Speed on Financial Crisis Document Highlights
Getting
up
to
Speed
on
the
Financial
Crisis
:
A
one
-
Weekend
-
Reader’s
Guide
-
--------
Gary
Gorton
and
Andrew
Metrick
Jingyu
Wang
Sep
.
12
th
Objective
•
speed on the literature of the crisis without having to go
into a cave and read for a whole year.
•
select and summarize sixteen documents, including
academic papers and reports from regulatory and
international agencies.
•
Covers the key facts and mechanisms in the build –up of
risk, the panics in short-term debt markets, the policies
reactions, and the real effects of the financial crisis.
Outline
•
Section
2:
Overview
and
Timeline
of
the
Crisis
2010
testimony:
Bernanke
in
front
of
the
Financial
Inquiry
Crisis
Commission
Report
Chapter
from
International
Monetary
Fund(IMF
2010)
Bank
for
International
Settlements(BIS
2009)
•
Section
3:
Historical
perspective
on
financial
crisis
Reinhart
and
Rogoff(2011)
Schularick
and
Taylor
Accelerations
in
economy
wide
leverage
and
subsequent
banking
crises
Outline
•
Section
4:
The
Crisis
Build-up
Pozar(2011):
Institutional
Cash
Pools
grew
Bernanke(2005):
sovereign
-
wealth
grew
Reinhart
and
Rogoff(2008):
sharp
increase
in
house
price
before
crisis
Case
and
Shiller(2003):
housing
bubble
before
crisis
•
Section
5:
The
panics
Covits,
Liang,
and
Suarez:
asset-backed
commercial
paper
McCabe(2010):
money-market
mutual
funds
Gorton
and
Metrick:
repurchase
agreements
and
securitization
Demand
of
short-term
debt
Provide
a
narrative
of
contagion
where
each
step
drains
the
banking
system
of
hundreds
of
billions
dollars
and
induces
higher
risk
Structure
•
Section
6:
Policy
response
IMF’s
Financial
Stability
Report
(Oct,
2009):
taxonomy
and
analyses
policy
actions
across
13
countries
from
2007-2009
•
Section
7:
Real
effects
of
the
financial
crisis
Ivashina
and
Scharfstein
(2010)
: decrease in lending related
to
bank’s
reliance
in
short-term
funding
Puri,
Rocholl,
and
Steffen(2011):
shock
to
credit
supply
reduced
consumer
loan
Campello,
graham,
and
Havey
(2010):credit
constraints
pulled
back
on
investment
•
Section
8:
Conclusion
Section
2:
Overview
and
Timeline
of
the
Crisis
•
Bernanke
testimony(2010):
•
Two
vulnerabilities in financial sector:
short-term
debt(main):
repurchase
agreement
and
commercial
paper
shadowed
bank
:serve
as
intermediaries
to
channel
savings
into
investment
Section
2:
Overview
and
Timeline
of
the
Crisis
•
IMF
Document:
Details
how
repo
market
work
Large
but
unregulated
Total
outstanding
repo:Between
20
and
30
percent
of
US
GDP
in
each
year
from
2
002-2007
Disruption
in
US
short
-
term
debt
creates
shortage
of
US
dollars
Section
2:
Overview
and
Timeline
of
the
Crisis
•
Bank
for
International
Settlements(BIS)
Document
Bankruptcy
filling
of
Lehman
Brother
exacerbated
whole
situation
Financial
institutions
facing
the
risk
of
default
Run
on
money
market
mutual
fund
far more damage then subprime losses
Section 3: Historical Background
•
understand the recent crisis from the phenomenon before
the financial crisis
•
Reinhart and Rogoff
Results:
external debt increases sharply, in advance of banking crisis
banking crises tend to lead sovereign debt crises
•
Schularick
and
Taylor
analyze financial crises with overall credit growth
build a 140-year panel data set for 14 developed countries
Results:
changes in credit supply(bank loans) are a strong predictor of
financial crisis, particular when these change are accelerate
Section 3: Historical Background
Provide a consistent picture :an acceleration of debt from both
governments and financial intermediaries are the most
important antecedents
Section
4:
The
Crisis
Build-up
•
Try to understand how the Crisis build- up
•
Previous
Section:
Credit booms often precede crises
•
Credit booms:
asset-baked securities
mortgage-backed securities
Shadow
banking
system
Securitization
Section
4:
The
Crisis
Build-up
Explosive
growth
in
the
six
or
seven
year
before
the
crisis,
which
consistent
with
credit
boom
•
Pozsar
(2011)”Institutional
Cash
Pools
and
the
Triffin
Dilemma
of
the
U.S
banking
System”
institutional cash pools
:
important Securitization
growth of institutional cash pools have a associated
demand for liquidity
demand for insured deposit
alternatives
Not enough safe asset from US treasury for US to hold.
