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Part 7   switzerland -  forum nexus finance class summer 2011
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Part 7 switzerland - forum nexus finance class summer 2011

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  • 1. Forum-Nexus Welcome to Switzerland!!
  • 2. Brian David Butler Professor of international finance and global entrepreneurship with Forum-Nexus Study Abroad. Guest lecturer with the IQS Business School of the Ramon Llull University in Barcelona, and the Catholic University of Milan . Previously, Brian taught finance, economics and global trade courses at Thunderbird’s Global MBA program in Miami, and worked as a research analyst with the Columbia Business School in New York City. Brian currently lives in Recife, Brazil where he is teaching classes on “Global Entrepreneurship” at the university FBV. A global citizen, Brian was born in Canada, raised in Switzerland (where he attended international British school), educated through university in the U.S., started his career with a Japanese company, moved to New York to work as an analyst, married a Brazilian, and has traveled extensively in Latin America, Asia, Europe and North America. [email_address] LinkedIn/briandbutler Skype: briandbutler
  • 3. Find my slides:
    • www.slideshare.net/briandbutler
  • 4. Midterm Exam material (potential)
    • Students responsible for content from:
      • Prof. Brian’s lectures
      • Guest lectures
      • Group discussions during class
      • International IQ sessions (including map)
      • Professional Visits
      • Assigned readings – book
    • Notes:
      • Exam questions may come from any of these sources
      • Recommended exam review – pay attention to my lectures. If there is something I think is important from professional visits, or international IQ sessions, or from the book…we will try to review it again in class.
  • 5. Expectations:
      • Attend classes – exams will be from lectures, from assigned readings and from guest lecturers/ professional visits
      • Turn in assignments before class
      • Be prepared for class discussions – lots of small group assignments during class
      • Contribute to group assignment (team grading / peer review)
      • No sleeping, no laptops, no phones (sorry) 
      • If your tired… standup, go get a drink, come back
  • 6. Required books
    • Required Textbook
      • 'An Introduction to Global Financial Markets', by Stephen Valdez, Palgrave Macmillan, 5th Edition, 2006
      • 'Fixing Global Finance', by Martin Wolf Yale University Press, updated 2010
  • 7. Assigned Readings
    • Martin Wolf book
      • Final chapter (ch 8) “ From Imbalances to the Subprime Financial Crisis ”
      • Recommended: First four Chapters
    • Finance book
      • Chapter 10 – foreign exchange
      • Chapter 11 - European Economic and Monetary Union
      • Switzerland – p 288
      • Euro – p 289, p304
    • Optional additional reading
      • Chapter 2 – banking background p30-38
      • Chapter 6 – the money and bond markets
      • Chapter 12 – traded options
      • Chapter 13 - Futures
  • 8. review
    • Discussion
  • 9. Discuss Switzerland/ Euro / crisis…
    • Articles? Observations? Discuss….
    • Note: observations should come from reading ( wall street journal , etc)… any other sources?
  • 10. Themes to cover:
    • Banking Business Model –continued
    • Finance: “Pyramid of Promises”
    • Fixed, Flexible currencies
    • Mundell Trilemma
  • 11. Solvency v Liquidity
    • Who can remind me…
    • What is the difference between:
    • a “Solvency” problem (for banks)
    • And a “Liquidity” problem (for banks)
    • * think of the business model
  • 12. Solvency v Liquidity
    • Insolvent: liabilities > assets (equity = 0)
      • Person: I owe more than Im worth
      • Bank: assets loose value (subprime mortgages)
      • Country: cant pay debts…default
    • Illiquidity: long term asset, short term liability
      • I owe money NOW, but have money tied up in my house, car, etc…
      • Bank: lend long term, borrow short term
      • Country: cant access credit markets to pay imports
  • 13. Solvent : not Solvent
    • Ok NOT OK
    • ASSETS
    • Include home mortgages
    • subprime
    Liabilities (Borrowing, debt) Equity
    • ASSETS
    • Include home mortgages
    • subprime
    Liabilities (Borrowing, debt) Equity
  • 14. PIMCO CEO Mohamed El-Erian Response: “Almost all independent observers of Greece have stressed from the beginning that Greece was facing a solvency , not a liquidity problem. This was also the case 10 years ago with Argentina; a country that had achieved financial stability by entering into a “quasi” monetary union using the US dollar and which had privatised every available public asset.
