1. The Credit Crunch and its Consequences Howard Davies Director, LSE LSE Alumni Lecture Series – Inaugural Lecture Wolfson Theatre, New Academic Building 19 th February 2009

2. A Five Act Shakespearian Tragedy Act One: Subprime

3. … real estate prices rise Source: Tano Santos

4. The growth of securitised credit

5. Recent ABX BBB Price History Price Source: Markit Partners

6. Resecuritisation 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

7. Act Two: Liquidity

8. Financial market liquidity Sources: Bank of England, Bloomberg, Chicago Board Options Exchange, Debt Management Office, London Stock Exchange, Merrill Lynch, Thomson Datastream.

9. Act Three: Unravelling -Bear Stearns, Indymac, Wa mu -HBOS, RBS -Fortis, Dexia etc.

10. Act Four: Meltdown Lehman’s failure leads to –indiscriminate sell-off of financial stocks –seizing-up of many markets –generalised market panic

11. Act Five: Pumping additional liquidity facilities fiscal stimuli near-zero interest rates quantitative easing

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

13. global imbalances loose monetary policy, leading to mispricing of risk credit bubble ‘excess’ growth of financial sector ‘excess’ leverage, facilitated by procyclical regulation But what are the underlying causes?

14. Global current account balances

15. China’s Growth Laggard Personal Consumption as % of GDP Source: China National Bureau of Statistics and Morgan Stanley

17. Household debt as a proportion of GDP Source: FSA, ONS, Federal Reserve, Eurodata, Datastream

18. UK Saving Rate Source: ONS; Morgan Stanley Research

19. The growth of the financial sector Source: FSA, Oliver Wyman

20. Major UK banks’ leverage Source: FSA, Bank of England

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

22. “ The owners of capital will stimulate the working class to buy more and more of expensive goods, houses, and mechanical products, pushing them to take more and more expensive credits, until their debt becomes unbearable The unpaid debt will lead to bankruptcy of the banks, which will have to be nationalised, and the state will have to take the road which will eventually lead to communism. ” Das Kapital

24. So what next? growth prospects have deteriorated sharply, across the world Europe mired in recession long downturn the most likely outcome, and (in the UK) anaemic recovery

25. Growth Rates: IMF Forecasts

26. Source: www.ft.com European Economic Forecast – April 2008

27. Source: www.ft.com European Economic Forecast – January 2009

30. Larger than previous crises

32. UK recovery options: V-shaped: sharp contraction, quick bounce-back U-shaped: longer trough, delayed but strong recovery L-shaped: Japanese style stagnation Nike swoosh: sharp downturn, weak recovery

33. Is London Reykjavik on Thames? Banks big, but not that big in relation to GDP Fiscal position poor, pre-recession, but stock of debt not excessive But needed fiscal tightening will mute the recovery.

34. Sovereign five-year CDS Source: Morgan Stanley (as at 21 January 2009)

35. General government debt rations in OECD countries in 2008 Source: OECD, Economic Outlook No. 84, November 2008

36. UK gross issuance forecast Source: Morgan Stanley

37. Discretionary policy change projected in the PBR Source: HM Treasury, Pre-Budget Report 2008

38. The Credit Crunch and its Consequences Howard Davies Director, LSE LSE Alumni Lecture Series – Inaugural Lecture Wolfson Theatre, New Academic Building 19 th February 2009