Financial Catastrophes of the 21 st Century Longevity, Pandemics, and Asset Bubbles Dr. Andrew Coburn Senior Vice President, RMS & Director of the External Advisory Board Centre for Risk Studies, University of Cambridge ICRM Symposium 2013
US House Price Bubble Spectacular rises in US house prices $250k from mid 1990s encouraged use of this growth in other financial assets $200k – Lending to sub-prime mortgage market – Creation of Mortgage-Backed Securities $150k – Enabled institutions and investors around the world to invest in U.S. housing market In 2007, bubble burst and US house $100k 1990 1995 2000 2005 2010 prices dropped 23% Many financial institutions exposed Losses triggered ‘credit crunch’ – a contagion spiral of lending withdrawal Lehman Brothers losses of $5.6 bn from toxic mortgages triggered their bankruptcy in September 2008 Major government bail-outs and capital injections to stem contagion ICRM Symposium 2013 2
Debt Contagion in Banking Network Individual Company’s Debt to the Federal Bank 2008-10 Morgan Stanley Royal Bank of Scotland State Street Corp. JPMorgan 1,000 Merrill Lynch Peak Debt Against Date Credit Suisse Wachovia Lehman 100 Brothers Peak Debt to Fed ($-Billions) Bear Stearns BNP Paribas 10 1 0 0 0 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Date 3 ICRM Symposium 2013
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 Austerity Protest Riots in Greece, 2012 ICRM Symposium 2013 4
It was Unexpected Traditional macroeconomic models, such as the Bank of Graphic from the front cover of The Economist, England dynamic stochastic general equilibrium’ (DSGE) failed July 18, 2009, encapsulating the crisis in economic theory to anticipate the impact of the credit crunch ICRM Symposium 2013 5
Models were Useless “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 ICRM Symposium 2013 6
Future Causes of Major Economic Shocks What kinds of stresses might result in financial shocks in 21 st century? Longevity Pandemics Asset Bubbles ICRM Symposium 2013 7
Global Life Expectancy has Increased Rapidly Life Expectancy gapminder.org Life Expectancy 8 ICRM Symposium 2013 Income per Person Income per Person
Causes of Mortality Improvement Current Future Lifestyle Regenerative Medicine • Smoking New classes of treatment for repairing • Obesity damaged systems e.g. • Other lifestyle trends • Stem cell therapy • Nanomedicine Medical Intervention • Individualized gene therapy Treatments for specific conditions: • Improvements in transplantation • Cardiovascular Disease Anti-Aging Processes • Cancers Treatments to extend life through slowing • Respiratory Disease natural processes of aging, e.g: • Dementia • Telomere Shortening • Other key diseases • IGF1 • Accident & Trauma • Caloric restriction Health Environment General impact of • Healthcare provision • Sanitation and housing • Other environmental factors ICRM Symposium 2013 9
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 ICRM Symposium 2013 10
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 ICRM Symposium 2013 11
Pandemic Shocks 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 occur 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 ICRM Symposium 2013 12
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 Zoonotic pathogens from wildlife, 1940-2004 increased dramatically in regions such as SE Asia 13 ICRM Symposium 2013
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 Countries with reported H5N1 infections productive people – similar to the age profile of life Humans, poultry and wild birds killed by H5N1. insurance policy-holders Poultry or wild birds killed by H5N1. ■ It caused a public health scare, massive eradication of poultry stocks, and major 120 Cases contingency planning by government agencies Number of people 90 Deaths and the World Health Organization 60 ■ Fortunately it was not infectious – humans 30 couldn’t spread it to each other 0 0 10 20 30 40 50 60 70 80 Age 14 1 ICRM Symposium 2013 4
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 Ron Fouchier, leader of the virus research team at Erasmus Medical Center, Rotterdam 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 23 rd , 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 15 ICRM Symposium 2013
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