A NEW WORLD

DISORDER ?
Causes and consequences of the global
financial crisis

Professor Thomas Clarke

UTS Centre for Corporate Governance

Dimensions
The most serious financial crisis
since the Great Depression of the 1930s
1930s.

The End of the Street?

Early Tremors of the Financial Crisis

STOCK MARKET JITTERS: DOW JONES INDUSTRIAL AVERAGE, LAST 24 MONTHS
(US dollars)
15,000
14,000
13,000
12,000
11,000
10,000

Sept 08: Collapse of

AIG Lehman Brothers,
AIG,
Brothers
Washington Mutual, etc.

9 Aug 07: Credit crunch starts

9,000

31 Oct 07: Fed lowers rate to 4.5%

8,000

Source: Bloomberg

Nov/08

Oct/08

Sept/08

Aug/08

Jul/08

Jun/08

May/08

Apr/08

Mar/08

Feb/08

Jan/08

Dec/07

Nov/07

Oct/07

Sept/07

Aug/07

Jul/07

Jun/07

May/07

April/07

Mar/07

Feb/07

Jan/07

Dec/06

Nov/06

7 000
7,000

30 Jan 08: Fed lowers rates to 3.0%

Is this a Rollercoaster or a Financial System?

Synchronized Sinking
Stock price changes over past year (Krugman 2008)

S&P 500

FTSE

Nikkei

Dow Jones

Nasdaq

-5
-10
-15

P
Percent

-20
-25
-30
-35
-40
-45
-50
Source: Bloomberg, Yahoo Finance

International Stock Markets in Free-Fall

(past three months)
FTSE 100

NIKKEI 225
Sept

Oct

Sept

Nov

Oct

Nov

Dow Jones

Sept

Oct

Nov

Cumulative Financial Institution Failures

and Multiple Rescue Operations

This is what a run on the bank looks like..

Sixth
Si
th llargestt
bank in the US
(assets $327
billion)

Lehman Brothers 158 years old

old, fourth largest investment bank on Wall Street
Street,
Self-proclaimed innovator in global finance.

Australias Casualties of the Financial Crisis

(Formerly MFS)

Reactions to the Crisis

(The behavioural theory of finance)
Finally, the global economic slowdown has prompted a re-evaluation
and re-pricing of risk, in the jargon.
Or, to translate, investors have in the course of 14 months gone from
the mad conviction that busts had been abolished to the fear that
everything's going bust.
Neither view was rational. But reason doesn't
doesn t hold much sway at
market peaks, when the prevailing emotion is greed, and troughs
when it's sauve qui peut.
Robert Peston BBC

Panic!

Fear!

Prayer!
y

Dominique Strauss-Kahn
President of the IMF

Ben Bernanke
Chairman
US Federal Reserve

Mervyn King
Governor of the
Bank of England

Reflection

Elation! (Mistaken?)

Cool? (Medication?)

Despair!

Hope!

Nope!

this sucker is going down.. (The US economy..)

(If the $US700 billion Troubled Asset Relief Program (TARP) does not pass Congress)

Perhaps..
Perhaps

Our objectives . which we believe these recommendations will achieve - are improved
transparency and disclosure, better risk awareness and management, and stronger oversight.
Collectively, these recommendations will mitigate systemic risk, help restore investor
confidence, and facilitate economic growth.

Wall Street Becomes a Tourist Attraction (Oct 2008)

dj vu ?

New York Stock Exchange on Black Thursday 1929

The Future?

There is always a market..

The Scale of the Present

Financial Crisis and the
Significance of the
Rescue Packages

Financial Institutions Heading

g For Trouble ((2007))
Total Shareholder Return at 11 Financial Firms

S
Source:
RiskMetrics April 2008

Bank Failures 2008

Bank

Date

Status

Website

Fannie Mae

07 Sep

Nationalised

Fannie Mae

Freddie Mac

07 Sep

Nationalised

Freddie Mac

Lehman Bros

15 Sep
p

Collapsed
p

Lehman Bros

Merrill Lynch

15 Sep

Taken over

Merrill Lynch

AIG

16 Sep

Part-nationalised

AIG

HBOS

17 Sep

Taken over

HBOS

WaMu

25 Sep

Collapsed and sold

WaMu

Fortis

28 Sep

Nationalised

Fortis

Bradford & Bingley

29 Sep

Nationalised

Bradford & Bingley

Wachovia

29 Sep
p

Taken over

Wachovia

Glitnir

29 Sep

Nationalised

Glitnir

Hypo Real Estate

06 Oct

Rescue package

Hypo Real Estate

RBS

13 Oct

Part-nationalised

RBS

Lloyds TSB

13 Oct

Part-nationalised

Lloyds TSB

(Source: BBC)

