing out of Manufacturing
Collapse in Personal Savings
Increasing HouseholdIndebtedness
‘Market Keynesianism’
Finance and Market IdeologyReign Supreme
Intermediate Patterns
Increasing GlobalImbalances
Financial Deregulation
Monetary Policy alone
Proximate Causes
Global Savings Glut(Lower Long Term Rates
Accommodative MonetaryPolicy (Low Short Term Rate
Financial InnovationGrowth of Shadow Banking
= Housing Bubble
Collapsed Real WagesCollapsed Real Wages
Real Wage Per Hour
7.50
7.70
7.90
8.10
8.30
8.50
8.70
8.90
9.10
9.30
9.50
19641 19663 19691 19713 19741 19763 19791 19813 19841 19863 19891 19913 19941 19963 19991 20013Year (Q)
Destruction in Household Balance Destruction in Household Balance Sheets (Personal Savings Rates)Sheets (Personal Savings Rates)
Personal Savings Rate
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
Growing Indebtedness of Growing Indebtedness of HouseholdsHouseholds
Ratio of Household Sector Debt to Personal Income
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1952-I 1957-I 1962-I 1967-I 1972-I 1977-I 1982-I 1987-I 1992-I 1997-I 2002-I 2007-I
Total Debt
Mortgage Debt
Finance and Manufacturing as Finance and Manufacturing as Percentage of National IncomePercentage of National Income
0%
5%
10%
15%
20%
25%
30%
35%
1948-I 1953-I 1958-I 1963-I 1968-I 1973-I 1978-I 1983-I 1988-I 1993-I 1998-I 2003-I 2008-I
Per
cent
of N
atio
nal I
ncom
e A
ccou
nted
for
Manufacturing
Finance, Insurance, Real Estate
Different Defn'
Global Global FFinancial inancial IImbalancesmbalances U.S. U.S. borrows 50 % of the worlds borrows 50 % of the worlds
capital that is exportedcapital that is exported
Deficits and DebtDeficits and Debt
“You mean to tell me that the success of the economic
program and my re-election hinges on the Federal Reserve
and a bunch of f***g bond traders?”
Bill Clinton- 1994From Woodward “ The
Agenda”
We’re Eisenhower Republicans here…We stand for lower deficits, free trade and the bond market. Isn’t that great?Bill Clinton-1998
Ideology
Feb 23, 2009Feb 23, 2009 Arjun Jayadev Assumption CollegeArjun Jayadev Assumption College1212
Financial DeregulationFinancial Deregulation
Gramm-Leach Bliley replaces Glass Gramm-Leach Bliley replaces Glass Steagall in 1998Steagall in 1998
Commodities Futures Modernization Commodities Futures Modernization Act (1999)Act (1999)
Sarbanes Oxley Rule (2002)Sarbanes Oxley Rule (2002) SEC deregulation of brokers (2004)SEC deregulation of brokers (2004) ‘‘Self Regulation’ and Trust in Ratings Self Regulation’ and Trust in Ratings
AgenciesAgencies
Proximate CausesProximate Causes
Easy CreditEasy Credit Search for YieldSearch for Yield Regulatory Loopholes (particularly CFMA Regulatory Loopholes (particularly CFMA
1999, SOX,2002 and Leverage Rule, 2004)1999, SOX,2002 and Leverage Rule, 2004) Shadow Banking/Securitization of Loan ChainShadow Banking/Securitization of Loan Chain Discovery of Enormous (Hidden) LeveragingDiscovery of Enormous (Hidden) Leveraging Inadequate capitalization leading to Liquidity Inadequate capitalization leading to Liquidity
and then Solvency Crisesand then Solvency Crises
Easy CreditEasy CreditFederal Funds Rate (Overnight)
0
1
2
3
4
5
6
7
8
1/1/
2000
5/1/
2000
9/1/
2000
1/1/
2001
5/1/
2001
9/1/
2001
1/1/
2002
5/1/
2002
9/1/
2002
1/1/
2003
5/1/
2003
9/1/
2003
1/1/
2004
5/1/
2004
9/1/
2004
1/1/
2005
5/1/
2005
9/1/
2005
1/1/
2006
5/1/
2006
9/1/
2006
1/1/
2007
5/1/
2007
9/1/
2007
1/1/
2008
5/1/
2008
9/1/
2008
Percent
Equity marketsEquity markets and the Search and the Search for Yieldfor Yield
Mortgage bubble took Mortgage bubble took off in the aftermath of off in the aftermath of declining yield from declining yield from sharesshares
Structured finance: Structured finance: The players in securitizationThe players in securitization
OriginatorOriginator
End borrowersEnd borrowers
Conduit/trust/ Conduit/trust/ SPV/SPE/SIVSPV/SPE/SIV
Investment bank Investment bank (underwriter)(underwriter)
Rating agencyRating agency Institutional Institutional investorinvestor
End lendersEnd lenders (wholesale)(wholesale)
Insurance Insurance companycompany
BrokerBroker
ServicerServicer
$$
$$
$$
$$
$$
MortgagesMortgages
MortgagesMortgages
MBSMBS
I&P ($)I&P ($)
I&P ($)I&P ($)
CDOsCDOs, I&P ($), I&P ($)
Financial Financial returns ($)returns ($)
LEGEND KEYLEGEND KEYO&G – interest and principalO&G – interest and principalSPV – special purpose vehicleSPV – special purpose vehicleSPE – special purpose enterpriseSPE – special purpose enterpriseSIV – SIV – specialspecial investment vehicle investment vehicleMBS – mortgage backed securitiesMBS – mortgage backed securities
Founder: loan originator or Founder: loan originator or investment bankinvestment bank
Purpose: transfering Purpose: transfering ownerhship of claims (loans) ownerhship of claims (loans) and collateral (mortgages) in and collateral (mortgages) in order to issue mortgage order to issue mortgage backed securities (bonds).backed securities (bonds).
