Showing posts with label banks. Show all posts
Showing posts with label banks. Show all posts

Sunday, May 9, 2010

Not as bad as it seems...

Personally I think that the likelihood of any sovereign default of Spanish bonds is much lower than thought by the financial press. If you're read the FT it feels like Spain will follow the path of Greece really soon, when in my opinion, the situation in the UK is not much better.

Anyway, a friend of mine (Jason Sturgess) sent me this picture below that is really interesting to show the linkages between EU countries. While Greece's overall impact is very small, with Spain things have a much bigger magnitude.

Tuesday, March 30, 2010

Profits

I still think that the US Treasury might make a profit on assets it bought during the crisis:

Saturday, March 6, 2010

Hedging World Cup Risk

Today I was walking around Barcelona and saw this interesting time-deposit offer from Banesto (a local bank). They promise you 3%/year, but IF Spain wins the World Cup, the investor gets 4%.


Around the World Cup we see all kinds of offers like this (in Spain, the UK, and Brazil at least): buy a flat-screen TV and if Brazil wins you get another one, etc.

An interesting question is how much money does the bank expects to spend with this offer? How should  this be hedged?  Of course, based on historical probabilities they won't lose a dime, but with Spain being one the favourites, what to do to at least find an estimate? 

Supose that the bank's reinvestment rate is 4%. If Spain does not win the World Cup, they make a 1% profit. If Spain does win, they make zero. The expected return is the 1%*(Prob Win), which looks good on their side given previous history.

I wonder if they could hedge this against a portfolio of online bets held by betting houses. 

Any ideas? This might turn into a nice exam question or topic for the derivatives course.

Tuesday, December 22, 2009

Macroeconomics Take-Home Exam: 2009 Crisis Version

During the hearings to reappoint Ben Bernanke to another term as chairman of the Federal Reserve, US senators asked many questions. The WSJ's Real Time Economics blog posted several questions from economists and Sen. David Vitter submitted them in writing. Mr. Bernanke replied and I find the  one below particularly interesting (beware, long read).

Two comments:
i) It's very nice to see public officials being held accountable and presenting their answers to questions from academic experts rather than journalists. All too often they lack the brainpower to reply and pin down inconsistencies and attempts by officials to avoid replying "tough" questions. In Brazil officials are never properly quizzed and there is no culture of being held accountable. Another thing is our list of needed improvements.

ii) The optimal size of banks is a fascinating topic. My hunch is that retail banks should be very large, benefiting from the large returns to scale they have and the relatively low risks associated with the business. On the other hand,  investment banks should not be as large, specially due to systemic risk. Unless we find a good way to measure/manage it, we'll still observe some too-big-to-fail institution making wrong bets (or their clients) in poorly-understood financial instruments. Perhaps this was one of the ideas being the Glass-Steagall Act.

Mark Thoma, University of Oregon and blogger: "What is the single, most important cause of the crisis and what s being done to prevent its reoccurrence? The proposed regulatory structure seems to take as given that large, potentially systemically important firms will exist, hence, the call for ready, on the shelf plans for the dissolution of such firms and for the authority to dissolve them. Why are large firms necessary? Would breaking them up reduce risk?"

Answer: The principal cause of the financial crisis and economic slowdown was the collapse of the global credit boom and the ensuing problems at financial institutions, triggered by the end of the housing expansion in the United States and other countries. Financial institutions have been adversely affected by the financial crisis itself, as well as by the ensuing economic downturn. This crisis did not begin with depositor runs on banks, but with investor runs on firms that financed their holdings of securities in the wholesale money markets. Much of this occurred outside of the supervisory framework currently established. An effective agenda for containing systemic risk thus requires elimination of gaps in the regulatory structure, a focus on macroprudential risks, and adjustments by all our financial regulatory agencies.
 

Supervisors in the United States and abroad are now actively reviewing prudential standards and supervisory approaches to incorporate the lessons of the crisis. For our part, the Federal Reserve is participating in a range of joint efforts to ensure that large, systemically critical financial institutions hold more and higher-quality capital, improve their risk-management practices, have more robust liquidity management, employ compensation structures that provide appropriate performance and risk-taking incentives, and deal fairly with consumers. On the supervisory front, we are taking steps to strengthen oversight and enforcement, particularly at the firm-wide level, and we are augmenting our traditional microprudential, or firm-specific, methods of oversight with a more macroprudential, or system-wide, approach that should help us better anticipate and mitigate broader threats to financial stability. 

Although regulators can do a great deal on their own to improve financial regulation and oversight, the Congress also must act to address the extremely serious problem posed by firms perceived as “too big to fail.” Legislative action is needed to create new mechanisms for oversight of the financial system as a whole. Two important elements would be to subject all systemically important financial firms to effective consolidated supervision and to establish procedures for winding down a failing, systemically critical institution to avoid seriously damaging the financial system and the economy.
 

Some observers have suggested that existing large firms should be split up into smaller, not-too big- to-fail entities in order to reduce risk. While this idea may be worth considering, policymakers should also consider that size may, in some cases, confer genuine economic benefits. For example, large firms may be better able to meet the needs of global customers. Moreover, size alone is not a sufficient indicator of systemic risk and, as history shows, smaller firms can also be involved in systemic crises. Two other important indicators of systemic risk, aside from size, are the degree to which a firm is interconnected with other financial firms and markets, and the degree to which a firm provides critical financial services. An alternative to limiting size in order to reduce risk would be to implement a more effective system of macroprudential regulation. One hallmark of such a system would be comprehensive and vigorous consolidated supervision of all systemically important financial firms. Under such a system, supervisors could, for example, prohibit firms from engaging in certain activities when those firms lack the managerial capacity and risk controls to engage in such activities safely. Congress has an important role to play in the creation of a more robust system of financial regulation, by establishing a process that would allow a failing, systemically important non-bank financial institution to be wound down in an orderly fashion, without jeopardizing financial stability. Such a resolution process would be the logical complement to the process already available to the FDIC for the resolution of banks.