Eclipsing Other Financial Crisis

Since the Great Depression
C
Comparison
i
off Fi
Financial
i l Crises
C i
(Losses in billions of US dollars)

1600

40

Other financials (left scale)

Bank losses (In billions of US dollars left scale)

1400

35

Percent of GDP (right scale)

1200

30

1000

25

800

20

600

15

400

10

200

0
U.S.
U
S savings
and loan crisis
(1986-95)

Japan banking
crisis (1990-99)

Asia banking
crisis (1998-99)

U.S.
U
S
subprime crisis
(2007-present)

Source: IMF Global Financial Stability Report: Financial Stress and Deleveraging, Washington: International Monetary Fund October 2008.

Losses So Far
Financial Sector Losses
Banks

(In billions of U
U.S.
S dollars 2007:02 August 2008)

700

600

Americas
Europe
Asia

700

Mortgages
Loans/ Leveraged Loan
Other
SIVs / conduits
Trading
Monolines

Hedge funds/Other
Insurers
800

700

600

600

500

500

500

400

400

400

300

300

300

200

200

200

100

100

100

Bank Writedowns by Region

GSEs

Bank Writedowns by Type

Financial Sector Writedowns

Source: IMF Global Financial Stability Report: Financial Stress and Deleveraging, Washington: International Monetary Fund October 2008.

Reported write-downs reached $760 billion by end of September 2008,

$580 billion of which were incurred by global banks

Critically weakened financial institutions

Market Capitalization
p
and Equity
q y Book Values of Select Financial Institutions
(In billions of U.S. dollars)

1200

1000

Market Capitalization end 2006

800

T otal Common Equity end 2007

Current Market Capitalization

600

400

200

U.S. commercial banks

U.S. broker dealers

U.K. banks

Euro area banks

Source: IMF Global Financial Stability Report: Financial Stress and Deleveraging, Washington: International Monetary Fund October 2008, table 1.28.

Collapsing
p g share p
prices of US financial institutions

Scale of the International Rescue of

Financial Institutions

Rescue Packages Compared to GDP

Source: BBC

Will US Bail
Bail-Out
Out be Enough?

The Full US Bill for the Financial Crisis?

US$1.4 Trillion

Origins of the Crisis

Alan Greenspan
Chairman of the Federal Reserve
1987-2006

Alan Greenspan, the Federal Reserve chairman, with Treasury

Secretar Robert E
Secretary
E. R
Rubin,
bin left
left, at a Ho
House
se hearing in 1995.

Fed Chairman Through

Four Administrations

Not only have individual financial

institutions become less vulnerable
to shocks from underlying risk
factors, but also the financial system
as a whole has become more
resilient
resilient.
Alan Greenspan in 2004

Fannie Mae and Freddie Mac

Massive Growth of Mortgage Bond Market

The Sub-Prime
Mortgage Crisis

The Sub-Prime Contagion

The Growth of Sub-Prime Mortgages

Sub-prime Mortgage Lending

Source: BBC

Collapsing
p g US House Prices: Negative
g
Equity?
q y

Escalation of Distressed Debt

Escalating Foreclosures

The End of the Neighbourhood?

g

House Prices Fall and Foreclosures Rise

When the Music Stops

p

Source: BBC

Rescue of Main Street or Bail-Out of Wall Street?

Source: BBC

Adrian Cadbury
I suggest that there are two aspects of what went wrong.
a)

One was that in general risk was undervalued by the financial

institutions.

b)

The second was that the banks simply did not know where their
risks lay.
-Sub-prime mortgages were parcelled out by banks and
sold through perhaps three or four levels of
intermediary.
-When house prices fell people handed in their keys.
The intermediaries found they were in the property
-The
business which they could not finance and in turn each
level went bust.
y responsible,
p
,
-The banks found that theyy were ultimately
a contingent liability they were unaware of and had not
provided for.

