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Securitisation, Shadow Banking and the Value of Financial Innovation. Adair Turner Chairman of the UK Financial Services Authority. School of Advanced International Studies (SAIS) Johns Hopkins University, Washington DC 19 April 2012 17:30 EDT. The conventional wisdom – 2006. - PowerPoint PPT Presentation
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Securitisation, Shadow Banking and the Value of Financial
Innovation
School of Advanced International Studies (SAIS) Johns Hopkins University, Washington DC
19 April 2012 17:30 EDT
Adair Turner
Chairman of the UK Financial Services Authority
Credit derivatives “enhance the transparency of the markets’ collective view or credit risks…. [and thus] … provide valuable information about broad credit conditions and increasingly set the marginal price of credit”
“There is growing recognition that the dispersion of credit risk by banks to a broader and more diverse group of investors, rather than warehousing such risk on their balance sheets, has helped make the banking and overall financial system more resilient.”
“The improved resilience may be seen in fewer bank failures and more consistent credit provision. Consequently the commercial banks may be less vulnerable today to credit or economic shocks.”
IMF Global Financial Stability Report, April 2006
The conventional wisdom – 2006
Stability via risk dispersion
Efficiency via price discovery
1
Additional credit creation
“Securitisation is a good thing. If everything was on bank balance sheets, there would not be enough credit.”
“Senior American Regulator”, quoted in the Economist Special Report on Financial
Innovation, February 2012
2
Development of the crisis: 2007 – 2008
Bear Stearns hedge funds under liquidity pressure
Major losses by ‘market neutral’ hedge funds
Carlyle Capital and Peloton Hedge Funds closed
Liquidity and solvency problems at off-balance sheet SIVs
Stresses at MMMFs: Reserve Primary Fund ‘breaks the buck’
Liquidity run in repo and other secured funding markets
Hedge fund deleveraging and asset sales exacerbate downward spiral of asset values
June 2007:
August 2007:
February 2008:
Autumn 2007 to Mid 2008:
Summer 2008:
August to October
2008:
Late autumn 2008:
3
Source: Financial Stability Board 4 A
Non-financialBusinesses
Governments
Financial Intermediation
Households Households
Non-financial Businesses
4BSource: Financial Stability Board
Banks
Maturity transformation +
leverage
Loans
Non-financialBusinesses
Governments
Households Households
Non-financial Businesses
Financial Intermediation
Deposits
Source: Financial Stability Board 4C
Non-financial Businesses
Direct Investment: Bonds + Equities
Insurance, Pension Funds + other intermediaries
Financial Intermediation
Households
Non-financialBusinesses
Governments
Households
Banks
• Less maturity transformation
• Less leverage
Non-financial Businesses
4D
Households
Governments
Financial Intermediation
Banks
Households
Non-financial Businesses
Non-financialBusinesses
MMFs
Sec
uritis
ation
SP
V
Source: Financial Stability Board
ABCP
Hedge Fund
Broker dealer
Households
Governments
Maturity/liquidity
transformation +
leverage … in multiple
steps
4ESource: Financial Stability Board
Households
Governments
Financial Intermediation
Banks
Households
Non-financial Businesses
Non-financialBusinesses
MMFs
Sec
uritis
ation
SP
V ABCP
Hedge Fund
Broker dealer
Households
Governments
Interconnected via bank sponsorship, liquidity puts, repo markets, funding flows, securities lending
5
US mortgages on bank balance sheets and securitised: 1952 – 2009
Source: U.S. Flow of Funds
0%
10%
20%
30%
40%
50%
60%
70%
80%
19
52
19
55
19
58
19
61
19
64
19
67
19
70
19
73
19
76
19
79
19
82
19
85
19
88
19
91
19
94
19
97
20
00
20
03
20
06
20
09
Private label RMBS issuers (home mortgage RMBS)Agency and GSE backed RMBS (home mortgages)Home mortgages
BANK
Mortgages outstanding as % of GDP
Home mortgages
6
Money market funds and bank deposits:US 1980-2010
US Household holdings of money markets funds
US Non-Financial business holdings of money markets funds
7
Percent of Household Cash and Liquid Deposits Percent of Non-Financial Business Short-Term Assets
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
1980 1985 1990 1995 2000 2005 2010
40%
45%
50%
55%
60%
65%
70%
75%
80%
85%
Checkable Deposits
Time & Saving Deposits
MMMF
Source: US Flow of Funds
0%
10%
20%
30%
40%
50%
60%
70%
1980 1985 1990 1995 2000 2005 2010
Checkable Deposits
Time & Saving Deposits
MMMF
Source: US Flow of Funds
Growth of assets in four financial sectors 1954 – 2006
Source: Brookings Papers on Economic Activity, 2010.8
1954 Q1 = 1
US Asset-backed commercial paper 1990 – 2008
Source: US Flow of Funds 9
Note: Not including ABCP of chartered banks0
100
200
300
400
500
600
700
800
900
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
20
08
Note: Not including ABCP of chartered banks
$bn
US Repo market 1990 – 2011
US repo market ($ trillion)
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
Reverse Repo Repo
Source: Federal Reserve Bank of New York.Note: US Primary Dealers only.
