The economic costs of the crisis were brutal
- Real GDP fell more than 4% and took more than 3 years to return to the pre-crisis peak
- Public debt has increased by more than 30% of GDP, mostly due to cyclical forces
- At market bottom, $15 trillion in household wealth had disappeared
But these costs would have been much greater in the absence of an effective financial rescue
Policy Failures – Before and During the Crisis
Failures Ex Ante
- Home equity was too thin
- Capital cushions were too thin—and, more importantly, too narrow in scope
- Too much issuance of shortterm, deposit-like liabilities, without regulatory constraints on leverage and without access to the safety net
Failures In the Crisis
- We escalated too late, mostly because of limitations of authority
- Fiscal policy turned too tight too soon
- Mortgage restructuring authority, resources, and incentives were too weak
“Too big to fail” is less of a problem
- The largest institutions are subject to a systemic capital surcharge
- The FDIC has resolution authority to manage the failure of systemic institutions
- We imposed tougher concentration limits on the financial system
- The Fed’s emergency lending authority has been curtailed, and the FDIC’s emergency guarantee authority has been eliminated
- Lots of economic damage remains from the crisis
- The housing finance system is still broken
- Our firefighting tools are too weak
- The regulatory oversight structure is a mess
Tough questions on housing finance
- How do we balance the imperatives of mortgage accessibility and market stability?
- Should we have mandatory down payment requirements? And how high should those down payments be?
- What should the government’s role be in the new system? Guarantee should be explicit, limited in scope, more expensive—with greater role for private capital But government needs authority to step in during crisis
- How do we transition to the new system?
Firefighting authorities are too weak
- Our shock absorbers are thicker and broader than they were
- But we will always need firefighting authorities
- Guarantee authority is essential for breaking panics and for recapitalizing the system
- The scope of the standing lender of last resort authority is still too narrow
- We need more “break-the-glass” authority for the President
The costs of regulatory balkanization
- There’s too much opportunity for regulatory arbitrage
- Regulators and regulations are too slow to adapt to changing markets and institutions
- The rules are too complex
- There’s little accountability
- There’s too much regulatory capture
Principles to govern a streamlined system
- Functional specialization
- More budgetary independence from Congress
- Stronger enforcement
- Better firefighting authority
Rule 01 – If you want peace, prepare for war
- The extreme crisis is unimaginable ex ante
- Manias are not preventable, and there’s no over-the-horizon radar for preempting panics and crashes
- So design the system not to prevent failure, but to be safe for failure
- This means you need strong shock absorbers
Rule 02 – Design the shock absorbers for the extreme crisis and apply them broadly
- Impose capital, leverage, and funding requirements on bank-like institutions; systemic surcharge on the biggest
- Place margin requirements on repo and derivatives
- Design for the migration problem: Use the regulated system to impose limits on the shadow system Build in the ability to expand the perimeter of prudential regulation
- Require thick down payments for home mortgages
- Have clear accountability for the design and enforcement of these limits
Rule 03 – The supplemental arsenal of ex ante tools
- Don’t let your banking system get too large relative to the size of your economy (size and concentration limits)
- Don’t let your “banks” borrow too much in foreign currency
- Deterrence and enforcement
Rule 04 – Maintain strong financial capacity and a powerful firefighting arsenal
- Shock absorbers will not save you from the risk of the extreme crisis, so you need firefighting tools and the capacity to use them
- The key sources of financial strength are: Relatively low public debt levels A credible central bank, with a strong record on inflation
- Your firefighting arsenal must include: Liquidity for vulnerable parts of the system Guarantee authority for banks and banklike institutions Capital and resolution authority
Rule 05 – When the fire starts, let it burn—but build a firebreak around the core
- At the beginning of a crisis, there is a fog of diagnosis—idiosyncratic or systemic?