I think a sound rule is that, if you do not understand the business you
are getting into, dont get in!"

Financialisation
of the Global Economy

Financialisation of the International Economy

Competing definitions of financialisation
financialisation include:

the ascendancy of shareholder value as a mode of corporate governance;

the growing dominance of capital market financial systems over bank-based financial
systems;

the increasing political and economic power of a particular class grouping: the rentier
class for some (Hilferding 1985);

the explosion of financial trading with a myriad of new financial instruments;

the pattern of accumulation in which profit making occurs increasingly through

financial channels rather than through trade and commodity production (Krippner
2005);

the increasing role of financial motives, financial markets, financial actors and
financial institutions in the operation of the domestic and international economies
(Epstein 2005).

US Finance Overtakes Manufacturing

Proliferation of Exotic Financial Securities

ABS
S = asset-backed
asse bac ed securities
secu es
CDO = collateralized debt obligation
CLO = collateralized loan obligation
CMBS = commercial mortgage
mortgage-backed
backed securities
MBS = mortgage-backed securities.

The Future Becomes Financial Instruments

Explosion of Derivatives

The Age of Derivatives

Financialisation Relative to GDP

Financialisation of the US Economy

Financial Services Trade Balance

Securitisation Issuance Based on

Originating Country or Region

Global Hedge Funds

Private Debt in US and Australia

Collapsing Value of Mortgage Bonds

Growing Bank Liabilities 2007

Regaining a sense of reality?

As the Archbishop of Canterbury argued recently,
Trading the debts of others without accountability has been the
motor of astronomical financial gain for many in recent years
The crisis exposes the element of basic unreality in the situation
the truth that almost unimaginable wealth has been generated by
equally unimaginable levels of fiction, paper transactions with no
concrete outcome beyond profit for traders
traders..
The biggest challenge in the present crisis is whether we can
recover some sense of the connection between money and material
reality the production of specific things, the achievement of
recognisable human goals that have something to do with a shared
good for the human community
y in the widest
sense of what is g
sense. (The Spectator 27 September 2008).

The Consequences

Would You Lend A$1 Trillion Dollars to this Man?

Henry Paulson

US Treasury Secretary

The Emergency Economic Stabilisation Bill 2008

The Emergency
Th
E
Economic
E
i Stabilisation
St bili ti A
Actt 2008 authorised
th i d th
the US
Treasurer Henry Paulson to spend up to $700 billion purchasing distressed
assets, particularly mortgage-backed securities from the banks. The
p rposed of the act was
purposed
as to p
purchase
rchase the to
toxic
ic assets
assets, ass
assuring
ring the worth
orth of
the banks remaining assets, and restoring the confidence of the market.

Objections: the idea that taxpayers should bail out Wall Street; the
ambiguity of objectives and lack of oversight of the new agency responsible
for buying assets; the prospect of over-paying for bad assets giving the
executives
i
and
d iinvestors iin fifinancial
i l fifirms a windfall
i df ll at taxpayers expense;
and a conviction that any purchase should be of preferred stock in the
banks, avoiding the problem of valuing complex assets, and offering a
greater
t degree
d
off control
t l and
d th
the possibility
ibilit off a more significant
i ifi
t return
t
ffrom
the exercise (Stiglitz 2008; Krugman 2008).

Emergency Economic Stabilisation Act 2008

The Emergency Economic Stabilisation Act 2008

Immediate access to $250 billion,

billion following that a further $100 billion can be
authorised by the President, with Congress confirming the last $350 billion.

Transparency details were required for each transaction, and a set of

oversight mechanisms involving a Financial Oversight Board, Congressional
Oversight Panel, and Special Inspector General of the program.

Th Treasurer
The
T
was required
i d to
t obtain
bt i the
th right
i ht tto purchase
h
non-voting
ti stock
t k
in companies that participated in the sale of assets giving the government
an equity interest in the companies.

The Treasury was required to maximise assistance to homeowners facing

foreclosure.

Finally companies participating in the scheme were prohibited from offering

executives incentives to take excessive risks, to offer golden parachutes to
executives, and were given the right to clawback senior executive bonuses
if theyy were later found to be based on inaccurate data.

European Action Plan?

