Você está na página 1de 63

FINA3010 Financial Markets

Chris Leung, Ph.D., CFA, FRM


Email: chrisleung@cuhk.edu.hk

1
Lecture 2

Financial Institutions and Crises

2
Lecture Preview
A vibrant economy requires a
financial system that moves funds ?
from savers to borrowers. But how
does it ensure that your hard- ?
?
earned dollars are used by those ?
with the best productive investment ?
opportunities? ?

? ?

3
Basic Facts About Financial Structure
Throughout the World

The financial system is a complex


structure including many different
financial institutions: banks,
insurance companies, mutual funds,
stock and bonds markets, etc.

4
Sources of Foreign External Finance

5
Facts of Financial Structure

1. Stocks are not the most important


source of external financing for
businesses.
2. Issuing marketable debt and
equity securities is not the primary
way in which businesses finance
their operations.

6
Facts of Financial Structure
3. Indirect finance, which involves the
activities of financial intermediaries, is
many times more important than direct
finance, in which businesses raise funds
directly from lenders in financial
markets.
4. Financial intermediaries, particularly
banks, are the most important source of
external funds used to finance
businesses.

7
Facts of Financial Structure

5. The financial system is among the


most heavily regulated sectors of
economy.
6. Only large, well-established
corporations have easy access to
securities markets to finance their
activities.

8
Facts of Financial Structure

7. Collateral is a prevalent feature of


debt contracts for both households
and businesses.
8. Debt contracts are typically
extremely complicated legal
documents that place substantial
restrictions on the behavior of the
borrowers.

9
Transactions Costs
Transactions costs influence financial
structure
E.g., a HK$5,000 investment only allows you to
purchase 100 shares @ $50 / share (equity)
Minimum brokerage commission HK$100
No diversification
Bonds even worsemost have a HK$100,000
size or larger

In sum, transactions costs can hinder


flow of funds to people with productive
investment opportunities

10
Transactions Costs

Financial intermediaries make profits


by reducing transactions costs
1. Take advantage of economies of scale
(example: mutual funds, commercial
banks)
2. Develop expertise to lower
transactions costs
Also provides investors with liquidity,
which explains Fact # 3

11
Asymmetric Information: Adverse
Selection and Moral Hazard

In the introductory finance course,


many people assumed a world of
symmetric informationthe case
where all parties to a transaction or
contract have the same information,
be that little or a lot.
In many situations, this is not the
case. We refer to this as asymmetric
information.
12
Asymmetric Information: Adverse
Selection and Moral Hazard

As we discussed in last lecture,


asymmetric information can be
quite complicated. However, to
begin to understand the
implications of asymmetric
information, we will focus on two
specific forms:
Adverse selection
Moral hazard

13
Asymmetric Information: Adverse
Selection and Moral Hazard
Adverse Selection
1. Occurs when one party in a transaction
has better information than the other
party
2. Before transaction occurs
3. Potential borrowers most likely to produce
adverse outcome are ones most likely to
seek loan and be selected
Used mobile phones (Why?)

14
Asymmetric Information: Adverse
Selection and Moral Hazard

Moral Hazard
1. Occurs when one party has an
incentive to behave differently once
an agreement is made between
parties
2. After transaction occurs
3. Hazard that borrower has incentives
to engage in undesirable (immoral)
activities making it more likely that
won't pay loan back
The admission for bachelor program in CUHK?
15
Asymmetric Information: Adverse
Selection and Moral Hazard

The analysis of how asymmetric


information problems affect
behavior is known as agency
theory.
We will now use these ideas of
adverse selection and moral hazard
to explain how they influence
financial structure.

