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Financial integration and global financial turmoil - Twisted Pear

VIEWS: 13 PAGES: 20

									Financial Integration and Global Financial Turmoil
Hamid Faruqee Assistant to the Economic Counsellor Research Department, IMF
June 25, 2008

Integrating Europe’s Financial Markets
Overview
 Financial Integration  Financial Stability

 Europe’s Road to a “Single Market” in Financial Services

Europe’s Road to a “Single Market” in Financial Services
FSAP Capital Flows Internal (2005) (1988) Market (1993)

Treaty of Rome (1957)

Single European Act (1986)

Banking Directive (1989)

EMU (1999)

Financial Integration: Concepts, Benefits & Risks
Completeness & Risk Sharing
Scale Economies & Innovation

Competition & Arbitrage

Autarky

Interdependent Markets

“Single Market”

Evolving Risks from Integrating Financial Markets
“As Europe’s system of financial markets

continues to evolve, so to will the risks... integration will introduce risks that are not yet known and that are more likely to spread...” (p. 40)

Global Financial Turmoil
 Epicenter — U.S. Subprime Mortgage Crisis  Tremors — Credit Squeeze & Rising Spreads, Liquidity Strains in Term-Funding (ABCP / Interbank)  Wider Aftershocks and Fault Lines —Frozen Markets in ABS/CDO, Valuation problems, Bank Capital, Monoline Insurers, Liquidity “run”  Policy Issues — “Front-end” (mortgages) and “Back-end” policy reactions (liquidity)

(in percent of total subprime loan amount; 2007Q1)

U.S. Subprime Delinquencies

6

0% to 9% 10% to 14% 15% to 19% 20% or more

(in percent of total subprime loan amount; 2007Q2)

U.S. Subprime Delinquencies

7

0% to 9% 10% to 14% 15% to 19% 20% or more

U.S. Mortgage Resets and Delinquencies
Monthly Mortgage Rate Resets
50 45 40 35 30 25 20 15 10 5 0 Jun07 Dec- Jun- Dec- Jun07 08 08 09 Months to first reset Dec09

8

(in billions of U.S. dollars)

(percent of total residential loans outstanding)

Housing Market Delinquencies

Option adjustable rate mortgage Subprime Alt-A Prime Agency

20 18 16 14 12 10

Foreclosures Prime Subprime

8 6 4 2

98 99 00 01 02 03 04 05 06 07 08

0

Mortgage Delinquency by Vintage year
(60+ days delinquencies; in percent of balance)
Prime
2.5

9

Subprime
30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 0
0 10 20 30 40 50 60 0

2006

2005

2000
2001 2002

2000

2.0

2004
2007 2003

2005 2006 2007 2004 2002 2003
10 20 30 40 50 60

1.5

2001
1.0

0.5

0.0

Months after origination

U.S. House Prices and Mortgage Delinquencies
8

10

Midwest West
Change in Mortgage Delinquency Rate, 05Q4 - 07Q4 (in percent points) 1/

South Northeast

6

4

2

0 -20% -10% 0% 10% 20%

-30%

-2 House Price Changes, 06Q2 - 07Q3 (in percent)

Sources: Moody's Economy.com, Equifax, Case-Shiller and OFHEO. 1/ Delinquency rate defined in percent of outstanding mortgages (in dollar amounts).

Virtual Shutdown of Subprime Lending
Mortgage-Related Company Failures and Acquisitions

11

100 90 80 70 60 50 40 30 20 10 0

failed

acquired

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

U.S. Interest Rate Spreads and Credit Squeeze
(in basis points; rel. to 1-m LIBOR)
500 450 400 350 300 250 200 150 100 50 0 Jan-06
6/9

12

Mortgage Spreads
Conforming Jumbo Subprime ABS (RHS)

Corporate Spreads
(basis points)
A-rated BBB-rated BB-rated
2000 1800 1600 1400 1200 1000 800 600 400 200
6/6

650 600 550 500 450 400 350 300 250 200 150 100 50

Aug-06 Mar-07

Oct-07

0 May-08

Jan-06

Aug-06

Mar-07

Oct-07

0 May-08

Corporate Default Rates and Bond Spreads 1/
(default rates in percent; bond spreads in basis points)
700
Default rates—Total (RHS)

13

12

600

Default rates—Speculative grade (RHS) AA (LHS) BBB (LHS)

10

500

8

400

BB (LHS)

6 300 4 200 2

100

0 97 98 99 00 01 02 03 04 05 06 07 08
1/ Speculative grade defaults based on Moody’s data through end-March.

