U.S. Department of the Treasury’s Office of Technical Assistance (UST-OTA) discussed worldwide financial crisis and the second order effects that have created the recession.
There were three catalysts for the international financial crisis:
- Excessive levels of investment capital, as liquidity moved from the stock to housing markets
- Elevated investor expectations based on the returns of the 1990s
- Sustained global economic growth that banks thought would continue.
Mr. Leonovich believes that the crisis was primarily caused by failures in risk management. Banks were thought to be safeguarders of investments. Instead, banks sought out more attractive returns and accepted too much risk. Asset prices increased excessively. Many banks did not realize the cyclical nature of real estate prices despite warnings from organizations like the IMF. Banks became over-leveraged at unsustainable rates. Much of this risk was carried off the balance sheet and was thought to not be of concern to banks. However, the reputation of these funds required banks to support these investments.
Companies that made loans were disincented to do so with the appropriate due diligence. Asset deflation in the United States created a vicious downward spiral that including the locking up of credit markets and crisis of confidence among banks.
Mr. Leonovich discussed the need for better regulatory standards. He pointed out the need for international vehicles and the issue of sovereignty. The standards need to be harmonized. He suggested that there needs to be a renewed focus on Basel II. The crisis has helped to better understand risk.
Mr. Leonovich compared credit swaps with a game of "3 card monte". Better capital allocations is going to be important in regulatory standards.
Me Leonovich pointed out best practices to overcome these issues. He hightlighted. approaches to recapitalization by government only after full diagnostic of bank viability and carving out bad assets. He pointed out some approaches like "Good Bank/Bad Bank", and bridging banks so that they can be acquired
Central Banks have an important role to create incentives for investment. The key challenge in easing monetary policies is how to avoide inflation or deflation. Governments require to provide fiscal stimuli, and safety net provisions. Governments and banks need an exit strategy according to Mr. Leonovich.