Exposure of founder: implicit Exposure of founder: implicit guarantee in case of large guarantee in case of large losses.losses.
Assigns credit Assigns credit rating to issued rating to issued MBSs.MBSs.
Organizes issuing of Organizes issuing of MBSs and places MBSs and places MBSs to investors in MBSs to investors in financial markets.financial markets.
Broker places mortgage Broker places mortgage loans to borrowers for feeloans to borrowers for fee
Manages the flow of Manages the flow of interests and principal interests and principal (I&P); usually, but not (I&P); usually, but not necessarilly the Originator necessarilly the Originator
Typically a specialized Typically a specialized mortgage bankmortgage bank
Mutual funds, Mutual funds, pension funds, pension funds, hedge funds…hedge funds…
Can assume part of Can assume part of risks (insurance of risks (insurance of mortgage loans, mortgage loans, insurance of MBS insurance of MBS returns).returns).
Feb 23, 2009Feb 23, 2009 Arjun Jayadev Assumption CollegeArjun Jayadev Assumption College1717
A bank balance sheetA bank balance sheet
AssetsAssets
LoansLoans
LiabilitiesLiabilities
DepositsDeposits
CapitalCapital
Feb 23, 2009Feb 23, 2009 Arjun Jayadev Assumption CollegeArjun Jayadev Assumption College1818
A shadow banking balance A shadow banking balance sheetsheet
AssetsAssets
Asset Backed Asset Backed SecuritiesSecurities
Mortgage Backed Mortgage Backed SecuritiesSecurities
Credit Default Credit Default SwapsSwaps
Interest Rate SwapsInterest Rate Swaps
LiabilitiesLiabilities
Collateralized Debt Collateralized Debt ObligationsObligations
Asset Backed Asset Backed Commercial PaperCommercial Paper
Feb 23, 2009Feb 23, 2009 Arjun Jayadev Assumption CollegeArjun Jayadev Assumption College1919
Banking versus Shadow Banking versus Shadow BankingBanking
BankingBanking
FDICFDIC Risk Adjusted Capital Risk Adjusted Capital
Adequacy RatiosAdequacy Ratios Interbank Market sets Interbank Market sets
price of liquidity price of liquidity (money) (LIBOR)(money) (LIBOR)
Monetary Policy affects Monetary Policy affects price, interestprice, interest
rates, macro balancerates, macro balance
No Equivalent of No Equivalent of
FDICFDIC No Capital No Capital
Adequacy RatiosAdequacy Ratios No state control No state control
over liquidity over liquidity creationcreation
Shadow BankingShadow Banking
IB Leverage
The ‘Magic’ of Securitization The ‘Magic’ of Securitization and Structured Financeand Structured Finance
The CDS Market
““Subprime” GrowthSubprime” Growth
SSubprime ubprime growth shot up in 2003-2005growth shot up in 2003-2005 By 2006, most Subprime mortgages were securitizedBy 2006, most Subprime mortgages were securitized
Share of subprimeShare of subprimeIn total U.S. economy In total U.S. economy (measured by GDP): (measured by GDP): 1% (2001), increasing 1% (2001), increasing to 5% (2005)to 5% (2005)
Bubble in Housing PricesBubble in Housing Prices
The Crisis Begins...The Crisis Begins...
In August 2007, Crisis begins with first wave of In August 2007, Crisis begins with first wave of sub prime Failuressub prime Failures
Overleveraged shadow banks (easy credit) were invested in very bad bets (subprime), at scale, with no liquidity backstop (unregulated credit markets).
Counterparty Risk was perceived as much larger. Liquidity starts freezing (Interbank markets start
to experience wild shifts in ability to borrow and lend and much higher rates for borrowing)
Residential Real Estate Prices Crash
Crisis in Subprime LendingCrisis in Subprime Lending
Crisis in Subprime Crisis in Subprime LendingLending
% of % of delinquent delinquent loans (60+ loans (60+
days)days)
Months from originationMonths from origination
MBS’s lose valueMBS’s lose value
Total Predicted Losses 2.2-3.6 Total Predicted Losses 2.2-3.6 Trillion Dollars! (Oct 08)Trillion Dollars! (Oct 08)
Feb 23, 2009Feb 23, 2009 Arjun Jayadev Assumption CollegeArjun Jayadev Assumption College3131
TED-Spread: Liquidity Crisis
Feb 23, 2009Feb 23, 2009 Arjun Jayadev Assumption CollegeArjun Jayadev Assumption College3232
LIBOR-Overnight Interest Swaps spread (Measure of Interbank liquidity)
Global Declines in Stock Global Declines in Stock MarketsMarkets
Famous Last WordsFamous Last Words
"We have a good deal of comfort "We have a good deal of comfort about the capital cushions at these about the capital cushions at these firms at the moment."firms at the moment."
- Christopher Cox, chairman of the - Christopher Cox, chairman of the U.S. Securities and Exchange U.S. Securities and Exchange Commission, March 11, 2008.Commission, March 11, 2008.
The Crisis of 2008--? Bailout of Fannie and Freddie, Collapse of Lehman, Bailout of AIG…. The Paulson Plan -- $700 bn. rescue Contagion to UK and EU…. The Paulson $200 bn. TARP, Citi takeover Recapitalization (still unclear) Collapse of Aggregate Demand Worldwide Crisis, Fiscal Stimulus?