losses, leverage, and liquidity the road ahead for risk management carl tannenbaum vice president,...
TRANSCRIPT
Losses, Leverage, and Liquidity
The Road Ahead for Risk Management
Carl TannenbaumVice President, Risk Specialist
DivisionFederal Reserve Bank of Chicago
Risk Conference, April 2009 Page 2
Presentation Outline
•Risk and Reinforcement: When Moods Add to Models
Risk Conference, April 2009 Page 3
Key Risk Metrics
Mean Blood Pressure Consumption Indicators
Caffeine Alcohol
Years Until Affordable Retirement
0
20
40
60
80
100
120
Mar J un Sep Dec Mar
What Word Best Describes Your Emotions?
Anger
Depression
Acceptance
Panic
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Spiraling Upward
Gains
Capital
ConfidenceAggression
Absence ofCaution
Risk Conference, April 2009 Page 5
Spiraling Downward
Losses
Capital
ConfidenceApprehension
Abundance ofCaution
Risk Conference, April 2009 Page 6
Models: Natural Accelerants
•Roll rates•VaR•Economic CapitalOnce bad things start to
happen, models close down fastL
osses
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Lessons Learned: 1
• Past is not always prologue; models should not assume that it is
• Life events are not normally distributed; why do models assume that they are?
• How do we avoid extreme overreactions?
Follow-up: models and their applications need to be recalibrated
Risk Conference, April 2009 Page 8
Source: Bloomberg, ICI Statistics & Research
Still in the MattressVolumes in Money Market Funds
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Assets of Commercial Banks
Ratio of Loans & Leases to Total Assets(All Commercial Banks, SA)
Ratio of Cash to Total Assets(All Commercial Banks, SA)
Week of Feb. 25
Week of Feb. 25
9
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Source: Federal Reserve
Still in the VaultExcess Reserves Held by Commercial Banks
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A Thought:
We’ve gone from disintermediation right
past re-intermediation to non-intermediation
Risk Conference, April 2009 Page 13
Presentation Outline
•Risk and Reinforcement: When Moods Add to Models
•Learnings Gained the Hard Way
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Spiraling Downward
Losses
Downgrades
Collateral CallsReducedLiquidity
DistressedAsset Sales
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Liquidity Issues to Think About• Mismatches matter
– Think about liquidity transfer pricing
• Look beyond the boundaries of the balance sheet– Commitments, SPVs, sponsored funds
• Value collateral conservatively– Don’t assume availability, even with FHLB– Know when you might be asked for more
• When will investors return to buy assets in the seconday market?– Structures go back to basics
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Loss Estimates Escalate
370
945
1405
2200
Sep '07 Apr '08 Oct '08 J an '09 • Contagion increases losses
• Initial capital raising proves inadequate
• Investors become hesitant to absorb new issues
Source: IMF
Projected Credit Losses, $$ Billions
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Lessons Learned: 2
• Declines in asset prices can be a cross product of loss and liquidity– Note: A pool with a 50% PD and 50% LGD still
has an intrinsic value of 75 cents on the dollar
• Credit and liquidity risk are closely related, for both markets and institutions
• Know where you stand in the capital hierarchy
Follow-up: linking events in stress testing for liquidity and market risk
Risk Conference, April 2009 Page 18
Presentation Outline
•Risk and Reinforcement: When Moods Add to Models
•Learnings Gained the Hard Way
•Where We Stand in the Journey Back to Normalcy
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Rebuilding the Base
•Public capital predominates
•More losses ahead
•Concerns over the “quality of capital”
•How to make capital levels countercyclical?
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Where We Stand:Credit Risk
Loss
Reco
gn
itio
nLo
ss R
eco
gn
itio
n
Risk RecognitionRisk Recognition
Residential RE
Commercial RE
Consumer Credit
C&I Lending
Issues•Recession Scenario•Guarantors•Models: High-end, low-end•Inexperience
Ag Lending
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Foreclosure Filings
2008 Foreclosure Rate United States: 1.8%
1.Nevada: 7.3%
2.Florida: 4.5%
3.Arizona: 4.5%
4.California: 4.0%
5.Colorado: 2.4%
6.Michigan: 2.4%
7.Ohio: 2.3%
8.Georgia: 2.2%
9.Illinois 1.9%
10.New Jersey: 1.8%
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Policy Steps
•$800 billion in fiscal stimulus•TALF, PPIFF for banks•Foreclosure mitigation•Bigger line for the FDIC•Review of Mark to Market Accounting
•Regulatory Restructuring
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Conclusions
• The American financial landscape has changed historically in just the past six months; maybe more ahead?
• The Treasury and the Fed have been exceptionally active
• We’ll be learning from and debating recent events for years to come