Marco Onado 20264 Comparative financial systems

1. Marco Onado20264 Comparative financial systems Course presentation Academic Year 2011 – 2012 February 13th, 2012

2. Objectives • Analyze the conceptual framework for comparing financial systems across countries and over time (in particular looking at the main channels of intermediation: banks vs financial markets). • Review the main characteristics of the financial systems of the industrialised countries looking at the households’ financial assets and the corporate sector’s financial liabilities. • Discuss – as significant case studies – the strategies of important global players of different countries, both American and European. • Analyze the long-term causes and implications of the 2007-09 financial crisis

3. Questions we will try to answer • What are the main characteristics of a financial system and how can they be measured? • Why structural characteristics differ across countries and over time? • What are the main causes (macro and micro) of the financial crisis? • Why the crisis spread to the Government bond market and to the banking systems, particularly in Europe? • What is the outlook at the beginning of 2012 for the main European banks? • What does that mean from the point of view of strategic decisions of financial intermediaries which want to be international or global?

4. Main parts • General issues (role of the financial system; literature on comparing financial systems); • Anatomy of a crisis (the effects on main financial systems and the main causes of the crisis); • The main weaknesses from a macro and a micro point of view; • The strategic issues for the European banks.

5. References • Teaching material • In particular Imf, Global financial stability report; Bank of England and Ecb, Financial Stability Review • Further reading • Presentations of each lecture • All documents are available on the mypage site • Office hours: Wed 10:30 – 12:00 • marco.onado@unibocconi.it (no answers on information available in the syllabus)

6. Valuation • Final written test: • 6 multiple choice questions (2 point each, -1 for wrong answers) • 2 open questions (10 points each) • >30 points = 30 cum laude. • Time: 70 minutes. • Bonuses can be obtained through active participation and discussion. • Individual essays (as a part or alternative to the final test) can be assigned to attending students.

7. The financial crisis • What is a financial crisis? • Are financial crises fortuitous accidents? • What are the costs of the present crisis? • Where are we now?

8. What is a financial crisis?From Rheinhart-Rogoff, This time is different • Crises defined by quantitative thresholds • Inflation crises • Currency crashes • Currency debasements • Bursting of asset price bubbles • Crises defined by events • Banking crises (bank runs) • Financial distress (milder) • Systemic (severe) • Debt crises • Domestic • External

9. A focus on banking crises • High frequency • 266 banking crises since 1800 • 105 since 1945 • Whether calculations are done from 1800 or from 1945 on average there are no significcant differences in either the incidence or the number of banking crises between advanced and emerging economies

10. The common denominator of financial crises • Excessive debt accumulation, whether it be by Government, banks, corporations or consumers, often poses greater systemic than it seems during a boom • Large-scale debt buildups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short-term and needs to be constantly refinanced

11. An important warning • Debt is a wonderful thing but it must be repaid • Von Mises: It may sometimes be expedient for a man to heat the stove with his furniture. But he should not delude himself by believing that he has discovered a wonderful new method of heating the premises • The Economist: lending is a sober business punctuated by odd moments of lunacy (The dark side of debt, 2006)

12. Rheinhart-Rogoff The “this time is different syndrome” • This syndrome is rooted into the belief that financial crises are things that happen to other people in other countries and at other times. • Crises do not happen to us, here and now • We are doing things better, we are smarter, we have learned from past mistakes • The old rules of valuation do not longer apply • Financial innovation led to a better assessment and distribution of risks • The current boom is based on sound fundamentals

13. When did the crisis begin? • The end of the US housing bubble (summer 2006) and defaults in the subprime mortgage market • Bear Stearns difficulties in Spring and Autumn 2007 • Liquidity crunch August 2007 (the “Black Swan”) • Lehman bankruptcy October 2008 • European sovereign risk (Greece, 2010) • Contagion to big European countries (Summer 2011)

14. The crisis was initially underestimatedThe Imf estimates of banks’ losses 14

15. The costs of the financial crisis • Losses for the banks • Wealth transfer from the taxpayer to the banks as a consequence of bailouts • Loss of output • Immediate (world: $ 4tn; UK £ 140 bn) • Permanent (between 60 and 200 tn for the world economy and £ 1.8 and 7.4 for the UK) • As Nobel-prize winning physicist Richard Feynman observed, to call these numbers “astronomical” would be to do astronomy a disservice: there are only hundreds of billions of stars in the galaxy. “Economical” might be a better description.

16. The effect on global growth

17. Size of financial system support measures

18. The Imf dashboard on intdebteness and leverage in selected countries (Sep11)

19. Contagion in Euroland: 2010-2012

20. Takeaways: a first conclusion that raises many questions • The biggest financial crisis ever • It came after a period of great financial innovation • According to the conventional wisdom (and most regulators) the international financial system was reasonably robust and resilient • The financial crisis is far from being resolved • Why it happened? • What will be the long-term consequences? • We need to get back to the fundamental question: what is the role of a financial system? What are the functions it performs?