The Global Response to the
Financial Crisis: Can We Avoid
a Repeat?
Robert C. Pozen
Chairman
MFS Investment Management
®
The views expressed in this presentation are those of the speaker and are subject to change at any time.
14173.1
“Never let a serious crisis go to waste.”
— Niccolo Machiavelli, 15th century philosopher
— Rahm Emanuel, current White House Chief of Staff
Pozen_Toronto_Jan2010 2
Major financial crises — World War II to
1995-97
139
• 22 major banking crises in
advanced industrial societies
• Including Europe, Turkey,
Russia, Japan, Canada, U.S.,
Australia, and New Zealand
38
1945 to 1971
1945 to 1995
1973 to 1997
Source: Michael Bordo and Barry Eichegreen, “Crisis Now and Then: What Lessons from
the Last Era of Financial Globalization?”, National Bureau of Economic Research Working
Paper No. 8716.
Source: Carmen M. Reinhart and Kenneth Rogoff, “This Time is Different: Eight Centuries
of Financial Folly”, 2009
Pozen_Toronto_Jan2010 3
U.S. exports and imports
U.S. international trade in goods and services ($B)
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009*
Exports
Imports
$1,071
1,005
977
1,020
1,159
1,281
1,452
1,646
1,836
1,411
$1,450
1,370
1,399
1,515
1,769
1,997
2,212
2,346
2,517
1,752
Current Account Deficit
(% of GDP)
4.2%
3.9
4.3
4.7
5.3
5.9
6.0
5.2
4.9
3.0**
*Through 11/30/09. **
As of 9/30/09.
Sources: U.S. Census Bureau; National Bureau of Economic Research
Pozen_Toronto_Jan2010 4
Continuing negative savings by U.S.
(Personal and government)
U.S. Personal
Saving Rate
Sources: Federal Reserve Bank of St. Louis; Congressional Budget Office; Brookings Institution
U.S. Budget
Deficits
External debt at end of fiscal year (FY) 2008 $5.8 trillion +
Budget deficit in FY 2009 $1.4 trillion =
External debt at end of FY 2009 $7.2 trillion +
Projected budget deficits in FY 2010 – 2018 $9.0 trillion =
Projected external debt at end of FY 2018 $16.2 trillion
Pozen_Toronto_Jan2010 5
Can the Fed be an effective inflation fighter?
Maximum and Actual Exposure of Federal Reserve to the Financial Bailout ($B)
As of March 25, 2009
Maximum
Exposure
Actual
Exposure
Pozen_Toronto_Jan2010 6
U.S. Treasury — Bailing out institutions
Problem
Solution
• Recapitalized too many banks
without clear rationale
• New statute to justify rationale
for every bailout of each institution
• AMEX and State Farm allowed to
become bank holding companies
• Provide liquidity support, not
capital, to non-banks
• Recapitalize troubled banks with
preferred stock (+15% warrants)
• Preferred stock with warrants to
purchase 100% of preferred
Pozen_Toronto_Jan2010 7
FDIC — Government guarantees
Problem
Solution
• Short-term liquidity crisis after
Lehman’s failure
• Fed did good job in allowing swaps
of Treasuries for illiquid securities
• Deposit insurance increased
to $250,000 (through 2013)
• Stay at $100,000, which
covers 98% of depositors
• Guarantee 100% of debt of banks,
thrifts, and their holding companies
• Limit FDIC guarantee to 90%
of debt of banks and thrifts
(not their holding companies)
Pozen_Toronto_Jan2010 8
Government actions: Executive
compensation for financial institutions
• Legislative limit for assisted institutions
– Bonus no more than 1/3 of base
– Example: Wells Fargo CEO
• Special Master for six TARP institutions
– Approve compensation specifics of top-25
– Approve compensation structure of next 75
• Federal Reserve – for all 8,200 banks
– Proposal to ensure appropriate incentive compensation
– Will reject arrangements with “excessive risks”
Pozen_Toronto_Jan2010 9
Improving boards of mega-banks
• Existing mega-bank board model
– Large boards: 12 to 18 members
– Lack of industry expertise
– Meet 6 times per year
• Board of “Super-Directors”
– Smaller number of directors: 5 to 7
– All directors with relevant experience
– Devote 2 to 3 days per month
Pozen_Toronto_Jan2010 10
Mortgages — Securitization process
Problem
Solution
• Brokers sold mortgages without
retaining any risk of loss
• Sellers of loans should retain at
least 5% risk of loss
• Securitization vehicles:
Multilayered and opaque
• Simpler vehicles with more
ongoing disclosures
• Credit rating agencies have
conflicts of interest
• SEC-appointed representative
to choose credit rating agency
Pozen_Toronto_Jan2010 11
Banks — Capital requirements
Problem
Solution
• Basle I reduced capital
requirements for mortgages, MBS
• Should have distinguished between
more and less risky mortgages
• Basle II based on internal risk
models of banks
• 12 to 16 categories of risk capital
plus subordinated debt
• Loan loss reserves limited to
probable losses
• Allow contingent loan
loss reserves plus disclosure
Pozen_Toronto_Jan2010 12
Key Canadian virtues
• Require 20% down payments for most home mortgages
and no tax deduction for interest paid on home mortgages
• Set higher amount and quality of capital for banks
• Did not buy products without understanding them
• Combination of commercial banking and securities
underwriting: Not a problem for Canadian banks
Pozen_Toronto_Jan2010 13
Close gaps in U.S. financial regulation
Problem
Solution
• Customized financial derivatives
exempt from most regulation
• More standardized contracts;
through one clearing corp
• Hedge funds, aggressive short
sellers, grew rapidly
• Require managers of hedge funds
to register as investment advisers
• Global insurers regulated
by 50 states
• Federal charter for a few
global life insurers
• Inadequate regulatory focus
on systemic risks
• Council of regulators, with Fed,
to monitor systemic risk
Pozen_Toronto_Jan2010 14
Proposed restructuring of financial agencies
Current Proposal
Better Approach
• Merge all four banking agencies
into one new agency
• Merge Office of Thrift Supervision
into Comptroller
• Create new agency to regulate all
retail financial products
• Limit new agency oversight to
home mortgages, nonbank lenders
• No merger of CFTC with SEC
because of Senate conflict
• Merge with joint sub-committee
from Agriculture and Banking
Pozen_Toronto_Jan2010 15
Five key recommendations
•
•
•
•
•
Stop bailing out so many institutions
Adopt a totally different board model
Revamp loan securitization process
Increase and redesign capital requirements
Close gaps in federal regulation
Pozen_Toronto_Jan2010 16
The Global Response to the
Financial Crisis: Can We Avoid
a Repeat?
Thank you.
The views expressed in this presentation are those of the speaker and are subject to change at any time.