SECTIONS
SECTION V
2008 Financial Crisis:
A Ten-Year Review
8 November 2018
“Opening Remarks,” Raghu Sundaram, NYU Stern School of Business
Sundaram opens the conference by recalling the events of the Great Financial Crisis (GFC). “That whole period,” he says, “every month, every day, was a period of wonder at what is happening in financial markets.” With each new development, it seemed the conventional understanding of the financial markets was undermined. But the financial crisis also created unprecedented critical reflection on what had gone wrong and unprecedented engagement among researchers, policy makers, and academics to answer that question, Sundaram observes, with NYU Stern at the forefront of those efforts. This conference, he says, will showcase some of the key economic insights that have developed in the aftermath of the crisis.
“Introduction to the Annual Review of Financial Economics,” Andrew Lo, MIT
Lo presents a history of Annual Reviews, particularly the Annual Review of Financial Economics, which he co-edits with Robert Merton, and he discusses his own analysis of scholarship on the financial crisis.
“Deglobalization: The Rise of Disembedded Unilateralism,” Harold James, Princeton
James leads off his presentation with a “Game of Thrones” reference: “Winter is coming.” He sees the financial crisis as having initiated the dismantling of the post-World War II Bretton Woods consensus of embedded liberalism, in which peace and prosperity were seen as inseparable and globalism was embraced. What’s taking its place is “a vision of extreme realism in political science” that he calls “disembedded unilateralism.” This zero-sum approach—typified by trade wars, border walls, and Brexit—has rendered the dominant center-right and center-left political party dynamic of the last 70 years obsolete. Pointing to Brexit, James observes that it is counterproductive to Labour and Tory alike. James holds out hope, however, that efforts to dismantle globalization may paradoxically lead to its reform and renaissance.
“Trust and the Future of Finance,” Robert Merton, MIT
The financial crisis led to a loss of trust in providers, regulators, and financial innovation among consumers, Merton observes. Some have proposed technology can stand in for trust, but he says fintech cannot create trust or succeed without it. Two things, however, can substitute for trust: verification and transparency. Some forms of fintech can provide verification, but financial advice tends to be opaque rather than transparent. Merton also discusses data showing retail investors as less satisfied with cost disclosures and performance from active portfolio managers than institutional investors.
“Architecture and Stability of the Financial System,” Franklin Allen, Imperial College
Many different aspects of financial architecture have been associated with assorted financial stability issues, Allen says. These include the exchange rate system with currency and sovereign debt crises; financial market structures with stock market crashes; and banks versus non-bank intermediaries with non-bank runs. He goes on to chart the literature on financial architecture and offers his own insights into testing for stability.
Ansgar Walther, Allen’s co-author on the paper, then takes the podium to talk about financial architecture in non-bank intermediaries—asset managers, in particular.
“Financial Crises,” Gary Gorton, Yale
“Financial crises are not rare,” Gorton says, noting that 147 systemic events have occurred since 1970. They generally come about when people no longer believe their banks are safe and thus want their money en masse, creating a run on the banks. History suggests that financial crises are inevitable because new forms of short-term debt continually transform the system, Gorton says. But regulation can potentially cushion these blows. Of course, there may be a tradeoff between crisis-avoiding regulations and economic growth.
"Accounting Issues that Impact Financial Stability," Stephen Ryan, NYU
“Bank financial reporting requirements and practices affect financial stability,” Ryan says. “But these effects are often misunderstood, overstated, or otherwise mischaracterized.” Ryan discusses the three main bank financial reporting areas and their alleged shortcomings.
“Deregulating Wall Street,” Kim Schoenholtz, NYU
Discussing topics from the paper he co-authored with Matthew Richardson and Lawrence White, Schoenholtz considers the strengths and weaknesses of Dodd–Frank financial regulations and the efforts to scale back the legislation. He outlines five key takeaways and considers new emerging risks and what might be done to counteract them.
