The Financial Crisis and the
Future of Financial Regulation
Adair Turner
Chairman of the Financial Services Authority
The Economist’s Inaugural City Lecture
21st January 2009
Global current account balances
1,400
1,000
600
200
$bn
-200
-600
-1,000
-1,400
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
US Oil Exporters China Japan Other Advanced Economies Other EME
Source: Datastream, FSA calculations 1
Real yields to maturity on UK index-linked gilts:
20 year bonds 1985 – 2007
Yield at May 25th (or nearest week day)
4.5
4
3.5
3
2.5
2
1.5
1
0.5
0
1985 1990 1995 2000 2005
Note: For the years 1985, 86, 89, 90 & 91 no 20 year yield is precisely available; the longest available yield (in range
16-19 years) is shown
Source: Bank of England Real Yield curve calculations
2
Household debt as a proportion of GDP
120%
100%
80%
percent
60%
40%
20%
0%
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
US UK EU
Source: ONS, Federal Reserve, Eurodata, Datastream
3
The growth of securitised credit
ABS – volumes outstanding, US
3,000
2,500 Securitisation issuance trends in the UK
200
2,000 180
160
$ billion
1,500 140
120
£bn
100
1,000 80
60
40
500
20
0
2000
2002
2006
2001
2007
2005
2003
2004
0
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
RMBS CMBS
ABS CDO
CLO Covered bonds
loans receivables leases loans loans Other
Source: SIFMA Source: Oliver Wyman
4
Value of outstanding credit default swaps
70
60
50
40
$ trn
30
20
10
0
Jun 03
Jun 04
Jun 05
Jun 06
Jun 07
Dec 03
Dec 04
Dec 05
Dec 06
Dec 07
Source: ISDA
5
Investment bank leverage Major UK banks’ leverage
100
90
80
70
Assets : Equity
60
50
40
30
20
10
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
CITIGROUP INC MORGAN STANLEY
GOLDMAN SACHS DEUTSCHE BANK Source: Bank of England
UBS
Source: Bloomberg
6
Corporate spreads
180
160
140
120
OAS bp
100
80
60
40
20
0
Jun-02
Jun-03
Jun-04
Jun-05
Jun-06
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Global Corporates AAA Global Corporates AA Global Corporates A
Source: Bloomberg
7
30 day volatility, percent
0
5
10
15
20
25
30
35
40
45
50
Jul 02
Source: Datastream
Jan 03
Jul 03
Jan 04
Implied volatility of S&P 500
Jul 04
VIX
Jan 05
Jul 05
Jan 06
Jul 06
Jan 07
8
Securitisation: the initial vision
Taking risks off balance sheets
L A
Deposits Loans
L A
Deposits Loans
Loan origination &
End investor
packaging
9
Estimates of mark to market losses on US credit
securities: at April 2008
Banks 470 530
GSEs & Government 55 80
Insurance
companies, pension 280 425
funds & direct
individual savings
Other (e.g.
55 125
Hedge Funds)
Source: IMF Global Financial Stability Report, October 2008 10
Securitisation as it actually evolved
L A
Deposits Loans
Bank
Bank 1 (or I-Bank) 2 Bank 3, etc
L A L A L A
Deposits Loans &
loan
End investors origination
11
US gross capital flows
2500
2000
1500
1000
$bn
500
0
-500
-1000
-1500
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Year
Gross capital inflows Gross capital outflows 12
Source: Datastream
The conventional wisdom – 2006
“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
13
The growth of the financial sector
600% UK debt as a % GDP by borrower type
500%
(1987-2007), Debt Liabilities on B/S
400% Corporate
300% Household
200%
100% Financial
0%
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
USA debt as a % GDP by borrower type
300% (1929-2007) 1987
250% Corporate
200%
Household
150%
100%
50% Financial
10%
1935
1941
1950
1971
1977
2002
2007
1929
1947
1953
1959
1983
1990
1996
Source: Oliver Wyman 14
Market capitalisation of FTSE All Share Financials
as a % of GDP
50%
40%
30%
% of GDP
20%
10%
0%
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
Source: Datastream 15
Trading book assets & capital 2007: examples
Market risk Trading assets Trading / market risk
capital requirement as % of total capital as % total
as % trading assets assets capital requirements
Bank 1 0.4% 34% 11%
Bank 2 0.4% 28% 7%
Bank 3 0.1% 57% 4%
Bank 4 1.1% 27% 7%
Source: BIS Estimates from Bank Annual Reports
16