以風險與獲利之平衡為前提來改造金融市場 - 政大學術集成

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(1)國立政治大學商學院國際經營管理碩士學程 International MBA Program College of Commerce National Chengchi University. 立. 治政碩士論文大. ‧. ‧ 國. 學. Master’s Thesis. io. sit. y. Nat. 以風險與獲利之平衡為前提來改造金融市場. n. al. er. Restructuring Financial Market with balancing risk and profit. Ch. engchi. i Un. v. Student: 徐國業 Advisor: 吳文傑. 中華民國九十八年十二月 December 2009.

(2) 以風險與獲利之平衡為前提來改造金融市場 Restructuring Financial Market with balancing risk and profit. 研究生：徐國業. Student: Kevin Tsui. 指導教授：吳文傑. Advisor: Jack Wu. 治政國立政治大學大. 商學院國際經營管理碩士學程立. ‧. ‧ 國. 學. 碩士論文. n. er. io. sit. y. Nat. A Thesis Submitted to International MBA Program a lNational Chengchi University v C hfulfillment ofUthen iRequirements in partial engchi for the degree of Master in Business Administration. 中華民國九十八年十二月 December 2009.

(3) Abstract Restructuring Financial Market with balancing risk and profit By (徐國業) This case study provides an analysis of the global financial crisis that began in 2007. What caused the crisis, who had been impact by this event, where does the economy currently stand, and what is the outlook for future going forward? The. 政治大. economy will surely recover at some time in the future.. 立. This case study. reviews key economic facts, provides an introduction to risk and financial. ‧ 國. 學. management concepts.. ‧. n. er. io. sit. y. Nat. al. Ch. engchi. 1. i Un. v.

(4) TABLE OF CONTENTS 1. Background…………………………………..………………………….4 2. Implications of the Financial Crisis…………………………………….12 3. Risk transfer market…………………………………………………….14 3.1 Securitization………………………………………………………………...……..14 3.2 Multi risk product…………………………………………………………………...15 3.3 Collateralized Debt obligation………………………………………………………16 3.4 The Problem of Credit Rating……………………………………………………….17. 政治大. 3.5 Dispute to the Credit Rating Agency (CRA)………………………………………..18. 立. 3.6 Bundling of Risk…………………………………….……………………………….19. ‧ 國. 學. 4. Enterprise response to the Financial Crisis……………………...…….....21. ‧. 4.1 Balancing risk and profit …………………………………………………...………...21 4.2 Identify Risk ………………………………….…………….…………………………22. y. Nat. er. io. sit. 4.3 Enterprise Risk Management…………………..…………………………..……….. ..23 4.4 Diversification strategy………………………..……………………………..……......25. n. al. Ch. i Un. v. 4.5 How risk affect the operation of banking system…………..…………………..……..27. engchi. 5. Governments response to the financial crisis……………………………..31 5.1 Repairing the Financial system………………………………………………….……..31 5.2 Purchases of “Toxic” assets……………………..……………………………………..31 5.3 Capital Injections into financial institutions……………………………………………31 5.4 Reorganizations of financial institutions……………………………………………….33 5.5 Government control on the Credit Agencies……………………………………………33 5.6 Balance of Advantage………………………………...………………………….……..37. 6. Consumer response to the crisis……………...…………………………....39. 2.

(5) 7. Conclusion………………………………………………………………...41 Reference……………………………………………………………….……42 Appendix 1…………………………………..………………………….……43 Appendix 2………………………………..…………………………….……44 Appendix 3………………………………………………………….………..45 Appendix 4……………………………………………………………...……46. 立. 政治大. ‧. ‧ 國. 學. n. er. io. sit. y. Nat. al. Ch. engchi. 3. i Un. v.

