what's changed since lehman
TRANSCRIPT
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Hamilton Place Strategies provides communications, policy, and advocacysolutions at the intersection of business, government, and media.
Primer: Whats Changed Since The Lehman
Failure 5 Years AgoThe crisis, the response, and the changes since
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In the "too-big-to-fail" (TBTF) debate, we can argue about how much and what type of changes need to be made in financialregulation. However, on the five-year anniversary of Lehman's failure, the question of whether changes have occurred since
then are not debatable. They have and they are significant. This deck provides a short primer on what has changed in the fiveyears since Lehman's failure.
The key takeaways include:
The five-year anniversary of Lehman's failure is not the five-year anniversary of the financial crisis, which began in2007 and was systemic, affecting banks of all sizes and non-bank financial institutions.
Policy changes since 2008 have sought to end TBTF by reducing the likelihood of failure and mitigating the impact
of a failure on the rest of the industry and the broader economy.
Compared to before the crisis, the six global U.S. banks have raised $290 billion more in capital, which is morethan the amount of TARP funds disbursed to the entire banking industry. In addition, the quality of capital and liquiditylevels has increased with new Basel III rules.
Evidence from bond prices and statements from credit ratings suggest markets believe the government is lesslikely to bail out a failing financial firm. Legal changes prohibiting bailouts, new powers with Orderly Liquidation Authority,and the broad political environment have led to a change in market expectations. Additionally, higher capital and liquidity
requirements and new premiums on non-deposit liabilities also act as a tax on size.
Since the passage of new regulations, the market share of large bank holding companies has decreased from 68percent to 63 percent. Contrary to popular belief, mid-sized banks have seen the largest growth since 2010, leading to amore competitive financial sector.
Many emergency authorities invoked during the crisis to bailout financial institutions are now illegal. In 2008, TARPwas voted on twice before passing. In the future, legislators will have to overturn elements of Dodd-Frank and also approvetaxpayer funds to bail out institutions.
Executive Summary
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From Housing Bust To Systemic Crisis To Reform
Aug 2007
Runs in money marketfunds begin withhaircuts in repomarkets peaking in theFall of 2008.
Sep 2007
After two of itshedge fundsfailed, Northern
Rock receivessupport fromBofE.
Sep 2008 Investment bank Lehman
declares bankruptcy RMC Money Market Fund
breaks the buck
Insurer AIG debtdowngraded BofA purchases Merrill Lynch Mortgage-broker WaMu
closed by OTS
June 2010 TARP in the
black forbanks
May 2009Fed administers firststress test
June 2009JPM, Goldman,and 7 otherbanks repayTARP money.
2
Mar 2008 After two of its hedge
funds failed, Bear Sterns,with support from the
Fed, is acquired by JPM.
Sep 2008
Treasury createsMMF Guaranteeprogram
GSEs are placed
into conservatorship
Oct 2008
TARP passes FDIC insurance raised 250k FDIC guarantees all senior
debt Capital injection plan
announced for 9 largestbanks
July 2010Dodd-Frank Act signedinto law
Oct 2008 Wells Fargo buys
Wachovia
June 2006
Housingprices
peak
Jul 2008
Thrift andmortgage
insurer IndyMac placedintoconservator-ship byFDIC
Feb 2008
NorthernRocknationalized.
Nov 2008 Fed, Treasury, and FDIC
announce additionalmeasures to support Citi
Jan 2009 TARP
investmentsfor 23communitybanks
Market event
Government action
Key
*Additionally, the Fed created a dozen programs to extend liquidity to financial institutions throughout the crisis.
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Policy Responses Aimed To End TBTF By ImprovingBank Safety And Minimizing Impact Of Failure
3
Orderly Liquidation Authority (OLA)gives regulators new tools to wind downlarge institutions without using taxpayermoney.
Living Wills provided by banks toregulators will show regulators how towind banks down and provide moredetails on bank structure.
Increasing the amount and quality ofcapital and liquidity reduces thelikelihood that bank losses lead to failure.
Improved oversight through regularstress tests and agency restructuringwill keep banks and regulators moreaware of risks.
Minimizing the impact of a failure on
broader economy.Reducing the likelihood
of failure.
In addition to these approaches, many of the emergency bailouts in 2008are now illegal, requiring legislative overhaul to be implemented again.
Policies end TBTF by
Banning proprietary trading through
the Volcker Rule to reduce risksassociated with trading operations atcommercial banks.
Restrictions on bank size through newrules that essentially prohibit large banksacquiring or merging with other firms.
