Lessons from the Financial Crisis
Research Questions:
- What are the lessons we can learn to avoid future crises?
- What the the economic policy lessons?
- What are the investment
lessons?
- Do we need more financial market regulations or less regulations?
Research Findings:
We identified several government policies, investments strategies
and risk management lessons. The following section lists some of these
lessons:
Policy Lessons
On May 7, 2009 , Chairman Ben Bernanke concluded in a speech at
the Federal Reserve Bank of Chicago Conference on Bank Structure and
Competition, Chicago, Illinois (via satellite) the the best way to
avoid future crises is to improve supervision of the banking sector
by Strengthening Capital, Liquidity, and Risk Management. He also
said
Looking forward, I believe a more
macroprudential approach to supervision--one
that supplements the supervision of
individual institutions to address risks to
the financial system as a whole--could help
to enhance overall financial stability. Our
regulatory system must include the capacity
to monitor, assess, and, if necessary,
address potential systemic risks within the
financial system. Elements of a
macroprudential agenda include
- monitoring large or rapidly
increasing exposures--such as to
subprime mortgages--across firms and
markets, rather than only at the level
of individual firms or sectors;
- assessing the potential systemic
risks implied by evolving
risk-management practices, broad-based
increases in financial leverage, or
changes in financial markets or
products;
- analyzing possible spillovers
between financial firms or between firms
and markets, such as the mutual
exposures of highly interconnected
firms;
- ensuring that each systemically
important firm receives oversight
commensurate with the risks that its
failure would pose to the financial
system;
- providing a resolution mechanism to
safely wind down failing, systemically
important institutions;
- ensuring that the critical financial
infrastructure, including the
institutions that support trading,
payments, clearing, and settlement, is
robust;
- working to mitigate procyclical
features of capital regulation and other
rules and standards; and
- identifying possible regulatory
gaps, including gaps in the protection
of consumers and investors, that pose
risks for the system as a whole.
Precisely how best to implement a
macroprudential agenda remains open to
debate (Source:
Federal Reserve Speech)
On June 26, 2009, William Dudley,
President & CEO of New York Federal Reserve
Bank gave a speech on Lessons Learned
from the Financial Crisis at the
Eighth Annual BIS Conference, Basel,
Switzerland. He concluded: In assessing the
lessons of the past two years, I will focus
on five broad themes that are interrelated:
- Interconnectedness of the financial
system
- System dynamics - How does the
system respond to shocks?
- Incentives - Can we improve outcomes
by changing incentives?
- Transparency
- How should central banks respond to
asset bubbles?
A recommended article can be found at the
New York Federal Reserve Bank
Med Jones outlined several policy and investment lessons in an
interview with CEO Quarterly Magazine
Policy lessons from the global economic crisis
- Lack of regulation is as bad as over-regulation. Governments
should not regulate free market choices, but they should
regulate to protect investors against conflict of interests and
negligence by investment bankers. Regulations should also ensure
full transparency and disclosures and should effectively
penalize violators. To be more specific, I mean investment
banking firms who knowingly sold investments to their clients
and later betted against them without informing the same clients; those who invested in fraudulent funds without proper due
diligence on behalf of their clients; and rating agencies that mis-rated subprime junk derivatives as grade A assets.
- Short-term policy orientation can have adverse affect in the
long-term with huge price to pay. The deficit spending, multiple
stimulus and bailout programs fall into this category.
- The US and other political leaders should not allow private
interest groups to dictate national economic policies and if
they are too powerful and can influence their elections, leaders
can mitigate the conflict of interest by including equal number
of independent advisors and opposing schools of thought in the
advisory and policy committees
- Insanity is defined as doing the same thing and expecting
different results. Hiring the same people who got us into the
economic recession in the first place or hiring those who did
not foresee the financial crisis to design the recovery policies
is not the right solution. Most of the economic advisors of Bush
and Obama did not see the crisis until it was too late and some
of them championed the policies that led to the crisis in
the first place. Recently Obama was forced to change his
economic advisors, but the question is whether the US can afford
another trial and error approach to solving the crisis, be it
the Democrats or the Republicans.
