1. The Financial Crisis: Who’s to blame? Howard Davies Director, LSE Confederation of Indian Industry New Delhi, 9 April 2010

2. Rolling Stone described Goldman Sachs as “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”

3. Who is to blame for the current financial crisis? % of respondents answering “a lot” to the given statement: “For each one please tell me if you think it has contributed a lot, some, or not at all to the downturn” Source: WorldPublicOpinion.org. Public Opinion on the Global Economic Crisis, 21 July 2009.

4. economists - “if anything needs fixing, it’s the sociology of the profession” – Dani Rodrik (Harvard) business schools – the Guardian testosterone – Scientific American: “risk-taking in an investment game with potential for real monetary pay-offs correlates positively with salivary testosterone levels and facial masculinity” video games – Professor Susan Greenfield of Oxford human greed – Rowan Williams Jews Some suspects

5. Who blames “the Jews” for the financial crisis? Source: N Malhotra, Y Margalit: State of the Nation. Boston Review, May/ June 2009.

6. % blaming 49US banks 29Investment banks 29 Credit Rating Agencies 28 US regulators 25Hedge funds 23EU banks 6EU regulators ……and the answer? Views of Members of the European Parliament

7. …66% recommend deeper political union in Europe, as a key response to the crisis

8. “ Bank failures are caused by depositors who don’t deposit enough money to cover the losses due to mismanagement”. Dan Quayle

9. Act One:Subprime Act Two:Liquidity Act Three:Unravelling Act Four:Meltdown Act Five:Pumping The Credit Crisis: A Five-Act Shakespearian Tragedy

10. The IMF forecast a modest recovery next year Source: IMF World Economic Outlook Database, October 2009. Gross domestic product forecast (% change), constant prices, 2007-2014

11. But global unemployment is likely to continue to rise Unemployment (Million) and unemployment rate (%), 1999 - 2009 Source: ILO, Trends Econometric Models, December 2008.

12. global imbalances loose monetary policy, leading to mispricing of risk credit bubble ‘excess’ leverage, facilitated by procyclical regulation, and regulatory arbitrage ‘excess’ unmanaged growth of the financial sector, which magnified risks, rather than diversifying them What are the underlying causes?

13. Global current account imbalances grew rapidly from 2003 Estimates of account balances for selected countries ($ Billion), 1993-2007 Source: Datastream, FSA Calculations.

14. Source: Bank of England, Speech of Charles Bean at the Annual Conference of the European Economic Association, 25 th Aug 2009. Monetary policy was loose, especially in the US Deviation of policy rates from Taylor rule (%), 2000-2009

16. Household debt as % of GDP, 1987-2007 Source: FSA, ONS, Federal Reserve, Eurodata, Datastream Household debt rose sharply

17. Case-Shiller Home Price Index (2000 Q1 = 100), Jan 1987 - 2005 Source: Silverlake, Case-Shiller Price Index. US house prices doubled in five years

18. Source: ECB, National Statistical Offices, IMF, EMF, Italian Ministry of Infrastructure, Morgan Stanley Research. House prices rose rapidly in much of Europe also Real house price changes over the last ten years (%), 1996-2006

19. Bank Balance Sheets expanded Source: Silverlake, Capital IQ. Large-cap banks’ aggregate assets rose to 43x tangible book equity

20. UK banks leverage grew sharply from 2003 onwards Source: Bank of England, Financial Stability Report, Issue 24, 28 October 2008. Major UK banks’ leverage ratio, %, 1998 - 2008 Note: Leverage ratio defined as total assets divided by total equity excluding minority interest. Excludes Nationwide due to lack of interim data.

21. Source: The Turner Review, March 2009. ABS – volumes outstanding, $ Billion, 1996 - 2007 As did the securitised credit market

22. Resecuritisation magnified credit creation SUPER SENIOR AAA AA A BBB Equity Capital Structure Containing Subprime Loans Subprime Mezzanine CDO Containing BBB Subprime Bonds 100% 28% 20% 11% 7% 0% 11% 7% 11% 8.6% 7% 100% 40% 0% CUMULATIVE LOSSES Source: Morgan Stanley.