16
The Lemons Problem
Price Goods Price Bads

Sg

Dg
Sb

Dm
Dmb Dm
Db Dmb
Db

Quantity Quantity
g: good
m: mean
b: bad 17
The Lemons Problem: How Adverse
Selection Influences Financial Structure

Lemons Problem in Securities


Markets
1. If can't distinguish between good and
bad securities, willing pay only
average of good and bad securities
value
2. Result: Good securities undervalued
and firms won't issue them; bad
securities overvalued so too many
issued
18
The Lemons Problem: How Adverse
Selection Influences Financial Structure

Lemons Problem in Securities


Markets
3. Investors won't want buy bad
securities, so market won't function
well
Explains Fact # 1 and # 2
Also explains Fact # 6: Less
asymmetric info for well known firms,
so smaller lemons problem

19
Tools to Help Solve Adverse Selection
(Lemons) Problems

1. Private Production and Sale of


Information
Free-rider problem interferes with this
solution

2. Government Regulation to Increase


Information
(explains Fact # 5)
For example, annual audits of public
corporations
Does not eliminate the problem
20
Tools to Help Solve Adverse Selection
(Lemons) Problems

3. Financial Intermediation
Analogy to solution to lemons problem
provided by used car dealers
Avoid free-rider problem by making
private loans (explains Fact # 3 and # 4)

4. Collateral and Net Worth


70% mortgage
Explains Fact # 7

21
How Moral Hazard Affects the Choice
Between Debt and Equity Contracts

Moral Hazard in Equity Contracts:


the Principal-Agent Problem
1. Result of separation of ownership by
stockholders (principals) from control
by managers (agents)
2. Managers act in their own rather than
stockholders' interest

22
How Moral Hazard Affects the Choice
Between Debt and Equity Contracts

Tools to Help Solve the Principal-


Agent Problem
1. Production of Information: Monitoring
2. Government Regulation to Increase
Information
3. Financial Intermediation (e.g, venture
capital)
4. Debt Contracts (lower the cost of
monitoring)
Explains Fact # 1: Why debt is used more
than equity
23
How Moral Hazard Influences Financial
Structure in Debt Markets

Because of the design of debt contacts,


borrowers only pay a fixed amount and
keep any cash flow above this amount.
In some circumstances, this creates an
incentive for borrowers to take on riskier
projects.
For example, if a firm owes $100 but only
has $90, it will be bankrupt. The firm
has nothing to lose by looking for risky
projects to raise the needed cash.

24
How Moral Hazard Influences Financial
Structure in Debt Markets

Tools to Help Solve Moral Hazard in


Debt Contracts
1. Net Worth
2. Monitoring and Enforcement of
Restrictive Covenants
3. Financial Intermediationbanks and
other intermediaries have special
advantages in monitoring

Explains Facts # 6,7,8,3,4

25
Asymmetric Information Problems and
Tools to Solve Them

26
What Are Conflicts of Interest
and Why Are They Important?

Financial intermediaries engage in a


variety of activities to collect,
produce, and distribute information.
By providing multiple services, they
realize economies of scope.
However, these services may be
competing with one another, and
this creates the potential for a
conflict of interest.
27
What Are Conflicts of Interest
and Why Are They Important?

The conflicts of interest may arise as


the concealment of information for
the dissemination of misleading
information.
We care about these conflicts of
interest because a reduction in the
quality of information increases the
presence of asymmetric information.

28
Ethics and Conflicts of Interest

Conflicts of interest generate


incentives to provide false or
misleading information. This
behavior is considered unethical.
Three classic conflicts developed in
financial institutions. Looking at
these closely offers insight in
avoiding these conflicts in the future.

29
Conflicts of Interest: Underwriting and
Research in Investment Banking

Investment banks may both research


companies with public securities, as well
as underwrite securities for companies
for sale to the public.
Research is expected to be unbiased and
accurate, reflecting the facts about the
firm. It is used by the public to form
investment choices.

30
Conflicts of Interest: Underwriting and
Research in Investment Banking

Underwriters will have an easier time if


research is positive. Underwriters can
better serve the firm going public if the
firms outlook is optimistic.
An investment bank acting as both a
researcher and underwriter of securities
for companies clearly has a conflict
serve the interest of the issuing firm or
the public?

