Transcript Global Finance in the 21st Century: Perspectives from a

Global Finance in the 21st Century:
A Practitioner’s Perspective
BITS EMBRYO
Suhail Kassim
The World Bank Group
February 2011
Why are you here today?
Finance = Quick Cash?
• “Greed is good”
(Wall Street)
• “Show me the money!”
(Jerry Maguire)
• “Lehman offers $340k to
IIMC grad!”
(Media reports)
Or
Finance = Art Meets Science?
• Mutual learning
• Theory versus experience
• You will live through the
next 5 crises! Will you cause
them or resolve them?
© Suhail Kassim 2011
Part A
An overview of the financial world
© Suhail Kassim 2011
Question:
What are the components of a financial system?
© Suhail Kassim 2011
Key components include…
 Government – Ministry of Finance
 Central Bank
 Regulator for Banking/ Securities/ NBFCs/ Microfinance/ Alternative Investments/
Insurance/ Pensions/ Mutual Funds/ Infrastructure/ Housing
 Super regulator? (e.g. FSDC)
 Monetary Authority
 Banker to Government
 Sovereign Wealth Fund
 Players:
o Commercial Banks (Public/ Private /Foreign, Urban/ Rural/ Local Area)
o Non-Banking Finance Companies
o NGOs including Microfinance Institutions
o Alternative Investment Vehicles (I-Banks, Private Equity, Venture Capital, Hedge Funds)
o Insurance, Pensions
o Mutual Funds
o Private Finance
 Capital markets (equity, debt, derivatives)
 Monitoring mechanisms: Credit rating agencies, analysts, media
 The customer
… and others
© Suhail Kassim 2011
India’s financial architecture landscape
© Suhail Kassim 2011
Source: World Bank
Part B
Before and Beyond the Crisis
© Suhail Kassim 2011
One Crisis After Another …
20th century
Panic of 1901 – crashing of the New York Stock Exchange
Panic of 1907 – pervasive USA economic recession
Panic of 1910–1911
1910 – Shanghai rubber stock market crisis
Wall Street Crash of 1929, followed by the Great Depression
1973 – 1973 oil crisis – oil prices soared, causing the 1973–1974 stock market crash
Secondary banking crisis of 1973–1975 – United Kingdom
1980s – Latin American debt crisis – beginning in Mexico in 1982 with the Mexican Weekend
Bank stock crisis (Israel 1983)
1987 – Black Monday (1987) – the largest one-day percentage decline in stock market history
1989–91 – United States Savings & Loan crisis
1990 – Japanese asset price bubble collapsed
early 1990s – Scandinavian banking crisis: Swedish banking crisis, Finnish banking crisis of 1990s
1992–93 – Black Wednesday – speculative attacks on currencies in European Exchange Rate Mechanism
1994–95 – 1994 economic crisis in Mexico – speculative attack and default on Mexican debt
1997–98 – 1997 Asian Financial Crisis – devaluations and banking crises across Asia
1998 Russian financial crisis
21st century
2001 – Bursting of dot-com bubble – speculations concerning internet companies crashed
2007–10 – Financial crisis of 2007–2010, followed by the 2010 European sovereign debt crisis
© Suhail Kassim 2011
Source: Wikipedia
… With Worrisome Consequences
Some results of the GFC:
• Government debt for advanced G-20 countries would reach 118 percent of GDP by 2014 (IMF)
• Only Australia, Canada, and Korea would have debt ratios well below 90 percent
• PIIGGS (Portugal, Italy, Ireland, Greece, Great Britain, Spain) affected heavily
• Immediate challenge: Recapitalization of banking systems and removal of toxic assets
Question: Why Did It Happen?
© Suhail Kassim 2011
The “moral gradient” of the financial world
The White?
The Grey?
The Black?
1. Commercial
banks
2. Private Equity
3. Venture Capital
4. Microfinance
institutions
5. Development
banks
1. Shadow banking
1. Offshore tax
havens
2. Practices
A. I-Banks
B. Hedge Funds
2. Sovereign Wealth
Funds
3. Products and
Practices
A. Derivatives
B. Corporate
Governance
© Suhail Kassim 2011
A. Chinese walls
B. Black market
economics
C. Money
laundering
D. Ponzi schemes
Investment Banking and Alternative Investments
•
•
•
•
•
•
Glass Steagall Act (1933) split the world of banking into Commercial and Investment banks.
In 1999, the Act was repealed.
Investment banking created parallel banking system (shadow banking) – huge wealth, taxes.
Greenspan – “Self regulation”
Motto: “Privatization of profits and socialization of risks”
IBs invested in:
–
–
–
–
–
–
•
IBs raised money from funders like:
–
–
–
–
–
–
–
–
•
Securities (listed stocks, unlisted stocks, bonds)
Commodities (oil, sugar, gold, metals, orange juice)
Currency
Real estate
Innovation (science and technology, IP, start-ups)
Asset pools (mix of the above)
Borrowings/ bonds
Funders
Private equity firms
Venture capital
Pension funds
Hedge funds (to minimise risk)
Mutual funds (to maximise results)
Sovereign wealth funds
Funders get money from HNIs, governments, pensions, institutional investors and petrodollars.
