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What happened in the market?

What happened in the market?. Brandon Davies - Managing Director Global Association of Risk Professionals LSE - 1 st October 2007. The Inevitable. Origin: – Bank new loans = 5%, new deposits = 5% result happiness Bank new loans = 10% new deposits = 5% result disaster

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What happened in the market?

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  1. What happened in the market? Brandon Davies - Managing Director Global Association of Risk Professionals LSE - 1st October 2007

  2. The Inevitable • Origin: – • Bank new loans = 5%, new deposits = 5% result happiness • Bank new loans = 10% new deposits = 5% result disaster • A relationship (give or take a lot of management you can do) is something all banks understand – so did they forget?

  3. The Inevitable • NO • House Price Inflation 2001 = 8.4%, 2002 = 17%, 2003 = 15.7%, 2004 = 11.8%, 2005 = 5.6%, 2006 = 6.3%, 2007 (so far) = 10.2%. • Nominal GDP Growth = 4% - 6% throughout • So when was the problem recognised? • UK ALMA 11th Annual Conference 29th/30th January 2004 - Liquidity, Liquidity, Liquidity!! • Core Problem asset (esp. mortgage) growth > liability growth due to affordability, and no sign this will reduce.

  4. The Inevitable • “obtaining liquidity by selling investments or loans ….called shiftability….management tactics that rely on shiftability are not well suited for systemic liquidity needs.” • Scenario for liquidity crises inc. loss of “shiftability” and drawdown of property related liquidity lines.

  5. The Defences • Sources of liquidity:- • Net cash flow • Capacity to borrow additional wholesale funds • Stock of marketable assets • Sterling stock liquidity • Constraint on illiquidity:- • Name in market limits • Wholesale borrowing guidelines (reduced 1993 – loss, Oct 98/ Mar 99 Russian Crisis) No funding problems – very credit quality sensitive ‘flight to quality’. • Commitments – CP backup lines, No Committed lines to competitors for liquidity, Capital to support B/S growth.

  6. Securitisation • Tactic Or Strategy? • Only one UK bank elevated securitisation to a strategy – Northern Rock • All others maintained it as a tactic, often despite attacks in the press for loosing market share e.g. Barclays/Woolwich, HBOS. • Britannia ALCO – Feb 07, concerns about liquidity in markets (note Britannia is the least reliant on market funding of any UK bank).

  7. Notes for Britannia ALCO Meeting Liquidity Definitions Total Defaults • Exogenous Liquidity – The liquidity that comes from your funding base, ability to hold assets even in extreme market or credit circumstances (LIABILITY DRIVEN – an issue of confidence in the Institution) • Endogenous Liquidity – The liquidity that comes from the ability to fund assets through a market (ASSET QUALITY DRIVEN – an issue of confidence in asset values and availability of short term funds

  8. Securitisation as a strategy • A bad idea – and virtually everyone knew it! • Why? • Market Liquidity • UK has none of the financial infrastructure necessary to support mass securitisation. • B of E support operations conducted against (primarily) government obligations i.e. it supports the UK Sterling stock rules. • ECB much wider discount role, but it is not lender of last resort (so is more a Fannie Mae).

  9. Securitisation as a strategy • US has Fannie Mae and Freddie Mac – lenders of first resort against conforming mortgage assets. • Note mixing LOLR and liquidity support produces ‘moral hazard’ – haircut Sir? (No 3 and they can pay, No 1 and they can’t). • So should we have? – must be thought through remember tail does not wag dog, unless you let it! • Could validate Securitisation as strategy. OK only if you want the consequences.

  10. So what did happen in markets? • More or less what the scenarios predicted. • “Flight to quality”. • Refusal of uncommitted lending. • Big banks held on to cash. • Real unwillingness to give liquidity support, BofE may be able to tell illiquidity from insolvency, commercial banks find it very difficult (information asymmetry + role of interest rates in solvency of market funded bank ).

  11. Effect of LIBOR • LIBOR is an ‘index’ against which many market contracts re-price e.g. derivative contracts. • Much of the price ‘action’ is in re-pricing the internal balance sheet. Libor is the transfer price between deposit and lending businesses for (all) UK banks. • This has real economic effects inc. an (unintended) tightening of monetary policy. • Particularly hard on SME borrowers.

