00:00:14
so what's the cause of all this well the
00:00:17
major cause as as both of them have
00:00:20
already said is the property
00:00:23
bubble I think there there's little
00:00:26
doubt now that there was a bubble in
00:00:28
property prices and I I would put that
00:00:31
to a large extent at the door of the
00:00:32
Federal Reserve when they reacted to the
00:00:36
recession following the collapse of the
00:00:38
tech bubble and then the 9/11 events
00:00:41
they kept interest rates low for a long
00:00:43
time and I think that's what sparked the
00:00:46
bubble and helped fuel
00:00:48
it now one interesting question is what
00:00:53
point should we have realized that there
00:00:55
was a bubble
00:00:57
now Jeremy gave this
00:01:00
data that if you look back in the US you
00:01:04
find that there's no year that the
00:01:07
average across the entire country has
00:01:10
fallen since the Great Depression so
00:01:13
there was about 70 75 years of data
00:01:16
suggesting that house prices on average
00:01:19
couldn't fall and that's the data that
00:01:21
was used by the rating agencies and many
00:01:25
others now the interesting thing is that
00:01:29
about the same same kind of time 2004
00:01:32
2005 2006 if you'd gone to the new stand
00:01:37
and bought a copy of the economist what
00:01:39
you would have found is many articles
00:01:41
suggesting that house prices were
00:01:44
getting too high and there might be a
00:01:46
bubble and by the time 2006 came they
00:01:49
were definitely saying that and they
00:01:51
used a number of very simple metrics of
00:01:54
course if you look outside the US it's
00:01:57
quite clear that there were a lot of
00:01:59
property bubbles
00:02:00
Jeremy mentioned briefly Japan I'll talk
00:02:03
about that in a minute but property
00:02:05
prices in Japan fell
00:02:08
75% roughly speaking over 15 years there
00:02:13
were also these huge bubbles in Hong
00:02:16
Kong and Singapore and many other places
00:02:19
in Asia so there were a lot of places
00:02:21
where property prices had fallen but not
00:02:24
in the US and one of the big problems is
00:02:27
how do we extrapolate evidence from
00:02:29
other countries
00:02:30
to our own
00:02:32
situation so in any case we we had the
00:02:35
bubble it it started to burst what
00:02:38
happened then
00:02:39
well property prices started to go down
00:02:43
and default rates started to go up on
00:02:46
the
00:02:47
subprime
00:02:48
now that's a problem but you know
00:02:51
relative to Assets in the US it's not
00:02:54
such a huge problem in terms of of um
00:02:58
dollar amounts now back in July of 2007
00:03:03
people suddenly realized that these
00:03:06
amounts that were falling these subprime
00:03:09
they were much riskier than people had
00:03:12
realized and so they started to
00:03:14
rebalance their portfolios now there was
00:03:17
a period of a few days in July when
00:03:20
prices of AAA tranches of
00:03:25
subprime
00:03:26
securitizations fell dramatically and
00:03:29
that that when things started to go B
00:03:32
bad because these were assets which were
00:03:34
thought to be extremely safe not much
00:03:38
different than treasury Securities and
00:03:40
people had had relied on that in the AAA
00:03:44
tranches now they fell
00:03:47
dramatically and the question is what
00:03:49
was happening then was that because we
00:03:51
were learning about default rates or
00:03:54
what now my own view is that something
00:03:57
somewhat different was happening there
00:03:59
was some learning about default rates
00:04:02
but in fact what I think happened was
00:04:04
that the liquidity capacity of these
00:04:07
markets which were fairly thin and IL
00:04:10
liquid was overwhelmed and the prices
00:04:13
fell when it was overwhelmed now
00:04:15
normally you say it' be like Finance 601
00:04:17
today well the prices fall to L too low
00:04:20
people should go in and Arbitrage that
00:04:23
and hold them and then they'll make a
00:04:25
profit now the problem with this was
00:04:28
that the link between fundamentals and
00:04:31
prices had been broken and it was broken
00:04:34
for long enough that it became a risky
00:04:36
Arbitrage now Jeremy was describing how
00:04:40
the investment Banks were doubling down
00:04:42
