Мировой экономический кризис:
предпосылки, этапы развития, перспективы
Выступление в Европейском Университете в С.Петербурге
10 ноября 2008
Максим Буев
FX Quantitative Analytics, ABN AMRO и RBS, Лондон
maxim.bouev@rbs.com
The World Economic Crisis:
Preconditions, Stages of Development, Perspectives
Presentation at the European University at St.Petersburg
10 November 2008
Maxim Bouev
FX Quantitative Analytics, ABN AMRO and RBS, London
maxim.bouev@rbs.com
Outline
Time line: stages of development
Sub-prime mortgage crisis
Transmissions mechanisms: mortgage backed securities,
CDOs
Credit crunch, stage I
Bank defaults
Transmission mechanisms: exotic derivatives, CDSs
Credit crunch, stage II (liquidity crisis)
Economic slowdown
The Great Depression II?
Perspectives (World, Russia)
Time line
1999-2004: housing price bubble
2004-2007: sub-prime mortgage crisis (the FED rises interest rates,
US housing prices start falling, foreclosures and repossessions
considerably increase)
April – August 2007: the start of Credit crunch, stage I (several US
and European banks report losses linked to sub-prime loans and
mortgage backed securities
17 August 2007: the FED starts cutting interest rates
September 2007: LIBOR soars
14 September 2007: a biggest “Bank run” in England over the
century: Northern Rock, a UK bank, nearly collapses
September – December 2007: Central Banks around the world start
easing access to additional capital for investment banks by auctioning
funds and providing additional loans
Time line (continued)
October 2007 – April 2008: more banks and insurance companies
report losses (the monster that eating the Wall Street is CDS)
December 2007 – July 2008: IMF, World Bank, British Chamber of
Commerce predict a global slow-down and then a likely recession in the
Western World
March 2008: large bank defaults start - Bear Stearns, a US bank, is
bought by JPMorgan, another US investment bank
April 2008: Central Banks are called on to kick-start the money
markets and ease the effects of credit crunch
June 2008: FBI mortgage-fraud arrests in the US
mid July 2008: investors start panicking - Fannie Mae and Freddie Mac,
America’s largest home loan lenders, might collapse; the start of the
Bear Market
Time line (continued)
July-August 2008: housing prices continue to drop, other asset prices
decline too; banks issue half-year reports that indicate more losses; on
counter party risk concerns banks start hoarding cash - Credit crunch,
enters stage II – the liquidity crisis; as credit conditions squeeze even
further the UK is facing the worst crisis in 60 years
September 2008: US government bails out Freddie Mac and Fannie
Mae; American International Group, a big mortgage insurer, collapses;
Lehman Brothers, a biggest US investment bank, defaults
September – October 2008: stock market panics, bank defaults and
(part-)nationalisations all across the globe; coordinated interest rate cuts
by all major CBs; G7, 8, 20 etc. meetings to stabilise the world economy
November 2008: Bank of England slashes the interest rate by 1.5% in
one go; IMF sees a global recession in 2009 (including a worst slowdown
in all Western Europe since WWII)
Sub-prime mortgage crisis
- end of the 90s: the Clinton Administration puts pressure on companies like
Fannie Mae to expand mortgage loans among low and moderate income
people:
Sub-prime mortgage crisis cntd.
- 2000-2004: the FED keeps interest rate very low;
- people borrow and buy houses in hope that their value will quickly rise
and they can re-mortgage or sell the house to obtain profit; the Greater
Fool Theory; housing price bubble forms;
- 2004-2006: the FED increases the interest rate from 1% to 5.35%;
- low income households find it difficult to maintain payments on
mortgages; defaults and repossessions increase;
- house prices begin to decrease: more h/h realise that the value of
their housing assets is evaporating, demand for houses drops;
- as the bubble bursts banks see more defaults on loans; payments on
mortgage backed securities and CDOs rise…
Summary I
Preconditions for the sub-mortgage crisis:
- low interest rates;
- a well-developed financial sector;
- widespread mortgage lending, including to low-income households
Source: BBC©
Transmission mechanisms I
Collaterised Debt Obligations (CDOs):
- an unregulated type of asset backed security and structured
(correlation) credit product;
- invented by Terri Duhon, a 25y.o. MIT graduate, while working on
JPMorgan’s credit swap desk in New York in the mid 90s;
Motivation for CDOs:
- arbitrage transactions which attempt to capture the spread between the
relatively high yielding assets and the lower yielding liabilities
(represented by rated bonds);
- take loans and other assets off the balance sheets, to reduce regulatory
capital requirements and improve return on risk capital
CDOs continued
Main idea:
CDOs continued
Main idea:
However, it all works well only when the market is growing. But what if…?