- To get it right, let the fire burn—and let the system adjust
- Escalate slowly at the beginning, but accelerate quickly when necessary
- And set the perimeter of protection so that you capture the solvent and the systemic, but not the insolvent and the peripheral
Rule 06 – When it’s time to escalate, apply the Powell Doctrine
- Use overwhelming force—fiscal, monetary, and financial Fiscal: as much as you can get Monetary: expansive throughout crisis and deleveraging Financial: liquidity, guarantees, capital, resolution
- None of these are powerful enough to work in isolation
- Together they must be powerful enough to remove risk of depression
Rule 07 – Plan for the long war
- Crises that follow booms entail long periods of deleveraging
- That makes growth weak and fragile
- Need sustained period of monetary policy accommodation to keep real rates negative
- And sustained fiscal support
- Avoid applying the brakes too early
Rule 08 – Impose conditions on the rescue
- Bagehot: Lend freely at a penalty rate
- Ideally, limit the scope of the rescue to the core of the financial system
- Price it to be valuable in the panic, but expensive when the panic breaks
- No naked, unconditional guarantees
- The guarantees should cover catastrophic risk, but not all risk
- Put the non-viable firms into resolution
- Accelerate restructuring and recapitalization of the core of the system to fuel the recovery
- Do the hard stuff early and quickly
Rule 09 – Distinguish the systemic from the idiosyncratic
- Faced with a systemic panic, do the opposite of what makes sense in a typical crisis
- Rather than imposing haircuts, you have to guarantee liabilities
- Rather than worrying about the potential costs of each specific intervention, you must try to limit the risk of broader failures and the greater costs they will entail
- You have to be prepared to take more potential risk if you want to limit actual risk to the taxpayer
- If you misdiagnose the systemic crisis as a normal crisis, then you will end up having to nationalize everything and socialize more risk
Rule 10 – Keep some perspective on moral hazard
- You can’t design a financial system or an effective financial rescue that eliminates moral hazard risk—you can wound moral hazard but you can’t kill it
- You can’t break a panic without creating moral hazard
- In a systemic crisis, the failure of small firms can jeopardize the stability of the system
- Without a firewall of guarantees around the core of the system, you won’t be able to get private capital to come in, and you won’t be able to allow failure and facilitate restructuring
- Preserving ambiguity around when you escalate and how broad to extend liquidity support buys you some market discipline
- Systemic capital surcharge and limits on size and/or consolidation are necessary
Conclusion – Accept the central paradox of financial crises
- It cannot be morally responsible to allow depression in the hopes of deterring future risk-taking
- What seems politically compelling in the moment is perilous and irresponsible
- What seems unjust is just; what seems risky is prudent
- You can’t solve the crisis by trying to fix the problems that caused the crisis; you have to solve the crisis first
Special thanks to Timothy F. Geithner (Lecturer in Management, Yale SOM, Former U.S. Secretary of the Treasury, Yale School of Management) and Andrew Metrick (Michael H. Jordan Professor of Finance and Management, Yale School of Management)
While the challenges posed by a growing company, a growing list of shareholders, a developing sense of entitlement, the paradox of success and the ever popular global folklore of the three-generation-rule all represent a warning of the unique difficulties faced by affluent families, new research also points to the tremendous opportunity that family enterprise represents worldwide. Here are some highlights:
Worldwide, family enterprises represent anywhere from 80% of all businesses in developed economies to 98% of all businesses in emerging economies. (They account for about 90% throughout Latin America, depending on the country.) They are responsible for anywhere from 64% of the GDP to 75% of the GDP of individual countries, achieve anywhere between 6.65% and 16% higher annual returns on assets and shareholder equity than other businesses, and have created most of the jobs in the last decade. In the U.S., family controlled companies enjoyed 6.65% greater return on assets on an annual basis between 1992 and 2001; family-controlled firms also reinvested more than non-family firms.
In the EU, family-controlled firms (min. 50% family stake) outperformed the Morgan Stanley Capital International Europe index by 16% annually from 2001 to 2006. Family-controlled firms (min. 10% family stake and $1 billion in market capitalization) outperformed the pan-European Dow Jones STOXX 600 Index by 8% a year from the end of 1996 to the end of 2006.
In Chile, a study of 175 firms traded on the Bolsa de Comercio, or Chilean Stock Exchange, found the 10 year performance of the 100 family firms in the sample (1994-2003) significantly higher in ROA and ROE terms. Tobin’s Q – proxy for market value created – was higher also. In almost every industrial sector researched worldwide – information technology, consumer staples, consumer discretionary and industrial – family-controlled firms produced higher total returns to shareholders between 1997 and 2009. The only exceptions were the health care and financial services industries. (In health care the state’s role in most countries probably accounts for the finding, whereas in the financial services industry, the business model for the industry requires the use of other people’s capital to make money, thereby constraining any advantage that the family effect would have on these firms.