they thought that this these assets were
00:04:44
underpriced so they bought more of them
00:04:47
now of course what happened was the
00:04:48
price went down further and caused a lot
00:04:51
more
00:04:52
problems
00:04:54
now the reason that I I think that this
00:04:57
was a problem with the Arbitrage pricing
00:05:00
going wrong was it wasn't just subprime
00:05:04
AAA securitizations that had problems
00:05:07
within that period of a few days in July
00:05:10
many other securitizations with
00:05:12
completely different fundamentals also
00:05:15
had problems so commercial backed
00:05:18
securitizations the AAA tranches of
00:05:20
those also started to fall and credit
00:05:23
default swap
00:05:26
securitizations on the riskiness of
00:05:28
firms they also started fall and the co-
00:05:31
movements spiked
00:05:33
dramatically so the problem was the
00:05:35
prices got out of line and they have
00:05:37
stayed in my view out of line because it
00:05:39
is a very risky Arbitrage and that's
00:05:42
exacerbated the problems
00:05:45
considerably now as we
00:05:47
saw there have been these effects so
00:05:51
first of all the interbank markets froze
00:05:54
and so the the central banks started to
00:05:56
try and unfreeze them they cut interest
00:05:59
rates they did a lot of things now it
00:06:02
wasn't really until this March that
00:06:06
things really got serious in the sense
00:06:08
that we started to see failures and be
00:06:10
Sterns was a very interesting case I
00:06:13
think the FED probably did the right
00:06:15
thing there they didn't know much about
00:06:18
their positions and they were faced with
00:06:20
a weekend to try and find out it's not
00:06:23
enough so what they did was play it safe
00:06:26
what they were worried about was
00:06:27
contagion risk that the notion that if
00:06:30
be Sterns had failed a lot of other
00:06:32
places who had claims on be Stern would
00:06:36
have suffered a a problem they might
00:06:39
have started to sell assets to try and
00:06:41
deal with some of those problems that
00:06:43
would have caused asset prices to fall
00:06:45
further and we get into this meltdown
00:06:48
and things go bad with a whole chain of
00:06:52
bankruptcies now after they rescued best
00:06:55
ears they gave access to the other
00:06:57
investment Banks and as
00:07:00
uh as is well known I think the quidd
00:07:03
pro quo for that access was that the New
00:07:06
York fed got to put examiners in there
00:07:09
and they were allowed to look at all the
00:07:11
books so when Leman came along they knew
00:07:15
pretty much what their positions were
00:07:17
and what the effects of allowing them to
00:07:20
go bankrupt would be so this time they
00:07:23
were able to let them go without too
00:07:27
much risk of systemic risk of this
00:07:30
contagion that we're talking
00:07:33
about now Fanny and Freddy Joe talked a
00:07:37
lot about that my own viewers they had
00:07:39
to act there that is such a major player
00:07:41
in the property markets they needed to
00:07:43
stabilize that and what they did there
00:07:46
was
00:07:47
appropriate I think one of the things
00:07:49
that I learned is that uh th is a very
00:07:51
smart man and on Sunday when he realized
00:07:55
that uh there may or may not be a deal
00:07:59
done with Leman what he should do is to
00:08:03
prevent meril Lynch being on the Block
00:08:06
this week is to just go and see if
00:08:09
anybody wanted to buy them and they did
00:08:12
and he got a very good price for
00:08:14
Merill so this week is AIG now I haven't
00:08:18
kept I've been teaching all day so I
00:08:19
don't know exactly what happened uh
00:08:22
Jeremy seems to be more informed I I
00:08:24
don't think they've done a deal from
00:08:26
what he said and from what I understand
00:08:28
but he hasn't been final it hasn't been
00:08:30
finalized so we'll see what what happens
00:08:33
with that again the feds are going to be
00:08:35
worried about this contagion risk I'm
00:08:37
not sure they know enough about uh aig's
00:08:41
positions to make a snap decision and
00:08:44
usually in those positions they do the
00:08:46
risk averse thing which is to uh to bail
00:08:50
them out or to make sure that there's no
00:08:52
spread now is this the end well I don't
00:08:55
