Globalisation and Finance at the Crossroads (eBook)

Adrian Blundell-Wignall is Adjunct Professor at the University of Sydney (School of Economics), and the former Director of Financial and Enterprise Affairs at the OECD (and special advisor to the OECD's Secretary General). He is an Australian citizen and obtained a PhD in Economics from Cambridge University, UK. He is the author of extensive publications on financial markets and monetary policy in learned journals and books. Prior to the OECD he was Head of Research Department at the Reserve Bank of Australia, and spent 15 years working in financial markets, most of it as a portfolio manager and Head of Asset Allocation at BT Funds Management in Sydney. He is founder and chairman of The Anika Foundation that raises and invests an endowment fund to provide research scholarships into the issue of adolescent depression and suicide.Paul Atkinson is a former Deputy Director of the OECD Directorate for Science, Technology and Industry and for many years editor of OECD Economic Outlook. He is a US national who received his Ph.D. from Cambridge University in the United Kingdom.  He has worked extensively on international macroeconomic, monetary and financial issues at the New Zealand Treasury and the Institute of International Finance as well as the OECD, where he continues to act as a consultant on an intermittent basis. Caroline Roulet is an economist and analyst in the OECD Directorate of Financial and Enterprise Affairs. She is a French national who received her Ph.D. from University of Limoges in France. She is working extensively on international finance, banking and corporate finance issues. 

Foreword 7
Contents 10
List of Figures 12
List of Tables 17
Introduction 28
1 Globalisation Sets the Background to the Crisis 37
Introduction to Globalisation 37
The OECD Countries Open Up 38
The Case of Japan 40
Mexico Crises 43
Washington Consensus 44
Emerging Asia 45
The China Growth Phase 47
In Summary 49
The China Path to Prosperity and the US Financial Crisis of 2007–2008 50
Export Success and Import Penetration Strategies 51
Exchange Rate Management and Pricing for Market Share 53
The Saving Glut and Real Interest Rates 56
Capital Inflows, Foreign Exchange Intervention and Bond Buying 59
The Impact of the Rise of Asia on the West 61
The Competitive Response of Western Companies to Competition from Asia 61
The Impact of Import Penetration and Firm Innovation on Western Labour Markets 64
Deflation Pressures in Firms Most Affected by Globalisation 67
Summing up the Globalisation Background to the Crisis in the USA 69
The Great Bond Rally 69
The Great House Price Rally 71
Appendix to Chapter 1: Modelling the Effect of Foreign Buying on US Bond Yields 72
References 73
2 Financial Innovation and Basel II 76
Introduction to Financial Deregulation and Innovation 76
The Basel Accords I and II 79
Financial Innovations: Securitisation and Derivatives 84
Support for Housing in the USA 84
Packaging Mortgages 86
Trading Mortgages Take off 88
Securitisation Follows 89
The ‘Waterfall’ 89
The Mortgage Conduit (REMIC) and Structured Investment Vehicles (SIVs) 91
Teaser Rates and On-Selling 94
Derivatives 94
Derivatives Have a Long History 94
But the Huge Expansion of Derivative Activity Is Recent 97
Regulating OTC Derivatives in the Run-up to the Crisis 98
The Demand for Securitisation and Derivatives 100
Basic Bank Balance Sheet Arithmetic 100
The Boom in Derivatives 102
Regulatory and Tax Arbitrage with Complete Markets in Credit 107
A Basic Regulatory Principle 109
Banks, Implicit Government Guarantees and Shadow Banks 110
Tax Arbitrage 111
Targeting the Ratio of Risk Weighted to Total Assets to Maximise the Return on Equity 112
Summary 114
Appendix to Chapter 2: Problems with Pillar 1 115
References 118
3 The Watershed Year of 2004: Origins and Causes of the Crisis 121
Introduction 121
Global Competition and the Equity Culture for Banking 122
Remuneration 124
Causality 125
Institutional and Regulatory Issues 125
Why Subprime Securitisation Was Concentrated in the USA 125
Why US Subprime Securitisation Accelerated from 2004 127
The American Dream Act 128
The Fannie and Freddie Caps 129
The Announcement of Basel II 130
