democratization of finance:democratization of finance · cycle, having survived many predictions of...
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Democratization of Finance:Democratization of Finance:How We Got Here and What It Means
Professor Mitchell PetersenFinance Department – Kellogg School
Director – Heizer Center for Private Equity & Venture CapitalNorthwestern University
Financial Crisis:Finding Someone to Blame
Greedy BankersIncompetent RegulatorsIncompetent RegulatorsCorrupt Politicians & Lobbyist
d l lGreedy or Cleverly Naïve InvestorsFinance Professors
Consumers without a Budget Constraint
Value of Financial History:yLooking Forward by Looking Back
“So what should business schools do to improve their performance?
Value of Financial History:yLooking Forward by Looking Back
“So what should business schools do to improve their performance?
More history classes would help. Would-be business titans need to learn that economic history is punctuated with crises and disasters, that booms p ,inevitably give way to busts, and that the business cycle, having survived many predictions of extinction, continues to prey on the modern economy ”continues to prey on the modern economy.
The Economist, September, 24, 2009
Value of Financial History:yLooking Forward by Looking Back
“History doesn’t repeat, but it does rhyme”
Mark TwainMark Twain
“The curious task of economics is to demonstrate to men how little they knowdemonstrate to men how little they know about what they imagine they can design.”
FA Hayek 1988 “The Fatal Conceit”FA Hayek, 1988, The Fatal Conceit
History & Evolutionof Consumer Finance
The Wealthy Are DifferentHow they investHow they investHow they borrow
Middle ClassMiddle ClassBank savings, not stocksN i t lNo signature loansLimited ability to borrow
Growth of Consumer Credit
1.201.301.40
0 800.901.001.10
0.500.600.700.80
0.401975 1980 1985 1990 1995 2000 2005
Cons Debt/Pers Income Cons Debt/Personal Cons Cons Debt/GDP
Consumer Credit: Too Much of A Good Thing?
“the prospect of even a mild recession is daunting because many individuals and companies would be unable to meet their obligations.” g
“…people …can't afford lobster,..(but) they buy them anyway (this shows) just how over leveraged the typical American credit-card-toting consumer is.” g
“American’s spending spree is being financed by heavy borrowing by ….households and firms, whose debts are growing at their fasted rate for a decade. Consumer debt is at record levels relative to income”
“The …reason… for fearing a recession is that the consumer is stretched quite thin. Consumer debt per household is near record highs. But these trends threaten only a small percentage of consumers, hardly enough to drag down the overall economy.”
Consumer Credit: Too Much of A Good Thing?
“the prospect of even a mild recession is daunting because many individuals and companies would be unable to meet their obligations.” Fortune, March, 1987g
“…people …can't afford lobster,..(but) they buy them anyway (this shows) just how over leveraged the typical American credit-card-toting consumer is.” Fortune, June, 1990g
“American’s spending spree is being financed by heavy borrowing by ….households and firms, whose debts are growing at their fasted rate for a decade. Consumer debt is at record levels relative to income” The Economist, June, 1999
“The …reason… for fearing a recession is that the consumer is stretched quite thin. Consumer debt per household is near record highs. But these trends threaten only a small percentage of consumers, hardly enough to drag down the overall economy.” Money, February, 2006
Growth of Consumer Credit
1.201.301.40
0 800.901.001.10
0.500.600.700.80
0.401975 1980 1985 1990 1995 2000 2005
Cons Debt/Pers Income Cons Debt/Personal Cons Cons Debt/GDP
The Great Moderation
4.5
4.6
4.7
4.2
4.3
4.4
3.9
4
4.1
3.7
3.8
Dec‐71 Dec‐76 Dec‐81 Dec‐86 Dec‐91 Dec‐96 Dec‐01 Dec‐06
Industrial Production: Consumer Products
Th G t M d tiThe Great Moderation
10.0
12.0
8.0
4.0
6.0
2.0
1972 1977 1982 1987 1992 1997 2002 2007
Unemployment rate
The Great Moderation“…if the Great Moderation was largely the result of good luck
rather than a more stable economy or better (monetary) policies, then we have no particular reason to expect the p , p prelatively benign economic environment of the past twenty years to continue.”
“My view is that improvements in monetary policy, though certainly y p y p y, g ynot the only factor, have probably been an important source of the Great Moderation. In particular, I am not convinced that the decline in macroeconomic volatility of the past two decades was primarily the result of good luck…”
Governor Ben S. Bernanke, February, 2004
Th G t M d ti ?!?The Great Moderation ?!?
10 0
12.0
8.0
10.0
4.0
6.0
2.0
1972 1977 1982 1987 1992 1997 2002 2007
Unemployment rate
Consumer Finance Revolution:A Good Idea Taken Too Far
Consuming Future Wealth Is AddictiveWhen times are bad borrowWhen times are bad, borrowWhen times are good, save borrow
Housing PolicyHousing PolicyExpanding home ownership is goodWh t d d h t fWhat do we do when we run out of households who can afford a house?
