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Wac Ncc041510 Global Finance,Uncharted Waters

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Wac Ncc041510 Global Finance,Uncharted Waters

  1. 1. Global Finance in Uncharted Waters<br />World Affairs Council – North County Chapter<br />April 15, 2010<br />1<br />
  2. 2. Capital Allocation<br />Transmission between Savers & Borrowers<br />Match Investment with Opportunity<br />Manage Financial Risk (example: insurance)(loans)<br />Systemic Liquidity: Trading & Speculation<br />Payments Processing<br />2<br />Purpose of the Financial System<br />
  3. 3. The Debt Supercycle<br />Borrowing as a Way of Life<br />borne of<br />Financial Incentives and American Exuberance<br />3<br />
  4. 4. 4<br />Total Credit Market Debt as a % of US GDP<br />
  5. 5. 5<br />
  6. 6. 6<br />
  7. 7. 7<br />
  8. 8. 8<br />
  9. 9. 9<br />
  10. 10. 10<br />
  11. 11. 11<br />
  12. 12. 12<br />Falling Interest Rates Encouraged Borrowing<br />
  13. 13. 13<br />
  14. 14. 14<br />
  15. 15. The Shadow Banking System<br />Non-Bank Finance<br />15<br />
  16. 16. 16<br />Securitization<br />
  17. 17. 17<br />Traditional Lending<br />
  18. 18. 18<br />
  19. 19. 19<br />
  20. 20. Increase Credit Flows (Earnings) without Increasing Leverage<br />Manage Risk by Selling Risk<br />Insurance Companies<br />Foreign Banks<br />Special Investment Vehicles (commercial paper)(borrow short, invest long)<br />Warehouse hi-yield assets<br />Repo deals<br />20<br />Why Securitize?<br />
  21. 21. Failed Regulation<br />Regulatory Arbitrage<br />Collapse of Lending Standards<br />Fraud (borrowers and lenders)<br />Agency conflicts<br />Crisis of the Quants<br />Move to California…<br />21<br />Problems<br />
  22. 22. Credit Default Swaps<br />Useful financial tool<br />or<br />The Latest Trick in the Casino<br />22<br />
  23. 23. Invented by JP Morgan 1994<br />Is a bilateral contract between the buyer and seller of protection <br />Swap (buy/sell) risk exposure<br />The buyer makes periodic payments to the seller, and in return receives a payoff if an underlying financial instrument defaults (1-10yrs; 5yrs)<br />A holder of a bond may “buy protection” to hedge its risk of default<br />AIG<br />23<br />Defining Credit Default Swaps<br />
  24. 24. 24<br />
  25. 25. “Naked credit default swaps” (no debt holding) allow traders to speculate (long or short)<br />Constitutes most of the market in CDS<br />Counterparty Risk (AIG dilemma)<br />ABS, SIVs<br />25<br />Speculating with CDS<br />
  26. 26. 26<br />Derivatives<br />
  27. 27. 27<br />
  28. 28. Regulatory Reform<br />Move OTC derivatives trade onto Exchanges<br />28<br />Regulation<br />
  29. 29. Sovereign Debt<br />Endgame<br />of the<br />Debt Supercycle<br />29<br />
  30. 30. 30<br />
  31. 31. 31<br />US Federal Debt: 1940-2010<br />
  32. 32. 32<br />
  33. 33. 33<br />
  34. 34. 34<br />
  35. 35. 35<br />
  36. 36. 36<br />Japan - National Debt<br />
  37. 37. 37<br />
  38. 38. State & Local Govt<br />Pensions<br />Infrastructure<br />news032910GrowingStateDebtWoesUS<br />recently recalculated the value of the 50 states’ pension obligations the way the bond markets value debt. They put the number at $5.17 trillion. <br />After the $1.94 trillion set aside in state pension funds was subtracted, there was a gap of $3.23 trillion — more than three times the amount the states owe their bondholders. <br />38<br />
  39. 39. 39<br />
  40. 40. 40<br />
  41. 41. Debt to GDP<br />HOUSEHOLD<br />Netherlands – 107%<br />Spain – 84%<br />Italy – 34%<br />CORPORATE<br />41<br />
  42. 42. 42<br />
  43. 43. 43<br />
  44. 44. Iceland<br />Greece<br />PIIGS<br />United Kingdom<br />Japan<br />United States<br />44<br />
  45. 45. Where Do We Go From Here?<br />Cyclical<br />and<br />Structural Outlook<br />45<br />
  46. 46. Global Economic Recovery<br />Partial Decoupling – China as Driver (India)<br />Strong Monetary Stimulus; Low Interest Rates<br />Strong Fiscal Stimulus; Large Budget Deficits<br />Inflation will appear first at the margin<br />Deflationary Tendencies in Developed World<br />Jobless Recovery<br />Strong Productivity Growth<br />46<br />Cyclical Outlook<br />
  47. 47. Property Sector, Domestic Debt – China<br />Industrial Overcapacity - China<br />Inflation<br />Interest Rates<br />Japan<br />Europe, PIIGS, UK, (The Euro)<br />Household Debt US<br />Sovereign Debt US (Unfunded Liabilities)<br />Trade Deficit US<br />Unemployment<br />Geopolitical Risk<br />47<br />Structural Outlook - Global Risks<br />
  48. 48. Low-yield Environment<br />Negative Real Interest Rates<br />Volatility Indexes Low<br />Incentive to Take Risk<br />Options Trading<br />Chasing Yield<br />Chasing Returns<br />“Risk-On”<br />Equity Melt-up<br />Cash Earns Trash<br />48<br />Financial Market Environment<br />
  49. 49. North vs. South<br />Monetary straightjacket<br />Unable to use currency revaluations to adjust cost structures<br />Productivity ($50.86 vs. $35.80)<br />Finland, Gr, Netherlands in top 10 competitive<br />Inadequate political union<br />German court Karlsruhe<br />Netherlands<br />49<br />The Euro Crisis<br />
  50. 50. 50<br />
  51. 51. 51<br />

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