CDOs continued
Main idea:
As market slows banks risk defaults on mounting tranche payments!
CDOs continued
Size of the market:
- aggregate global CDO issuance reached $552 billion in 2006;
- the CDO global market is $2 trillion by the end of 2006;
- for comparison, nominal GDP (2007): USA - $13.8 trillion, Russia - $1.3
trillion
Problems:
- no proper regulation of CDOs; tax treatment is uncertain;
- CDOs on CDOs on CDOs, etc: CDOn;
- grading methods by rating agencies: are they adequate?
- pricing methods of CDOs: to determine the price of a bond based on a
particular tranche one needs to take into account correlation effects
between loans in the credit portfolio, however no proper methods still
exists (although David Z. Li introduced Gaussian copula models in 2001)
Credit crunch, stage I
As market conditions deteriorate, banks stop payments on CDOs as
losses mount; banks stop lending, some start defaulting
Source: BBC©
As more banks default, the cost of protecting their debt through another
derivative instrument CDS, begin to rise rapidly.
Transmission mechanisms II
Credit Default Swaps (CDSs):
- a credit derivative contract between two counter parties, whereby the
buyer makes periodic payments (insurance premiums) to the seller in
exchange for the right to a (hefty) payoff if there is a default of a third
party;
- put together by JPMorgan bankers in 1994 on an off-site weekend at
Boca Raton resort in Florida; Terri Duhon, the CDOs inventor, was working
on JPMorgan’s credit swap desk in New York in the mid 90s;
Motivation for CDSs:
- primary idea back in 1994: protect the loans on the bank’s books and,
thus, free up the capital in reserves;
- usual: speculation, hedging, arbitrage;
CDSs continued
Main idea: insure the investor against the third party default risk
CDSs continued
Size of the market:
- by far the most widely traded derivative product;
- by end of 2007 there were about $50 trillion worth of CDS contracts
outstanding worldwide;
- for comparison: the size of the US stock market was $22 trillion in mid
2007;
- for comparison: the size of the US mortgage market was $7.1 trillion in
the same period;
- for comparison, again: nominal GDP of the USA was $13.8 trillion, of
Russia - $1.3 trillion in 2007
CDSs continued
Problems:
- no proper regulation of CDSs either (no clearing houses); tax treatment
is uncertain;
- CDSs can be written on the same debt again and again: in September
2008 Lehman Brothers had approximately $155 billion of outstanding
debt, but about $400 billion notional value of CDS contracts had been
written which referenced this debt!!
- pure madness: allegedly, Lehman Brothers would write CDSs
on…themselves!
- AIG would write CDSs on mortgages but did not hedge them!
- pricing methods borrowed from insurance industry (probability
approach; as well as no-arbitrage model by Duffie, Hull and White) are
not adequate: defaults are not independent!!
Credit crunch, stage II
- the more banks/companies/etc default the more payments on CDS
contracts their sellers face;
- many cannot cope with that and default in turn;
- as more banks default, the cost of protecting their debt through CDS
begin to rise rapidly;
- investors see that to be a sign of more defaults and start panicking;
- banks hoard cash and liquid instruments; raise inter bank offered rates
(LIBOR, EURIBOR) or stop lending to each other altogether
Source: BBC©
Summary II
Global effect of the housing bubble burst in the USA through CDOs/CDSs:
Source: BBC©
Economic slowdown
As the crisis develops, the US Fed and the European Central Bank try to
bolster the money markets by making funds available for banks to borrow
on more favourable terms;
interest rates are cut in an effort to encourage lending;
however, the short-term help does not solve the liquidity crisis as banks
remain cautious about lending to each other;
a lack of credit - to banks, companies and individuals - brings with it the
threat of recession, job losses, bankruptcies, repossessions and a rise in
living costs;
meanwhile investors start avoiding risky trades/assets, including
investment in the Emerging Markets – capital flees emerging economies
(including Russia);
emerging market currencies are under the real threat of devaluation;
global growth slows down even despite the decoupling phenomenon
The Great Depression II?