US
$tn
10
US financial sector assets as % of GDP
0%
50%
100%
150%
200%
250%
300%
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Banks MMMFsGSE Agency and GSE- Mortgage PoolsIssuers of ABS Finance CompaniesSecurity Broker-Dealer Funding Corporation
11Source: US Flow of Funds
USA debt as a % of GDP by borrower type
Source: Oliver Wyman
Household
Corporate
Financial
1929
1935
1941
1947
1953
1959
1971
1977
1983
1990
1996
2002
2007
10%
50%
100%
150%
200%
250%
300%19
29
1935
1941
1947
1953
1959
1965
1971
1977
1983
1990
1996
2002
2007
10%
50%
100%
150%
200%
250%
300%
12
Underlying features of shadow banking
• Pooling, tranching (and re-tranching) to “create” apparently low risk assets
• Marked-to-market collateral and margin to “create” money equivalent claims
13
Real return on US treasury 20 year index-linked bond, 1999 – 2012
14
0%
1%
2%
3%
4%
5%
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
15
Source: Zoltan Pozsar, Institutional Cash Pools and the Triffin Dilemma of the U.S. Banking System, IMF Working Paper 11/190
Non-Financial corporations' cash and cash equivalents
Increasing demand for cash equivalent assets
Institutional Cash Pools
Banking and other financial balance sheets: in US and Eurozone
Deposit-taking Institutions as % of GDP Other financial institution as % of GDP
Source: IMF World Outlook Database, US Flow of Funds; ECB Statistical Data Warehouse
US
Euroarea
0%
50%
100%
150%
200%
250%
300%
350%
400%
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
US
Euroarea
0%
50%
100%
150%
200%
250%
300%
350%
400%
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
16
Frequency distribution of debt payouts
100% of principal and due interest
Observed in good times100%
Not observed in good times
0
17
Financial firms’ CDS and share pricesExhibit 1.27: Composite Time Series of Select Financial Firms' CDS and share prices
0.0%
0.2%
0.4%
0.6%
0.8%
1.0%
1.2%Dec
02
Apr
03
Aug
03
Dec
03
Apr
04
Aug
04
Dec
04
Apr
05
Aug
05
Dec
05
Apr
06
Aug
06
Dec
06
Apr
07
Aug
07
Dec
07
Apr
08
Aug
08
Dec
08
Ave
rage
CDS
Spre
ad in P
erc
ent
-
0.50
1.00
1.50
2.00
2.50
Mar
ketC
ap Index
CDS SHARE-PRICE-ADJ USTED
Firms included: Ambac, Aviva, Banco Santander, Barclays, Berkshire Hathaway, Bradford & Bingley, Citigroup, Deutsche Bank, Fortis, HBOS, Lehman Brothers, Merrill Lynch, Morgan Stanley, National Australia Bank, Royal Bank of Scotland and UBS.
CDS series peaks at 6.54% in September 2008.Source: Moody’s KMV, FSA Calculations 18
Gennaioli, Shleifer and Vishny, 2010
recent policy proposals, while desirable in terms of their intent to control leverage and fire sales, do not go far enough.
It is not just the leverage but the scale of financial innovation and of the creation of new claims itself, that might require regulatory attention”
“We recognise the benefits of private supply of safe securities, but at least in some cases, such securities owe their very existence to neglected risks…
19
Bank credit and money creation
Asset Liability
Loan to non-financial business
100 Deposit from non-financial business
100
Immediately available “private money”Not immediately repayable
20
Maturity transformation in banks and shadow banks
BANK
Long-term loans
Instant access / short-term deposits
SHADOW BANK CHAIN
Long-term loans
Instant access “deposits”
ABCP SIV /
Conduit MMF
Broker dealer
Hedge Fund
21
Credit and asset price cycles
Expectation of future asset price
increases
Increased credit extended
Low credit losses: high bank profits• Confidence reinforced • Increased capital base
Increased asset prices
Increased lender supply of credit
Favourable assessments of
credit risk
Increased borrower demand
for credit
22
Bank credit and creation of unsecured private money
Asset Liability
Loan 100 Deposit100
Not secured May be secured
23
Shadow bank credit and creation of secured private money
InvestorBorrower Hedge Fund
Broker Dealer
Money Market Fund
Repo /Prime broker
finance
Repo
Secured money equivalent
Secured money equivalent
24
Hardwired procyclicality in secured funding contracts
Asset value falls
• Assets sold to cover margin calls
• Reduced funding available
• More collateral required even if % haircuts/margins unchanged
• Variation margin paid
Increased risk awareness Increased % haircuts
25
Source: Gary Gorton and Andrew Metrick, “Shadow banking and the run on repo, 2009
Average repo haircuts: US bilateral repo market 2007 – 2009
26
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
50.0%
01/
01
/07
01/
04
/07
01/
07
/07
01/
10
/07
01/
01
/08
01/
04
/08
01/
07
/08
01/
10
/08
01/
01
/09
Four distinctive features of financial innovation
• Regulatory arbitrage
• Tax arbitrage
• Non-transparent embedded options
• Excessive churn
Complexity
and
interconnectedness
27
Hypothesis I: The value of ‘market completion’
Th
eore
tica
lly
avai
lab
le
allo
cati
ve e
ffic
ien
cy
Neg
ati
ve e
xter
nal
ity
of
incr
ease
d p
ote
nti
al
inst
abil
ity
More complete financial markets
Complexity and interconnectedness
Increased financial intensity
Net social value derived
28
Hypothesis II: The value of ‘increased liquidity’?
Eff
icie
ncy
/ p
rice
d
isc
ove
ry
Increased liquidity
Increased market liquidity
Net social value derived?
Po
ten
tia
l fo
r vo
lati
lity
, p
ure
mo
men
tum
ef
fect
s an
d a
rbit
rary
p
rici
ng
Increased role of algorithmic trading
?
29
Household deposits and loans: 1964 – 2009
Source: Bank of England, Tables A4.3, A4.1
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009
% o
f G
DP
Securitisations and loan transfers Deposits Loans
30
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