The Financial Crisis of August 2007

Transcription

1 The Financial Crisis of August 2007 Stephen G. Cecchetti Rosenberg Professor of Global Finance Brandeis International Business School 1 Outline Symptoms of the Crisis Causes of the Crisis Central Bankers Objectives & Tools Federal Reserve Interventions 2

2 Symptoms Interest Rates Libor Treasury Bills Commercial Paper Commercial Paper Issuance Total Asset-backed Inter-bank Lending 3 Dollar Libor One-Month Three-Month /6 11/6 21/6 1/7 11/7 21/7 31/7 10/8 20/8 30/8 4

3 3-Month Treasury Bill Rate /6 11/6 21/6 1/7 11/7 21/7 31/7 10/8 20/8 30/8 5 Commercial Paper Rates AA 30-Day Nonfin A2/P2 30-Day NonFin /6 11/6 21/6 1/7 11/7 21/7 31/7 10/8 20/8 30/8 6

4 Commercial Paper Outstanding Total Asset-Backed Difference /8/05 30/11/05 28/2/06 31/5/06 31/8/06 30/11/06 28/2/07 31/5/07 31/8/07 7 Bank Lending Billions of Dollars, weekly, NSA /3/07 1/17/07 1/31/07 2/14/07 2/28/07 3/14/07 3/28/07 4/11/07 4/25/07 5/9/07 5/23/07 6/6/07 6/20/07 7/4/07 7/18/07 8/1/07 8/15/07 8

5 Symptoms 1. Risky premia have risen 2. Decline in willingness to accept collateral of uncertain quality 3. Borrowers have shifted from direct issuance to bank credit 9 Changes in the Financial System Financial Innovation Allows individuals to purchase & sell virtually any payment stream with any risk characteristics they want. Ideally, risk goes to those most able to bear it. Breaks geographic relationship between sources and uses of resources Consequences: Macroeconomic stability: Faced with income volatility, individuals can smooth consumption 10

6 Causes of the Crisis Failure of delegated monitoring in lending Investors imposed insufficient discipline on sub-prime mortgage originators Created complex and insufficiently transparent securities difficult to value 11 Causes of the Crisis [T]he growth of tranched CDOs and other structured credit products with substantial embedded leverage has made it more difficult to assess the degree of leverage of individual institutions or of the financial system as a whole. Federal Reserve Vice Chairmen Donald Kohn 16 May

7 Causes of the Crisis Information Asymmetries Worsened: Losses have been larger than expected Investors question previous risk assessments Possibility of sales by leveraged participants Increase in the cost of capital Reduction in risk tolerance Lemons Problem and Flight to Quality 13 Central Bankers Objectives 1. Macroeconomic Stability Low, Stable Inflation High, Stable Growth 2. Financial Stability Liquid Markets Low Price Volatility Achieving Objectives Reduces Systematic Risk 14

8 Central Bankers Objectives "It is not the responsibility of the Federal Reserve nor would it be appropriate to protect lenders and investors from the consequences of their financial decisions. Federal Reserve Chairmen Ben Bernanke 31 August Central Bankers Operational Tools Balance Sheet Size Use: Influence Risk-Free Rate Methods: Open Market Operations (Policymaker decides) Discount Lending (Borrowers decide) Asset Composition Use: Influence risk premia/spreads Methods: What to buy/accept in OMO What to accept as collateral in Lending 16

9 Using the Operational Tools Long Term: Interest Rate Target Are current financial conditions appropriate to attain medium-term macroeconomic stabilization objectives? Short Term: Balance sheet size and composition Do financial institutions and markets have sufficient funds to carry out their daily business? Do market determined risk spreads accurately reflect current uncertainties in economic fundamentals? 17 Federal Reserve Interventions 9 August: Open Market Operations 1. Balance Sheet Size: 50 bps decline in fed funds rate 2. Asset Composition: Collateral primarily MBS 17 August: Discount Rate Balance Sheet Size? Asset Composition: bps Reduction in Primary Lending Rate 2. Increase in the term of the loans to 30 days 3. Emphasized broad collateral acceptance 18

10 Federal Funds Rate: Effective & Target Jul-00 Nov-00 Mar-01 Jul-01 Nov-01 Mar-02 Jul-02 Nov-02 Mar-03 Jul-03 Effective Rate Nov-03 Mar-04 Jul-04 Nov-04 Mar-05 Target Rate Jul-05 Nov-05 Mar-06 Jul-06 Nov-06 Mar-07 Jul Federal Funds Rate: Effective & Range /1/2007 6/15/2007 6/29/2007 7/16/2007 7/30/2007 8/13/2007 8/27/

11 Federal Reserve Lending Sept 12, Billions Weekly Average of Daily Data 21 Federal Reserve s Short-Term Objectives Ensure markets remain liquid Encourage rational valuation of collateral Operations are primarily aimed at spreads 22

12 Big Questions 1. Do policymakers have the tools for the job? Mix of Collateral in Open Market Operations Price, Term, and Collateral in Lending Public Disclosure of Actions 2. How can we mitigate information problems that plague financial arrangements? Collateral, Net Worth Ratings agencies Data collection and disclosure 23 24

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