Would You Lend A$1.2 Trillion Dollars to this Man?

Gordon Brown

UK Prime Minister

UK Government $1.2 Trillion Dollar Rescue Plan

Source: BBC

US Federal Government Capital Investments in US Banks October 2008

The Cost of the UK Rescue

European Union summit in Brussels

British Prime Minister Gordon Brown (left) and European

Commission President Jos Manuel Barroso at this week's

Regulation of International Financial Markets

Transparency
a spa e cy

Capital Adequacy

Corporate Governance

Prudential Regulation

Risk Management

G7 Finance Ministers Meet in Washington

Deposit Insurance (Before)

OECD 2008

Deposit Insurance (After)

Would you like to be interviewed by this man?

Rep. Henry A. Waxman (D-Calif.) seeks to learn if banks are

using taxpayer dollars to pay bonuses to their executives.

Richard Fuld CEO Lehman Brothers

Before Congressional Committee 5 October 2008

Henry Taking Aim Again

Rep. Henry A. Waxman, Democrat of California, on the committee investigating hedge funds.

Hedge Fund Directors

Five prominent leaders of giant hedge funds testified before Congress on Thursday. From left,
George Soros, James Simons, John A. Paulson, Philip A. Falcone and Kenneth C. Griffin.

Emerging
g g Multi-Polar World ?

The Indian prime minister, Manmohan Singh, left, with President Nicolas Sarkozy of
France, center, and the European Commission president Jose Manuel Barroso in
Beijing for European/Asia Summit 25 October 2005

G20 Summit

A New Bretton Woods?

July 1944: The U.S. delegation to the Bretton Woods conference in New Hampshire, the
multi-nation confab that set up the international banking-and-finance protocols and
institutions that still exist today

Getting Used to the New Multi

Multi-Polar
Polar World

G20 Analysis
G20 summit are comprehensive and based on a sober analysis of the
causes off the
h crisis:
i i
Weak underwriting standards,
unsound
d risk
i k managementt practices,
ti
increasingly complex and opaque financial products,
and consequent excessive leverage
combined to create vulnerabilities in the system
system.

Policy-makers regulators and supervisors

Policy-makers,
supervisors, in some advanced countries:
did not adequately appreciate and address the risks building up in financial
markets,
keep pace with financial innovation,
or take into account the systemic ramifications of domestic regulatory
actions.

G20 Recommendations

The commitments to strengthening transparency and accountability

accountability,
enhancing regulation, promoting integrity in financial markets,
reinforcing cooperation and reforming international financial
p
an ambitious agenda.
g
institutions,, represents

These commitments and the diplomatic process that has delivered

gg
that an important
p
consequence
q
of the financial crisis is
them suggest
a defining move towards a multi-polar world, with a new economic
order in which global regulation of international business and global
market oversight will be accepted as the basis for market stability
and integrity,
integrity

With executive incentives aligned to prevent excessive risk taking,

and reward sustainable business development
development.

Corporate Governance? Boards of US Banks

Costs of the Financial Crisis

20 million unemployed
Insecurity for hundreds of millions dependent on
supe a uat o
superannuation
Undermining
g of other industry
y sectors p
property,
p y
manufacturing and services
Lost opportunities for innovation and
sustainability investments

The US Auto Industry Comes to Washington

Ford, Chrysler and General Motors CEOs

The end of
the US
auto
I d t ?
Industry?
(45% fall in
Sales in 2008)

Never Again?

From NASDAQ Bubble (1997-2000)

Total market value: NASDAQ. 11% annual growth derived from pre-bubble valuation (peak occurred
March 10, 2000, when the NASDAQ traded as high as 5132.52 and closed the day at 5048.62)

Source: Janszen (2008)

To US Real Estate Bubble (2001

(2001-2007)
2007)

Total
o a market
a e value:
a ue Real
ea es
estate.
a e Actual
c ua market
a e value
a ue from
o Federal
ede a Reserve
ese e Flow
o o
of Funds
u ds
Accounts of the United States. Historical trend from Robert J. Schiller, Irrational Exuberance.
Source: Janszen (2008)

The Next Bubble?

Alternative Energy and Infrastructure?

Total market value: Alternative energy and infrastructure.

infrastructure
Estimated fictitious value of next bubble compared with previous bubbles
Source: Janszen (2008)