American Perspectives: Hope Springs Eternal Dr Don Russell

1
American Perspectives Hope Springs Eternal?Dr
Don Russell

• Has the USA lost the leadership of the western
  world or can it recover its reputation as the
  worlds last, best hope?
• Can it bail out the world?

18 June 2009
2
Markets are less fearful but volatility is still
high
VIX reached 80.9 on 20 Nov 08
Russian Default 1998
Tech Bubble 9/11 2001
Asian Crisis 1997
Source CBOE Volatility Index VIX Close as of
June 09 2009
3
Liquidity has returned to the banking system
Source BNY Mellon, IRESS, TED spread is the
difference between 3 month LIBOR (LIBOR.IR) and
the 3mth US Treasury Bill rate (USTB3.IR), 8 June
2009
4
The US consumer is important
The US consumer in perspective (percent share of
global GDP 2008)
Source Federal Reserve, Banc of America
Securities Merrill Lynch Not your fathers
recession, 10 March 2009
5
The market sees glimmers of light
GDP UBS Estimates Forecasts ( YOY)
Stan
6
Why did boom/bust get so out of control?

• Hard to believe the world has become more greedy
  or more short sighted
• The China/US current account and exchange rate
  imbalance has caused big problems
• In the past, lax monetary policy has not
  threatened the global banking system
• Additional factors have been at work

7
Leverage has made boom/bust more dangerous
Archimedes Give me a place to stand and I will
move the earth.
Archimedes was right and leverage shook the world
Source http//www.healthphysicspersonnel.com/imag
es/Lever.GIVE20ME20A20PLACE20TO20STAND20AND
20I20WILL20MOVE20THE20EARTH.jpg
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The growth in leverage was not an accident

• It was very much a phenomenon of the developed
  world
• A static regulatory structure was not finally
  overwhelmed
• Change has been afoot we have been living
  through a major experiment
• Who should be held to account?

9
Greenspan concedes error on regulation

• Those of us who have looked to the self-interest
  of lending institutions to protect shareholders
  equity, myself included, are in a state of
  shocked disbelief
• Yes, Ive found a flaw. I dont know how
  significant or permanent it is. But Ive been
  very distressed by that fact.

But it is unfair to single out Greenspan
Source House Committee on Oversight and
Government Reform 23 October 2008 New York Times
24 October 2008
10
The problems in the US are well known

• The repeal of Glass Steagall (1999), left a major
  regulatory gap
• The SEC tried to fill the gap with a voluntary
  program (2004)
• The 5 institutions covered by the program have
  disappeared or converted to banks
• Bear Stearns
• Goldman Sachs
• Lehman Brothers
• Morgan Stanley
• Merrill Lynch
• AIG was running a hedge fund outside effective
  regulation

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But the problem extends beyond the US

• Not just US financial institutions that were over
  levered
• There have been major banking failures in the UK
  and Europe
• The root problem has been that US and European
  banks were undercapitalised

12
The Basel II framework covers Europe

• The framework dates from 2004 and took a long
  time to formulate
• Basel II assumes that risk can be modelled and
  bank capital should be directly linked to a
  banks risk Value at Risk (VaR) appeared to be
  the answer
• The Basel II framework is intellectually
  satisfying but is now seen as badly flawed

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The Basel II concerns
The Basel II concerns

• Banks are highly regulated why have so many
  failed?
• There are clear gaps in the existing capital
  rules
• The rules are pro-cyclical
• Too much trust was put in rating agencies
• Value at Risk (VaR) can be dangerous

14
Summary
Summary

• The world economy is in sharp decline
• Markets are positive about China and expect world
  recovery at end 2009 or early 2010 - if this is
  delayed there will be a reaction
• The great experiment in banking regulation pushed
  the global financial system to the edge of
  collapse

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