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Global U.S. Banks Capital Increased 67% Since
Lehman And Exceeds Previous Amount Plus TARP
Source: Bloomberg, U.S. Treasury, Pro Publica
*Before = third quarter 2008, After = second quarter 20134
435 435
290
160
0
100
200
300
400
500
600
700
800
Before* After*
$InBillions
595
725
+67%
New CapitalTARP Base CapitalTier 1 Capital and TARP for banks with greater than $500billion in assets
Bank Capital:
Prior to Lehmans failure, large
BHCs accounted for $435 billion incapital.
In October of 2008, Treasury
began injecting TARP funds intothe banking system.
- TARP to the banking industrytotaled to $245 billion.
- TARP to the largest bankstotaled to $160 billion.
As of June 30, 2013, these same
institutions collectively accountedfor $725 billion in capital, a 67percent increase from the thirdquarter of 2008.
- Base and new capital for thelargest banks is 22 percentabove base capital plus TARP.
Large U.S. bankspaid back TARP infull plus interest.
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-8
-6
-4
-2
0
2
4
6
-8.1*Percent
4
6
8
10
12
14
4.0*
Percent
18,000
15,000
12,000
9,000
6,000
3,000
Index -52%
Q
42015
Q
42014
Q
42013
Q
42012
Q
42011
Q
42010
Q
42009
100
110
120
130
140
150
-21%
Q
42015
Q
42014
Q
42013
Q
42012
Q
42011
Q
42010
Q
42009
Index
Regulators Are Smarter: Annual Stress Tests HelpRegulators Gain More Knowledge
Source: Federal Reserve*Percentage points
**The international component of the severely adverse scenario features recessions in the euro area, the United Kingdom, and Japan and below-trend growth in developing Asia.5
Real GDP Growth Unemployment
Dow Jones Total Stock Market Index U.S. House Price Index
Stress TestImprovements
More models: In 2009, theFed relied on banks own
models for testing. Today, the
Fed has more than 40internal models, an internalindependent model validator,and a council of externalmodeling experts.
More data: For the last roundof testing, the Fed collected
and analyzed loan- andaccount-level data on morethan two-thirds of the $4.2trillion in accrual loans andleases projected to be heldby the 18 firms.
Stress Test Scenario** Projection
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8.2
13.8
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
Worst Case Scenario
Under Stress Test
Actual Q3 2012
Percent
Even Under Significant Duress, Bank Capital LevelsAre Expected To Remain Well Above Five Percent
Source: Federal Reserve 6
Average Tier 1 Common Capital Ratio For Six Largest Banks
Other Components of CCAR
The results of these stresstests are just one component ofthe Feds evaluation of a bank
holding companys financialstrength.
For example, despitemaintaining adequate capitallevels, the Fed still is workingwith banks to improve capitalplanning processes andsystems for monitoring internal
risk models.
Banks are also tested underfour different types of capitalratios.
Regulatory minimum
These tests are being extended toall bank holding companies andnonbank financial firms with over$50 billion in assets and institutionsbetween $10B and $50B are
required to run their own.
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No Unfair Advantage: Large Banks Funding AdvantageHas Completely Reversed Since The Crisis
Source: Goldman Sachs 7
-10
6
-10
-8
-6
-4
-2
0
2
4
6
1999-2007 average Today
BasisPoints
Bond spread differential between the six largest U.S. banks andall other bond-issuing US banks
What Past Studies Get Wrong?
Too broad of a sample: Many of studiestrying to measure the TBTF implicit subsidyinclude non-bank financial institutions andnon-U.S. banks, which operate in a differentregulatory and political environment.
Rely on credit ratings which lag the
market: Changes in ratings always lag thebond market, meaning that those estimatesare skewed high.
Inaccurately apply these advantages inbond markets to all funding markets:Some analyses apply a subsidy on bonds toall liabilities including insured deposits. Thiswill also lead to an inaccurate estimate.
Still relying on crisis data: Many studiescited relied on data during the crisis when weexplicitly subsidized the banks. Those studiesare now outdated.
Recently, credit ratings agencies Moody's and S&P indicated large banks are more likely to be wound down thanbailed out in the future, further supporting the notion that market expectations have changed.
Prior to the crisis, smallerbanks paid 6 basis pointsmore for funding in the
bond market.
Now, largebanks pay10 basispoints morefor fundingthan smallerbanks.
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Financial Markets Are More Competitive: Large BHCs'Market Share Has Declined Since 2010
Source: Bloomberg
Values account for BHC failures, M&A, and in the case of AIG, a re-privatization in the second quarter of 2013.
Data is from second quarter of 2010 to second quarter of 2013 and includes current and historical Y-9C filers (Bank Holding Companies).8
Asset growth since the passage of Dodd-Frankhas occurred in the middle tier of banks
40200-20 1008060
> $500B 16%
$100 to $500B71%
$10 to $100B38%
$1 to $10B
26%
< $1B-3%
68%63%
10%
19%
14%
9%
6%6%
0%
15%
30%
45%
60%
75%
90%
105%
2%
2010Q2
3%
> $500B
$100 to $500B
$10 to $100B
$1 to $10B
< $1B
2013Q2
Market share by assets (%)2010 Q2 to 2013 Q2
Leading to a more competitive banking
sector.