31
Conflicts of Interest: Auditing and Consulting
in Accounting Firms

Auditors check the assets and books of a firm for


the quality and accuracy of the information. The
objective in an unbiased opinion of the firms
financial health.
Consultants, for a fee, help firms with variety of
managerial, strategic, and operational projects.
An auditor acting as both an auditor and
consultant for a firm clearly is not objective,
especially if the consulting fees exceed the
auditing fees.

32
Conflicts of Interest: Credit Assessment and
Consulting in Rating Agencies

Rating agencies assign a credit rating to


a security issuance of a firm based on
projected cash flow, assets pledged,
etc. The rating helps determine the
riskiness of a security.
An rating agency acting as both a rater
and consultant for a firm clearly is not
objective, especially if the consulting fees
exceed the rating fees.

33
What Is a Financial Crises?

Financial crises are major disruptions


in financial markets characterized by
sharp declines in asset prices and
firm failures. Beginning in August
2007, the U.S. entered into a crisis
that was described as a once-in-a-
century credit tsunami.

34
What Is a Financial Crises?

We had discussed how a functioning


financial system is critical to a
robust economy.
However, both moral hazard and
adverse selection are still present.
The study of these problems
(agency theory) is the basis for
understanding and defining a
financial crisis.

35
What Is a Financial Crises?

Asymmetric information creates


barriers between savers and firms
with productive investment
opportunities.
A financial crisis occurs when
information flows in financial
markets experience a particularly
large disruption. Financial markets
may stop functioning completely.

36
Dynamics of Financial Crises in
Advanced Economies

Financial crises hit countries like


United States so often, and each
event helps economists gain
insights into present-day turmoil.
These crises usually proceed in 2 or
3 stages, as the next two slides
outline:

37
Sequence of Events in U.S.
Financial Crises (a)

38
Sequence of Events in U.S.
Financial Crises (b)

39
Stage One: Initiation

Financial crisis can begin in several


ways:
Credit Boom and Bust

Asset-Price Boom and bust

Increase in Uncertainty

40
Stage One: Initiation

The seeds of a financial crisis can


begin with mismanagement of
financial liberalization or
innovation:
elimination of restrictions
introduction of new types of loans or
other financial products
Either can lead to a credit boom,
where risk management is lacking.

41
Stage One: Initiation

Government safety nets weaken


incentives for risk management.
Depositors ignore bank risk-taking.
Eventually, loan losses accrue, and
asset values fall, leading to a
reduction in capital.
Financial institutions cut back in
lending, a process called
deleveraging. Banking funding falls
as well.
42
Stage One: Initiation

As FIs cut back on lending, no one


is left to evaluate firms. The
financial system losses its primary
institution to address adverse
selection and moral hazard.
Economic spending contracts as
loans become scarce.

43
Stage One: Initiation

A financial crisis can also begin with


an asset- price boom and bust:
A pricing bubble starts, where asset values
exceed their fundamental values.
When the bubble bursts and prices fall,
corporate net worth falls as well. Moral
hazard increases as firms have little to lose.
FIs also see a fall in their assets, leading
again to deleveraging.

44
Stage One: Initiation
Finally, a financial crisis can begin with an
increase in uncertainty:
Periods of high uncertainty can lead to crises,
such as stock market crashes or the failure of
a major financial institution.
E.g., 2008, when AIG, Bear Sterns, and Lehman
Bros. failed
With information hard to obtain, moral hazard
and adverse selection problems increase,
reducing lending and economic activity

45
Stage Two: Banking Crisis
Deteriorating balance sheets lead financial
institutions into insolvency. If severe enough,
these factors can lead to a bank panic.
Panics occur when depositors are unsure which
banks are insolvent, causing all depositors to
withdraw all funds immediately
As cash balances fall, FIs must sell assets quickly,
further deteriorating their balance sheet
Adverse selection and moral hazard become
severe it takes years for a full recovery