“Causes and Consequences of Mortgage Defaults,” Christopher Foote, Federal Reserve Bank of Boston
Foote discusses his joint paper with Paul Willen, which explores the connections among the housing cycle, the recession, and mortgage defaults. A chief area of focus is the relationship among underwater mortgages, adverse life events, and defaults.
“Housing Markets,” Antoinette Schoar, MIT
Schoar talks about the role of housing markets in the run up to and in the aftermath of the crisis—the topic of the paper she co-authored with Manuel Adelino and Felipe Severino. Her main point is that the prevailing narratives about the housing crisis are largely incorrect. The crisis was not chiefly driven by subprime mortgages or lower income cohorts. Instead, she concludes that a major culprit was optimistic house price expectations, which led to an expansion of credit and delinquencies.
“Measuring the Cost of Bailouts,” Deborah Lucas, MIT
Lucas sets out to define and measure bailouts, a process that is much more subtle than meets the eye. In the aftermath of GFC-related bailouts, competing narratives surfaced: The public paid untold billions in unfair bailouts of financial institutions, or the bailouts were paid back with interest. Bailouts tend to be measured in three different ways, Lucas says: fair value cost as of the time of the bailout; fair value cost ex ante as of the time of a granted subsidized guarantee; or sum up ex post realized cash flows. The example of the largest bailout, of Fannie Mae and Freddie Mac, demonstrates the huge variations depending on the method, Lucas notes: The fair value cost was $311 billion; ex ante was $8 billion; and ex post the government made $58 billion. Lucas herself calculates the direct cost of bailouts at around $500 billion, or 3.5% of 2009 GDP.
Fireside Chat with Peter Hancock, former president and CEO of AIG, and Gillian Tett, Financial Times
Hancock, who took the helm at AIG in February 2010, discusses his role in “putting Humpty Dumpty back together again,” in an interview with Tett. His task was especially difficult, he says, because of the degree of vilification. AIG was a poster child, rightly or wrongly, for the excesses that brought on the financial crisis. Hancock set out to restore trust in AIG and stave off liquidation. That meant 120 board meetings in a single year and countless negotiations with government agencies. “We had to persuade people that the whole was worth more than the sum of its parts,” he says. AIG insured 100,000s of businesses that would have fallen if the company hadn’t been saved. The government bailout was paid back in full in November 2012, according to Hancock. “Part of what we saved is still the largest insurance company in the world,” he says.
“Reflections on the Financial Crisis,” Myron Scholes, Stanford
Scholes presents his research into what the markets were saying about the risks in the S&P 500 in the years before, during, and after the financial crisis, focusing on two-month put options. He concentrates on the tails of the distributions. “When tail events occur,” Scholes says, “then risky assets all behave as one.” He notes the cliché that ‘diversification is free’ and instead observes, “In times of stress, it isn’t enough.” He highlights four distinct periods in the data, which cover the years 2005 to 2009.
9 November 2018
“Keynote Address: Short-Term Debt, Liquidity, and the Financial Crisis,” Douglas Diamond, University of Chicago
Diamond’s presentation focuses on bank runs and problems of short-term debt and how they can inform our understanding of the financial crisis—indeed, all financial crises—and whether the measures taken to design more fail-safe financial architecture post-crisis were sufficient. As he states, “Private financial crises are everywhere and always due to problems of short-term debt.” He focuses his analysis on runs on money market funds and the role of excess liquidity in shoring up the system.
“Intermediary Asset Pricing and the Financial Crisis,” Arvind Krishnamurthy, Stanford
Krishnamurthy talks about two things from his paper co-authored with Zhiguo He: academic/research progress inspired by the financial crisis and measurement. In 2005 and 2006, he says, people thought about asset pricing largely through the prism of the Campbell–Cochrane consumption habits model and the long-run risk model of Bansal and Yaron. There’s virtue in these models, Krishnamurthy says, but they’re “like looking at the world through a telescope from Mars.” He goes on to provide a sampling of the new models that have emerged since the crisis and discusses different ways to measure risk.