- Countries that quit producing real products, spend more than
they produce, lag in education, burden their middle class with
higher taxes, and continue to import billions from other
countries, bail out failed businesses and reward bad behavior
instead of investing in good businesses, will eventually lose
their leadership and wealth.
- Countries pay a big price not only for their wrong economic
policies, but also for wrong foreign policies. Countries that
allow foreign lobbies, special interest groups or extreme
nationalist movements to dominate their foreign policies by
becoming active participants in international conflicts will end
up creating more enemies and wasting their valuable resources in
defending their own security. Countries that try to spread their
ideologies by force, be it religion, socialism, capitalism,
democracy or something else, will be overwhelmed by the human
and economic cost of conflicts. Those countries will lag behind
other countries that are focusing on developing their economies
and advancing their interests via global partnerships and trade.
The global economic landscape is not like it was after World War
II; at that time, the US had no real competition in rebuilding
war-destroyed European and Asian countries. With the new global
knowledge and global competition, if you take your eye off the
economic ball someone else will pick it up. This lesson is not
only for the Americans but also for the Chinese, Russians,
Indians, Middle East and countries all over the world.
- Globalization of markets, competition, partnerships and
risks should carry far more weight in the designing of strategic
national development plans. It is not enough to think about
government budgets anymore, you need to build your economy and
businesses for global markets and competition. The challenge is
that CEOs now think like global investors, while the political
leadership thinks like local civil servants. A new model for
socioeconomic development with global partnerships is emerging.
Getting the right policies to attract and develop talented
labor, capital and diversify the income sources will determine
the prosperity and wealth of the people of each nation.
Investment lessons from the financial crisis
- Be careful of whose advice and what advice you buy. Many of
the top investment bankers lost money because they could not
foresee the crisis. You will be more surprised to learn how many
people lost money because they invested with fraudulent
investment schemes, such as that of Bernard Madoff. Just Google
the list of Madoff's victims and you will see that the list
includes the largest investment banks and funds around the
globe. That should tell you a lot about the soundness of the
current investment strategies and risk management practices in
the industry. Most of them treated their investments as black
box with no real due diligence. Madoff's Ponzi scheme defrauded
about $65 billion from top investment firms and lasted more than
15 years.
- Economists and financial analysts are not much better; most
of them are academic experts, statisticians or quantitative
analysts, with little or no real-life business experience. Very
few have strong knowledge of the business drivers and
qualitative forces that drive investment and operational
decisions. Without that knowledge, you cannot accurately
determine the performance of assets and markets
- Investment by imitation is not an investment strategy. So do
not invest in an asset just because everyone else is doing so or
because the largest investment bank has invested in it. When you
decide to buy the advice of anyone, buy it based on the merit of
the advice not on who is the source. Those are the ABC of
critical thinking and sound decision making.
- Informed investors can make money in any environment
including recessions. More millionaires were made during the
Great Depression in the US than any other time, and more
millionaires will be made globally because of this crisis than
ever before. In my opinion, the markets now are full of
undervalued assets that can make you rich; but you have to be
very careful of which ones to pick.
- The adage that knowledge is power is true. In the world of
financial markets and investments, knowledge is the ultimate
power. Educate yourself before you invest. If you know something
that others don't, you will make a lot of money.
- Success in the investment world is all about
decision-making. Wrong decisions are based on lack of
information or misinformation. If you are an investor or a CEO,
try not to invest in an asset, a project or a product line, if
you are not sure that the information is complete and accurate.
