Transcript Document

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Comments on Pasani-Ferry and Sapir
Banking crisis management in the EU:
An interim assessment
September 10, 2009
Thomas Glaessner
MD Global Policy Strategy
[email protected]
212-723-1410
EU actions taken in Europe exceeded the market’s expectations in some respects
 Slides 1-16 provide an assessment of the drawbacks inherent in the institutional
arrangements for coordination in Europe with which I largely concur
– Market integration went forth as large European banks diversified geographically
inside Europe (Pan European) and beyond
– Importantly institutional arrangements for crisis management lagged in six essential
areas per slide 15. All six of the points noted are important in my view
 Information asymmetries—remains an issue in the US as well
 Disparate national deposit insurance regimes
 Unspecified LOLR role of ECB
 Potential disparity in liquidity provision across currency areas
 Clashes between state support and competition
 No common war chest for recapitalization operations of pan-European FIs
– I would add no over-arching prompt corrective action (PCA) framework providing
extra-judicial authority for resolution of systemic FIs.
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Key Conclusions and Take Aways
 EU crisis management outperformed market expectations in several areas:
– Liquidity provision and dollar lines and arrangements with other Central banks
including the FED eventually were worked out—future arrangements?
– Treatment of blanket debt guarantees and lack of coordination was overcome fairly
rapidly after a shaky start—and coordination in pricing—but how will exit work?
– Recapitalization operations of specific banks in countries and in cases of Pan
European banks and subsidiaries were adequately coordinated despite national
responsibilities for financial stability—subs helpful—how sustainable?
– Flexibility in the application of state aid rules
– Principles for treatment of impaired assets useful
 Were the responses truly fast enough in a global financial system—what are changes that
can be institutionalized in future?
 Many of us warned that coordination abilities in the case of systemically important FIs
would be tested?
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The Road Ahead
 Remaining Issues the Authors raise
– Information Asymmetries was a serious unsolved problem throughout the crisis—will
stress tests European style mitigate this risk and if so how?
– Is the division of responsibilities truly adequate for the next crisis—especially
regarding financial stability and differing fiscal situations and regimes?
– Is the risk of zombies real and is the ECB trapped in cheap liquidity support—have
European banks taken adequate write downs?
– Supervision of Pan European banks?
5
Where are European and US
Banks: A Snapshot
Global Leverage
7
Delinquency rates for 100 US banks still rising at increasing rates
Source:Citi, IMF, FED

Futures markets are pointing to substantial further declines in home prices and even FHFA expect a further
decline of 10% in home prices into next year. In the United States, delinquency and foreclosure rates have
continued to rise on both prime and nonprime loans and foreclosure moratoriums and other work-out efforts have
only just started to reverse the deterioration (mainly for poorest credits by FICOs).

In some cases, public interventions, including large-scale purchases of mortgage-backed securities (MBS), have
helped reduce primary and secondary mortgage rates and contain or narrow spreads. Bank de-leveraging still has
a long way to go.

Commercial real estate and property based lending is another lingering issue and not only among smaller US
banks
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Charge-Offs and Write-downs by Region—US more Aggressive
Charge-Off Rates
Write Downs By Region
Percent of Loans
1.8
100%
1.6
90%
US
Europe
1.4
Other
80%
1.2
1.0
70%
Trading /
securities /
derivatives
60%
Monolines
50%
0.8
40%
0.6
30%
0.4
20%
0.2
10%
Unsecuritized
mortgages &
loans
SIVs and
conduits
0%
0.0
1985
1990
Source: Bloomberg, Citi.
1995
2000
US
2005
Europe
Asia
ABS & CDOs of
ABS
Source: Federal Reserve, Company data, Citi Investment Research.
 Loan losses to become much, much worse.
 Bank de-leveraging still has a long way to go.
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Bank Capital Requirements

The IMF expects lower operating earnings going forward will reduce the cushion against further credit write-downs on capital. Under the stylized
scenario, banks’pre-provision earnings are forecast to drop by between a third and a half.

