Financial Catastrophes of the 21 st Century Longevity, Pandemics, - - PowerPoint PPT Presentation

• Dr. Andrew Coburn

Senior Vice President, RMS & Director of the External Advisory Board Centre for Risk Studies, University of Cambridge

Financial Catastrophes

• f the 21st Century

Longevity, Pandemics, and Asset Bubbles

ICRM Symposium 2013

ICRM Symposium 2013

US House Price Bubble

 Spectacular rises in US house prices

from mid 1990s encouraged use of this growth in other financial assets

– Lending to sub-prime mortgage market – Creation of Mortgage-Backed Securities – Enabled institutions and investors around the world to invest in U.S. housing market

 In 2007, bubble burst and US house

prices dropped 23%

 Many financial institutions exposed  Losses triggered ‘credit crunch’ – a

contagion spiral of lending withdrawal

 Lehman Brothers losses of $5.6 bn

from toxic mortgages triggered their bankruptcy in September 2008

 Major government bail-outs and

capital injections to stem contagion

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1990 1995 2000 2005 2010

$100k $150k $200k $250k

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Debt Contagion in Banking Network

Individual Company’s Debt to the Federal Bank 2008-10

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1 10 100 1,000 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Peak Debt to Fed ($-Billions)

Date

Peak Debt Against Date

Bear Stearns BNP Paribas Morgan Stanley Royal Bank of Scotland State Street Corp. JPMorgan Merrill Lynch Credit Suisse Wachovia

Lehman Brothers

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The Impacts Have Been Painful & Lengthy

 The ensuing double (triple?) dip recession has

been lengthy & painful

 Eurozone crisis and regional instability  Economic austerity programs undertaken in

many countries to redress national debt levels

 Civil unrest and political unpopularity

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Austerity Protest Riots in Greece, 2012

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It was Unexpected

5 Traditional macroeconomic models, such as the Bank of England dynamic stochastic general equilibrium’ (DSGE) failed to anticipate the impact of the credit crunch Graphic from the front cover of The Economist, July 18, 2009, encapsulating the crisis in economic theory

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Models were Useless

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 “We suffered adverse 25-standard deviation events, several days in a row according to our models.”

– CFO of one of the world’s largest hedge funds, after it had suffered huge losses in 2008

 “The 1987 ‘Black Monday’ has a likelihood of 10-148 in traditional ‘random walk’ mathematics.”

– Economist Gene Stanley, Boston University

 “according to our models this just could not happen”

– Robert Merton, one of the nobel-prizewinning architects of the Black-Scholes model, 1998 on the day after Long-Term Capital lost $4.4 Billion

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Future Causes of Major Economic Shocks

Longevity

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Pandemics Asset Bubbles

What kinds of stresses might result in financial shocks in 21st century?

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Global Life Expectancy has Increased Rapidly

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gapminder.org

Income per Person Income per Person Life Expectancy Life Expectancy

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Causes of Mortality Improvement

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Lifestyle

• Smoking
• Obesity
• Other lifestyle trends

Medical Intervention

Treatments for specific conditions:

• Cardiovascular Disease
• Cancers
• Respiratory Disease
• Dementia
• Other key diseases
• Accident & Trauma

Health Environment

General impact of

• Healthcare provision
• Sanitation and housing
• Other environmental factors

Regenerative Medicine

New classes of treatment for repairing damaged systems e.g.

• Stem cell therapy
• Nanomedicine
• Individualized gene therapy
• Improvements in transplantation

Anti-Aging Processes

Treatments to extend life through slowing natural processes of aging, e.g:

• Telomere Shortening
• IGF1
• Caloric restriction

Current Future

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More Pensioners than Children

 By 2050, the number of older persons in the world will exceed

the number of young for the first time in history

 By 2050, people over 60 will make up a fifth of the world’s

population

– More than a third in developed countries.

 Two thirds of people who have ever reached pensionable age

(65) are alive today

 Potential support ratio (PSR) of people of working age (15-64)

to pensioners (65 and older)

– Declined from 12 in 1950 to around 8 today – By 2050 the PSR will be half that of today – below 4

 Traditional public sector pension funding relies on taxation

from the working population - the tax burden per worker to support retirees will effectively double

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ICRM Symposium 2013

The Greying of the Planet Has Financial Costs

 Private sector pension plans are unsustainable

– Underfunding ratios (reserves vs expected liabilities) are currently running around 75% – Defined benefit schemes are closing rapidly – Corporations are seeking to ‘de-risk’ their pension liabilities by shedding them to other financial institutions