institutional cash pools demand for insured deposit
alternatives exceeded the outstanding amount of short-
term government guaranteed instruments.
Section
4:
The
Crisis
Build-up
Section
4:
The
Crisis
Build-up
•
Bernanke
(2005)”The
Global
Savings
Glut
and
the
U.S
Current
Account
Deflict”
foreign official investors hold large amounts of US
Treasuries
institutional cash pool
had
to find
substitutes
1)
short-term bank debt-like products(repurchase agreements and asset-
backed commercial paper)
2)
indirect holdings of unsecured private money market instruments through
money market mutual fund
Asset-backed securities
mortgage’s preferred
collateral
credit boom
borrow
money(buy
houses)
house
price
increase
Bubble?
•
Case
and
Shiller(2003)”Is
there
a
bubble
in
the
housing
market”
House
price
increasing
is not a conclusive evidence of a
bubble
Bubble:
a situation in which excessive public
expectations of future price increases causes price to be
temporarily elevated
Section
4:
The
Crisis
Build-up
Section
4:
The
Crisis
Build-up
•
House price run-ups prior to crises are common
•
Reinhart and Rogoff(2008)”Is
the
2007
U.S
Sub-Prime
Financial
Crisis
so
Different
?
An
international
Historical
Comparison.
“
Section
4:
The
Crisis
Build-up
run-up in
housing prices in
U.S.before crisis
Section
5
:
The
Panics
•
Two main panic period of the financial crisis : Aug. 2007, and
Sep-Oct 2008.
•
Three
paper
:
Each focus on a different component of the
short-term debt market
major
causes
of
financial
crisis
Section
5:
The
Panics
•
Covitz, Liang, and Suarez(forthcoming)
•
Analyze runs on the asset-backed commercial paper
market began in Aug. 2007
Commercial paper is important security for the financing
of industrial firms
minimize transaction cost
Demand of CP is high increase use of long-term
financial asset(Asset-baked commercial paper) Can
bundle mortgages(securitization) transparent, lower
funding cost, save on regulatory capital 1.2 trillion
ABCP outstanding by July 2007
Section
5:
The
Panics
•
Covitz, Liang, and Suarez(forthcoming)
Meaning of a run on ABCP program
: if lender(depositor)
in bank are unwilling to refinance CP when it come to due.
Mechanically, in any week a program does not issue any
new paper despite having at least ten percent of its CP
maturing
Backup
support from
the program
sponsor
Force to sell
asset
Section
5:
The
Panics
Beginning in
the week of
Aug. 7
th
, the
frequency of
runs
increased
dramatically.
By the end of
2007, 40% of
program in a
run, unable
to finance
themselves
•
Covitz, Liang, and Suarez(forthcoming)
Program more likely experience a run:
high credit risk(exposure to subprime-related securities)
high liquidity risk
Section
5:
The
Panics
Section
5:
The
Panics
•
ABCP market fell a lot in 2007
significant impact on
the balance sheet of those sponsor focus on money
market mutual fund(MMFs), a major holder of ABCP
•
McCabe(2010)
Shirking ABCP downward pressure on asset classes
held by many MMF’
Section
5:
The
Panics
•
Comprehensively analyses short-term debt market and the
linking between ABCP and MMF’s help to know how
contagion in these market can spread.
•
Did not figure out ABCP panic was drive by a weakness in
subprime mortgage
•
Repo
markets
play
an
important
role
in
the
contagion
•
Gorton and Metrick(forthcoming)
Section
5:
The
Panics
•
Gorton and Metrick(forthcoming)
Repo is the shadow banking equivalent of a deposit
market.
When
cash holdings far exceed insured deposit limits,
large
institutional
money
pools can lend short-term to a
financial institution and receive collateral as protection
For every $100 of collateral , an institution can receive
$(100-x) in loans, with x% represent the haircut.