Making the right investment decision requires a detailed set of
information about macro and microeconomics conditions, markets,
sectors, industries, companies, qualitative and quantitative
analysis, fundamental and technical analysis, behavioral finance
and risk management. Unfortunately, a substantial part of the
information available in the media is just noise and the advice
of many analysts is based on either incomplete decision-making
frameworks or contaminated with biases and misinformation. The
ability to distinguish between valid and invalid assumptions,
more important vs. less important information, and to control
the emotions of fear and greed during the ups and downs of
markets are keys to the success of the investor. Because there
are many uncontrollable variables, no one can forecast the
future with 100% accuracy. However, by refining your investment
decision-making framework and processes and by cleaning your
information inputs, you can increase your success rate
significantly. You only need to be right 70% of the time to be a
very successful investor.
(Source:
CEO Quarterly
Magazine)
Research Comment:
Knowing something on Wall Street that others don't know can make
you very rich. John Paulson, John Paulson, Philip Falcone, Kyle Bass, and
Jeff
Greene profited tens of billions of
dollars by betting against mortgage backed securities and the banks
that invested in them. Though there is no evidence that they predicted the economic aftermath of the
subprime collapse, the knew to a point of certainty to invest
their money in a sector that made them some of the richest people in
the US. They were not lucky in their prediction, but they were lucky to be
in the right industry with the right money connections to use their
knowledge to their advantage.
On November 4, 2008 An opinion article
appeared on
Wall Street Journal by Stephen
Schwarzman. The article outlined seven lessons
First, we need to finalize a common set of
accounting principles across borders. In
global markets, you cannot have global
institutions abiding by differing standards
of accounting and disclosure simply because
they are headquartered in different
countries.
Second, the financial regulatory regimes
in the world's major markets need to be
structured along broadly the same lines.
Each country needs a finance minister at the
political level, a central bank and one
single financial services regulator with a
very broad mandate.
The regulatory agencies in the U.S. are
too small, too fragmented and often not
powerful enough to cope with a system-wide
crisis. Our hodgepodge of regulatory
agencies also encourages financial
institutions to play regulatory arbitrage,
seeking the most compliant and accommodating
regulator. No major financial market can
afford that.
Third, you need full transparency for
financial statements. Nothing should be
eliminated. Off-balance-sheet vehicles that
suddenly return to the balance sheet to
wreak havoc make a mockery of principles of
disclosure.
Fourth, you need full disclosure of all
financial instruments to the regulator. No
regulator can do its job of assessing risk
and systemic soundness if large parts of the
financial markets are invisible to it. A
regulator must be able to monitor all
derivatives, including, for example, $60
trillion in credit default swaps.
Fifth, the regulator should have
oversight over all financial institutions
that participate in the markets, regardless
of their charter, location or legal status.
For example, it makes no sense if you are
worried about leverage in the system to
exclude major categories of borrowers, such
as hedge funds.
Sixth, we need to abolish mark-to-market
accounting for hard-to-value assets. There
is now emerging a broad realization that
mark-to-market accounting has exacerbated
the current crisis. We are not talking about
publicly traded equities with a readily
ascertainable value. The problem involves
securities held for investment purposes, and
those instruments during certain times of
the cycle for which there is no readily
observable market. These securities and
instruments would be fully disclosed to the
regulator. However, a financial institution
would not be forced to suddenly take huge
write downs at artificial, fire-sale prices
and thus contribute to financial
instability.
Finally, we have to move to a
principles-based regulatory system rather
than a rules-based system. A system of rules
and regulations is utterly incapable of
dealing with the speed and complexity of the
modern financial system. Current SEC and
bank regulation was unable to stem the
current crisis.
(Source:
Wall Street Journal)
In 2009 OECD (A United Nations Agency) published a report,
authored by Grant Kirkpatrick, and titled The Corporate
Governance Lessons from the Financial Crisis
The report analyses the impact of failures and weaknesses in
corporate governance on the financial crisis, including risk
management systems
and executive salaries. It concludes that the financial crisis can
be to an important extent attributed to failures and weaknesses in
corporate
governance arrangements which did not serve their purpose to
safeguard against excessive risk taking in a number of financial
services companies.