In Japan, a 2008 study of listed but family-controlled firms found higher returns on assets, returns on equity and returns on invested capital by family enterprises when compared to nonfamily firms. In Taiwan, a study of 228 firms listed in the Taiwan Stock Exchange, found family control not impacting financial performance. But two more recent ones have found family involvement to positively impact the financial performance of the firm.
In almost every industrial sector researched worldwide – information technology, consumer staples, consumer discretionary and industrial – family-controlled firms produced higher total returns to shareholders between 1997 and 2009. The only exceptions were the health care and financial services industry. (In health care the state’s role in most countries probably accounts for the finding, whereas in the financial services industry, the business model requires the use of other people’s money to make money, which might explain family business not outperforming in this industry, notwithstanding the positive “family effect” seen elsewhere.)
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In the run-up to the World Economic Forum on Latin America 2014, President Ricardo Martinelli outlines Panama’s progress and invites you to participate in the discussions that will help to shape its future
It has been a privileged experience to lead this country and help chart its path of economic and social transformation over the course of the past five years. Based on a clear vision of the imperative of development and through an aggressive $20 billion investment plan focused on the areas where the country has its greatest potential, Panama has become the country with the highest economic growth in the region and presently rivals that of any other country in the world. Despite a troubled international economic environment, the rate of growth of its GDP has reached double digits for 2011 and 2012.
We can also now proudly say that Panama’s economy has become the second most competitive in Latin America, after that of Chile. We have, from the beginning, clearly appreciated that this progress must be based upon a joint effort between the local public and private sectors – securely grounded in free-market principles combined with a strong sense of social responsibility.
In addition, Panama has come to stand out as one of the best places to establish business operations for multinational companies. Foreign direct investment has tripled – to $4.6 billion since 2009 – and the investment grade rating of its bonds has been maintained. As a result, Panama has achieved truly global commercial projection and is now one of the most outstanding centres of banking and other financial services in the world. And the number of tourists visiting our beautiful country is now more than 2.2 million annually.
What gives this impressive growth real meaning, however, is that it has come hand in hand with social progress. The past five years of strong economic performance has reduced the unemployment rate from 6.6% to 4.1%, inflation has been controlled, and the number of people afflicted by poverty has steadily fallen. Robust infrastructure investments in healthcare, public transportation and education have resulted in billions of dollars for new hospitals, a vastly improved and expanded transportation system, schools and other social services. Central America’s first subway system will be inaugurated in Panama City next month. Also, we are expecting that once its expansion is completed, Panama and Tocumen International Airport, which we call the “Hub of the Americas”, will become Latin America´s foremost point of connectivity.
For me, it is an honour to host the 2014 World Economic Forum on Latin America in Panama City. The Forum is a particularly prestigious organization that brings together the most important figures from government, the business community, academia and other key elements of civil society.
Panama has a wonderful story of accomplishment to tell. But even more importantly, the country now possesses the energy, dynamism and confidence to continue its trajectory in the coming years and decades – thereby contributing significantly to a hopeful regional future. The forthcoming event presents a unique opportunity for Latin America to double its efforts to achieve the bright future its peoples deserve. And we are confident that its deliberations will greatly contribute to that common objective.
Under the theme of Opening Pathways for Shared Progress, we invite you to accompany us in offering perspectives on, and thoroughly discussing, the opportunities and challenges outlined in the agenda: Driving Economic Dynamism, Innovation for Social Inclusion, and the Modernizing of Infrastructure. We Panamanians will make certain that our greatest infrastructure project – the Panama Canal and its ongoing expansion – figures prominently within that agenda, especially since this year we celebrate its 100th anniversary.
I deeply believe in the unique beauty, opportunities and potential of Panama – and Latin America as a whole. And I am most pleased to invite you all to become active participants in deliberations that will, hopefully, serve to guide the next stage of our region’s development.
Author: Ricardo Martinelli, President of Panama. He is participating in the World Economic Forum on Latin America 2014 in Panama City.