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An Evening with Anat Admati An evening with Anat Admati. Location: Swedish House of Finance. Monday, October 15, 2018. 6:00 – 8:00 pm. Banking, Governance, and Politics Anat Admati Stanford Graduate School of Business Swedish House of Finance and Stanford GSB Alumni Chapter Stockholm, October 15, 2018 1 My daughter came home from school one day and said, ‘daddy, what’s a financial crisis?’ And without trying to be funny, I said, ‘it’s the type of thing that happens every five, seven, ten years.’ Jamie Dimon, January 2010 (to Financial Crisis Inquiry Commission) 2 “The Sequel to the Financial Crisis is Here” Frank Partnoy, Financial Times, July 31, 2017 “The Next Financial Crisis is Closer than You Think,” Tim Lee, Washington Post, October 10, 2018 Italy political crisis hits financial markets BBC News, May 29, 2018 Natural Disaster? Sudden “Shock?” “100-year flood?” 3 A Liquidity Problem? “A Classic Bank Run?” 4 The financial crisis was avoidable Widespread failures in financial regulation Breakdown in corporate governance Explosive and excessive borrowing. Lack of transparency Government was ill-prepared and responded inconsistently Widespread breaches in accountability at all Delivered January 27, 2011 levels. The crisis reflected distorted incentives and failure of rules and governance. 5 Household and Other Debt in Sweden Source: Financial Stability Report, Riksbank 2018 6 To Spot the Next Financial Crisis, Look Who Was Spared by the Last One James Mackintosh, Wall Street Journal, April 26, 2018 Leading the list are Australia, Canada and Sweden. Sweden offers a case study in financial crises. Private debt in general and mortgage debt in particular is one of the most reliable indicators of trouble ahead. Sweden’s indicator of financial vulnerability is higher than ahead of its 1992 crisis. Riksbank, Sweden’s central bank, has been warning about the risks from the housing market, and worrying in public about the strength of its banks. $400,000 - $380,000 = $20,000 7 $410,000 - $380,000 = $30,000 2.5% 50% $420,000 - $380,000 = $40,000 5% 100% 8 $440,000 - $380,000 = $60,000 10% 200% $390,000 - $380,000 = $10,000 -2.5% -50% 9 $380,000 - $380,000 = $0 -5% -100% 10 What about the lenders? Total Liabilities and Equity of Barclays 1992-07 1.4 Customer Total MMF Other Equity Deposits Funding Liabilities 1.2 1 0.8 0.6 Trillion pounds Trillion 0.4 0.2 0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Hyun Song Shin, “Global Banking Glut and Loan Risk Premium,” IMF Annual Research Conference, November 10-11, 2011; Figure 22. 11 12 13 14 Historical Equity/Asset Ratios in US and UK 30 25 Mid 19th century: 50% equity, United States unlimited liability 20 After 1940s, limited liability 15 everywhere in US 10 “Safety nets” expand Percentage (%) Percentage United Kingdom 5 Equity ratios decline 0 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 Year Alesandri and Haldane, 2009; US: Berger, A, Herring, R and Szegö, G (1995). UK: Sheppard, D.K (1971), BBA, published accounts and Bank of England calculations. JPMorgan Chase Balance Sheet Dec. 31, 2011 (in Billions of dollars) 4,500 4,060 4,000 3,500 3,000 2,500 2,260 2,000 1,500 1,000 500 126 0 GAAP Book Assets IFRS Book Assets Market Equity 15 Banks Remain Extremely Heavily Indebted Source: Financial Stability Report, Riksbank 2018 The Mantra in Banking: “Equity is Expensive” To whom? Why? Only in banking? 16 Fallacies, Irrelevant Facts and The Leverage Ratchet Effect Myths in the Discussion of Capital Regulations: Why Bank Equity is Not Socially Expensive August 2010 (revised 2013) Journal of Finance, 2018 Anat Admati, Peter DeMarzo, Martin Hellwig and Paul Pfleiderer https://www.gsb.stanford.edu/faculty-research/excessive-leverage Zombie (Insolvent) Borrowers: Opaque and Dysfunctional 17 Zombie (Insolvent) Borrowers: Opaque and Dysfunctional Unable to raise equity “Gamble for resurrection” Anxious to take cash out Avoid equity Sell assets, even at fire-sale prices Underinvest in worthy “boring” assets Try to hide insolvency in disclosures Lobby policymakers for supports Regulatory Measures are Uninformative “Tier 1” capital ratios: 0.1 What crisis? 0.09 0.08 Between summer 2007 and end 0.07 of 2008, the largest 19 US 0.06 institutions paid out nearly $80B 0.05 to shareholders. 0.04 0.03 'No crisis' banks 0.02 'Crisis' banks 2006 was a great year in 8% threshold 0.01 banking Lehman failure 15 Sep 08 0 May Nov May Nov May Nov May Nov May Nov May Nov May Nov 02 02 03 03 04 04 05 05 06 06 07 07 08 08 From: Andrew Haldane, “Capital Discipline,” January 2011 18 Regulatory Measures are Uninformative “Tier 1” capital ratios: 0.1 What crisis? 0.09 0.08 Largest 19 institutions received 0.07 ≈$160B under TARP. 0.06 0.05 Fed committed $7.7 trillions in 0.04 below-market loans to 407 banks. 