Reflections by an economist on the lessons from the crisis for capital adequacy and accounting principles

Jesper Berg - 2009

” Now Joseph was thirty years old when he came before Pharaoh, king of Egypt. And Joseph went out from before the face of Pharaoh and went through all the land of Egypt. Now in the seven good years the earth gave fruit in masses. And Joseph got together all the food of those seven years, and made a store of food in the towns: the produce of the fields round every town was stored up in the town. So he got together a store of grain like the sand of the sea; so great a store that after a time he gave up measuring it, for it might not be measured..”Source: Old Testament Gênesis 41.

1. A buffer for bad years

2. Outline

Turner and de Larosiere From Modigliani and Miller and onwards Four lessons to be remembered Procyclicality, liquidity and the liability side

3. Policy messages

Capital requirements up Shift relative taxation Assets at mark-to-market/Fair value Liabilities at Max (Nominal value, mark-to-

market) Alternative valuations in notes Transparent cyclical buffers Tightening implemented in years of plenty

4. Turner and de Larosiere

5. Do the MM-Proposition apply to banks”Yes and no”

Source: M. Miller, J. of Banking and Finance, 1995.

6. The difference between going and goneSelected items from failed banks, mill. kr.

Source: Finansiel Stabilitet

EBH Bank FIONIA Roskilde Bank

1. half 2009 2008 1. half 2009 1. half 2009 2. half 2008

Writedowns 1105 1945 1362 3503 Result -1470 -2200 -1901 -1115 -3501 Loans outstanding 3349 17000 17839 20457 Own Funds 1476 -1300 -79 2857 -1028

7. Years of plenty and years of famine LOAN LOSS PROVISIONS, PER CENT OF LOANS

Denmark Sweden Norway Finland

1982 ................................................................ 3.1 0.5 0.2 0.6 1993 ................................................................. 2.5 0.5 0.3 0.5 1984 ................................................................. 1.5 0.7 0.3 0.5 1985 ................................................................ 1.5 0.5 0.4 0.6 1986 ................................................................ 0.6 0.6 0.5 0.6 1987 ................................................................ 1.1 0.5 1.3 0.7 1988 ................................................................ 2.0 0.3 2.0 0.7 1989 ................................................................ 1.6 0.4 2.6 0.7 1990 ................................................................ 2.3 1.2 2.3 0.6 1991 ................................................................ 2.7 4.0 4.3 1.7 1992 ................................................................ 3.3 7.6 2.5 5.8 1993 ................................................................ 3.2 6.3 1.6 5.6 Average 1982-90 ............................................ 1.8 0.6 1.1 0.6 Average 1982-93 ............................................ 2.1 1.9 1.5 1.5

8. SIV and conduits or the danger of a liquidity guarantee

ABCPMoney Market Mutual Fund

Bank

SIV/Conduit

Ratings Agency

Assets Liabilities

ABCP Shares

Assets Liabilities

Home loans ABCP

OK!

OK!

Liquidity guaranty (non-balance sheet)

9. The game is skewed

HOW OFTEN IS SIV AND CONDUITS MENTIONED IN FINANCIAL STABILITY REPORTS

Financial Stability Report SIV Conduit

IMF spring 2007 .............................................. 0 0 IMF autumn 2007 ........................................... 26 30

ECB spring 2007 ............................................ 0 0 ECB autumn 2007 ........................................... 28 26

Bank of England spring 2007 ....................... 0 0 Bank of England autumn 2007 ..................... 33 21

BIS annual report spring 2007 ...................... 0 0 BIS annual report spring 2008 ...................... 5 3

Source: Financial Stability Reports.

10. The ostrich strategyPeople and governments have never learned anything from history, or acted on principles deduced from it .

Source: Hegel, as quoted in "History of the 80s, vol. I, An examination of the banking crisis of the 1980s and early 1990s", Federal Deposit Insurance Corporation, 1997.

11. Procyclicality, liquidity and the liability side”The large bike blade”.Source: Expressions used when Bjarne Riis during the Tour de France in 1996 gave his competitors rear by running a high gear up the hill. Bjarne Riis has subsequently indicated that he was drugged.

12. Policy messages

Capital requirements up Shift relative taxation Assets at mark-to-market/Fair value Liabilities at Max (Nominal value, mark-to-

market) Alternative valuations in notes Transparent cyclical buffers Tightening implemented in years of plenty

13. Concluding observation To understand the world is like peeling an onion. Each time,

removing a layer, you discover a new layer and occasionally you weep.

Source: An analyst philosophy of life.