Section
5:
The
Panics
Beginning
of
2007,
average
haircut
were
near
0.
First
shock
at
the
time
of
ABCP
panic
Steady
rise
each
year
Lehman
failure,
large
drain
Section
5:
The
Panics
•
Gorton and Metrick(forthcoming)
subprime securities
(small)
Financial
Crisis
Subprime
failure(ABCP 40%
market)
Price
drop
,
unprecedented
problems
on
MMF’s(43
funds
required
support
from
their
sponsors)
Initial
panic
on
Aug.
2007
Pressure
on
repo
market
Lehman
collapse
interbank
market
near
collapse
government
intervention
Section
6
:
Policy
Response
•
IMF
Report
Look
short-term
reaction
of
both
“economic
stress
index”(ESI)
and
“financial
stress
index”(FSI)
Interest
rate
cut:
no
short-run
impact
on
the
ESI,
only
limited
evidence
of
a
positive
effect
on
the
FSI
Liquidity
support
was
effect
at
calming
interbank
credit
market
in
the
early
stages
of
the
crisis,
but
not
after
the
fall of
Lehman
Later
stage,
capital
injection
were
the
most
effective
policy
Section
7:
Real
Effect
of
the
financial
Crisis
•
Crisis is global in nature
•
Ivshina and Scharfsterin(2010)
study the supply of credit during the crisis in order to
understand the real effects of the panic on the corporate
sector
lending volume in the fourth quarter of 2008 was 47%
lower than it was in the previous quarter, and 79% lower
than at the peak of credit boom(2007:Q2)
main conclusion: the decline in lending was in large part
an effect of reduced bank loan supply
Section
7:
Real
Effect
of
the
financial
Crisis
•
Puri, Rocholl, and Steffen(2011)
focus on the issue of the supply of credit
examine the effects of the U.S financial crisis on lending
to retail customers in Germany
Landesbanken(the regional banks , each in a province)
suffer different extents due to their exposures to US
subprime mortgages
Overall decrease in demand for consumer loans, result of
bank reduced the supply of credit
Section
7:
Real
Effect
of
the
financial
Crisis
•
Effect of a reduced bank loan supply have on the real
economy, on the activities of nonfinancial firms
•
Campello, Graham, and Harvey(2010)
1,050 CFOs in thirty-nine countries in North America,
Europe and Asia in Dec. 2008:whether they were
financially constrained during the crisis.
Section
7:
Real
Effect
of
the
financial
Crisis
81% of the very
affected firms
reported that
they experience
less to credit,
20% has
problems with
lines credit
Reduction in
credit supply
had significant
impact on credit-
constrained firm
Conclusion
•
Financial crisis of 2007-09 was the most important
economic event since the Great Depression.
•
Similarity: the acceleration of system-wide leverage just
before the crisis
•
The crisis was exacerbated by panics in the banking
system where various types of short-term debt suddenly
became subject to runs.
•
Novelty: location of runs, which took place mostly newly
evolving “shadow banking” system, including money-
market funds, commercial paper, securitized bonds, and
repurchase agreements
My
opinion
•
CDS
•
Short
-term
interest
rate,
government
intervention
"Reader's guide summarizes key documents on financial crisis build-up, panics, policy responses, and real effects. Covers historical perspective, crisis timeline, and recommended readings for quick understanding."
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Presentation Transcript
Getting up to Speed on the Financial Crisis : Aone-Weekend-Reader s Guide ---------Gary Gorton andAndrew Metrick Jingyu Wang Sep. 12th
Objective speed on the literature of the crisis without having to go into a cave and read for a whole year. select and summarize sixteen documents, including academic papers and reports from regulatory and international agencies. Covers the key facts and mechanisms in the build up of risk, the panics in short-term debt markets, the policies reactions, and the real effects of the financial crisis.