The Great Depression in the US in the 30s (Irving Fisher, 1933):
- stock market crash in 1929;
- American households borrowed to play on the stock market – heavy
debts;
- asset price bubble bursts, people cut down on expenses to pay off
loans, etc; debt liquidation follows along with distress selling;
- credit was ample but people were reluctant to add new debt;
- contraction of money supply as bank loans are paid off;
- low asset prices plus a drop in commodity prices result in the drop in
the net worth of business (including farmers), bankruptcies follow;
- a drop in both money supply and overall level of demand (IS-LM curves
shift left) causes a fall in profits;
- a reduction in output, trade and employment;
- hoarding of money;
- a fall in nominal interest rates and a rise in the deflation adjusted
interest rates
The Great Depression II?
Problems back in the 1930s:
Debt/price deflation;
The US government failed to quickly increase deficit spending (a
critique by Keynes);
It did not provide support for failing banks either by injecting cheap
liquidity in the market or by direct intervention;
Households with debts were not helped with restructuring/delaying
payments on their liabilities;
Smoot-Hawley Tariff Act (30 June 1930) seriously reduced
international trade by causing retaliatory tariffs in other countries
The Great Depression II?
So, the Great Depression II? Not really. Now:
As the world entered into the crisis there was a real risk of high
inflation;
Governments do provide banks with liquidity and direct support;
Governments do plan to provide households with help with the
restructuring of their debts;
International trade is much more important these days, and efforts
made towards globalisation pay off;
Decoupling
The Great Depression II?
However:
Many countries are running huge CA and budget deficits – so there is
no scope for outright expansionary fiscal policy;
Governments seem to start losing the control over the monetary
policy as interest rates are already low, while spreads charged by banks
are still high;
As the economies are much more integrated these days, a better
coordinated set of measures is required;
Reform of the derivatives industry and new regulations in that field
might take a very long time to work out
Perspectives: the World
Source: BBC©
Perspectives: the World
Source: BBC©
Perspectives: the World
The problem is not so much survival as finding the right policy mix to
minimise the effects of sharp slowdown. However:
- Euro area is to experience the worst recession in 40 years;
- countries with high leverage and exposure to global economy to be hit
hardest (mainly due to deteriorating conditions in export markets): Germany
is for an output decline of 1%;
- Euro unemployment to rise by 1%; 1.5 mio people to become
unemployed;
- capital flight will cause many currencies either to float or devaluate:
Hungary, Poland, the Baltic states;
- tighter fiscal policies and lower output contraction for several years: the
Baltic states;
- USD to strengthen in the mid term but weaker in the longer term;
- political instability in Eastern Europe (Ukraine including);
- B(R)IC is likely to come out on top with strong performance
Perspectives: Russia
- Fantastic fundamentals (hard ccy reserves, low unemployment rate), but
high concealed inflation;
- first to suffer: banking and construction/development sectors: the latter is
driven by loans in foreign ccys;
- reduction in export revenues: as oil price drops below $60 for barrel;
however Paul Krugman believes that oil/metal prices will stay generally high
due to resource depletion;
- spill-over effects: service sector should somewhat shrink;
- capital flees the country (bad timing for the war with Georgia!), so there is
pressure on rouble to devalue;
- foreign ccy reserves are spent to support the rouble: how long is the
government able/willing to do that?
- as stab fund money is injected to help the financial sector it will work
through into a higher inflation rate;
- wages will fall as wage negotiation is literally absent;
- however, the labour market is tight in general due to demographic
problems; so it is likely that the effect of the crisis on it will be short-lived
References
RBS research
Bloomberg
Economist
Time
Newsweek
BBC
Wikipedia