“Leverage,” Tobias Adrian, IMF
Adrian’s presentation focuses on theories of financial crisis. He and his co-authors, Hyun Song Shin and John Kiff, theorize that the financial crisis was a product of the leverage cycle. He notes that leverage has declined since the crisis even amidst an extended economic expansion and an era of easy credit. Adrian believes that new regulations have tamed the leverage cycle and created a safer system, albeit with some unintended consequences that are nevertheless acceptable in terms of magnitude.
“Systemic Risk,” Robert Engle, NYU
“Is the financial system going to erupt again or not?” Engle asks. He addresses that question and discusses the monitoring tools available to measure systemic risk, including those on the Volatility Laboratory (V-Lab) website. Much of his emphasis is on the systemic risk, or SRISK, metric, which seeks to answer the question of how much capital a financial institution would need to raise to function normally in the event of another financial crisis. He concludes, “I think we’ve some things to worry about. I’ll leave you with that.”
“Regulatory Reform,” Andrew Metrick, Yale
Metrick talks about “some open questions in financial regulations—systemic risk regulations, in particular.” His presentation is derived from a paper he co-authored with June Rhee. Metrick doesn’t think there’s much incentive for researchers to delve into this area, so he describes his presentation as “a much more depressing talk” than the earlier ones. He goes on to define systemic risk, discuss the post-GFC regulatory changes, and present six open questions related to the regulation of systemic risk.
“The Role of Central Banking in Crisis Management”
Moderator:
- Stanley Fischer
Panel:
- Ben Bernanke, former chair of the US Federal Reserve Board of Governors
- Mervyn King, former governor of the Bank of England
- Jean-Claude Trichet, former president of the European Central Bank
Fischer, himself former governor of the Bank of Israel and former vice chair of the US Federal Reserve Board of Governors, introduces the three heads of the major central banks during the financial crisis. Their discussion focuses on the causes and nature of the crisis, the lessons they learned, and what they would each do differently.
One of the chief points Bernanke emphasizes is distinguishing between a financial crisis, which he describes as any kind of big shock to the financial system, and a panic, which is a general run on intermediaries and a very particular kind of crisis. In the United States, “The panic was the most important thing,” he says. He doesn’t think the Great Recession would have been so severe without it. His recommendation: “In the crisis, look for the short-term liabilities, look for where the run potential is.” He also stresses how critical it is for central bankers to have robust lender of last resort tools to guard against future panics.
“The essence of this was a run,” King says. “The impact on the economy was based on that run.” His major takeaways are that the banking system was undercapitalized, lender of last resort facilities were inadequate, and politics were problematic.
One of the major lessons for Trichet was the speed with which the run took place. It created an unprecedented contagion. “The herd formed up in one day,” he says. And while he acknowledges that we are safer today, he still sees some of the same issues. “We are still in this interconnection, and we have to prepare.” He stresses the importance of maintaining central bank independence. He also points out the resilience of the often-maligned eurozone. Although 5 of the 19 countries had a dramatic crisis, the union still held.
Conference Summary, Stanley Fischer
Fischer sums up the discussion and thanks the panelists, who he says staved off a second Great Depression. While applauding all these efforts, he also notes that they were not enough. “I believe there is a clear link between the populism that is seen now and the fact that we were not able to handle this crisis without major economies going through massive difficulties,” he says. “I suspect the very good results of what we did were not enough to keep the Western countries, the leading democracies, on the path they had succeeded in laying out after World War II and continued to pursue until very recently. And I very much doubt that we’d be in this position without the Great Financial Crisis and the Great Recession.”
Closing Remarks, Andrew Lo
Lo closes out the conference by thanking all the participants. He also recalls the toll of the crisis and stresses that far from a celebration, this meeting is meant as an opportunity for soul-searching, to better understand the crisis, and to make sure it either does not occur again or that we are prepared when it does.
Section V Content:
