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Slide 1: Archaeology of the credit crisis Pierre Cailleteau Chief International Economist – MIS
Slide 2: Outline 1. From the anatomy to the archaeology 2. No simple solution to complex problems: the key roots of the crisis 3. Rating agencies: a yellow card to the referee? 4. When will the crisis end? 5. Conclusions 2
Slide 3: From the Anatomy to the Archaeology  Superficial causes The similarity of the causes to recurrent crises calls for a deeper analysis  3
Slide 4: The main roots (1)  Flawed incentive structures and lack of bio-diversity – Why is excessive risk-taking difficult to curb? – The unintended consequences of regulation  The Faustian Pact between policy makers and the financial industry – Growth versus stability? – When financial innovation stops being welfare enhancing? 4
Slide 5: The main roots (2)  The mystifying interaction between credit risk and the economic cycle – What is the financial “cycle” by the way?  Reduced risk traceability in the financial innovation process – Risk transfer not “information-neutral” – Has risk traceability been lost forever? 5
Slide 6: The main roots (3)  Intellectual confusion over critical concepts – A liquidity crisis in an abundantly liquid world – Conditional versus unconditional liquidity  The absence of a satisfactory valuation paradigm – Fair-value like democracy: the “worst system after all the others” – Can credit spreads be misaligned with fundamentals?  Spurious precision in an exponentially complex world – Financial reporting versus risk management 6
Slide 7: Rating agencies: a yellow card to the referee?  The question of incentives: the issue of independence – Conflicts of interests are inherent to financial markets – Are they adequately managed?  Credit risk and market price Could we have done a better job? – When is a stress-test stressful enough?   Should structured finance ratings be ear-marked? – Or should risk measures become multi-dimensional?  Learning from crises… 7
Slide 8: When will the crisis end (1)?  How to get the negative feed-back loop between MtM losses and banks' capital crunch interrupted? – The real sector “way out”: when the housing market improves in the US… – The accounting “solution”: forbearance à la 80's – The “easy” way: when capital replenishment will grow faster than loss accumulation… – The “hard” way, through very conservative mark-down that eventually lead to write-backs… 8
Slide 9: When will the crisis end (2)?  Public responses: from lending in last resort to buying in last resort (distressed assets)  Anchors in the storm: is the USA Aaa rating safe? 9
Slide 10: Conclusion  The “phoney war”? – The most costly banking crisis in history, at the centre of the world financial system… in a booming global economic environment  Back to the regulatory drawing board Will have financial disintermediation and securitisation been no more than an ephemeral era?  10
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