© Suhail Kassim 2011
Understanding Financial Innovation
•
Class assignment: Develop a product which can beat regulation and maximise profits (5 min).
•
How about this approach?
– Risky assets of different risk profiles
– Pooled in different ways (not necessarily to minimise risk)
– Split in different ways (Principal vs interest, by currency, by country, by maturity)
– The interest itself can be packaged and resold as products
– Such products then sold to different investors
•
These split up and bundled products are a standard example of “derivative securities”
– E.g. Mortgage-backed securities (MBS); Collateralised Debt Obligations (CAO);
Collateralised Mortgage Obligations (CMO); Credit Default Swaps (CDS)
•
•
•
Nexus between product, sales, research – “Chinese Wall”?
IBs’ leverage rose to 25-50%; CRAR fell to 1-2%; NPAs rose to 30%
Government and regulators cannot keep track of it
– Also Wall Street is darling of government because of its record profits and taxes
Compounded by failure of credit rating agencies and market analysts
•
© Suhail Kassim 2011
Wall Street brings down the world !
•
Investment Banks ran out of cash and trust
–
–
•
Fall of the Big Five on Wall Street:
–
–
–
–
–
•
Bear Sterns – sold to Bank of America; first to go down
Lehman Brothers – Government allowed it to go down
Merrill Lynch – sold to Bank of America
Goldman Sachs – converted into commercial bank
Morgan Stanley – converted into commercial bank
Global contagion –
–
–
–
–
•
•
“The interbank lending market died with Lehman Bankruptcy”
Bank run and bank-to-bank run
Western EU banks ran out on Eastern European banks and into Iceland (insured, high interest rate)
Result: Debt burden 10x GDP  Three largest banks collapsed in October 2008
Wall Street hits main street : Credit freeze, exports hit
Africa – The forgotten continent
Compounded by food and fuel crisis
Government stimulus packages up to $5 trillion have been given out (IMF)
–
Five Indias put together!
© Suhail Kassim 2011
Role of Hedge Funds
“Finance is a zero sum game” (??)
10x exposure on down
payment = $100bn
Derivatives
Debt
+1%
Leverage 1:9 = $10bn
Capital
10 HNIs x $100mn = $1bn
© Suhail Kassim 2011
+100%
Commercial Banks – “Not Guilty” ?
•
2001 dotcom crash and 9/11 – interest rates fell as a stimulus measure.
•
By 2007, gigantic exposure to potentially toxic/ sub prime assets at Sub PLR
 High pool of bad debts and defaults on repayment
 Contagion effect and systemic breakdown
•
Banks in Catch 22 situation:
–
–
•
Debtors defaulted because they didn’t want to pay interest on a $80 asset bought for $100
The bank took over the asset but couldn’t sell it because of valuation and demand problems
Why was India not affected as much (in case of the housing sector crash)?
–
Banks loan only up to 80 per cent of asset value
© Suhail Kassim 2011
Flight to “Tax Havens”
1. Very low regulation
2. Very low taxes
3. Very low disclosures
© Suhail Kassim 2011
What next?
•
•
•
•
•
•
Wall Street still has large investment divisions
Risky market behaviour is picking up
The buzzwords are capital and risk
“The crisis was a lost opportunity for long-term reform”
Krugman – “The next crisis will be worse than this one” (nations not banks)
Roubini – “We are planting the seeds of the next crisis”
Doomsday careerists or real prophets? Wait and watch...
© Suhail Kassim 2011
Part C
Some other topics in finance
© Suhail Kassim 2010
Development Finance and IFIs
•
Bretton Woods Institutions
•
Other Multilateral Development Banks
•
Bilateral Donors
•
Foundations, Funds and Trusts
•
Concept of ODA
© Suhail Kassim 2011
Home Assignments
 Case Study 1: Launch a new microfinance program in Iraq.
 Case Study 2: Structure a grassroots venture capital fund-of-funds in India.
 Case Study 3: You are the Finance Minister of a newly formed small country.
Develop a new currency, 5-year economic development plan, and fiscal budget.
Interested students may submit their assignments to [email protected]
© Suhail Kassim 2011
Suggested Further Study
Movies:
• Wall Street (1987)
• Wall Street: Money Never Sleeps (forthcoming 2010)
• Enron – The smartest guys in the room: http://www.youtube.com/watch?v=o5clNtt7PgM
• Walmart – Good for America? http://www.youtube.com/watch?v=wTDY1MrXJPY
• Rogue Trader: http://www.youtube.com/results?search_query=rogue+trader&aq=f
• GFC documentary 1: http://www.youtube.com/watch?v=w2kihFVXW-w
• GFC documentary 2: http://www.youtube.com/watch?v=sZd2qKYQd1s
Readings:
• Liar's Poker by Michael Lewis
• The New Power Brokers by McKinsey:
http://www.mckinsey.com/mgi/publications/The_New_Power_Brokers
• Masters of Illusion: The World Bank and the Poverty of Nations (1996)
© Suhail Kassim 2011
Thank You !
Questions?
Reach me at [email protected]
© Suhail Kassim 2011