Franklin Allen’s The Global Financial Crisis (lecture)
The Failure of the IMF
A Masterclass lecture given at the Beijing site of the Wharton Global Alumni Forum 2009 on June 13, 2009. Franklin Allen is the Nippon Life Professor of Finance and Economics at the Wharton School of Business. Additionally, he is a co-director of Financial Institutions Center at Wharton, and formerly vice dean and director of Wharton Doctoral Programs. He has served in various editorial capacities at several of the world’s top academic journals for finance and economics.
- Reasons
- Following Asian crisis, Asian countries incl Japan and China stocked up reserves (largely putting it into debt like FNMA and only recently equity like BX and Rio Tinto) in part due to mistrust of West-led IMF
- Fed was too loose – focused on the CPI to guide its policies, ignored asset price inflation on purpose because it could not identify a bubble
- Wrong decisions were being made for about a decade
- Savings pumped up asset prices which increased loans (and now they burst, property price adjustments take a long time and people are not sure what they are truly worth – so they just wait)
- Housing – flipping without renting. Property prices affecting Rent v Buy decision. Need to burst bubble, but Bernanke arguing that they cannot detect it.
- Problem did not originate in financial system but the huge feedbacks made a housing problem into a general problem of credit. This was not helped by the flight to quality.
- Market stopped doing its job of deciding who should get funded.
- Government is fundamentally incapable of regulation, or regulation is incapable of regulating.
- Banks are worried about lending to each other – liquidity hoarding – because banks want cash to deal with coming counterparty risk crisis. Also anticipation of deflation – it would price down debt so you should lend less. The public view also becomes that you only borrow if you ahve a problem.
- US needs money, but China wants to ensure it will get its money back.
- Solutions
- Regulations to stop crisis? These are ineffectual.
- Bank regulation is different from other regulation. There is no agreement as to what the market failure is. (e.g In environmental issues the market failure is the missing market for pollution compensation. Antitrust, etc.)
- Only patchwork regulation is politically feasible but it offers no overall view of what we are trying to achieve, and it is costly because it makes banks focus on satisfying regulation rather than worrying about real business problems.
- Basel framework had no effect on stopping crisis
- Market failures
- Inefficient liquidity provision
- Liquidity has low yield; you need price volatility for people to have incentives to hold
- Toxic assets – mortgages held by banks => assets were mispriced
- looks cheaps to banks and SWFs in Fall 2007 – doubled up -> fell some more
- The tech bubble was extremely risky to short
- TARP made govt the arbitrageur of last resort
- Geithner PPIP didnt get off the ground
- Mark to market debate – there is a missing 500b out there. Models value toxic assets higher than market prices
- Lehman – it was ok to let them fail? Unforeseen: Lehman CP made money market fund break buck, causing run on mutual fund industry
- Inefficient liquidity provision
- Contagion
- SDR proposal – not practical. If it is issued by IMF, asian countries would be disadvantaged. RMB needs to be a reserve currency.
- What other countries have had similar crises? Japan in the 90′s, similar housing price bubble. The Nikkei was 10k in the 80′s, 40k in 1989, and today is back to 10k. Property prices fell continuously for 15 years, and fell 70-75% below peak. Jpn economy slowest growing in the world. Comparing to US: prop prices are 25% above trend so it has room to fall still.
- But – Japan had a differnt economy. Firms were stakeholder firms – where people were employees as well as suppliers of finance. (viz US shareholders). Attitude to corporate governance affects employment.
- Temporary nationalize banks – citi, BOA, use preferred stock to control votes. Don’t give blank check from govt to let them do what they want.
- Govt policy is not dealing with the issue of price adjustments, or getting banks to stop foreclosures.
- Risk taking in private sector would be more efficient – it would regulate banks much better
- Central banks must remain independent, watching over inflation and financial stability
- Governance of central banks is slipping
- Quantitative easing is nontraditional monetary policy but nobody is worrying about it. Its irresponsible! Central bank is printing money without oversight
- Angela Merkel at the prompting of Axel Weber at the Bundesbank is the only world leader voicing concerns at ECB. Tho there is of course internal debate.
- Original point of IMF was for it to be a risktaking institution. It has failed and needs reform. Its supposed to loan money if a currency gets into trouble. Asians dont trust IMF anymore. Self-insurance wastes money. China has 2tril in reserves, very inefficient way to do this.
- China – switching to internally driven growth because of the fall in trade (30-35% of GDP, but net amount is 9% so not huge). China already controls all its banks. Directing growth toward inland infrastructure.
- Chavez and Castro joking about “comrade obama”
- Regulations to stop crisis? These are ineffectual.
- Interesting Facts
- Japan is down 4% on the year. Germany is down 3.8% in the first quarter of 2009. (DE produces a lot of capital goods, which suffers with cutbacks on investment)
- Oil was up to $147, then down to $40, and at $70 at the time of lecture. Euro/dollar was 1.6, then 1.25, then 1.4. Pound/dollar was 2, then 1.4, then 1.6.
- Fed balance sheet went from 800b to 2.5 trillion in assets, maybe going on to 4 trillion
- From 1945 to 1970 there were no major banking crises except in Brazil.
- ML sold AAA tranches of securitized subprime mortgages for 22c on the dollar.
- What default rate is assumable? even in great depression it was only 50%.
- Survey in differnt countries asking what the primary purpose of business was – > max shareholder value? (US, UK) or provide job security (DE, FR, JPN) implications on job elasticity. Do you cut dividends first or do you cut workers? So even tho in DE it is more affected by crisis, US unemployment rose more sharply (9.4%). (Some difficulty comparing unemployment stats btw diff countries because for e.g. Japan doesnt count temporary workers)
- The US has already experienced 3 years of downward price adjustment.
- (taking present differential growth rates) By 2015 China will be 1.4x size of USA. By 2020 it will be 2x USA.
- What is a risk free rate? any such thing? TIPS rate?
- 50 years ago China was poorer than Africa.
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