  12. EUR LIBOR the interesting dates Date 1w 1m 3m ECB Date 1w 1m 3m ECB 22-Aug-07 4.31 4.46 4.67 4 23-Aug-07 4.30 4.51 4.71 4 24-Aug-07 4.35 4.57 4.72 4 28-Aug-07 4.32 4.61 4.72 4 29-Aug-07 4.33 4.60 4.71 4 30-Aug-07 4.36 4.52 4.72 4 31-Aug-07 4.42 4.52 4.81 4 03-Sep-07 4.42 4.52 4.81 4 04-Sep-07 4.42 4.52 4.81 4 05-Sep-07 4.62 4.54 4.82 4 08-Aug-07 4.14 4.17 4.35 4 09-Aug-07 4.28 4.29 4.46 4 10-Aug-07 4.25 4.29 4.42 4 13-Aug-07 4.38 4.46 4.40 4 14-Aug-07 4.35 4.46 4.40 4 15-Aug-07 4.29 4.46 4.41 4 16-Aug-07 4.30 4.46 4.58 4 17-Aug-07 4.28 4.46 4.67 4 20-Aug-07 4.28 4.45 4.65 4 21-Aug-07 4.28 4.45 4.66 4

  13. EUR LIBOR the interesting dates Date 1w 1m 3m ECB Date 1w 1m 3m ECB 19-Sep-07 4.39 4.47 4.78 4 20-Sep-07 4.42 4.47 4.78 4 21-Sep-07 4.40 4.47 4.78 4 24-Sep-07 4.45 4.47 4.78 4 25-Sep-07 4.45 4.57 4.89 4 26-Sep-07 4.52 4.47 4.79 4 27-Sep-07 4.39 4.57 4.85 4 06-Sep-07 4.37 4.54 4.82 4 07-Sep-07 4.28 4.47 4.8 4 10-Sep-07 4.34 4.50 4.8 4 11-Sep-07 4.37 4.51 4.81 4 12-Sep-07 4.33 4.49 4.80 4 13-Sep-07 4.24 4.48 4.79 4 14-Sep-07 4.22 4.49 4.79 4 17-Sep-07 4.27 4.48 4.80 4 18-Sep-07 4.32 4.48 4.80 4

  14. USD LIBOR the interesting dates Date 1w 1m 3m Fed Date 1w 1m 3m Fed 21/08/07 5.47 5.65 5.46 5.25 22/08/07 5.47 5.64 5.48 5.25 23/08/07 5.52 5.66 5.56 5.25 24/08/07 5.47 5.65 5.54 5.25 28/08/07 5.58 5.68 5.56 5.25 29/08/07 5.68 5.7 5.62 5.25 30/08/07 5.8 5.8 5.7 5.25 31/08/07 5.95 5.97 5.81 5.25 03/09/07 5.95 5.97 5.81 5.25 04/09/07 5.95 5.97 5.81 5.25 08/08/07 5.38 5.39 5.41 5.25 09/08/07 5.73 5.52 5.52 5.25 10/08/07 5.8 5.7 5.7 5.25 13/08/07 5.65 5.66 5.64 5.25 14/08/07 5.62 5.72 5.68 5.25 15/08/07 5.45 5.65 5.55 5.25 16/08/07 5.45 5.64 5.54 5.25 19/08/07 5.38 5.62 5.5 5.25 17/08/07 5.38 5.62 5.5 5.25 20/08/07 5.44 5.62 5.47 5.25

  15. USD LIBOR the interesting dates Date 1w 1m 3m Fed Date 1w 1m 3m Fed 18/09/07 5.42 5.6 5.6 5.25 19/09/07 5.12 5.37 5.3 5.25 20/09/07 5.15 5.23 5.26 4.75 21/09/07 5.15 5.17 5.23 4.75 24/09/07 5.20 5.2 5.22 4.75 25/09/07 5.20 5.21 5.27 4.75 26/09/07 5.20 5.23 5.24 4.75 27/09/07 5.09 5.20 5.30 4.75 28/09/07 5.10 5.20 5.27 4.75 05/09/07 6.02 5.97 5.85 5.25 06/09/07 5.92 5.97 5.85 5.25 07/09/07 5.92 5.98 5.83 5.25 10/09/07 5.92 5.92 5.8 5.25 11/09/07 5.87 6.02 5.81 5.25 12/09/07 5.6 5.92 5.81 5.25 13/09/07 5.5 5.86 5.77 5.25 14/09/07 5.35 5.72 5.75 5.25 17/09/07 5.47 5.65 5.6 5.25

