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 or 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 14

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 15

Change in Assets by Bank Size Groups in the United States, 1984-2012 16

The Growth of the Largest Banks Bank Assets as Percent of GDP, Largest 6 bank holding companies in the United States, 1995-2014 70.0% 60.0% 50.0% Morgan Stanley 40.0% Goldman Sachs Wells Fargo Citigroup 30.0% JPMorgan Chase Bank of America 20.0% 10.0% 0.0% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

We Should Measure Total Exposures, Not Just Balance Sheet Assets Bank Assets as Percent of GDP (showing "total exposures" in 2014), Largest 6 bank holding companies in the United States, 1995-2014 90.0% 80.0% 70.0% 60.0% Morgan Stanley 50.0% Goldman Sachs Wells Fargo 40.0% Citigroup JPMorgan Chase 30.0% Bank of America 20.0% 10.0% 0.0% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 TE 2014

What Went Wrong? The US Crisis, 2007-09 End-of-Day CDS Spreads, 9 Major Banks (AXP, BAC, COF, C, GS, JPM, KEY, MS, WFC) 0.16 0.14 0.12 SCAP announced 0.1 Joint Gntees 0.08 Paulson's gift Bear failure QE1 begins 0.06 Lehman failure 0.04 0.02 Mny Mkt Gntees GS/MS become BHCs SCAP results 0 Mean Max 19

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 7.23 3.98 leveraged 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 7.57 7.57 $50bn assets Source: Tom Hoenig, FDIC; https://www.fdic.gov/about/learn/board/hoenig/statement4-2-2015.html 21

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Is This Enough Equity? Leverage Ratio (Tangible Equity / Tangible Assets) Morgan Stanley Percent JPMorgan 5.00 Deutsche Bank 4.50 UBS 4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 - 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: Form 10K of MS and JPM. Bloomberg for DB and UBS Note: US bank assets are converted to IFRS equivalent values.

Resolution Strategy: Work-in-Progress Source: FDIC, presentation to Systemic Resolution Advisory Committee 24

The Struggles of Big European Banks Stock prices for selected European GSIBs (monthly data) Index Jan 2000=100 350 Societe Generale Standard 300 Chartered 250 200 BNP Paribas 150 100 Barclays 50 RBS 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Bloomberg

A Few US Banks Take Advantage Stock prices for selected American GSIBs (monthly data) Index Jan 2000 = 100 300 Morgan Stanley Wells Fargo 250 Bank of America 200 150 JP Morgan 100 50 Goldman Sachs Citigroup 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Bloomberg

Too Important To Fail Subsidy Structure Source: International Monetary Fund, GFSR, April 2014 27

TITF: Subsidy Size, 2014 Source: International Monetary Fund, GFSR, April 2014 28

Some Historical Perspective Global Financial Crises from 1800 Source: Alan M. Taylor, “The great leveraging”. 29

Output Cost of the Crisis Source: US Treasury 30

Another Inconvenient Truth Increase in U.S. National Debt Due to Financial Crisis 80 70 August 2009 Baseline Projection 60 50 Percent of GDP 40 30 January 2008 Baseline Projection 20 10 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: CBO, Budget and Economic Outlook , January 2008; Budget and Economic Outlook: An Update , August 2009. 31

From Private Debt to Public Debt Public Debt in Cyprus, Iceland, Ireland, Spain, Switzerland, USA, and UK, 1970-2012 140.0 120.0 100.0 80.0 60.0 40.0 20.0 0.0 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 USA Ireland Iceland Spain UK Cyprus Switzerland 32

Political Strength of TBTF Banks: But Who Exactly Gains From This? Real Corporate Profits, Financial vs. Nonfinancial Sectors, through Q4 2010 1000 900 800 Financial 700 600 500 400 300 200 100 Nonfinancial 0 -100 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 profits (index=100 in 1980) Nonfinancial profits (index=100 in 1980) 33

The Fate of RBS and Citigroup Shareholders Stock prices for RBS and Citigroup (monthly data) Index Jan 2000=100 250 200 RBS 150 100 Citigroup 50 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Bloomberg

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