The Financial Crisis and the Future of Financial Regulation

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 1 US Oil Exporters China Japan Other Advanced Economies Other EME Source: Datastream, FSA calculations 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 EU 2007 3 US Source: ONS, Federal Reserve, Eurodata, Datastream UK The growth of securitised credit ABS – volumes outstanding, US 3,000 2,500 Securitisation issuance trends in the UK 200 180 160 140 £bn 120 100 80 60 40 20 0 2,000 $ billion 1,500 1,000 500 2000 2002 2001 2006 2003 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 loans receivables leases loans loans Other RMBS ABS CLO Source: SIFMA Source: Oliver Wyman 2004 CMBS CDO Covered bonds 2005 2007 4 Value of outstanding credit default swaps 70 60 50 $ trn 40 30 20 10 0 Jun 03 Jun 04 Jun 05 Jun 06 Dec 03 Dec 04 Dec 05 Dec 06 Jun 07 Dec 07 5 Source: ISDA Investment bank leverage 100 90 80 Assets : Equity 70 60 50 40 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 Major UK banks’ leverage CITIGROUP INC GOLDMAN SACHS UBS MORGAN STANLEY DEUTSCHE BANK Source: Bank of England 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 Dec-02 Dec-03 Dec-04 Dec-05 Jun-06 Dec-06 7 Global Corporates AAA Source: Bloomberg Global Corporates AA Global Corporates A 30 day volatility, percent 10 15 20 25 30 35 40 45 50 0 Jul 02 5 Implied volatility of S&P 500 Source: Datastream Jan 03 Jul 03 Jan 04 Jul 04 VIX Jan 05 Jul 05 Jan 06 Jul 06 Jan 07 8 Securitisation: the initial vision Taking risks off balance sheets L Deposits A Loans L Deposits A Loans End investor Loan origination & packaging 9 Estimates of mark to market losses on US credit securities: at April 2008 Banks 470 530 GSEs & Government Insurance companies, pension funds & direct individual savings Other (e.g. Hedge Funds) 55 80 280 425 55 125 Source: IMF Global Financial Stability Report, October 2008 10 Securitisation as it actually evolved L Deposits A Loans Bank Bank 1 L A (or I-Bank) 2 L A Bank 3, etc L A Deposits End investors Loans & loan 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 12 Year Source: Datastream Gross capital inflows Gross capital outflows 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% 500% 400% 300% 200% 100% 0% 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 UK debt as a % GDP by borrower type (1987-2007), Debt Liabilities on B/S Corporate Household Financial 300% 250% 200% USA debt as a % GDP by borrower type (1929-2007) 1987 Corporate Household 150% 100% 50% 10% 1935 1941 1950 1971 1977 2002 1929 1947 1953 1959 1983 1990 1996 2007 Financial Source: Oliver Wyman 14 Market capitalisation of FTSE All Share Financials as a % of GDP 50% 40% % of GDP 30% 20% 10% 0% 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 15 Source: Datastream Trading book assets & capital 2007: examples Market risk capital requirement as % trading assets Bank 1 Bank 2 Bank 3 Bank 4 0.4% 0.4% 0.1% 1.1% Trading assets as % of total assets 34% 28% 57% 27% Trading / market risk capital as % total capital requirements 11% 7% 4% 7% Source: BIS Estimates from Bank Annual Reports 16