This is less than the 50 percent drop experienced by U.S. banks during the Great Depression, but in line with the experience of Japanese banks
during the 1990s.

Charge-offs are forecast to peak at 4.2 percent in the United States, 3.4 percent in the United Kingdom, and 2.8 percent in the Euro area. In each
case, these are levels that are well above those experienced during the 1991–92 recession, though below those estimated to have been
experienced in the United States during the Great Depression.
Source:Citi, IMF
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Write Downs and Capital Needs of Emerging Market Banks

Write downs in emerging market banking systems (including subsidiaries of foreign parent banks ) could reach US
800 billion or 7 percent of assets

In CEEMEA alone US 140 billion in fresh capital could be needed as shown in the table above of which 102 billion
would be needed in Eastern Europe including the CIS and Russia.

Will official financing along with fiscal resources from specific EM governments and IMF be enough?

Can foreign banks adequately make up the capital shortfalls of their subsidiaries. This is an ongoing concern of
local EM supervisors.
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Leverage Ratios Have Improved from 2008 Levels
CT1 / RWA
T1 / RWA
T1 / TA
TCE / TA
2009 Capital Ratios
USA
Europe
UK/Intl
UK
Switzerland
Sweden
Spain
Poland
Italy
Hungary
Greece
Germany
France
Denmark
Czech
Cyprus
Benelux
Austria
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
CT1 / RWA
T1 / RWA
T1 / TA
TCE / TA
Change in Ratios from 2008
5.0%
4.0%
3.0%
2.0%
1.0%
Source: Bloomberg, Citi
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USA
Europe
UK/Intl
UK
Switzerland
Sweden
Spain
Poland
Italy
Hungary
Greece
Germany
France
Denmark
Czech
Cyprus
Benelux
-1.0%
Austria
0.0%
US Bank CDS Have Come to Parity with European Banks especially in the
aftermath of the stress tests
Average Bank 5Y CDS
Bear Stearns Rescue
FED QE Announced
Lehman Bankuptcy
Stress Test Results
TARP Passed
600
500
400
300
200
100
0
Apr-07
Source: Bloomberg, Citi
US Banks
European Banks
Aug-07
Nov-07
Feb-08
Jun-08
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Sep-08 Dec-08 Mar-09
Jul-09
Bank Debt in the US Has Traded Better Since the Release of the Stress Tests
3000
C Sen CDS
2500
C Sub CDS
2500
MS Sen CDS
C 6.875% 38s
2000
C 6.125% 36s
2000
MS 6.625% 18s
C 8.30% 37s
1500
Stress Test Results
1500
MS Sub CDS
MS 4.75% 14s
Stress Test Results
1000
1000
500
500
0
Oct-06
Apr-07
Nov-07
Jun-08
Dec-08
Jul-09
Jan-10
Jul-09
Jan-10
1600
1400
1200
1000
800
BAC Sen CDS
BAC Sub CDS
BAC 5.65% 18s
BAC 5.42% 17s
BAC 6.625% 36s
Stress Test Results
600
400
200
0
Oct-06
Apr-07
Source: Bloomberg, Citi
Nov-07
Jun-08
Dec-08
14
0
Oct-06
Apr-07
Nov-07
Jun-08
Dec-08
Jul-09
Jan-10
Some Thoughts on Issues Ahead
Seven issues that may deserve analysis and attention but not treated in this paper
1. Sequencing of exit across multiple areas of intervention when not all exit is automatic—CB
policies and micro—interventions relating to bank liabilities or deposit insurance—
2. Markets have a sense that European authorities are “papering over the cracks”
(information asymmetry) and that relative write downs and impacts on access to credit will
act as a drag for a longer time in Europe despite ECB exceptional support
3. Regulatory interventions that impact rights of claimants within the capital structure for FIs
getting “meaningful state aid” (e.g. RBS) and actions taken in support of “burden sharing”
and “competition policy” (interference with loan pricing) can have un-intended impacts
4. Re-defining capital, leverage, and liquidity buffers and timing of implementation across
Europe given that some forms of capital disappear in a crisis—”quality of capital”
5. Fiscal transfer arrangements to allow for cross border resolutions and the need for PCA
6. Treatment of derivative operations for European banks and interconnectedness
7. How to make the market discipline pillar vibrant in Europe via quality of information
improvements and greater attention to governance beyond executive compensation
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FED BOE and ECB Balance Sheet Expansion—Liquidity and Special Facilities
Bank of England Consolidated balance Sheet
(billions of £)
350
Federal Reserve Balance Sheet
300
250
2400
200
Short term Lending to Financials
2000
150
Rescue Operations
100
Broader Credit Conditions
1600
50
800
Other assets
Longer-term reverse repos
Short-term market operations
400
Ways and Means advances to HM Government
Bonds and other securities acquired via market transactions
7/3/2009
5/3/2009
3/3/2009
1/3/2009
11/3/200
9/3/2008
7/3/2008
5/3/2008
3/3/2008
1/3/2008
11/3/200
9/3/2007
7/3/2007
5/3/2007
1200
3/3/2007
0
1/3/2007
$ Billion
Treasury Portfolio
0
Jan-07 Apr-07 Jul-07
Oct-07 Jan-08 Apr-08
Jul-08 Oct-08 Jan-09 Apr-09
Jul-09
ECB Open Market Operations, (Euros, bn)