0.03 'No crisis' banks 0.02 'Crisis' banks Tier 2 capital proved useless to 0.01 8% threshold Lehman failure 15 Sep 08 absorb losses (except Lehman). 0 May Nov May Nov May Nov May Nov May Nov May Nov May Nov 02 02 03 03 04 04 05 05 06 06 07 07 08 08 From: Andrew Haldane, “Capital Discipline,” January 2011 Regulatory Measures are Uninformative “Tier 1” capital ratios: Market-based measures 0.1 What crisis? 0.14 0.09 0.12 0.08 0.07 0.1 0.06 0.08 0.05 0.06 0.04 0.03 'No crisis' banks 0.04 'No crisis' banks 0.02 'Crisis' banks 'Crisis' banks 0.02 5% threshold 0.01 8% threshold Lehman failure 15 Sep 08 Lehman failure 15 Sep 08 0 0 May Nov May Nov May Nov May Nov May Nov May Nov May Nov May Nov May Nov May Nov May Nov May Nov May Nov May Nov 02 02 03 03 04 04 05 05 06 06 07 07 08 08 02 02 03 03 04 04 05 05 06 06 07 07 08 08 From: Andrew Haldane, “Capital Discipline,” January 2011) 19 Basel “Capital Regulation” (No proper justification) Basel II (pre-crisis) Basel III (reformed rules) “Common equity Tier 1 capital” to “Common Equity Tier 1 Capital” to risk-weighted assets: 2% risk-weighted assets (RWA): 4.5% » Plus 2.5% conservation buffer » Plus 1.5% “Tier 1” to RWA Leverage Ratio: “Tier 1” to total » Basel III: 3% » US: BHC: 5%, insured banks: 6% “Tier 2” Loss-absorbing debt “Tier 2”/TLAC (“loss-absorbing debt”). Tripling almost nothing does not give one very much. Martin Wolf, “Basel III: The Mouse that Didn’t Roar,” Financial Times, Sep 13, 2010 20 Tough Reforms? 3% 5% 6% If at least 15% of banks’ total assets were funded by equity, the social benefits would be substantial. And the social costs would be minimal, if any. Temporarily restricting bank dividends is an obvious place to start. Anat R. Admati, Franklin Allen, Richard Brealey, Michael Brennan, Markus K. Brunnermeier, Arnoud Boot, John H. Cochrane, Peter M. DeMarzo, Eugene F. Fama, Michael Fishman, Charles Goodhart , Martin F. Hellwig, Hayne Leland, Stewart C. Myers, Paul Pfleiderer, Jean Charles Rochet, Stephen A. Ross, William F. Sharpe, Chester S. Spatt, Anjan Thakor Financial Times, November 9, 2010 21 Don’t Believe Reassurances ___________________________ The system is too complex, opaque, and dangerous; “systemic (contagion) risk” is significant. This situation reflect policy failures Investors can’t understand the “nature and quality of the assets and liabilities... The disclosure obfuscates more than it informs. Kevin Warsh, Jan. 2013 The unfathomable nature of banks’ accounts make it impossible to know which are sound. Derivatives positions, in particular, are difficult for outside investors to parse. Paul Singer, Elliot Management, Jan. 2014 Wells Fargo: Quaint? “What’s Inside America’s Banks?” Eisinger and Partnoy, Atlantic, Jan 2013 ” 22 Shadow Banking Pozsar, Adrian, Ashcraft, and Boesky, Federal Reserve Bank of New York, July 2010: revised February 2012 23 Nonbank and Bank Nexus Ultimate Ultimate Borrowers Savers Intermediaries Money Ultimate Money Short- Borrowers Money term (from SHORT-TERM (REPO) Market household Banks and FUNDING Banks Funds and corp. Nonbanks) Collateral (Commercial and savings – however REPOs/PRIME Dealer) Money only key BROKERAGE dealer Hedge Collateral banks Funds shown in Money SECURITIES this “bank/ LENDING nonbank” Custodians (for asset nexus Collateral Long-term manager, map/1 household Money/Collateral pensions, Money and corp. insurers, savings official Money/Collateral Risk Transfer (OTC derivatives) sector) CCPs Source: Collateral and Financial Plumbing, Manmohan Singh, 2014; “Leverage: A Broader View,” Manmohan Singh and Zohair Alam The omission of off-balance sheet items in the standard measures implies a substantial underestimation of bank leverage Off-balance sheet funding is higher now than in 2007 “Leverage, a Broader View,” Singh and Alam, IMF, March 2018 24 Monstrous global institutions are a symptom of failed markets and rules ___________________________ “Let fail” defies credibility 25 Size of 28 Global Banks 2006 2013 $37.8 trillion total $49.2 trillion total Average Average $1.35 trillion $1.76 trillion Sources: SNL Financial, FDIC, bank annual reports, Bank of England calculations. Derivatives for 21 Banks 2006 2013 $409 trillion (notional) $661 trillion (notional) Average Average $31 trillion $19 trillion Sources: SNL Financial, FDIC, bank annual reports, Bank of England calculations. 26 Too complex to Resolve? Dexia's structure, 2011 Associated Dexia Dexia SA (DSA) Technology Services DBNL (ADTS) 100% Belgium 100% Belgium 100% Netherlands DCL Paris Deniz Bank DHI DCL London Branch DCL Global Dexia Holdings Inc Dexia Banque CBX IA1 SARL, Banque, Dexia FP (FP) Dexia Bank Belgium Dexia Credit Local (DCL) Funding (GF) (DHI) Internationale a DenizBank (DzB) (DBB) Luxembourg (BIL)
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