0

Bank Surveys and Tighter Lending Conditions
(Change in credit standards over past 3 months; in percent 1/)

14

Fed’s Lending Survey
80 70 60 50 40 30 20 10 0 -10 -20 -30 -40 -50 -60 -70 -80 2005 C&I loans to firms Commercial real estate Residential mortgages Residential mortgages: prime Residential mortgages: subprime Consumer loans (excl. credit cards) 2006 2007 2008 2005

ECB’s Lending Survey
60 Loans to small/mediumsized companies Loans to large companies Consumer credit Housing loans 50 40 30 20 10 0 -10 -20 2006 2007 2008

1/ Change in the balance of respondents between the “tightened considerably and tightened somewhat" and the "eased somewhat and eased considerably.“

Liquidity and Credit Strains
3-Month LIBOR Spreads to OIS
(Overnight index swap; in basis points)
120 100 80 60 40 20 0 -20 Jan-07
6/6

15

(5-years; in basis points; Median)
260

Bank CDS Spreads

United States Euro area Japan United Kingdom

240 220 200 180 160 140 120 100

U.S.

80 60 40

Europe

6/6

20 0

May-07

Sep-07

Jan-08

Jun-08 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08May-08

Global CDS Spreads
United States
500 450 400 350 300 250 200 150 100 50
Below Investment Grade

16

(5-years; in basis points)
Major Economies 1/
350 325 300 275 250 225 200 175 150
Asia ex. Japan

World 1/ 2/
350 325 300 275 250 225 200 175 150 125

Investment Banks Investment Grade

125 100 75 50
Europe Japan 6/9 U.S.

100 75 50 25
6/9

0 0 0 Jul- Sep- Nov- Jan- Mar- MayJul- Sep- Nov- Jan- Mar- MayJul- Sep- Nov- Jan- Mar- May07 07 07 08 08 08 07 07 07 08 08 08 07 07 07 08 08 08 Source: IMF staff estimates. 1/ Consolidated series based on investment grade entities from various sectors. Asia ex. Japan includes some non-investment grade entities. 2/ Median based on U.S., Europe, Japan, Asia ex. Japan. Shaded area represent (+/-) one standard deviation.

Commercial Banks 6/9

25

Global Bank Writedowns and Capital Infusion
700

17

(in billions of U.S. dollars)

600

US

Europe

Asia

500

400

392.4 291.7

300

200

100

0 Writedowns 1/ Capital Raised

1/ Includes writedowns due to asset valuation, yet to be passed through income statement.

House “Price Gaps” and Monetary Policy Rates
(in percent of real house prices)
35 30 25 20 15 10 5 0 -5 -10
U Ne I ni t r e te he la d rl n d Ki a n n A gd ds us o tr m F ali N N ra n a ew o c e Ze rwa D al y en a n B ma d el rk gi u Sp m Sw a ed i n e U It n ni al te J a y d pa St n a Fi te G nl s er a m nd Ca a n n y A ad us a tr ia

18

House “Price Gaps”

Monetary Policy Rates
(in percent)
8 7

Australia U.K.

6 5

U.S.
4

ECB

3 2

Japan

1 0

Jan-06

Aug-06

Mar-07

Oct-07

May-08

Source: IMF staff calculations.

Key Lessons and Policy Issues
 Incentives and Standards — Oversight & Agency Problems in “Originate-to-Distribute” / Securitization  Credit Risk Transfer — ”Boomerang” from SIVs back to Banks; off-balance sheet transparency  Liquidity Fragility — at times of market stress, Complacency Problem & Counterparty Implications  Complex Products — Valuation Problems, Reliance on Rating Agencies, Breakdown of Due Diligence


								
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