The Fall of the House of Credit: What Went Wrong in Banking and What can be Done to Repair the Damage?

Cover......Page 1
Half-title......Page 3
Title......Page 5
Dedication......Page 7
Copyright......Page 8
Contents......Page 9
Figures......Page 12
Tables......Page 13
Boxes......Page 14
Acknowledgements......Page 15
What this book is about......Page 17
Who this book is for......Page 21
The writing of this book......Page 25
How the book is organized......Page 28
Notes on further reading......Page 32
1 Where did all the money go? An analysis of the causes and cure of the current global banking crisis......Page 40
Banks create money by lending......Page 42
Funding is a key constraint on lending......Page 43
Renting money: how banks have come to depend on short-term wholesale funding......Page 45
Using loan-backed securities to raise wholesale funding......Page 46
Borrowing short and lending long......Page 48
There are other feedback loops......Page 51
Dealing with the aftermath of a credit cycle......Page 53
This credit cycle is different......Page 54
The problem is lack of trust and confidence, not the new loanbacked securities......Page 56
Borrowing and saving in the short and the long run......Page 58
Fiscal stimulus: an appropriate temporary response......Page 59
Restoring faith in banks and restarting bank lending......Page 61
Further reading......Page 64
The several stages of the crisis......Page 66
The macroeconomic context: structural current-account imbalances......Page 68
How will these global current-account imbalances correct: gradual adjustment or sudden shock?......Page 72
Bank exposure to structured credit markets......Page 74
The spread of the crisis......Page 83
Holding of traded credit securities has amplified bank losses, but they are still manageable......Page 85
A ‘mark to market’ accounting controversy......Page 87
The responses to the crisis......Page 89
Further reading......Page 94
3 We have been here before, haven’t we?......Page 99
The panic of 1907......Page 101
The Latin American debt crisis of the 1980s......Page 104
The protracted Japanese financial crisis......Page 108
The emergence of the Scandinavian banking crises......Page 113
The resolution of the Scandinavian banking crises......Page 115
The build-up to the Asian banking and exchange-rate crisis......Page 119
The 1997 Asian crisis: the trigger and the policy response......Page 123
A coda to the Asian crisis: Russian default and LTCM......Page 127
Other crises and a conclusion......Page 130
Further reading......Page 131
4 A basic funding tool – the tranched mortgage-backed security......Page 134
The origins of tranching......Page 135
Creating low risk assets that investors will buy......Page 136
Preliminary: a corporate bond example......Page 137
Safe senior tranches......Page 139
Safe senior tranches really are very safe......Page 141
If tranched mortgage-backed securities are so safe, why will no one buy them?......Page 143
A real world example: the issue of tranched mortgage-backed securities by Countrywide Financial......Page 145
Subordinated senior, mezzanine and junior equity tranches......Page 151
The main motivation for commercial bank-sponsored MBS and ABS is to reduce funding costs, not to transfer credit risk......Page 152
Beyond the basic tranched mortgage-backed security......Page 155
Further reading......Page 157
What is different about transaction deals?......Page 159
Transaction deals are very attractive during a credit boom......Page 161
Structured finance: fee income versus transaction profits......Page 169
Transaction profits and the hunt for yield......Page 171
The hunt for yield was not just in sub-prime......Page 173
The decline in credit spreads and credit quality......Page 176
Restructured credit products......Page 179
Structured financial products: how much money was raised?......Page 181
Structured financial products: where did the money all go?......Page 183
Further reading......Page 185
6 Borrowing short and lending long: the illusion of liquidity in structured credit......Page 186
Short-term leveraged funding......Page 187
The vicious circle of falling prices......Page 188
How the maturity transformation or ‘yield-based trade’ was conducted......Page 190
How these trades were carried out......Page 191
A puzzle about the economics of yield-based trading......Page 196
A second puzzle......Page 198
Different ways to yield-based trade: conduits and SIVs......Page 199
Further reading......Page 209
Background: the new global linkages......Page 211
The financial storm: first signs of rain......Page 213
The financial storm: rain becomes a deluge......Page 219
Financial storm: the levees burst......Page 223
Further reading......Page 234
8 The flood of losses......Page 236
UBS comes clean......Page 237
More failures of control......Page 239
The largest bank losses of all......Page 240
US mortgage banks......Page 243
The liquidity crisis at Bear Stearns......Page 245
Monoline insurers and credit default swaps......Page 249
Knock-on effects......Page 253
The collapse of AIG......Page 254
Conflicts of interest at Fannie Mae and Freddie Mac......Page 258
Fannie and Freddie are taken into ‘conservatorship’......Page 261
The wider picture – not quite so bad......Page 264
The losses are manageable......Page 269
Further reading......Page 272
9 Central banks and money markets......Page 273
Banks need access to short-term borrowing......Page 274
Banks borrow and lend liquidity in the money markets......Page 275
Banks borrow on a secured basis in the money markets using repo......Page 277
The spread between unsecured Libor and secured repo......Page 278
Lack of good collateral removed liquidity from the money markets......Page 279
Orthodox monetary policy......Page 281
The implementation of orthodox monetary policy......Page 282
Expectations and the shift to unorthodox monetary policy......Page 286
Central bank liquidity provision during a financial crisis......Page 289
Bank runs......Page 290
Runs usually occur among wholesale, not retail, depositors......Page 292
‘Lender of last resort’......Page 293
Central bank actions during the first year of the current credit crisis......Page 294
An assessment: liquidity provision but no new funds for lending......Page 297
Further reading......Page 300
10 The run on the world’s banks......Page 301
The failure of Lehman Brothers......Page 302
The run on the banks: week 1......Page 305
Weeks 2 and 3......Page 308
Week 4: the government rescue packages......Page 312
The response of central banks to the global bank run......Page 314
The aftermath: banks are stabilized but equity markets weaken......Page 318
The underlying problem: continuing pressure on bank balance sheets......Page 320
‘Scandinavian’ solutions to the crisis......Page 322
Extreme loss insurance......Page 324
Further reading......Page 328
Conclusions: repairing the house of credit......Page 330
How panic and illiquidity initiated the crisis . . .......Page 331
. . . and helps to explain the course of subsequent events......Page 333
Restoring confidence......Page 336
Government-backed support for the banking system......Page 337
Insurance of senior structured credit securities......Page 340
Government-backed insurance guarantees and unorthodox monetary policy......Page 341
Presentation and expectations......Page 342
Political obstacles to support of the banking system......Page 344
The future of banking......Page 347
Further reading......Page 354
Glossary......Page 357
Index......Page 373