(6) 1. Background The subprime crisis, which has its roots in the closing years of the 20th century, became apparent in 2007 and has exposed pervasive weaknesses in financial industry regulation and the global financial system.”.. It did not only lead to the collapse of financial institutes such. as the New Century Financial Corporation, Washington Mutual, LBH. great fluctuation on the real estate price.. Indeed, there was a. The financial crisis in 2007 addressed the problems. that the traditional risk evaluation methodology is no longer able to make a reasonable. 治政大 or government sector who Therefore, for all those individual investors, instituted investors 立 judgment on these new financial products: structure finance, interest derivative etc.. relied on risk rating from the “Credit rating agency (CRA)” to make an investment decision. ‧ 國. 學. had been impacted from the incident to some extent. However, during the period of strong. ‧. expectations in global economic growth, growing capital flows, and prolonged stability,. sit. y. Nat. market participants were seeking higher yields without an adequate appreciation of risks and. io. er. thus, failed to exercise proper due diligence. At the same time, inappropriate underwriting. al. standards, poor risk management practices, increasingly complex and unclear financial. n. iv n C products, and the excessive leveragehcreated more uncertainty e n g c h i U to the market. Policy-makers, regulators and supervisors, in some developed countries, did not effectively address the problems on risks building up in financial markets, and the pace with financial innovation; this was an example of someone who drove a super roadster without a good control system. In the following section, I summarized some of the root cause of the (2007 to current) financial crisis.. Over expectations on strong economic growth All eyes are on the Beijing Olympic Games. The Chinese Government put a large amount of. 4.

(7) resources to prepare for the 2008 Beijing Olympus game. As a result, people have high expectations on the economic growth during and after the Olympics. The Olympic Games increased in tourism numbers, investment in infrastructure, inflation, exchange rate, and economic growth. From an economic point of view, it is not clear how important the Olympics will be. There is a foreseeable increase in aggregate demand in a short period of time. But it remains a relatively small percentage of the total GDP.. Indeed, the multiplier. effect could magnify the aggregate demand. Similarly, the investment improvements could lead to future economic growth.. All of the above could be a consequence of the 2008. 政治大. Olympics game in the long run. A problem could be caused due to the over expectations on. 立. the short run of economic growth in China.. As a result, the investors will expect the oil and. ‧ 國. 學. commodity price to increase. The price of oil and commodity always break the highest record which had never been met before. The price had been a fluctuation, which created a huge. ‧. international payments imbalances and unleashed inflationary forces in oil and commodity. sit. y. Nat. consuming nations.. n. al. er. io. Figure1: Research by Price water house and Coopers find that Olympic games rarely lead to a boost in economic growth rates. Ch. engchi. 5. i Un. v.

(8) The fluctuation of Housing prices Another major macroeconomic shock in recent years is a large decline in housing prices. In the decade leading up to 2006, housing prices grew rapidly before collapsing by more than 25 percent over the next three years. Fueled by demand pressure during the new economy of the late 1990s, by low interest rates in the 2000s, and by ever-loosening lending standards, prices increased by a factor of nearly 3 between 1996 and 2006, an average rate of about 10% per year. Gains were significantly larger in some coastal markets, such as Boston, Los. 政治大. Angeles, New York, and San Francisco.. 立. Alarmingly, The National index for housing prices in the United States declined by 26.6%. ‧ 國. 學. between the middle of 2006 and the end of 2008. This is remarkable because it is by far the largest decline in the index since its inception in 1987. By comparison, the next largest. ‧. decline was just 7% during the 1990 to 91 recession.. What caused the large rise and then. y. Nat. er. io. sit. sharp fall in housing prices? The answer brings us to the financial turmoil in recent years. Figure 2: Bubble in U.S. Housing Price (Robert Shiller. A Supplement Macroeconomics. W.W. Norton, 2008). n. al. Ch. engchi. 6. i Un. v.

(9) Subprime lending The subprime was launched in the market since 1993. Many companies entered the market when the interest rate was low; the negative real interest rate was another reason for the growing mortgage market and the more complex subprime market. Subprime lending is a financial term which represented the classification of obligors with a faulty or limited credit record to the bank.. Subprime loans actually carry more credit risks in the perspective of the. mortgage loan owners. Hence, the obligors would most likely have to bear higher interest rates. The reason is due to the subprime borrowers who tend to have a shorter time extent,. 政治大. higher default rates and fewer opportunities to refinance at a lower interest rate from the loan. 立. Also, the strong expectation on the continuing growth of real estate market which. 學. ‧ 國. market.. made the bank have less awareness on the liquidation issue. The loan originator of subprime lending maintains the practice that extends credit to people who would otherwise not have. ‧. access to the credit market. Subprime lending developed market demand in high-risk. y. Nat. er. io. a. sit. borrowers with imperfect credit.. n. iv Over expectations on shortl term profit and lack of incentives for the long run growth. Ch. n engchi U. The expectation of profit has been increasing every year. Growing does not seem to be a word, which can shock the stakeholders anymore; this is an issue that a company should deal with no matter what circumstances they are in or even in the recession period, since investors tend to have an assumption that their companies are always the exceptional. For instance, it is almost impossible for a big commercial bank to have a growth of 10 percent per year; this unexpected growth rate has given a good reason for the management to increase the leverage or the risk level of investment to attain an unachievable target.. Second, most of the senior. management’s compensation or the people called “Fat Cat” are largely based on the stock 7.