46
Stage Three: Debt Deflation
If the crisis also leads to a sharp
decline in prices, debt deflation can
occur, where asset prices fall, but debt
levels do not adjust, increasing debt
burdens.
This leads to an increase in adverse
selection and moral hazard, which is
followed by decreased lending
Economic activity remains depressed
for a long time
47
Stock Market Prices During
The Great Depression

48
Credit Spreads During
The Great Depression

49
The Great Depression
The deflation during the period lead to
a 25% decline in price levels.
The prolonged economic contraction
lead to an unemployment rate around
25%.
The Depression was the worst
financial crisis ever in the U.S. It
explains why the economic
contraction was also the most severe
ever experienced by the nation.
50
The Global Financial Crisis of
2007-2009

We begin our look at the 20072009


financial crisis by examining three
central factors:
financial innovation in mortgage markets
agency problems in mortgage markets
the role of asymmetric information in the
credit rating process

51
The Global Financial Crisis of
2007-2009

Financial innovation in mortgage


markets developed along a few
lines:
Less-than-credit worthy borrowers
found the ability to purchase homes
through subprime lending, a practice
almost nonexistent until the 2000s
Financial engineering developed new
financial products to further enhance
and distribute risk from mortgage
lending
52
The Global Financial Crisis of
2007-2009
Agency problems in mortgage markets
also reached new levels:
Mortgage originators did not hold the actual
mortgage, but sold the note in the secondary
market
Mortgage originators earned fees from the
volume of the loans produced, not the quality
In the extreme, unqualified borrowers bought
houses they could not afford through either
creative mortgage products or outright fraud
(such as inflated income)
53
The Global Financial Crisis of
2007-2009
Finally, the rating agencies didnt help:
Agencies consulted with firms on
structuring products to achieve the highest
rating, creating a clear conflict
Further, the rating system was hardly
designed to address the complex nature of
the structured debt designs
The result was meaningless ratings that
investors had relied on to assess the
quality of their investments
54
The Global Financial Crisis of
2007-2009

Many suffered as a result of the


20072009 financial crisis. We will
look at five areas:
U.S. residential housing
FIs balance sheets
The shadow banking system
Global financial markets
The failure of major financial firms

55
Housing Prices: 20022010

56
The Global Financial Crisis of
2007-2009

As mortgage defaults rose, banks


and other FIs saw the value of their
assets fall. This was further
complicated by the complexity of
mortgages, CDOs, defaults swaps,
and other difficult-to-value assets.
Banks began the deleveraging
process, selling assets and
restricting credit, further depressing
the struggling economy.
57
The Global Financial Crisis of
2007-2009

The shadow banking system also


experienced a run. These are the
hedge funds, investment banks, and
other liquidity providers in our
financial system. When the short-
term debt markets seized, so did
the availability of credit to this
system. This lead to further fire
sales of assets to meet higher credit
standards.
58
Stock Prices: 20022009

59
Credit Spreads: 20022009

60
The Global Financial Crisis of
2007-2009

Finally, the collapse of several high-


profile U.S. investment firms only
further deteriorated confidence in the
U.S.
March 2008: Bear Sterns fails and is
sold to JP Morgan for 5% of its
value only 1 year ago
September 2008: both Freddie and
Fannie put into conservatorship
after heaving subprime losses.
61
The Global Financial Crisis of
2007-2009

Finally, the collapse of several high


profile U.S. investment firms only
further deteriorated confidence in
the U.S.
September 2008: Lehman Brothers
files for bankruptcy. Merrill Lynch
sold to Bank of America at fire
sale prices. AIG also experiences a
liquidity crisis.

62
Assignment 1.2

Textbook Chapter 7 (page 203)


Questions: 3
Textbook Chapter 8 (page 223)
Questions: 15

63

Você também pode gostar