Getting up to Speed - PowerPoint Presentation

1. Getting up to Speed on the Financial Crisis :A one-Weekend-Reader’s Guide ---------Gary Gorton and Andrew MetrickJingyu WangSep. 12th

2. 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.

3. OutlineSection 2: Overview and Timeline of the Crisis2010 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

4. OutlineSection 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 crisisCase and Shiller(2003): housing bubble before crisisSection 5: The panics Covits, Liang, and Suarez: asset-backed commercial paperMcCabe(2010): money-market mutual fundsGorton and Metrick: repurchase agreements and securitizationDemand of short-termdebt Provide a narrative of contagion where each step drains the banking system of hundreds of billions dollars and induces higher risk

5. StructureSection 6: Policy responseIMF’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 fundingPuri, 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

6. Section 2: Overview and Timeline of the CrisisBernanke 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

7. Section 2: Overview and Timeline of the CrisisIMF Document:Details how repo market workLarge but unregulatedTotal outstanding repo:Between 20 and 30 percent of US GDP in each year from 2002-2007Disruption in US short-term debt creates shortage of US dollars

8. Section 2: Overview and Timeline of the CrisisBank for International Settlements(BIS) DocumentBankruptcy filling of Lehman Brother exacerbated whole situationFinancial institutions facing the risk of defaultRun on money market mutual fundfar more damage then subprime losses

9. Section 3: Historical Backgroundunderstand the recent crisis from the phenomenon before the financial crisis Reinhart and Rogoff   Results:external debt increases sharply, in advance of banking crisisbanking crises tend to lead sovereign debt crises

10. 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 BackgroundProvide a consistent picture :an acceleration of debt from both governments and financial intermediaries are the most important antecedents

11. 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 systemSecuritization

12. Section 4: The Crisis Build-upExplosive growth in the six or seven year before the crisis, which consistent with credit boom

13. 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

14. Section 4: The Crisis Build-upBernanke(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 short-term bank debt-like products(repurchase agreements and asset-backed commercial paper) indirect holdings of unsecured private money market instruments through money market mutual fundAsset-backed securities mortgage’s preferred collateral credit boom borrow money(buy houses) house price increaseBubble?

15. Case and Shiller(2003)”Is there a bubble in the housing market”House price increasing is not a conclusive evidence of a bubbleBubble: a situation in which excessive public expectations of future price increases causes price to be temporarily elevated Section 4: The Crisis Build-up

16. Section 4: The Crisis Build-upHouse 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. “

17. Section 4: The Crisis Build-uprun-up in housing prices in U.S.before crisis

18. Section 5: The PanicsTwo 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

19. Section 5: The PanicsCovitz, 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

20. Section 5: The PanicsCovitz, 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 sponsorForce to sell asset

21. Section 5: The PanicsBeginning 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

22. 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

23. Section 5: The PanicsABCP 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’

24. Section 5: The PanicsComprehensively 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 contagionGorton and Metrick(forthcoming)

25. Section 5: The PanicsGorton 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.

26. Section 5: The PanicsBeginning of 2007, average haircut were near 0.First shock at the time of ABCP panicSteady rise each yearLehman failure, large drain

27. Section 5: The PanicsGorton and Metrick(forthcoming) subprime securities (small) Financial CrisisSubprime 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

28. Section 6: Policy Response IMF ReportLook 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 FSILiquidity support was effect at calming interbank credit market in the early stages of the crisis, but not after the fall of LehmanLater stage, capital injection were the most effective policy

29. Section 7: Real Effect of the financial CrisisCrisis is global in natureIvshina 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

30. Section 7: Real Effect of the financial CrisisPuri, 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

31. Section 7: Real Effect of the financial CrisisEffect 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.

32. Section 7: Real Effect of the financial Crisis81% 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

33. ConclusionFinancial 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

34. My opinionCDSShort-term interest rate, government intervention

35. Thanks!