  • 15. PIMCO CEO Mohamed El-Erian “ the Greek government is losing control of the streets. As protests turn increasingly ugly, the pursuit of a national political consensus becomes even more elusive. This is especially true if all Mr Papandreou, or another leader, can offer is a step back to a discredited approach that involves sacrifices with no evidence of lasting benefits.”
  • 16. Solvency v Liquidity
    • How does this relate to the Financial Crisis 2008 (US)?
      • Anyone?
  • 17. Solvency v Liquidity Timeline
    • 2007 – September 2008
      • Problem = Solvency
      • Mortgages (assets on Banks balance sheet) worth less than anticipated… write down
      • Results: Hedge funds Funds go under (Bear Stearns)
      • Bankruptcy threat
    • ASSETS
    • Include home mortgages
    • subprime
    Liabilities (Borrowing, debt) Equity
  • 18. Credit bubble led to housing bubble, led to bust… http://www.abc.net.au/reslib/200802/r220644_867185.jpg
  • 19. Credit Crisis timeline – key dates in September
    • September 7, 2008 : Federal takeover of Fannie Mae and Freddie Mac [25][26]
    • September 14, 2008 : Merrill Lynch sold to Bank of America amidst fears of a liquidity crisis and Lehman Brothers collapse [27]
    • September 15, 2008 : Lehman Brothers files for bankruptcy protection [28]
    • September 16, 2008 : Moody's and Standard and Poor's downgrade ratings on AIG 's credit on concerns over continuing losses to mortgage-backed securities, sending the company into fears of insolvency . [29][30]
    • September 17, 2008 : The US Federal Reserve loans $85 billion to American International Group (AIG) to avoid bankruptcy.
    • September 19, 2008 : Paulson financial rescue plan unveiled after a volatile week in stock and debt markets.
    • September 25, 2008 : Washington Mutual was seized by the Federal Deposit Insurance Corporation , and it's banking assets were sold to JP MorganChase for $1.9bn.
  • 20. Solvency v Liquidity Timeline
    • September 2008 – 09
      • Crisis CHANGED
      • No longer just a SOLVENCY CRISIS
      • Became a MIXED crisis of BOTH solvency and liquidity
      • How? Why? What does that mean?
      • Someone tell me again…what is “liquidity”?
  • 21. Questions:
    • Question: if a bank is having a SOLVENCY trouble… should the government come to their rescue?
    • (clue – remember the discussion on “moral hazard”)
    • ASSETS
    • Include home mortgages
    • subprime
    Liabilities (Borrowing, debt) Equity
  • 22. Solvency v Liquidity Timeline
    • Answer: NO! (probably not) *
    • * but, gets complicated by worries about systemic risk, and interconnectedness, and “too big to fail” banks
    • ASSETS
    • Include home mortgages
    • subprime
    Liabilities (Borrowing, debt) Equity
  • 23. How about a “Liquidity” crisis?
    • Should the government step in to help a bank facing a “liquidity” crisis?
  • 24. How about a “Liquidity” crisis?
    • YES!!
    • To help banks bridge the gap between short term liabilities and long term assets
    • * this is exactly why the FDIC, insurance was offered.
  • 25. The trouble during the crisis…
    • … after September 2008… it was difficult to tell which banks faced “liquidity” crisis (and should be helped), and those that faced “solvency” crisis, and should be allowed to fail (to avoid “moral hazard” from saving them)
  • 26.
    • PYRAMID OF PROMISES
  • 27. International Finance Pyramid of promises
  • 28. What “promises”?