 Public sector pensions are funded through taxation –

pressures on social security spending will force reforms

 Individuals will have to save for their retirement more than

they do – and it may be too late for today’s pensioners

 Healthcare of elderly is expensive and costs will spiral  RMS reckons that there’s a 1-in-100 chance of pensions

costing $1Trillion more than expected

 The default of pension schemes and annuity providers would

cause a shock far larger than the housing bubble of 2007

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Pandemic Shocks

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 Despite modern medicine curing many

diseases, the natural evolution of viruses produces new diseases for which we initially have no medical treatments

 These trigger epidemics that cause

social and economic impacts

 Recent emerging infectious diseases:

– SARS, AIDS, e-Coli, Ebola, Avian Flu

 Pandemics from new strains of influenza

• ccur 3 times a century

 A severe pandemic could freeze

economic activity while the world’s population hides from the disease

 It is possible for a severe pandemic to

cause a loss of 10-20% of the world’s annual GDP

 This shock would dwarf the housing

bubble of 2007

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Emerging Infectious Diseases

 The rate at which new diseases emerge may be increasing  40 previously unknown pathogens have emerged since 1970s  Animal populations are the main reservoirs of new viruses that transfer to humans (zoonosis)  Animal populations have increased dramatically in regions such as SE Asia

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Zoonotic pathogens from wildlife, 1940-2004

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H5N1 – The deadliest strain of influenza

■ In 2005 and 2006 a new form of influenza

emerged, A(H5N1), which kills 60% of people who catch it

■ It could only be caught from close contact with

birds – mostly domestic poultry

■ It particularly hit young adults and economically

productive people – similar to the age profile of life insurance policy-holders

■ It caused a public health scare, massive

eradication of poultry stocks, and major contingency planning by government agencies and the World Health Organization

■ Fortunately it was not infectious – humans

couldn’t spread it to each other

1 4

Humans, poultry and wild birds killed by H5N1. Poultry or wild birds killed by H5N1. Countries with reported H5N1 infections

30 60 90 120 Number of people

Age Cases Deaths

10 20 30 40 50 60 70 80

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Transmissible H5N1 made in the lab

■ Two teams of scientists have now artificially created mutations of H5N1 to enable airborne transmission in ferrets ■ The intention of this research is to improve surveillance for similar mutations in nature, and to create vaccines ■ The versions created are probably fairly mild – but they want to continue and develop more virulent strains. This is known as H5N1 ‘gain-of-function’ research ■ The danger is that viruses could escape from the labs and trigger a virulent pandemic ■ The controversy triggered by the announcement led to a moratorium of further research until the safety implications had been fully debated ■ On January 23rd, the research community decided to resume their research ■ Researchers decided it was OK to continue research in level 3 biosecurity labs, rather than confine it to maximum security biosecurity level 4

Yoshihiro Kawaoka (left) lead researcher in pathobiological sciences lab at UW-Madison Ron Fouchier, leader of the virus research team at Erasmus Medical Center, Rotterdam

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ICRM Symposium 2013

A Lab Escape Could Trigger a Pandemic

RMS IDM Event ID Transmissibility (R0) Virulence

(Case Fatality Rate)

Vaccination

achieved in yr 1

Total Deaths Worldwide Global Death Rate 10996 2.0 0.3 ~30%

50 million

7

per 1,000 population

11218 2.25 0.025 ~50%

18 million

2.5

per 1,000 population

Laboratory escape likelihoods are small, but they do happen: ■ 42 laboratories are currently working with potential pandemic pathogens (PPPs) ■ Over 5000 recorded cases of Laboratory-Acquired Infections in researchers since 1930 ■ Accidental release: Virus flushed down the drains from the Pirbright BSL-4 research laboratory caused an outbreak of foot-and-mouth disease in cattle in England in 2007 ■ Malicious release: 2001 anthrax letters mailed in the US, distributed by a microbiologist at Fort Detrick’s bioweapons defense research institute ■ One critic of the research has estimated that there is an 80% chance within 13 years

• f an escape of a virus from ‘gain-of-function’ H5N1 research

If a high virulence version of an H5N1 virus escaped from a research lab, 50 million people could die prematurely

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RMS model of pandemic resulting from highly-pathogenic H5N1 virus lab escape

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• 0.55
• 0.45
• 0.35
• 0.25
• 0.15
• 0.05

0.05 0.15 0.25 0.35 2009Q4 2010Q2 2010Q4 2011Q2 2011Q4 2012Q2 2012Q4 2013Q2 2013Q4 2014Q2 2014Q4 2015Q2 2015Q4 tourism shocks health services shocks labour producitivity shocks population and labour supply shocks

