Too Big to Fail: Risk - Return Considerations for Pension Trustees - - PowerPoint PPT Presentation

Too Big to Fail: Risk - Return Considerations for Pension Trustees

Moderator: Erin Shackelford, Trustee Leadership Forum for Retirement Security, Initiative for Responsible Investment, Harvard Kennedy School Presenters: Simon Johnson, Ronald A. Kurtz (1954) Professor of Entrepreneurship, Professor of Global Economics and Management, MIT Heather Slavkin Corzo, Director of the AFL-CIO Office of Investment

Agenda

• Introduction

Erin Shackelford, Trustee Leadership Forum for Retirement Security, IRI, Harvard Kennedy School

• Presentation:

Heather Slavkin Corzo, Director of the AFL-CIO Office of Investment

• Presentation: Too Big to Fail – Risk-Return Considerations for Pension Trustees

Simon Johnson, Ronald A. Kurtz (1954) Professor of Entrepreneurship, Professor of Global Economics and Management, MIT

• Questions and Comments
• Conclusion

Universal Investors, including pension funds, benefit when the economy is healthy.

Universal Investors are “Investors of such size that their investments are diversified across all asset classes and across investment opportunities within those asset classes, and therefore can be said to be invested in the economy as a whole.” “Consequently economic growth that lifts the value of all investments, as opposed to the appreciation in the price of a particular investment, is of paramount importance to Universal Investors.” “Because of their size and diversification, public pension funds are examples of Universal Investors.” from “Universal Investors and Socially Responsible Investors: A Tale of Emerging Affinities” by Steve Lydenberg in Corporate Governance, May 2007

And, alternatively, Universal Investors suffer when the economy suffers.

Universal Investors lose when “through fraud, corruption or lack of management skills – corporations

• r governments extract value from the economy and society, creating a poorer, less just and

sustainable world.” from “Universal Investors and Socially Responsible Investors: A Tale of Emerging Affinities” by Steve Lydenberg in Corporate Governance, May 2007

Too Big to Fail Banks: Risk-Return Considerations for Pension Trustees

Simon Johnson MIT Sloan School of Management Peterson Institute for International Economics http://BaselineScenario.com Presentation prepared for TLF Webinar Monday, September 14, 2015, 2pm Eastern Confidential: not for distribution or quotation without permission

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How Should We Think About The Largest Global Banks Today?

• Some facts

– “Big” banks became much larger in the past two decades

• What happened in 2008?

– The largest banks received unprecedented levels of government support – Assistance for insiders and for creditors, not so much for shareholders

• How much has changed in the past 7 years?

– Capital levels – Observed behavior (internal controls) – Attitudes and policies of regulators

• Implications for your broader portfolio and

responsibilities

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Change in Assets by Bank Size Groups in the United States, 1984-2012

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The Growth of the Largest Banks

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Bank Assets as Percent of GDP, Largest 6 bank holding companies in the United States, 1995-2014

Morgan Stanley Goldman Sachs Wells Fargo Citigroup JPMorgan Chase Bank of America

We Should Measure Total Exposures, Not Just Balance Sheet Assets

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0% 90.0% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 TE 2014

Bank Assets as Percent of GDP (showing "total exposures" in 2014), Largest 6 bank holding companies in the United States, 1995-2014

Morgan Stanley Goldman Sachs Wells Fargo Citigroup JPMorgan Chase Bank of America

What Went Wrong? The US Crisis, 2007-09

0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16

End-of-Day CDS Spreads, 9 Major Banks (AXP, BAC, COF, C, GS, JPM, KEY, MS, WFC)

Mean Max

Bear failure Lehman failure Mny Mkt Gntees GS/MS become BHCs Paulson's gift QE1 begins Joint Gntees SCAP announced SCAP results

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Market Analysis in October 2008

20

Where Are We On Capital Really?

Leverage Ratios

(Equity as a percent of Total Assets)

GSIBs, end of Q4, 2014 Leverage Ratio (GAAP) Leverage Ratio (IFRS) US big bank average 7.26 4.97 US big 6 bank most leveraged 7.23 3.98 Foreign G-SIBs average n.a. 4.97 Europe most leveraged n.a. 3.05 ROW most leveraged n.a. 5.84 Ten largest US banks under $50bn assets 7.57 7.57

Source: Tom Hoenig, FDIC; https://www.fdic.gov/about/learn/board/hoenig/statement4-2-2015.html

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• 0.50

1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005

Morgan Stanley JPMorgan Deutsche Bank UBS Leverage Ratio (Tangible Equity / Tangible Assets) Percent

Source: Form 10K of MS and JPM. Bloomberg for DB and UBS

Is This Enough Equity?

Note: US bank assets are converted to IFRS equivalent values.

Resolution Strategy: Work-in-Progress

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Source: FDIC, presentation to Systemic Resolution Advisory Committee

50 100 150 200 250 300 350 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Stock prices for selected European GSIBs (monthly data) Index Jan 2000=100

Source: Bloomberg

Barclays Standard Chartered BNP Paribas Societe Generale RBS

The Struggles of Big European Banks

50 100 150 200 250 300 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Stock prices for selected American GSIBs (monthly data) Index Jan 2000 = 100

Source: Bloomberg

Morgan Stanley Wells Fargo JP Morgan Goldman Sachs Citigroup Bank of America

A Few US Banks Take Advantage

Too Important To Fail Subsidy Structure

Source: International Monetary Fund, GFSR, April 2014

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TITF: Subsidy Size, 2014

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Source: International Monetary Fund, GFSR, April 2014

Source: Alan M. Taylor, “The great leveraging”.

Some Historical Perspective Global Financial Crises from 1800

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Output Cost of the Crisis

Source: US Treasury

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10 20 30 40 50 60 70 80

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Percent of GDP

Increase in U.S. National Debt Due to Financial Crisis

Source: CBO, Budget and Economic Outlook, January 2008; Budget and Economic Outlook: An Update, August 2009. January 2008 Baseline Projection August 2009 Baseline Projection

Another Inconvenient Truth

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From Private Debt to Public Debt

0.0 20.0 40.0 60.0 80.0 100.0 120.0 140.0 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Public Debt in Cyprus, Iceland, Ireland, Spain, Switzerland, USA, and UK, 1970-2012

USA Ireland Iceland Spain UK Cyprus Switzerland

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Political Strength of TBTF Banks: But Who Exactly Gains From This?

• 100

100 200 300 400 500 600 700 800 900 1000

Real Corporate Profits, Financial vs. Nonfinancial Sectors, through Q4 2010

Financial profits (index=100 in 1980) Nonfinancial profits (index=100 in 1980)

Source: Bureau of Economic Analysis, NIPA Tables 1.1.4, 6.16; calculation by the authors. Financial sector excludes Financial Reserve banks. Annual through 2009, quarterly for 2010 (annualized; seasonally adjusted).

Financial Nonfinancial

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50 100 150 200 250 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Stock prices for RBS and Citigroup (monthly data) Index Jan 2000=100 Source: Bloomberg RBS Citigroup

The Fate of RBS and Citigroup Shareholders

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