Accounting standards and regulatory requirements have also proved
insufficient in some areas. Last but not least, remuneration systems
have
in a number of cases not been closely related to the strategy and
risk appetite of the company and its longer term interests. The
article also
suggests that the importance of qualified board oversight and robust
risk management is not limited to financial institutions. The
remuneration of
boards and senior management also remains a highly controversial
issue in many OECD countries. The current turmoil suggests a need
for the
OECD to re-examine the adequacy of its corporate governance
principles in these key areas. (Source:
OECD)
In February 4, 2009 the IMF published a report titled: Lessons
of the Financial Crisis for Future Regulation of Financial
Institutions and
Markets and for Liquidity Management, Prepared by the Monetary
and Capital Markets Department (Principal contributors: Luis
Cortavarria, Simon Gray, Barry Johnston, Laura Kodres, Aditya Narain,
Mahmood Pradhan, and Ian Tower) and Approved by Jaime Caruana
This paper draws particular attention to the following issues:
- Instituting a macroprudential approach to supervision and
assigning a clear mandate to a systemic stability regulator.
- Expanding the perimeter of financial sector surveillance to
ensure that the systemic risks posed by unregulated or less
regulated financial sector segments are addressed.
- Ensuring that prudential regimes encourage incentives that
support systemic stability and discourage regulatory arbitrage,
and assure effective enforcement of regulation.
- Addressing the procyclicality of existing capital
requirements and other prudential norms, preferably in a manner
that is rules based and counters the cycle.
- Filling the information gaps, especially with regard to
lightly regulated financial institutions and ‘off balance sheet’
transactions, ensuring that both supervisors and investors are
provided more disclosure and a higher level of granularity in
information provided.
- Resolving the political and legal impediments to the
effective regulation of cross-border institutions, develop
special insolvency regimes to be used for large cross-border
financial firms, and harmonize remedial action frameworks.
- Strengthening the capacity of central banks to provide
liquidity and respond to systemic shocks.
- Improving the capacity of national authorities to respond to
systemic crises, including by establishing mechanisms for
coordination both within and across borders.
- Establishing the basis for fiscal support during the crisis
containment and restructuring phase, and an exit strategy for
withdrawing public support and for a transition to a new and
more stable financial market structure.
(Source:
IMF)
Other research questions and findings
-
Why did the world's top economists fail to predict the financial
crisis? (Others who missed the crisis, include government
leaders, award-winning scientists, market analysts and
investors). Was the crisis predictable or was it a Black Swan
(unpredictable) event? Are government policy makers competent
enough to manage the nation's financial freedom and security?
Are economists and their policies helping or hurting our
economic growth? Do we need to re-define the education of
economic science and the role that economists play in our
financial markets, government policies and business regulations?
-
Who is to
blame for the financial crisis? Who contributed to the
creation of the crisis? Can they be held responsible
for their actions or inactions? Was there a conspiracy by some
Wall Street executives and government officials? Do investors
have legal cause to seek compensation for damages caused by Wall
Street firms?
- Who predicted
the financial crisis and the ensuing economic crisis?
Is there a documented evidence supporting their claims? Were those who warned about the crisis lucky or did they have a clear logic behind their
predictions? Can we use their knowledge to predict future crises?
What are their future predictions? How do their predictions
compare with each other? Where do the experts agree and where do they
disagree? How accurate are their economic predictions? Can they
be relied on for investment decisions?
- Who are the
top winners and losers of the financial crisis? Top
investors, economists, intellectuals, government officials,
think tanks, and universities that lost or won because of the
crisis.
- What are the lessons we can learn to
avoid future
crises? What the the economic policy lessons? What are the
investor's lessons? Do we need more or less financial regulations?
|
Economic
predictions from the world's top experts on the financial crisis
Dean Baker's
Predictions
Med Jones
Predictions
Nouriel Roubini's
Predictions
Peter Schiff's
Predictions
The Rise & Fall of Financial Assets
Knowledge
@
Wharton
University
Wall Street
Economic
&
Financial
Research
London
School of Economics
Financial Journalism Ethics
City
University
London
Challenges of Financial
Journalism
|