So far the Fed has purchased:
–
$268/300 bn of Treasuries
–
$117/200 bn of Agency Debt
–
$767/1250 bn of Agency MBS
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Source: ECB, Citi Economic Research
Fed Activity in Agency MBS
CurrentCoupon Purch
Program focus has been
historically in near-par priced
MBS
Fed CC Purchasesasa % ofTotalPurchases

This has shifted over recent
weeks

WA new Prod Cpn
60%
Daily Fed demand roughly
$500MM to $1B more than
origination
4.75
50%
40%
30%
4.50
20%
10%
0%
4.25
Total30YR Purchases
Fed Owned MBS ($B)
400
Week5
Fed Ownership % ofSettled MBS
Week9
84%
300
72%
250
60%
200
48%
150
36%
100
24%
50
12%
0%
3.5s
4.0s
4.5s
5.0s
5.5s
6.0s
Source: Federal Reserve, Fannie Mae, Freddie Mac, Ginnie Mae, and CIRA.
6.5s
18
Week17
Week21
Week25
Week29
Week33
96%
350
0
Week13
Fed Ownership of MBS (%)
Week1

Fed ownership of low coupons
extremely high relative to
available float

Lack of clarity on program
termination could be contributing
to recent move away from near
par-priced MBS
Coupon (%)

Fed’s Balance Sheet Roll-Off

Growth in Fed balance sheet is mostly a result of QE programs

Prepayments on the Fed MBS portfolio are likely to be fairly slow with the majority of the portfolio
consisting of 30yr 4.0s and 4.5s
3,000
MBS QE
Actual
Debt + Tsy QE
Other Special Lending Facilities (Non-QE)
Forecast
2,500
2,000
1,500
1,000
500
0
Jun 08
Jun 09
Jun 10
Jun 11
Jun 12
Jun 13
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Source: Federal Reserve, and CIRA.
Jun 14
Jun 15
Jun 16
Jun 17
Jun 18
Rethinking the Market Discipline Framework
Block 1: Information and Dislcosure





Block 4: Internal Governance



Accounting and financial reporting
External auditors
Prudential disclosures
Credit rating agencies
Valuation providers
Risk Governance
Executive Compensation
Board of Directors (Independence and
qualifications)
Influence
Monitoring
Block 2: Stakeholders
Block 3: Discipline Mechanisms



Market participants (Counterparties, depositors,
shareholders, debt investors, etc.)
Media and research analysts



Source: Rethinking Market Discipline, Constantino
Stephanou, World bank
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Quantity/price adjustments in bank instruments
(equity, debt, deposits, hybrids, derivatives
etc.)
Market for corporate control
Legal redress (investor protection rules, court
system)
Supervisory actions
Bank Capital Framework
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Bank Capital Framework
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