  16. GBP LIBOR the interesting dates Date 1w 1m 3m BoE Date 1w 1m 3m BoE 21-Aug-07 6.08 6.35 6.50 5.75 22-Aug-07 6.08 6.35 6.50 5.75 23-Aug-07 6.07 6.35 6.50 5.75 24-Aug-07 6.07 6.40 6.55 5.75 28-Aug-07 6.00 6.40 6.50 5.75 29-Aug-07 6.01 6.40 6.50 5.75 30-Aug-07 6.10 6.55 6.60 5.75 31-Aug-07 6.18 6.80 6.85 5.75 03-Sep-07 6.18 6.80 6.85 5.75 08-Aug-07 5.93 5.95 6.14 5.75 09-Aug-07 6.10 6.01 6.15 5.75 10-Aug-07 6.30 6.15 6.25 5.75 13-Aug-07 6.35 6.20 6.25 5.75 14-Aug-07 6.20 6.20 6.30 5.75 15-Aug-07 6.10 6.20 6.25 5.75 16-Aug-07 6.07 6.35 6.30 5.75 17-Aug-07 6.10 6.35 6.32 5.75 20-Aug-07 6.10 6.35 6.35 5.75

  17. GBP LIBOR the interesting dates Date 1w 1m 3m BoE Date 1w 1m 3m BoE 17-Sep-07 6.05 6.60 6.85 5.75 18-Sep-07 6.05 6.60 6.8 0 5.75 19-Sep-07 6.45 6.45 6.50 5.75 20-Sep-07 5.95 6.30 6.40 5.75 21-Sep-07 5.90 6.35 6.40 5.75 24-Sep-07 5.90 6.35 6.40 5.75 25-Sep-07 5.97 6.35 6.45 5.75 26-Sep-07 5.95 6.35 6.40 5.75 27-Sep-07 6.00 6.25 6.40 5.75 28-Sep-07 6.00 6.30 6.40 5.75 04-Sep-07 6.18 6.80 6.85 5.75 05-Sep-07 6.15 6.8 6.9 5.75 06-Sep-07 6.07 6.75 6.95 5.75 07-Sep-07 6.07 6.75 7 5.75 08-Sep-07 6.07 6.8 7 5.75 09-Sep-07 6.07 6.75 7.1 5.75 10-Sep-07 6.07 6.75 7.1 5.75 11-Sep-07 6.07 6.75 7.1 5.75 12-Sep-07 6.07 6.75 7 5.75 13-Sep-07 6.03 6.7 6.95 5.75 14-Sep-07 6.03 6.75 6.9 5.75

  18. Unintended consequence • GBP Libor v USD Libor v EUR Libor, beginning 8th Aug & ending 28th Sept no evidence GBP Libor tightens more than USD or EUR. • EUR = rose 25bp to 55bp against ECB rate • USD = rose 20bp to 35bp against (lower) Fed rate • GBP = rose 5bp to 25bp against BoE rate • I urge you all to “mine” these figures for all they are worth, there is a lot to learn from them. For Example:-

  19. Unintended consequences • Was there more tightening in GBP Libor than there could have been? • Was this tightening caused by certain B of E actions/inactions? • Needs more evidence than I have, but a question I asked of the data:- • Did the naming (and shaming – well that’s how it came out) of Barclays for accessing the emergency facility on 29th August have an effect?

  20. Unintended consequences • GBP 1.3bn is a lot to be short but NOT when everyone else is long and the Crest (Gilt) payment system has failed to settle. It just shows you are not holding on to liquidity. • But I would not be caught twice! • Lets look at the GBP Libor data after 29th August (see ‘bold numbers Slide 16 & 17). • By the way the share price data tells at most a one day story, professional investors understood?

  21. Unintended ConsequenceBarclays share price around29th August 2007

  22. RBS share price

  23. So how should the markets be supported? • I learned crisis management in the biggest FX trading room in the UK, when the cable rate really mattered! • Chris Bennett – “Don’t panic”, “the guy who got you into the mess is often the best one to get you out”, “it’s the shareholders whose interests matter, right and wrong has nothing to do with it”, “its about learning so learn and teach”, “vengeance (if appropriate) is mine and when I choose”

  24. So how should the markets be supported? • Providing liquidity is vital and the up to 5 days only is nonsense as is 1 month (forget the ‘Sterling stock’ regime think like Fannie Mae), bus tickets have a value - OK not that far! But mortgages do! • How about helping the market value some of those difficult to value assets some banks are holding (if the central bank agrees a value it should be good enough for the auditors). • Remember if you want to sell that rusty old banger a bit of filler and a re-spray work wonders, a 6 month warranty miracles.

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