The Global Financial Crisis according to Roddy Boyd

Global Financial Crisis Survey

Roddy Boyd runs The Financial and is the author of Fatal Risk: A Cautionary Tale of AIG's Corporate Suicide.

1. Which FCIC View best represents the causes of the Financial Crisis?

Majority Conclusions. I say this with reservations since it does not take into account macro-economic factors, such as a low savings rate in the U.S., a socio-political emphasis on consumer spending (post 9-11 entreaties to spend, spend, spend) and housing stock; nor does it address the savings glut abroad that send multi-trillions of dollars to the U.S. in search of yield.

2. Which narrative presented by Douglas Elliott and Martin Baily of the Brookings Institute in Telling the Narrative of the Financial Crisis: Not Just a Housing Bubble best represents the causes of the Financial Crisis?

“Everyone” was at fault: Wall Street, the government, and our wider society.

3. I believe the crisis is ongoing and I project the Global Financial Crisis will end in the year

2013 or beyond.

4. What were the primary causes of the Global Financial Crisis?

Ultimately it had its terminal root in U.S. regulatory failure and the diminishment of corporate risk-management capabilities. In the U.S. domestically, the eradication of the Glass-Steagall Act in 1998 completely skewed the financial playing field to the commercial banks. Institutions that had no corporate history of managing dynamic (daily) capital markets risk were allowed to fund inventories of securities and loans at LIBOR or cheaper. With the standard quarterly earnings pressures, it became necessary to have massive exposure to “carry,” or higher-yielding bond assets that were funded cheaply. The initial easy profits of 02-05’s low rate-regime begat the drive to own conduits, structure securitized products in ever more esoteric fashions and above all, to own land.

The only way the investment banks could compete was through leverage so Bear and Lehman ran their firms at between 30- and 40-times their equity capital base.

So mid-2007 happens, Bear’s hedge fund collapses and UBS, to pick a name, began to liquidate nearly $100 billion in various mortgage loans and securities.

Much hilarity did not ensue.

5. What still needs to change as a result of the crisis?

A separation of commercial and investment banks, a la Glass-Steagall above, is the first and most important order of business. Entities such as large banks that fund overnight via the Fed, or which accept consumer deposits, should not have more than a fraction--say 10%--of their earnings derived from capital markets. The corollary also holds true: It does not serve the U.S. public interest to have risk-oriented enterprises such as banks or mortgage companies (Countrywide, which had applied to be a primary-dealer in 2007 if memory serves, and Washington Mutual, which also had a large capital markets unit, are the primary examples here) able to fund or claim protection from commercial bank/Thrift holding companies.

Secondly, the secondary market for residential mortgages needs to be rethought entirely. It is unclear that three years on either Freddie Mac or Fannie Mae can exist without direct government subsidy. It appears a run-off of these institutions needs to be considered, perhaps followed with an evolution to a German-style pfandbriefe securitized mortgage structure.

Regardless, it is imperative that U.S. policy be to allow risk-taking from institutions with no exposure to the Federal Reserve or the U.S. consumer’s deposits. As such, their risk exposure is limited to a combination of equity capital and market willingness to extend short-term financing. Thus collapses such as Drexel Burnham Lambert in 1989, Enron in 2001 or Refco in 2005 are absorbed by the market.

Compiled by Gary Karz, CFA
Host of InvestorHome

Global Financial Crisis Survey

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