    • Financial assets represents “promises of future, often contingent, receipts in return for current payments”
    • Bonds
      • Represent PROMISES of fixed payment (in time), plus PROMISE of regular payments in between
    • Equity (stocks)
      • Represent PROMISES a share in future corporate profits
    • Pensions
      • Represent PROMISES for a stream of income in retirement
    Martin Wolf, “Fixing Global Finance”… based on McKinsey “Mapping Global Capital Markets”, 2005
  • 29. What “promises”?
    • Life Insurance Policy
      • Represent PROMISES of payment after some fixed date or death
    • Accident / Health Insurance Policy
      • Represent PROMISES of payment if something happens
    • Mutual Fund
      • Promises to return to investors the proceeds from mutual funds purchase of promises from corporations
    • Options
      • Is a promise to hand over a claim to a certain promise under specific conditions
    Martin Wolf, “Fixing Global Finance”… based on McKinsey “Mapping Global Capital Markets”, 2005
  • 30. Remember 2 dangers of international finance…
    • Currency might devalue
    • Foreign governments might default (less obligation to foreigners, not to voters)
    • * Promises based on trust
  • 31. Pyramid of Promises
    • “ Central feature of the financial system: it is a Pyramid of promises- often promises of long or even indefinite duration. This makes it remarkable that sophisticated finance systems exist”
    • Promises may not be kept
    • Interest of those who make promises NOT to keep them
    Martin Wolf, “Fixing Global Finance”… based on McKinsey “Mapping Global Capital Markets”, 2005
  • 32. Pyramid of “promises”?
    • “ As the financial system grows more complex… it piles PROMISES on PROMISES”.
    Martin Wolf, “Fixing Global Finance”… based on McKinsey “Mapping Global Capital Markets”, 2005
  • 33. Just how big is the MOUNTAIN of promises…?
    • Amazing….
    data from McKinsey report 2005, " Mapping the global capital market "  and http://www.federalreserve.gov/releases/ Martin Wolf, “Fixing Global Finance”… based on McKinsey “Mapping Global Capital Markets”, 2005
  • 34. Size of Finance…
    • “ What is amazing is that the financial sector ballooned to the size that it has...with a worldwide total of $140 trillion in promises outstanding in 2005”  
    Martin Wolf, “Fixing Global Finance”… based on McKinsey “Mapping Global Capital Markets”, 2005
  • 35. Size of Finance…
    • Of that total, the US was the prime holder of promises (assets). 
    • The US household sector held about $39 trillion (28% of world total), and with the US as a whole holding nearly $52 trillion (37% of all world financial assets, or promises).
    Martin Wolf, “Fixing Global Finance”… based on McKinsey “Mapping Global Capital Markets”, 2005
  • 36. Size of Finance… Martin Wolf, “Fixing Global Finance”… based on McKinsey “Mapping Global Capital Markets”, 2005
  • 37. Size of Finance… Martin Wolf, “Fixing Global Finance”… based on McKinsey “Mapping Global Capital Markets”, 2005
  • 38. Martin Wolf, “Fixing Global Finance”… based on McKinsey “Mapping Global Capital Markets”, 2005
  • 39. Size of Finance… Martin Wolf, “Fixing Global Finance”… based on McKinsey “Mapping Global Capital Markets”, 2005
  • 40. “ PYRAMID of Promises”
    • Modern economies depend on pyramids of promises far more impressive and complex than those of stone constructed almost 5 thousand years ago”
    Martin Wolf, “Fixing Global Finance”… based on McKinsey “Mapping Global Capital Markets”, 2005
  • 41. “ PYRAMID of Promises”
    • But, the system is extremely FRAGILE
    • Confidence that sustains them could be misplaced
    • People could end up with promises NOT WORTH the paper (they used to be) printed upon
    Martin Wolf, “Fixing Global Finance”… based on McKinsey “Mapping Global Capital Markets”, 2005
  • 42. Underneath that “PYRAMID”
    • The “Foundation” of all of these PROMISES is = title to real assets
      • Housing, land, property, factories, machines, etc
      • Need to BELIEVE the original owner really ownes what they say they own.