Pandemic Scenario Macro-Economic Impacts

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Effects of Scenario on GDP for selected regions assuming asymmetric real wage response (percentage deviation from baseline) Effects of individual shocks of scenario on global employment (percentage deviations from baseline) Effects of Scenario on global employment, GDP and exports assuming asymmetric real wage response (percentage deviation from baseline)

• 12.0
• 10.0
• 8.0
• 6.0
• 4.0
• 2.0

0.0 2009Q4 2010Q2 2010Q4 2011Q2 2011Q4 2012Q2 2012Q4 2013Q2 2013Q4 2014Q2 2014Q4 2015Q2 2015Q4 China Singapore USA Germany Rest of Asia Japan

• 7.0
• 6.0
• 5.0
• 4.0
• 3.0
• 2.0
• 1.0

0.0 1.0 2009Q4 2010Q2 2010Q4 2011Q2 2011Q4 2012Q2 2012Q4 2013Q2 2013Q4 2014Q2 2014Q4 2015Q2 2015Q4 Global GDP Global employment Global exports

• 6.0
• 5.0
• 4.0
• 3.0
• 2.0
• 1.0

0.0 1.0 2.0 3.0 20

Tourism Shock Health Services Shock Labour Productivity Shock Population and Labour Supply Shock China Singapore USA Germany Rest of Asia Japan Global GDP Global Employment Global Exports

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Portfolio Structure Tests Against Pandemic Scenario

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50% equities; 50% bonds 60% equities; 40% bonds 70% equities; 30% bonds Without Rebalancing With Annual Rebalancing

back to the intended weights

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Long Term Historical Views of Financial Catastrophes

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Source: Jay (2010)

http://fintrend.com/tag/bear-market/

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Financial Catastrophes Endogenous shocks

Inherent attributes of the financial system

 Boom & bust cycles  Asset bubbles  Bank runs  Sovereign defaults  Confidence collapse  Credit crisis

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Exogenous shocks

External events causing loss and economic change

 Massive destruction of

supply side outputs of economy

 Interruption and depletion of

demand side of economy

 Limited number of potential

causes of extreme events

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Real-World Central Banking Network

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Source:

A network analysis of global banking: 1978-2009; Minoiu, Camelia ; Reyes, Javier A., IMF Working Paper http://www.imf.org/external/pubs/ft/wp/2011/wp1174.pdf

United Kingdom Ireland China France Switzerland Netherlands Luxembourg Denmark Italy Sweden Germany Belgium Austria Japan Canada United States Brazil Chile Mexico Colombia Panama Bahamas Argentina Costa Rica Aruba Barbados Netherlands Antiles Belize Guatemala Dominican Republic Peru El Salvador Trinidad and Tobago St Vincent Saudi Arabia Egypt Qatar Israel Lebanon Kuwait Morocco Oman Bahrain Jordan Tunisia United Arab Emirates Libya Pakistan India Brunei Liberia Mauritius Ghana South Africa Cote d’Ivoire Kenya Namibia Nigeria Singapore Hong Kong SAR Indonesia Malaysia South Korea Vietnam Philippines Thailand Australia New Zealand Hungary Norway Portugal Finland Spain Russia Slovakia Cyprus Albania Kazakhistan Belarus Bosnia and Herzegovina Estonia Azerbaijan Latvia Lithuania Croatia Bulgaria Ukraine Czech Republic Montenegro Slovenia Serbia Greece Iceland Malta Turkey Poland Romania

Core Periphery Network

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A Banking Liquidity Contagion Model

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Co-Pierre Georg, 2012, ‘Black Rhino’ model of shocks on a banking network

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 Equity markets in different countries are twice as correlated as they were 15 years ago

– i.e. the measured correlation index between price movement in pairwise equity markets in many different countries have doubled in the past 15 years

A Globalizing Economy Means Increasing Correlation

23 SP New York S&P FTSE London NK Japan DAX Germany CAC Canada AUS Australia RL SP Singapore HK Hong Kong IBEX Spain SA South Africa SM Shanghai EO QC Conditional Correlations of Equity Futures (weekly returns) Source: Hasham Pesaran

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Globalization is Increasing Systemic Risk

 Increasing connectivity improves efficiency and drives

growth, but increases the chances of one big shock causing contagion throughout the whole system

 We are in a period of extraordinary financial innovation and

creativity – ultimately this holds out the promise of a new wave of economic growth

 However, periods of innovation are also associated with

• ccasional failure – expect more crashes, bubbles and dips

before we properly master the art of financial engineering!

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