Theoretische achtergronden van de financiële crisis

Theoretische achtergronden van de financiële crisis

HOVO College 3

Hoofdverklaringen Financiële Crisis

• Financiële alchemie en de sub-prime hypotheekmarkt.

• Perverse prikkels in de financiële sector (en meer algemeen de opkomst van de markteconomie).

• Macro-economische onbalans en kapitaalstromen.

Diversification

Suppose that there are two countries A and B. Both have one industry. Citizens in each county can invest in their own industry or, when capital mobility is possible, in the other country.

There are two possible states of the world ‘normal’ and ‘bad’. The chance on normal is p=¾, and for bad is 1-p= ¼ .

When it is normal, returns are 100, and when bad 0. Hence, expected returns when citizens invest in home only are ¾ *100 + ¼ *0 = 75.

When citizens invest 50% of their portfolio in home (A) and 50% in foreign (B), expected returns are: ¼ * ¼ *0+ ¼ * ¾ *2 *50 + ¾ * ¾ * 100 = 75

However, when citizens are risk averse, they choose international diversification. This is also the reason why banks exist: there is arbitrage between risk neutral institutions and risk averse individuals.

Risk aversion2/1xU

X50 10075

2/150U

2/1100U

2/175U2/12/12/1 75)10050(

21

U

People put positive value on obtaining a certainty equivalent. This is a role for banking.

Optimal portfolio450

A

B

Risk

Return

Capital allocation line

Risk free rf

The big question: how specific is the risk to the asset? How systematic is the risk across assets?

Structured Debt Transfornation

Bond X $1 (B) Bond Y $1(B)

CDO $2

Senior Tranche

AAA

Junior Tranche

BBB

Two bond with default probability Pd.

Two tranches:

Senior bears first dollar loss

Junior bears second dollar loss

Diversification

Bond X $1 (B) Bond Y $1(B)

CDO $3

Senior Tranche $2

AAAJunior T $1

BBB

BOND Z $1

By pooling more reserves, a larger share of the CDO can be sold as AAA

CDO2

Bond X $1 (B) Bond Y $1(B)

CDO $3

ST $2 AAAJT $1 BBB

BOND Z $1

CDO $3

JT $1 BBB

CDO2

ST AAA (!) Junk Bond

The Financial System

Own capital

Deposits

Money markets

Mortgages

Loans to firms

Securitization

CDSCDO

Commercial BankInvestment Bank

Value At Risk (VAR):-Own portfolio-Combined with structured products-Portfolio theories and stress tests-Non-linear default risk-Non-linear conter parties risk

Concentrated insurance riskRating agencies moral hazard risk

Transformation in the financial system

Institutional

investors

Investment

Banks

Commercial

Banks

Savers

Fix for Flex

Subsidizing mortgage

actors (Fanny May)

CDO

Rating agencies Information moral hazardMoody’s, S&P, Fitch

Individual to Pooled

Incentive problemen in het bankwezen

• De bonuscultuur:– Op zich zijn bonusregelingen efficiënt in verband met

‘moral hazard’.– Maar, bij banken is de ‘leverage’ met andermans geld

zo groot dat het niet reëel is.• Banken hebben ‘private kennis’ van hun eigen

onderliggende assets, wat kan leiden tot adverse selection:– De markt voor tweedehands auto’s.– Het libor schandaal.

The Balance of Payments

Money flows in Money flows out uit

Exports

Sell domestic assets

Decrease in reserves

Imports

Buy foreign assets

Increase in reserves

Source: The Economist

Global Imbalances: The US

Import

Buying assets

Increase reserves

Export

Selling assets

Decrease reserves

Consumption

Investment (!)

Gov. Spending

Global savings glut:

- China

- Oil exporters

Domstic imbalances

- Loose monetary policy

- Rising asset prices

- Financial innovation

- Increased government spending

US Balance of Payments

Global Imbalances: China

Import

Buying assets

Increase reserves

Export

Selling assets

Decrease reserves

Investment

Sources:

- Outsourcing

- Low prices

- Undervalued exchange rate (?)

- Supporting the fixed exchange rate

- Sterilizing money supply effects

China Balance of Payments

- Growth

- FDI

Export led growth Asia China’s fixed exchange rate

Surplus oil exporters

Macroeconomic Financial Imbalances

US savings rate US government deficit

Unbalanced Europe