      • So, key = property rights , law, institutions – for trust, and development of financial system
    Martin Wolf, “Fixing Global Finance”… based on McKinsey “Mapping Global Capital Markets”, 2005
  • 43. Fixed, Floating FX discussion…
  • 44. Exchange Rate Practices Dr. Kishore Dash, January 20, 2007
    • Pegging
            • Floating
  • 45. Exchange Rate Options Official Dollarization Currency Board Free Float Peg More Flexible Less Flexible Crawling Peg Band Dirty Float Source: Rafael Barraza Dr. Kishore Dash, January 20, 2007
  • 46. Fixed vs. Flexible exchange rates
    • Fixed exchange rates
      • Any examples?
    • Floating exchange rates
      • Any examples?
    • What system is active today? (globally)
    • Important to INTERNATIONAL business managers to pay attention to changes
      • why?
  • 47. Fixed vs. Flexible exchange rates
    • What system is Better? Why?
      • Groups of 2-3 students, answer
  • 48. Brief History – Key points
    • Key point: there is NO “best” system
    • It all depends on what you want to achieve…
    • History: Cycle from Fixed to Flexible to Fixed to Flexible……(future?)
    Fixed Fixed Flexible Flexible The gold standard (~1850–1914) Fixed exchange rates during the 1920s Great Depression era Post WWII Bretton Woods / IMF system (1944–1971) 1970’s –today: since U.S. left the gold/dollar standard ?????
  • 49. Brief History – Key points
    • QUESTION:
      • Why change from flexible to fixed? (give 1 reason)
      • Why change from fixed to flexible?
    Fixed Fixed Flexible Flexible The gold standard (~1850–1914) Fixed exchange rates during the 1920s Inter-war period Great Depression era Post WWII Bretton Woods / IMF system (1944–1971) 1970’s –today: since U.S. left the gold/dollar standard
  • 50. Brief History – Key points
    • ANSWER:
      • Why change from flexible to fixed?
        • CONTROL, STABILITY, LOWER INFLATION, END CHAOS
        • Note: Too chaotic in depression… so fixed for stability
        • Note: Argentina = fixed to dollar was “brilliant” at the time…but should have dropped sooner (not just in 2002)
      • Why change from fixed to flexible?
        • EASE ADJUSTMENT PROCESS, IMPROVE LOCAL MONETARY CONTROL, INCREASE GLOBAL FLOW OF FUNDS
  • 51. FIXED system…
    • Painful ADJUSTMENT mechanism:
    • Example: Under the GOLD Standard:
      • If exports > imports… build up gold reserves
      • If imports > exports… run out of gold reserves
    • KEY QUESTION:
      • Under a fixed system, how do you increase exports? (to stop burning through gold reserves)?
            • … .Group answer
  • 52. FIXED system…
    • Answer
      • need to decrease prices, wages
      • So exports more competitive
      • Can’t adjust FX rates, so adjustment has to be painfully with wages, prices
    • KEY POINT:
      • adjustment in fixed system is = painful process, slow, very unpopular!
  • 53. FIXED system…
    • KEY QUESTION:
      • Under a fixed system, how do you increase exports?
            • … .Group answer
  • 54. Fixed vs. Flexible exchange rates
    • What system is Better? Why?
      • Groups of 2-3 students, answer
  • 55. Brief History – Key points
    • Key point: there is NO “best” system
    • It all depends on what you want to achieve…
    • History: Cycle from Fixed to Flexible to Fixed to Flexible……(future?)
    Fixed Fixed Flexible Flexible The gold standard (~1850–1914) Fixed exchange rates during the 1920s Great Depression era Post WWII Bretton Woods / IMF system (1944–1971) 1970’s –today: since U.S. left the gold/dollar standard ?????