Outline Section 2: Overview and Timeline of the Crisis 2010 testimony: Bernanke in front of the Financial Inquiry Crisis Commission Report Chapter from International Monetary Fund(IMF 2010) Bank for International Settlements(BIS 2009) Section 3: Historical perspective on financial crisis Reinhart and Rogoff(2011) Schularick and Taylor Accelerations in economy wide leverage and subsequent banking crises
Outline Section 4: The Crisis Build-up Pozar(2011): Institutional Cash Pools grew Bernanke(2005): sovereign-wealth grew Reinhart and Rogoff(2008): sharp increase in house price before crisis Case and Shiller(2003): housing bubble before crisis Section 5: The panics Covits, Liang, and Suarez: asset-backed commercial paper McCabe(2010): money-market mutual funds Gorton and Metrick: repurchase agreements and securitization Demand of short-term debt Provide a narrative of contagion where each step drains the banking system of hundreds of billions dollars and induces higher risk
Structure Section 6: Policy response IMF s Financial Stability Report (Oct, 2009): taxonomy and analyses policy actions across 13 countries from 2007-2009 Section 7: Real effects of the financial crisis Ivashina and Scharfstein (2010) : decrease in lending related to bank s reliance in short-term funding Puri, Rocholl, and Steffen(2011): shock to credit supply reduced consumer loan Campello, graham, and Havey (2010):credit constraints pulled back on investment Section 8: Conclusion
Section 2: Overview and Timeline of the Crisis Bernanke testimony(2010): Two vulnerabilities in financial sector: short-term debt(main): repurchase agreement and commercial paper shadowed bank :serve as intermediaries to channel savings into investment
Section 2: Overview and Timeline of the Crisis IMF Document: Details how repo market work Large but unregulated Total outstanding repo:Between 20 and 30 percent of US GDP in each year from 2002-2007 Disruption in US short-term debt creates shortage of US dollars
Section 2: Overview and Timeline of the Crisis Bank for International Settlements(BIS) Document Bankruptcy filling of Lehman Brother exacerbated whole situation Financial institutions facing the risk of default Run on money market mutual fund far more damage then subprime losses
Section 3: Historical Background understand the recent crisis from the phenomenon before the financial crisis Reinhart and Rogoff Results: external debt increases sharply, in advance of banking crisis banking crises tend to lead sovereign debt crises
Section 3: Historical Background Schularick and Taylor analyze financial crises with overall credit growth build a 140-year panel data set for 14 developed countries Results: changes in credit supply(bank loans) are a strong predictor of financial crisis, particular when these change are accelerate Provide a consistent picture :an acceleration of debt from both governments and financial intermediaries are the most important antecedents
Section 4: The Crisis Build-up Try to understand how the Crisis build- up Previous Section: Credit booms often precede crises Credit booms: asset-baked securities mortgage-backed securities Shadow banking system Securitization
Section 4: The Crisis Build-up Explosive growth in the six or seven year before the crisis, which consistent with credit boom
Section 4: The Crisis Build-up Pozsar(2011) Institutional Cash Pools and the Triffin Dilemma of the U.S banking System institutional cash pools: important Securitization growth of institutional cash pools have a associated demand for liquidity alternatives Not enough safe asset from US treasury for US to hold. institutional cash pools demand for insured deposit alternatives exceeded the outstanding amount of short- term government guaranteed instruments. demand for insured deposit
Section 4: The Crisis Build-up Bernanke(2005) The Global Savings Glut and the U.S CurrentAccount Deflict foreign official investors hold large amounts of US Treasuries institutional cash pool had to find substitutes 1) short-term bank debt-like products(repurchase agreements and asset- backed commercial paper) 2) indirect holdings of unsecured private money market instruments through money market mutual fund Asset-backed securities collateral credit boom houses) house price increase mortgage s preferred borrow money(buy Bubble?
Section 4: The Crisis Build-up Case and Shiller(2003) Is there a bubble in the housing market House price increasing is not a conclusive evidence of a bubble Bubble: a situation in which excessive public expectations of future price increases causes price to be temporarily elevated
Section 4: The Crisis Build-up House price run-ups prior to crises are common Reinhart and Rogoff(2008) Is the 2007 U.S Sub-Prime Financial Crisis so Different ?An international Historical Comparison.