The SEC Rule Changes in 2004 132
Corporate Governance 134
The Crisis Hits, the Lehman Moment 143
Appendix to Chapter 3: Modelling the Acceleration of US RMBS from 2004 144
References 146
4 Business Models of Banks and Global Contagion 148
Introduction 148
Contrasting Banking Conglomerate Asset and Liability Composition 149
Synthetic CDO Issuance by Banks 151
Issuance of Credit Derivative Structured Products 154
Bank Losses at the Time of the Crisis 156
The AIG Payouts 156
Too Big to Fail, Contagion and Counterparty Risk 157
Commercial Versus Investment Banking 160
External Cost of Crises and Resolution Credibility 161
Appendix A to Chapter 4: The Role of Credit Rating Agencies in the Crisis 164
Appendix B to Chapter 4: Accounting Standard Controversy Around the Crisis and IFRS9 167
References 169
5 Managing the Crisis, Exit and Requirements of Reform 170
Introduction 170
Crisis Management 172
Provision of Liquidity 172
Deposit Guarantees (and the Covered Bond Fallacy) 175
Separation of Bad Assets 176
Recapitalisation of the Banks 179
Exit from Emergency Measures 180
Unconventional Monetary Policy and Interest Rates 181
Requirements for Long-term Reform 182
The Bank Separation Issue 186
The Non-operating Holding Company Structure 187
Conclusions 188
References 189
6 The Determinants of the Riskiness of Banks 190
Introduction 190
The Different Aspects of Bank Risk 193
Determinants of Bank Default Risk 199
Conclusions 202
Appendix to Chapter 6: Modelling the Distance-to-Default 203
Model of GSIB Banks’ DTD 204
References 206
7 Why Bank Separation Must Complement the Leverage Ratio 207
Introduction 207
Business Model Risk for GSIBs Cannot Be Dealt with by Capital Rules 208
The Structural Separation Proposal 210
Illustrating the Separate Effects of Leverage Ratios and Investment Bank Separation 213
Comparisons with Other Separation Proposals 216
The Attempt to Separate Speculative Functions (Volcker & Swaps Push-Out Rule)
Thoughts on the Mnuchin Review 221
European Liikanen Proposal 222
The UK Vickers Rule 223
Switzerland Resolution Approach Is a Non-starter 223
Criticisms of the Full Bank Separation Proposal 224
That Lehman and AIG Were Not Bank Conglomerates 225
That It Was Mainly Mortgage Banks That Failed 225
That Investment Banks Will Shift to 100% Wholesale Funding 227
That Banks Are Too Complex to Separate 227
Isn’t Ring-Fenced NOHC Really Just Glass-Steagall via Another Name? 228
Concluding Remarks 229
References 230
8 Assessing the Finalised Basel III Banking Regulation Regime 232
Introduction 232
Key Elements of the First Phases of Basel III Reforms 233
The Final Phase Basel III Reforms 236
Changes to the Standardised Approach to Credit Risk 236
Restrictions on the Use of Bank Models 239
The Credit Valuation Adjustment for Derivative Counterparty Exposures 240
Operational Risk 243
The Leverage Ratio 243
Output Floors 245
Assessment of the Revised Basel III 246
Structural Differences Across Economies That Lead to Regulatory Competition 248
Sequencing of Policies in Europe 251
Leverage Ratios: The Equity and Netting Issues 252
Leverage by Region 255
Leverage by GSIBs 256
The Derivatives Threshold and the Need to Separate Excessively Complex Banks 258
Derivative Intensity by GSIBs 259
Conclusions on the Final Basel III 259
Appendix to Chapter 8: Technical Details of Revisions to Securitisation, Market Risk and Counterparty Credit Risk Capital Charge Frameworks 261
References 265
9 Globalisation and Finance at the Crossroads 267
Introduction 267
Advanced Country Monetary Policy Supporting Banks and Distorting Returns 269
Globalisation and the Monetary Response to the Crisis Distorting Markets 273
Banks Versus Pensions and Insurance 274
The Cost of GSIB Interconnectedness 277
China’s Belt and Road Initiative: An Alternative Globalisation Strategy 282
The Belt and Road Strategy Versus the Washington Consensus 283
China’s GSIBs and Off-Balance-Sheet Risk 288
Concluding Remarks 291
Appendix to this Chapter: A Guide to the Chinese Financial System 295
References 298
Erratum to: Globalisation Sets the Background to the Crisis 300
Erratum to:Chapter 1 in: A. Blundell-Wignall et al., Globalisation and Finance at the Crossroads,< ExternalRef>
Bibliography 301
Index 311