(10) price and which is to be driven by the short term event. For example, if you invested in a long term investment and give a company over twenty years of stable growth after the five years basis construction. In comparison with the management which invests in risky business and has a high return in the next year along with a high default rate. In the current compensation mechanism, which drives most of the senior management to pick the later one, since long run profits are not able to sustain their positions in the short run and most of the investors are looking after their short run profit rather than the long run profit. Also most of the top executives have the “Golden Parachute” to protect them from being taken over by another. 政治大. firm; resulting in loss of their jobs. (An exceptional compensation package offered by the. 立. acquiring company to the top executives of the company being bought): the offer is meant to. ‧ 國. 學. keep those executives interested in retaining their positions. The offering of the In-The-Money options and additional large bonuses may also not be in the best interests of shareholders, as. ‧. the executive holding the options could be unaffected by large swings in share prices.. y. Nat. sit. Furthermore, there is lack of incentives to make the best possible decisions, which could. n. al. er. io. impact its share prices, since the executives often receive the benefits irregardless of how well the company performs in the long run.. Ch. engchi. i Un. v. Overwhelm in Money supply and Easy Credit in the Market Too much money was seeking a high investment return. Rapid increases in the money supply (or by decreasing interest rate/ easy credit) cause an unsustainable investment boom (Figure 3). The increased money supply lowers interest rates, and thereby, lower interest rates cause businesses to invest more in longer term projects. In contrast, low interest rates cause households to put less money into savings while focusing more on immediate consumption. It is obvious that the recent boom was driven largely by both a boom in household consumption and investment in new construction. The problem with all this consumer and business 8.

(11) spending is that it is financed by increased money supply, rather than by real increases in economic productivity, and such monetary booms must lead to inflation. Efforts by central banks to sustain money which was driven by booms lead to uncontrolled increases in inflation. Of course, it takes years for inflations to become noticeable, but once inflation begins to build, the only way to prevent it from getting worse is for central banks to raise interest rates. At the same time, increased interest rates have a depressing effect on economic activity; in this case, higher interest rates led to a major financial crisis. This has always been a difficult decision for the central bank.. 立. 政治大. Figure3: Estimated Global Monetary Aggregates from 1971 to 2009. ‧. ‧ 國. 學. n. er. io. sit. y. Nat. al. Ch. engchi. i Un. v. Inappropriate risk rating Instead of using an in-house risk analysis for each investment opportunity. More companies used risk rating result from CRA, e.g. Fitch Ratings, Moody's, Standard & Poor's, and Credit Pointe.. A credit rating agency is a company that assigns credit ratings for issuers of certain. types of debt obligations as well as the debt instruments themselves. In some cases, the servicers of the underlying debts are also given ratings. In most cases, the issuers of securities 9.

(12) are companies, special purpose entities, state and local governments, non-profit organizations, or national governments issuing debt-like securities that can be traded on a secondary market. A credit rating for an issuer takes into consideration the issuer's credit worthiness, and thus, affects the interest rate applied to the particular security being issued. When the Securities and Exchange Commission submitted a report to Congress detailing plans to launch an investigation into the anti-competitive practices of credit rating agencies and issues including conflicts of interest, the value of such ratings has been broadly challenged after the 2008 financial crisis. This in turn increases the total supply of risk capital in the economy, leading. 政治大. to stronger growth. It also opens the capital markets to categories of borrowers who might. 立. otherwise be shut out altogether: small governments, and startup companies.. ‧ 國. 學. Fluctuation of Oil Price. ‧. After nearly two decades of relative calm of oil Price, oil prices again rose in mid-2008 to. y. Nat. sit. levels never seen before. From a low of about $20 per barrel in 2002, oil prices peaked at. n. al. er. io. more than $140 per barrel during the summer of 2008 (Figure 4). This seven-fold increase is. i Un. v. comparable in magnitude to the oil shock of the 1970s. Other basic commodities such as. Ch. engchi. natural gas, coal, steel, corn, wheat, and rice also featured large price increases. Then, spectacularly, oil prices declined even more sharply so that by the end of 2008, they suspended around $40 per barrel. Why did these prices rise and then fall so sharply? It is instructive to consider the case of oil more carefully. The first fact to appreciate is that world oil consumption has increased significantly during this same period of sharply rising prices. For example, during the first half of 2008, a decline in oil consumption among OECD countries was more than offset by increases in China, India, and the Middle East. Rising prices coupled with rising quantities are a classic sign of an outward shift in demand, and it appears that rising demand — throughout the world but especially among some rapidly 10.

