Initially, the financial crisis due to the sub-prime problem
(mainly in the USA)
Initially, a drop of $2 trillion in the value of houses
The drop in the value of houses is due to excess building,
unbridled granting of mortgages (a mortgage higher than
the value of the house, too long a period of grace for
overdue mortgage payments, and so on)
The existence of overly sophisticated financial assets that
hide the extent of the problem (securitization of mortgages,
‘new assets’, and more) and prevent a simple solution
There is a problem of liquidity in the various banking
The response of the US government: purchase of troubled
assets from financial institutions
What and how to buy? (buy bonds using the right
How much to pay? (today the market price is low due to
The government needs to help where there is a problem of
liquidity. It should not rescue badly managed financial
institutions (with weak customers, inefficient management,
too high risk, etc)
Banks (financial institutions) that are badly managed should
be allowed to go under. The receivership process should
be fair (selling assets to other institutions)
Reasons for the financial crisis
The bubble in the real estate market.
Too many overly complex financial assets
(throughout the world).
Financial systems with regulation that is
defective or completely absent.
Defective regulation systems in other
Signs of problems in financial markets
Exist for a long time
Are reflected in many real markets
Are reflected mainly in the ‘alternative investments’ markets
We did not ‘connect’ all the signs
Governments (economists) did not understand the problems
No government response
to actions in
Banks hold a lot
of ‘short term’
‘long term’ assets).
It is difficult for
The modern financial system was meant to
supplement (in reality it bypasses) the ‘old’
Its development over the last 30 years may be
attributed to four main factors:
Growing international mobility of capital
Globalization in real markets
The development of the financial markets over the
last 30 years
Securitization: Banks collected together bank loans,
particularly mortgages, and sold the package to various
Other banks, particularly investment banks, collected
these assets and repackaged them according to various
risk types (and additional categories), added a bit of
leverage, and sold the package on. This process was
repeated several times.
Technological developments, including the appropriate
algorithms, made possible the creation of several types of
derivatives, the trade in which ballooned significantly
(credit-default swaps, for instance). At the end of 2007 the
total number of contracts was 600 trillion (12 times the
Development of the Financial Markets (2)
The financial innovations created enormous profits for the
players in the market and the market makers.
Some of the financial innovations were designed to
circumvent the prevailing regulations.
For example: A large part of the sub-prime loans were
created when Fannie Mae and Freddie Mac began to
purchase sub-prime mortgages in 2004 to enable and even
to broaden the availability of affordable housing (as
demanded by the politicians).
A developed capital market certainly gives rise to growth. It
is clear today that it is no easy matter to regulate a
developed capital market, however much wisdom is applied
to the issue.
Growth is not the only goal!
Understand the problems
Do not blame ‘greedy Wall Street’ and
managers of financial institutions (there
are few, if any, ‘action items’ here)
Generally, managers acted rationally
The markets moved into ‘inferior
equilibrium’ due to defective or altogether
Short run (now) – solve the liquidity (lack
of trust) problem
Inject capital to banks, boost the economy
(mostly in infrastructure), pay attention to
the poor, weak and old (they will be hurt)
Long run – set better regulation in financial
and real markets (governments should not
replace the private sector)
Is it possible to regulate the market better?
It’s difficult. Individual players will always be one step
ahead of the regulators (preferably, they should be only one
step ahead and not more).
The tension between nationality and international regulation
In general (the economists’ answer): Politicians should be
prevented from introducing distortions into the capital
Set simple regulation and simple rules
Changes that will take place following the
All the important financial markets in the West (derivatives,
mutual funds, securitization, etc) will be subject to stronger
(hopefully better) regulation. The minimum capital
regulation will be stronger and more conservative, leading
to much smaller leverage than at present.
The regulation array itself will change substantially and will
be arranged in an orderly fashion (it will be clear who
regulates what and the relations between the various
regulators will be plainly set out).
There will be more government intervention in real
markets, particularly, but not only, through regulation.
Changes that will take place following the
Emerging markets will have more of a say in what goes on
in the financial markets.
Generally speaking, inconsistent and unwise government
activity in financial and real markets (defective regulation,
inappropriate subsidies, poorly executed ideological
reforms, etc) contributed substantially to the current crisis.
Governments will now be more conservative and certainly
wiser (less ‘ideology’ and more knowledge).
The comparative advantage of countries with high levels
of human capital will increase.
Why is Israel in “good” shape?
There is no real estate bubble.
The economy is in good shape (five years of
healthy growth, low unemployment, an export
We lagged behind in adopting the overly complex
The banks are fairly well regulated (the alternative
capital market less so).
A problem: Defective regulation in most of the
A strong, growing and successful private sector
A government sector with many planning and
Infrastructure planning and operations by a weak
public sector: defense, education, higher
education, the legal system
Defective regulation of oligopolistic markets:
water, electricity, the ports, telecommunications
Why does the public sector have so many problems?
The public sector is burdened by many difficult
tasks (security, welfare, …)
The public sector has no strategy and lacks
The pay in the public sector is low, it has a large
number of unskilled employees and a small
number of skilled employees
It suffers from a lack of awareness of the need for
long-term planning (in a rapidly changing world!)
There is a lack of professional knowledge and
experience (managerial and other), particularly at the
center, amongst the integrators (MOF, PM)
Policy required in Israel (we are somewhat
lucky in the current crisis)
In the short run – concentrate on the crisis
In the long run – there is a need for long-term
planning in a number of focal areas
Need for a serious level of professional knowledge,
permanently in place
Need for professional personnel with the ability to
manage complex systems
Need for knowledge and professional personnel to
regulate rapidly changing markets
Policy in Israel
Moderation (no extreme capitalism or socialism)
Acquire more knowledge
Be more modest