Crisis: Cause, Containment and Cure

231 Pages·2010·4.714 MB·English

by  Thomas F. Huertas (auth.)

Crisis: Cause, Containment and Cure
Also by Thomas F. Huertas
CITIBANK, 1812–1970 (with Harold van B. Cleveland)
THE FINANCIAL SERVICES REVOLUTION (co-edited with Catherine England)
Crisis: Cause, Containment
and Cure
Thomas F. Huertas
© Thomas F. Huertas 2010
Softcover reprint of the hardcover 1st edition 2010 978-0-230-23618-9
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First published 2010 by
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ISBN 978-1-349-31433-1 ISBN 978-0-230-27743-4 (eBook)
DOI 10.1057/9780230277434
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10 9 8 7 6 5 4 3 2 1
19 18 17 16 15 14 13 12 11 10
Contents
List of Figures vi
List of Tables viii
Acknowledgements ix
Introduction 1
Part I Cause
1 Rational Exuberance 7
2 Too Much of a Good Thing 17
Part II Containment
3 Conditional Containment 39
4 Moving towards Meltdown 60
5 Unconditional Containment 76
Part III Cure
6 Better Macroeconomic Policy 97
7 Better Resolution 109
8 Better Deposit Guarantee Schemes 123
9 Better Regulation 134
10 Better Supervision 168
Conclusion 182
Notes 197
References 207
Index 217
v
Figures
I.1 A $13 trillion cheque: official support to the
financial system, 2007 to 2009 2
PI.1 Does monetary policy crank the asset cycle? 6
1.1 The financial system as transmission mechanism 8
1.2 Productivity parameters 10
1.3 A high wire act: the world economy, 2004–07 15
2.1 The great search for yield: responses to the challenge
of falling spread on investment grade names 18
2.2 Shadow banking 19
2.3 Securitisation structure protects investors and
funds sponsor banks 20
2.4 US securitisation issuance, 1996 to 2006 22
2.5 Credit derivatives, 2001–07 24
2.6 Money market mutual funds versus checkable
deposits, United States, 2002–06 27
PII.1 A vicious cycle 38
PII.2 Containment of the crisis: three phases 3 month
USD LIBOR-OIS spread in %, June 2007–November 2009 38
3.1 Crisis, what crisis? Official forecasts, fall 2007 40
3.2 Interest rate policy, Eurozone, UK and US, 2007–08 41
3.3 Conditional containment overview, August
2007–September 2008 42
3.4 Northern Rock 45
3.5 Asset-backed commercial paper outstanding,
July 2008–July 2009 in $ billions 49
3.6 Capital raised by 32 largest banks by type (cumulative),
1 August 2007 to 15 September 2008 in $ billions 50
4.1 Moving towards Meltdown, 3-month $ LIBOR-OIS
spread in %, 15 September to 15 October 2008 61
4.2 Federal Reserve pumps out liquidity post-Lehmans,
10 September to 1 October 2008 66
5.1 Unconditional containment, 3-month $ LIBOR-OIS
spread in %, October 2008–November 2009 77
5.2 The world economy goes into free fall – real GDP
growth, advanced (OECD) economies quarter
over quarter, annualised, in %, 2007–09 77
vi
Figures vii
5.3 Governments prime the pump for further bank
recapitalisations – capital raisings by 32 largest
banks by type (cumulative) 15 September
2008–26 November 2009, in $ billions equivalent 81
5.4 Fed floods the market with liquidity – central bank
liquidity operations, September 2008–October 2009 82
5.5 Central banks slash interest rates effectively to zero 84
5.6 Massive fiscal stimulus – fiscal deficit/GDP
in %, 2007–09 86
5.7 Possible recovery scenarios, end 2009 – GDP
index 2008, 1Q = 100 91
PIII.1 A cure requires a comprehensive and
consistent framework 94
6.1 Eligibility criteria for bank borrowing from
the central bank 101
6.2 Economic scenarios 105
7.1 Official resolution policy 110
7.2 Resolution in practice 110
9.1 Regulation sets the stage for strategy at financial firms 135
9.2 The quality of capital has to improve 137
9.3 Pro-cyclicality 142
9.4 Good remuneration practice: bonus comes after
profit, not before 159
C.1 Contingent capital can limit too big to fail and/or
too complex to contemplate 188
C.2 Living wills 191
C.3 Calibrating the new regime: impact,
probability and cost 194
Tables
7.1 Loss given resolution for various bank liabilities
under different resolution methods to implement
‘constructive ambiguity’ 118
8.1 Total deposit guarantees available to each person,
selected countries, June 2009 124
10.1 Macro-supervision of financial infrastructures 179
10.2 Possible macro-prudential policy tools 180
viii
Acknowledgements
This book is an expansion of the arguments made in a number of
speeches and articles that I delivered during the course of the crisis,
in particular the papers, ‘The Rationale for and Limits of Bank
Supervision’, presented to the London School of Economics (LSE)
conference on the crisis on 19 January 2009, and ‘Too Big to Fail and
Too Complex to Contemplate: What to do about Systemically Important
Firms’ at another conference at the LSE on 15 September 2009. I am
grateful to the discussants at those conferences as well as to participants
at presentations at the Institute for Law and Finance at the Johann
Wolfgang Goethe University in Frankfurt.
Although the book does not necessarily represent the views of the
Financial Services Authority, I am deeply grateful to my colleagues
for discussion of the issues and for the opportunity to participate in
the work of dealing with the crisis and laying the foundation for the
future of financial regulation and supervision. Similarly, the book does
not necessarily represent the views of the Committee of European
Banking Supervisors, but it has certainly benefited from discussion
with colleagues on that Committee, in particular the Expert Group on
Prudential Requirements.
Finally and most importantly, I would like to thank my wife and son
for their continuous encouragement and support. Without this, the
book would not have been possible.
January 2010
ix