(13) growing emerging economies — is a major driving force behind the increase in the prices of basic commodities. Shorter-term factors such as supply disruptions, macroeconomic volatility (in the United States, China, and elsewhere), and poor crop yields appear to have played a role in exacerbating the price movements. The economic slowdown associated with the global financial crisis then relieved this demand pressure, at least partially, which goes some way toward explaining the recent declines. Nevertheless, it is difficult to justify both $140 per barrel in the summer of 2008 and $40 per barrel more recently as both being consistent with fundamentals; some speculative elements seem to have played a important role in the price fluctuation.. 學. ‧ 國. 立. 政治大. Figure 4: Crude oil prices Trend (1990-2008). ‧. n. er. io. sit. y. Nat. al. Ch. engchi. 11. i Un. v.

(14) 2. Implications of the Financial Crisis Impact on Global economy “2008 would see a clear global recession, with recovery unlikely for at least two years” reported by UBS analysis on October 6, 2009.. The world was starting to make necessary. actions to fix the crisis for example capital injection by governments, interest rate cutting to help borrowers. The report also stated that US needed to implement systemic injection in huge amount of budget. The failure of banks to manage risks has led to an enormous sell-off. 治政 Even as Central Banks inject money into 大 the global economy, interbank 立. of their stocks, further draining them of liquidity, and leading many of them to almost bankruptcy.. lending was even hard to achieve because banks are afraid of dispensing their outstanding. ‧ 國. 學. credit line to unstable counterparties.. ‧ sit. y. Nat. Impact on Financial sector. io. er. The 2008 financial crisis is likely to bring the biggest banking slump, since the financial. al. crisis in 1930s. The first victim was Northern Rock, a medium-sized British bank. The. n. iv n C highly leveraged nature of its business to request security from the Bank of h eledntheg bank chi U England. This in turn resulted in awareness for the investors. Thereafter, followed by a series of bank and insurance company failures triggered a financial crisis that effectively halted global credit markets and required one of the largest government intervention ever. Fannie Mae and Freddie Mac were both taken over by the government. Lehman Brothers declared bankruptcy on September 14th after failing to find a buyer. The Bank of America agreed to purchase Merrill Lynch, and American International Group AIG was rescued by an $85 billion capital injection by FED. Thereafter, J P Morgan agreed to purchase the assets of Washington Mutual, which was the biggest commercial bank failure in history.. 12.

(15) Impact on Consumer Market There is a direct relationship between declines in wealth, consumption investment environment, and government spending - the economic engine, which in turn decreased the future GDP growth.. The US Retail Sales ratios are estimated to have declined by 2 to 3%. for the 2008 holiday seasons in compared to previous year as a result of falling consumer spending. Retail sales figures will continue to fall as household budgets are constrained by lower disposable incomes.. Tax rate cuts to lower and middle income families should. support the ongoing recovery of household spending in the second half of 2009 and. 政治大. thereafter. Housing price has been decreasing significantly since 2006.. 立. Insufficient Effective demand to cover and the expectation on long run recession, which. ‧ 國. 學. led to the higher saving ratio. In this situation, increasing money supply cannot solve the problem; inflation can only increase the price in the long run.. If existing expected. ‧. inflation, instead of the long run effective demand growth occurs, then the long run. y. Nat. n. er. io. al. sit. unemployment rate will continue to grow. (Figure 4). i Un. v. Figure 4: Average Outcomes of 2007 Financial Crisis in US market. Ch. engchi. (Carmen Reinhart and Kenneth Rogoff, The aftermath of Financial Crises Dec 2008). 13.

