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Faith and Finance: a business perspective

Faith and Finance: a business perspective. Revd Patrick Gerard 8 th October 2008. Outline. Finance now, compared to 1970s Finance from the perspective of a non-financial business Financial Businesses What has caused the credit crunch?. Finance in the 1970s. Financial Institutions.

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Faith and Finance: a business perspective

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  1. Faith and Finance:a business perspective Revd Patrick Gerard 8th October 2008

  2. Outline • Finance now, compared to 1970s • Finance from the perspective of a non-financial business • Financial Businesses • What has caused the credit crunch?

  3. Finance in the 1970s Financial Institutions Investments Investors Pension Funds Gilts Investment Funds Bonds Brokers Equities Banks Mortgages Building Societies

  4. Finance in 1970s Characteristics: • Security and stability seen as important • Relationships very important • Banks knew the businesses they invested in • Assessment of credit risk was a key skill • People knew their bank manager • Brokers knew their clients • Trust and integrity of vital importance • Limited flexibility and choice • Operations slow and methodical

  5. Finance in the 2000s Investors Financial Institutions Investments Pension Funds Gilts Credit Default Swaps Hedge Funds Investment Funds Bonds Insurers Collateralised Loan Obligations Brokers Credit rating Agencies Equities Banks Collateralised Debt Obligations SIVs Building Societies Mortgages Options Off balance Sheet accounts Commodities

  6. Finance in 2000s Characteristics: • Profit of financial institutions important • Incentives in Performance Related Pay • Investments cycled and recycled • Many investments very short term • Extraordinary flexibility and choice • Complexity • Minimal understanding of overall situation • Rapid response • Automated credit approval • Relationships marginalised

  7. Non-financial business perspective Strengths: • Banks much more responsive • They want the business and will compete for it • Huge range of auxiliary services available • Different forms of credit available • Easier to find a usable form of finance Concerns: • Are the financiers concerned for our business? • Do they care if the project goes wrong? (Are they insured?) • Is the deal best for us, or most profitable for them? • Do the financiers know our business? • Can we outmanoeuvre them? • Short term focus of equity investment • Potentially excessive volatility of equity and bond prices

  8. Financial Business What caused the credit crunch?

  9. The Bubble Grows House Prices are rising People can borrow more and spend more on houses Mortgage lending looks safer Banks increase Mortgage lending. 120% Mortgages!

  10. The Bubble Busts More houses Built, so prices fall House Prices are rising People can borrow more and spend more on houses Mortgage lending looks safer Banks increase Mortgage lending. 120% Mortgages! Higher interest rates reduce borrowing

  11. The use of Mortgage Backed Securities Bank pays for securities Lends Money Mortgage Lender Splits into Mortgage Backed Securities House Buyer Bank Securities Mortgage Sells securities To bank Receives Mortgage Advises Bank Takes information Credit Assessment Agent

  12. Causes of the Credit Crunch • Fall in house prices, after a prolonged rise • Toxic Assets (Mortgage Backed Securities) • Excessive and lax lending Caused by: • Excessive liquidity - too much money around • Banks over leveraged • Too much lending relative to their capital • Reaction to the dot.com bubble? • Flight from equity investments to bonds & secured loans • Low interest rates on bonds & secured loans • Failure to understand the overall picture • Regulatory “gap” between Bank of England, FSA and Treasury • Company boards not understanding the big picture

  13. Underlying Causes (1) • Complexity – nobody has overview • Executive Pay • Short term incentives (profit not long term value) • Individualised incentives (collective overview lost) • Excessive Pay (Fiduciary Duty undermined) • Large scale speculative trading • Benefits of risk management & market making • But speculative trading is a nil-sum game • Real costs – traders salaries & bonuses • Concealed costs – capital instability

  14. Underlying Causes (2) • Individualism • Each person works to optimise personal position • Nobody looks after the “Common Good” • No overall perspective of public value • Marginalisation of relationships • Creditor / Debtor relationship controls lending and default • Fiduciary Duty necessary for rational investment • Undermining of the “efficient market assumption” • Focus on the quantifiable • Profit as the only reason for doing business • Salary as the only reason for working • No holistic or ethical understanding of work

  15. Finding the Way Out? • Need to build values • Common Good • Reasons for doing things, beyond money • Relationships in business • Difficult while goals are very financial • Company objectives • Executive pay

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