think so I think that we will have
00:08:58
problems going forward forward in in the
00:09:00
US so if you look at uh credit default
00:09:02
swaps on City Group they're beginning to
00:09:05
rise dramatically and they may be next
00:09:08
there may also be some of the smaller
00:09:09
Banks like Washington Mutual and maybe
00:09:12
wacovia and some of these other ones
00:09:14
that have
00:09:15
problems but I think the real risk is
00:09:19
overseas and particularly in Europe so
00:09:23
if we have a problem here even if City
00:09:25
Group which is a massive Bank goes down
00:09:29
the treasury can step in and arrange a
00:09:32
bailout make sure that the systemic risk
00:09:36
isn't realized now the big problem in
00:09:39
the world today though is Big banks in
00:09:42
small
00:09:44
countries and in Europe there are many
00:09:46
of them so in particular if you think
00:09:48
about Belgium and the Netherlands first
00:09:51
of all they have massive Banks and the
00:09:54
one which has lots of problems at the
00:09:55
moment is Fortis so Fortis will come
00:09:59
come under scrutiny fairly soon in the
00:10:01
next few weeks now you say but isn't
00:10:03
Belgium part of the EU the answer is yes
00:10:07
and they have a a memorandum of
00:10:09
understanding about how things will be
00:10:11
done but they don't specify exactly how
00:10:15
burdens will
00:10:17
be spread out and what that means is
00:10:20
that if Fortis gets into trouble for
00:10:22
example there's going to be a delay and
00:10:25
that's going to lead to this kind of
00:10:27
contagion risk that we've been talking
00:10:30
about but the real country that is
00:10:33
problematic in my view is Switzerland
00:10:36
they have two massive Banks which are
00:10:38
UBS and credit Swiss and they have
00:10:41
assets which are six times the GDP of
00:10:45
Switzerland UBS has lots of problems you
00:10:48
know if you followed the problems about
00:10:51
the tax avoidance and so on they have a
00:10:54
lot of ethical issues there they've also
00:10:56
had iner trading scandals in various
00:10:58
countries
00:10:59
and so
00:11:00
on they've had a lot of problems with
00:11:03
subprime loans and a lot of problems
00:11:05
with their Risk Management Systems now
00:11:08
if they have a big problem the Swiss
00:11:11
government cannot afford to bail them
00:11:15
out and that is where the problem comes
00:11:17
because if they go down the kind of
00:11:20
sequence of events that the FED talks
00:11:22
about when it justifies rescuing bare
00:11:25
Sterns that can happen in real time in
00:11:29
Europe and then spread to the US and to
00:11:32
other parts of the world and I think
00:11:34
that's the real danger now hopefully it
00:11:36
won't happen hopefully Jeremy's right
00:11:38
everything will now calm down but I
00:11:41
think that's that's the worrying thing
00:11:44
what Joe was talking about is also very
00:11:47
worrying property prices have got a ways
00:11:49
to go in my view if it spills over into
00:11:52
commercial property that's a big problem
00:11:55
and then we get into the other major
00:11:58
problem facing us which is the feedback
00:12:01
effect all this is assuming that things
00:12:04
don't go too bad in the real economy
00:12:07
things haven't gone too bad yet but they
00:12:10
may well do if people start losing their
00:12:13
jobs if we have a lot of dis more
00:12:15
disruption in the financial system and
00:12:17
that's the real worry now Jeremy
00:12:20
mentioned
00:12:21
Japan my own view is Japan actually
00:12:24
didn't do too badly you know if you want
00:12:27
to look at the way not to deal with this
00:12:29
the ultimately bad example is the Great
00:12:32
Depression when unemployment went to 25%
00:12:36
or so and it lasted for many years now
00:12:39
if you look at some other instances if
00:12:42
you look at Asian
00:12:44
crisis again or you look at the
00:12:46
Scandinavian crisis they got into deep
00:12:48
recessions Japan didn't it stopped
00:12:51
growing it had the last decade but it
00:12:53
didn't have ordinary people suffer great
00:12:57
pain now you know the the interesting
00:12:59
question is what are the in feedback
00:13:01
effects how far is this going to spread
00:13:05
and where are we going to be 5 to 10
00:13:07
years from
00:13:11
now