E t ti E i Ri k i S llExpectations: Economic Risk is Small
How to Building a Fragile Economy
Expectations: Economic Risk is SmallAllocate more to the risky assetAllocate more to the risky asset
More stock in our portfoliosMore stock in our pension plansMore stock in our pension plansBuy more house
B /S lBorrow more/Save lessLarger credit card balancesLarger mortgages/Less home equity
The Way Forward:Consumers
Asset Values are LowerStock market is still downStock market is still downReal estate values are still down
Equity Market Returns:DJIA Then & Now
12000
14000
16000
300
350
400
8000
10000
12000
200
250
300
2000
4000
6000
50
100
150
0
2000
0
50
0 52 104 156
DJIA 1929 DJIA 2007
Equity Market Returns:DJIA Then & Now
‐10%
0%
0 50 100 150 200
40%
‐30%
‐20%
‐60%
‐50%
‐40%
‐90%
‐80%
‐70%
‐100%DJIA 2007 DJIA 1929
House Prices Rise & Fall
90 00
100.00
110.00
70 00
80.00
90.00
50.00
60.00
70.00
30.00
40.00
-10.00 -8.00 -6.00 -4.00 -2.00 0.00 2.00
Japanese RE Index US RE Index
House Prices Rise & Fall
90 00
100.00
110.00
70.00
80.00
90.00
50.00
60.00
30.00
40.00
10 00 5 00 0 00 5 00 10 00 15 00-10.00 -5.00 0.00 5.00 10.00 15.00
Japanese RE Index US RE Index
The Way Forward:Consumers
Asset Values are LowerUnemployment is higherUnemployment is higherWage growth is lower
k h hRisk aversion is higher ?Job, House, Portfolio
Frugality is in fashion ?
Google Trends: H1N1
Google Trends:How Do I Save?
The Way Forward:Consumers
Asset Values are LowerUnemployment is higherUnemployment is higherWage growth is lower
k h hRisk aversion is higher ?Job, House, Portfolio
Frugality is in fashion ?Ability to borrowing is lowerAbility to borrowing is lower
The Way Forward:Governments
Federal Government Debt$7 8T now was $4 6T in 2005$7.8T now, was $4.6T in 2005
State Government DebtProjected 2010 Deficit: 192B (28%)Projected 2010 Deficit: 192B (28%)Under funded pensions (equities)
Fi l P li S l tiFiscal Policy SolutionsCash for clunkersFirst time (any) home buyer tax credit
The Way Forward:Restricted Capital Access
Tighter Bank CreditDrop in credit quality (recession)Drop in credit quality (recession)Limited bank capitalLoan officer have learnedLoan officer have learnedLoan officer risk aversion Regulator risk aversionRegulator risk aversion
Evolution of Business Bank Lending
The Way Forward: Restricted Capital Access
90000
100000
14000
15000
N
70000
80000
12000
13000
Num
ber o
of Ban
ks
50000
60000
9000
10000
11000
of Offices
Num
ber o
30000
40000
7000
8000
9000
1973 1978 1983 1988 1993 1998 2003 2008
N
1973 1978 1983 1988 1993 1998 2003 2008
The Way Forward: Restricted Capital Access
Lending at Greater Distances3 50
3.00
3.50
2.00
2.50
1.00
1.50
73 78 83 88 93
Year
The Way Forward: Restricted Capital Access
Tighter Bank CreditEvolution of Business Bank LendingEvolution of Business Bank Lending
Greater distance and more impersonalJustifying opaque credit risks:Justifying opaque credit risks: “This firm is a good credit risk, trust me”
The Way Forward: Reduced Consumption
Parable of the ForestLower Wealth Lower ConsumptionLower Wealth Lower Consumption
Housing, equity, and income
S l ti B i A i t th F t ?Solution: Borrowing Against the Future?Less feasible, less desirable, & temporary
Positive Feedbacks: Up & DownLower consumption Lower wealth
The Importance of Experiencep pFinancial Trivia Quiz
Fall 1998: LTCM and A Near MissFederal Reserve Calls Meeting of 15 BanksFederal Reserve Calls Meeting of 15 Banks Bankers Trust, Barclays, Bear Stearns, Chase, Credit Suisse First Boston, Deutsche Bank, Goldman Sachs, J.P.Morgan, Lehman Brothers, Merrill Lynch, Morgan Stanley, Paribas,Lehman Brothers, Merrill Lynch, Morgan Stanley, Paribas, Salomon Smith Barney, Societe Generale, UBS
Fall 2007: Only 2 CEOs RemainTrivia Question: Which Two?
Your Turn: Questions & Thoughts