23. Private Equity Leverage Multiples grew Source: Silverlake, Morgan Stanley, Capital IQ. Debt/EBITDA, 2002 - 2007 X

24. Growth in Hedge Fund Assets & Leverage accelerated Source: Silverlake, Through Q308 – HFR industry report; Q408 projections based on CS analysis.

25. This points to the need for monetary policy to focus more on - credit growth - financial intermediation, and - asset prices …with a stronger emphasis on the risk of financial instability

27. Weak regulation may not have been the main cause of the crisis, but it is important to reform it trust in markets, and in regulation, has been affected, which damages investment and economic growth the global system does not meet the needs of global markets

28. The crisis revealed problems with the existing regulatory architecture: Hopelessly complex global structure Lacking a central authority to drive co-operation and make changes happen US system balkanised and ineffective European system a fudge – neither truly European nor truly national No two national systems the same

29. Global Committee Structure - A Regulator’s View G-20 (Gov’ts) Financial Stability Board WTO OECD (Gov’ts) FATF (Money Laundering) IASB (Accounting IASC Bank for International Settlements (Central Banks) G-10 (Central Banks) CGFS CPSS Basel Committee (Banking) IOSCO (Securities) Joint Forum IAIS (Insurance ) Monitoring Group IAASB (Audit) PIOB IMF World Bank (Gov’ts) IFIAR (Audit) Source: Adapted with permission from Sloan and Fitzpatrick in Chapter 13, The Structure of International Market Regulation, in Financial Markets and Exchanges Law, Oxford University Press, March 2007.

30. National Regulatory Structures Source: How Countries Supervise their Banks, Insurers and Securities Markets 2007: Central Bank Publications. 57 35 2 49 3 54 28 7 39 10 Other bank regulators Central banks as banking regulator Central bank as one pillar No Central Bank interest Non-Central Bank Central Bank

31. And there were a number of regulatory failures US Financial markets regulation was uncoordinated and overlapping - Promoted regulatory “competition” European Regulation also at fault: complex mix of European and national rules In the UK, weak FSA regulation of Northern Rock, and the Bank of England too distant from financial markets

32. More regulatory failures Key markets were unregulated –Non-bank private mortgage industry –Credit Default Swaps No exchange, central clearing or capital requirements Insurance industry in the US was lightly regulated –No federal regulator –Missed “one-sided” credit insurance & CDS risks taken on by AIG and others Basel II capital requirements were flawed –Allowed too much leverage, over-reliance on credit ratings, and didn’t encompass liquidity –Pro-cyclical: as asset prices rose, banks seemed to need less capital

33. G20 Summits “Reshaping the global financial and regulatory System” Enhance corporate governance and risk management Strengthen prudential regulation, but with a ‘managed transition’ to avoid exacerbating the downturn Regulate financial activities according to their economic substance and ensure regulation is consistent in all jurisdictions

34. “Reshaping the global financial and regulatory system” Financial Stability Board with standing committees Membership of FSB, Basel etc extended to BRICs and others Expanded coverage of regulation to include systemic hedge funds Tighter controls on offshore centres Tighter regulation of credit rating agencies More and better quality capital in the banking system Macro-prudential mechanism to respond to asset price bubbles Regulatory controls on bank remuneration G20 Summits

35. What about the bankers themselves?

36. Poor risk management –excessive reliance on Value at Risk Models –herding behaviour –inadequate hedging Flawed capital allocation mechanisms –trading strategies under-capitalised Incentive structures which reward short-term risk-taking Weak corporate governance: boards ignorant of the risks management were taking on Failures in the financial firms themselves may have been even more important

37. Much of the past 30 years of macroeconomics was “spectacularly useless at best, and positively harmful at worst” Prof. Paul Krugman, Princeton “The unfortunate uselessness of most ‘state of the art’ academic monetary economics” Prof. Willem Buiter, LSE “The modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year” Alan Greenspan And, finally, there are major problems with Economics – and efficient markets

38. Macro imbalances, loose monetary policy and financial innovation Rapid credit growth, asset price bubbles, overborrowing Global finance without global government Flawed assumptions about market efficiency and investor rationality Such a complex failure has many parents

39. The Financial Crisis: Who’s to blame? Howard Davies Director, LSE Confederation of Indian Industry New Delhi, 9 April 2010