Section 4: The Crisis Build-up run-up in housing prices in U.S.before crisis
Section 5: The Panics Two main panic period of the financial crisis : Aug. 2007, and Sep-Oct 2008. Three paper: Each focus on a different component of the short-term debt market major causes of financial crisis
Section 5: The Panics Covitz, Liang, and Suarez(forthcoming) Analyze runs on the asset-backed commercial paper market began in Aug. 2007 Commercial paper is important security for the financing of industrial firms minimize transaction cost Demand of CP is high increase use of long-term financial asset(Asset-baked commercial paper) Can bundle mortgages(securitization) transparent, lower funding cost, save on regulatory capital 1.2 trillion ABCP outstanding by July 2007
Section 5: The Panics Covitz, Liang, and Suarez(forthcoming) Meaning of a run on ABCP program : if lender(depositor) in bank are unwilling to refinance CP when it come to due. Mechanically, in any week a program does not issue any new paper despite having at least ten percent of its CP maturing Backup support from the program sponsor Force to sell asset
Section 5: The Panics Beginning in the week of Aug. 7th, the frequency of runs increased dramatically. By the end of 2007, 40% of program in a run, unable to finance themselves
Section 5: The Panics Covitz, Liang, and Suarez(forthcoming) Program more likely experience a run: high credit risk(exposure to subprime-related securities) high liquidity risk
Section 5: The Panics ABCP market fell a lot in 2007 significant impact on the balance sheet of those sponsor focus on money market mutual fund(MMFs), a major holder of ABCP McCabe(2010) Shirking ABCP downward pressure on asset classes held by many MMF
Section 5: The Panics Comprehensively analyses short-term debt market and the linking between ABCP and MMF s help to know how contagion in these market can spread. Did not figure out ABCP panic was drive by a weakness in subprime mortgage Repo markets play an important role in the contagion Gorton and Metrick(forthcoming)
Section 5: The Panics Gorton and Metrick(forthcoming) Repo is the shadow banking equivalent of a deposit market. When cash holdings far exceed insured deposit limits, large institutional money pools can lend short-term to a financial institution and receive collateral as protection For every $100 of collateral , an institution can receive $(100-x) in loans, with x% represent the haircut.
Section 5: The Panics Beginning of 2007, average haircut were near 0. First shock at the time of ABCP panic Steady rise each year Lehman failure,large drain
Section 5: The Panics Gorton and Metrick(forthcoming) subprime securities (small) Subprime failure(ABCP 40% market) unprecedented problems on MMF s(43 funds required support from their sponsors) 2007 Pressure on repo market interbank market near collapse intervention Financial Crisis Price drop, Initial panic onAug. Lehman collapse government
Section 6: Policy Response IMF Report Look short-term reaction of both economic stress index (ESI) and financial stress index (FSI) Interest rate cut: no short-run impact on the ESI, only limited evidence of a positive effect on the FSI Liquidity support was effect at calming interbank credit market in the early stages of the crisis, but not after the fall of Lehman Later stage, capital injection were the most effective policy
Section 7: Real Effect of the financial Crisis Crisis is global in nature Ivshina and Scharfsterin(2010) study the supply of credit during the crisis in order to understand the real effects of the panic on the corporate sector lending volume in the fourth quarter of 2008 was 47% lower than it was in the previous quarter, and 79% lower than at the peak of credit boom(2007:Q2) main conclusion: the decline in lending was in large part an effect of reduced bank loan supply
Section 7: Real Effect of the financial Crisis Puri, Rocholl, and Steffen(2011) focus on the issue of the supply of credit examine the effects of the U.S financial crisis on lending to retail customers in Germany Landesbanken(the regional banks , each in a province) suffer different extents due to their exposures to US subprime mortgages Overall decrease in demand for consumer loans, result of bank reduced the supply of credit
Section 7: Real Effect of the financial Crisis Effect of a reduced bank loan supply have on the real economy, on the activities of nonfinancial firms Campello, Graham, and Harvey(2010) 1,050 CFOs in thirty-nine countries in North America, Europe and Asia in Dec. 2008:whether they were financially constrained during the crisis.
Section 7: Real Effect of the financial Crisis 81% of the very affected firms reported that they experience less to credit, 20% has problems with lines credit Reduction in credit supply had significant impact on credit- constrained firm
Conclusion Financial crisis of 2007-09 was the most important economic event since the Great Depression. Similarity: the acceleration of system-wide leverage just before the crisis The crisis was exacerbated by panics in the banking system where various types of short-term debt suddenly became subject to runs. Novelty: location of runs, which took place mostly newly evolving shadow banking system, including money- market funds, commercial paper, securitized bonds, and repurchase agreements
My opinion CDS Short-term interest rate, government intervention
