20100629

Global Financial Crisis: Implications

for Future Business Education

Stephen Y L CHEUNG

Professor (Chair) of Finance

Dean, School of Business

Hong Kong Baptist University

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Contents

• Causes of sub-prime crisis

• Consequences

• China and India

• Policy implications

• Sovereign Crisis

• Consequences

• Future Business Education

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Origins

• Financial crisis derives from the US housing market

• Housing market in US

• An unparalleled boom in 2007

• Negative real interest rates in US

• Excess liquidity offered by financial innovation

• High leverage

• Causes of sub-prime crisis• Consequences• China and India• Policy implications

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• GraphCurrent Account Balance of Emerging Markets and US

Real Interest Rates (Fed Funds Rate minus US CPI-Urban)

-200

-100

0

100

200

300

400

500

600

700

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

CAB Real_IR

• Causes of sub-prime crisis• Consequences• China and India• Policy implications

Real interest rate

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Financial Innovation

• Housing loans offered at back loaded teaser interest rates• Assuming that borrowers could refinance the sub prime loans

through gains in home equity • But loan originating banks were smart …

• Causes of sub-prime crisis• Consequences• China and India• Policy implications

Structured Derivatives

Housing Loans Sub-prime borrows

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What is Sub-prime loans?• Causes of sub-prime crisis• Consequences• China and India• Policy implications

(1) low credit scores (2) No 20% down-payment for a home (3) Unable to fully document their income

No Conventional mortgages No Best market interest rates

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What did the banks do?

• Offloaded the sub-prime loans through instruments like

Collateralized Debt Obligations

• Modus Operandi of banks (loan originators)• Pool together mortgages, including sub prime loans, into CDOs

• Get top notch credit ratings for senior tranches

• Retain the highly rated senior derivatives through SIVS

• Repackage the lower rated derivatives to transform them into synthetic CDOs

• Investors : Hedge funds, money market and pension funds

• Causes of sub-prime crisis• Consequences• China and India• Policy implications

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The boom begins to unravel from 2004

• US Fed reacts to rising consumer and asset prices by monetary tightening from second half of 2004

• Housing prices begin to fall by end of 2006

• Rising interest rates and falling housing prices lead to

rise in subprime mortgage delinquencies & foreclosures

• Causes of sub-prime crisis• Consequences• China and India• Policy implications

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• Causes of sub-prime crisis• Consequences• China and India• Policy implications

Overloading…

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Suffering…• Causes of sub-prime crisis• Consequences• China and India• Policy implications

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“Do you know the true balance sheet of US Investment banks?”

There are two sides on the balance sheet: the left side and the right side.On the left side, there is nothing right.and on the right side, there is nothing left.

• Causes of sub-prime crisis• Consequences• China and India• Policy implications

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“Yes, it’s true that the Chinese have been selling us toxic toothpaste, toxic pet food, toys with toxic lead paint —”

“but all the while US was selling them toxic investments.”

• Causes of sub-prime crisis• Consequences• China and India• Policy implications

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China and India

are the Saver

• Causes of sub-prime crisis• Consequences• China and India• Policy implications

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Policy implications

• More hazard

• A new financial order– Financial innovations

– Credit rating agencies

• Regulatory framework– Highly leveraged institutions

– Regulator quality

• Causes of sub-prime crisis• Consequences• China and India• Policy implications

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Next Phrase in the Financial Crisis

• Let us not be overly optimistic because of the buoyant world trade, stock market and GDP growth;

• Financial crisis still among us;

• Next phrase in the financial crisis (after subprime, banking & economic crisis);

• Sovereign crisis

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Government Budget Deficits, Percent of GDP, 2009Budget deficits have exploded all over with the worst affected being in the advanced

industrial world

0 2 4 6 8 10 12 14 16 18

Iceland Greece

UK Spain

Ireland USA

Portugal France

Japan Czeck

Belgium Russia

Turkey Italy

Netherlands Canada

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Advanced Economies: Gross Debt-to-GDP Ratios, 2010 IMF Projections

Debt-GDP ratios have been rumped up dramatically in many countries

Strategies for Fiscal Consolidation in the Post-Crisis World, IMF, February 4, 2010

0

25

50

75

100

125

150

175

200

225

250Percent (%) of GDP

Japan Iceland

Greece Italy

Belgium USA

France Canada

Portugal Israel

UK Germany

Ireland Austria

Netherl Spain

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Is the Greek Crisis Coming to America ?

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Consequences

• Contagion risk

• Condition of spending costs and tax hikes

• Market confidence & panic

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Consequences

• Liquidity squeeze => Excessive liquidity

• Asset bubbles; stock and property prices

• Commodity prices up

• Inflation?

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Consequences

• Economy not recovered yet

• High interest rates, negative impact on the fragile economy

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Day after tomorrow:

• Incentive system; how to compensate senior management?

• Exit strategy?

• Financial markets will be different

• Risk management

• Corporate governance

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Future Business Education

• The existing criteria for business school selection

–Easy to get a job

–How much the student can earn

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More important

• Professionalism• Integrity• Accountability• Ethic

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Emphasis on:

• Business Ethics

• Corporate Governance

• Corporate Social Responsibilities

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發財立品

•未”發財 ”先”立品 ”

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The End