Asset growth (%)2010 Q2 to 2013 Q2
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Bank Competition: As the banking sector
consolidates, the numberof mid-size and large
banks will increase,creating a morecompetitive environmentamong firms of similarsize.
Moreover, the largestbanks are competing both
domestically andinternationally withforeign bankinginstitutions, which are notrepresented in this data-set.
Consolidation Has Increased The Number OfCompetitors Among Mid-Tier And Large Banks
Source: Bloomberg
Data is from second quarter of 2010 to third quarter 2013 and includes current and historical Y-9C filers (Bank Holding Companies).9
10
7
45
8
15
62
$500B +
$100 to $500B
$10 to $100B
$1 to $10B415
354
< $1B521
614
2013Q22010Q2
-15.1
17.2
37.8
50.0
14.3
PercentChange (%)
Number of bank holding companies withineach asset range
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No More Bailouts: Many Crisis-Era Emergency ActionsAre Now Prohibited Or Curtailed Under Dodd-Frank
10
Intervention StatusExplanation
TARP Illegal going forward: Purchase authorityended in 2010. To date, 111.4 percent of fundshave been recovered. Global banks have re-paid plus interest. Some midsize and smallbanks still owe.
To shore up capital and confidence, Congressapproved $700 billion, of which $245 billion was putinto the banking system.
Fed ReservePrograms
Using authority in Section 13(3) of the FederalReserve Act, the Fed created a dozen emergency
programs to stabilize f inancial markets throughout theglobe. The Fed also made loans to specificinstitutions such as AIG and Bear Sterns.
Must be broad-based and only to solventinstitutions: Dodd-Frank prohibits lending
authorized under Section 13(3) to insolventborrowers and requires lending to be broad-based to stop any future loans specific to oneinstitution.
Fannie andFreddie Support
Through the Housing and Economic Recovery Act(HERA), Congress authorized Treasury to purchaseobligations and securities to support GSEs and the
housing market.
Expired: HERA authority expired at the end of2009. Treasury is expected to be fully paid backplus 10 percent interest by early 2014.
MMF GuaranteeProgram
Treasury guaranteed $3 trillion of money market fundshares through the Exchange Stabilization Fund tostop runs on these institutions.
Illegal going forward: The program ended inSeptember 2009 with Treasury collecting $1.2billion and TARP legislation made any futureguarantees of the MMFs illegal.
FDIC Programs The FDIC guaranteed all senior debt and, through theTemporary Liquidity Guarantee Program (TLGP), theFDIC established guarantees for noninterest-bearingdeposits and newly issued unsecured debt to calmcredit markets.
Must be broad-based and requiresCongressional approval: TLGP has expiredand open bank assistance and guarantees arenot permitted except for widely-availableguarantee programs pursuant to Liquidity Event
Determination, which require joint resolution ofapproval by Congress.
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Other Regulations Ensure Global Banks And TheBroader Financial System Are More Secure
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From To
Unregulated and nontransparentderivatives market
Central clearing houses fortransparency, and margin andliquidity requirements for safety
Size limit for mergers onlyapplied to market share ofdeposits
No firm can grow through acquisitionto be more than 10 percent of allbank liabilities as well.
No prudential supervisor for
nonbank financial institutions
Systemically important nonbanks
are regulated by the Fed
Counterparty risk regulation onlyapplied to bank loans
All institutions are subjected toexposure limits across all types ofexposures including derivatives
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The Pace Of Implementation Is Stark Given TheMagnitude Of The Challenge
Source: Davis Polk 12
1,207
1,7951,8702,173
4,950
0
1,000
2,000
3,000
4,000
5,000
ConsumerProtection
Derivatives MortgageReforms
P
ages
Banking andSystemic
Risk
PrivateFunds
13,789 pages of rules have been created by more than 10 regulators There is a new rule every 2.8 days
Over 15 million words of rules cutting across all sectors of the financialsystem
48 Congressional hearings have taken place to discuss the progress andefficacy of Dodd-Frank
Pages of New RulesEven with more than13,000 pages of rules,more regulations continueto be written for thefinancial sector.
Recent discussionaround the pace ofDodd-Frankimplementation hasfocused on whetheragencies met deadlines
and the percentage ofrules completed.
However, these focusesignore the challenge ofmore than ten agenciesimplementing rules ofthe 848-page bill.Implementation is notperfect, but regulatorshave written andfinalized many of ruleswith significantly moreto come.