(16) 3. Risk transfer market This crisis was not caused by single independent events, but it also caused a series of risk transfer methodology, people were trying to quantity the risk and properly transfer to other party or insurance companies. But we were still using the old school theory; to govern this new service and the risk rating method is the same. Investors used standardized risk rating number to make investment decisions, would be wrong direction. And based on this risk rating number, we are not able to proper evaluate the risk tolerance of the product. The. 治政大 which seems to be another And the capability of risk acceptance of the insurance company 立. same issuer will transfer risk to insurance company, which made them less exposed to risk.. question we are trying to understand.. ‧ 國. 學. 3.1 Securitization. ‧. Securitization is the process of removing assets, liabilities, or cash flows from the corporate. y. Nat. sit. balance sheet and conveying them to third parties through tradable securities- has been a. n. al. er. io. feature of the financial markets for several decades. During the late 1970s and early 1980s. i Un. v. Wall Street investment banks became active in pooling assets and placing them in trust. Ch. engchi. vehicles that issued multiple tranches of securities, each with its own risk and return characteristics. Bundle assets in portfolios results in a reduction in the variance of returns to investors – a considerable benefit to those providing risk capital. Securitization efforts started with mortgage –backed securities (MBS, pools of residential mortgages), collateralized mortgage obligations (CMO, pools of MBS), commercial MBS, and asset-backed securities. During the early to mid 1990 securitization technology was extended to the credit markets, leading to the creation of collateralized loan obligations (CLOs, pools of loans), and collateralized bond obligations (CBOs, pools of corporate bonds)- together comprising the broad class of CDOs, providing another link between the 14.

(17) financial and insurance markets<1>. Credit enhancement: Under a generic financial securitization, an issuing trust is structured as an independent, bankruptcy-remote entity, responsible for managing cash flows, administering receivables and payables, arranging swap hedges, and so on. In order to generate the desired risk and return profiles for each tranche, the trust redirects cash flows from the underlying assets, repaying investors’ principal and interest in order of priority. In most instances the issues are supported by a highly subordinated equity –like tranche, known as the residual, which carries equity returns and risks. In most instances the issues are supported by a highly subordinated equity –like. 政治大. tranche, known as the residual, which carries equity returns and risks. In some instances, the. 立. arrangers also credit-enhance certain tranche through letters of credit, overcollateralization,. ‧ 國. 學. financial guarantees, or insurance scraps, thus creating a higher rating. The intent behind any securitization is two fold: to remove assets or liabilities from the balance sheet, and. ‧. transfer risk to investors. (Appendix 1). sit. y. Nat. n. al. er. io. 3.2 Multi risk product. i Un. v. Multi risk products represent an innovative, flexible, and gradually expanding segment in. Ch. engchi. Risk transfer market. As the name suggests, a multi-risk product is an instrument that combines various exposures into a single contract, giving a firm an efficient and cost-effective risk solutions. Since multi-risk products provide post-loss financing based on the occurrence of one of several events, the effects of correlation and joint probabilities typically result in risk protection that is cheaper than the sum of the individual parts. Multi-risk products can be regarded as a subclass of enterprise risk management or integrated programs, though an integrated program often features multiple instruments, programs or structures covering multiple risk exposures, multi-risk products typically embed risk transfer features into a single contract. Multiple risk contracts have several 15.

(18) beneficial characteristics, including lower transaction cost, lower premium, since the exposures included in such policies are often uncorrelated (recalling that a diversified portfolio had less risk). Less chance of over insurance: since it is unlikely that, in the normal course of business, a firm will suffer simultaneous losses from each of its named exposures.. 3.3 Collateralized Debt obligation The origin of the home mortgage securitization was started from Fannie Mae.. At that time,. Fannie Mae was only focused on high quality home loan with high percentage of down. 政治大. payment and thus, the default ratio was relatively low. The product is now extending to the. 立. low quality of mortgage securitization sector i.e. the Sub-prime securitization. For such a. ‧ 國. 學. high risk product, loan originator will provide a higher expected return ratio to compensate the higher default ratio compared with the regular mortgage. This is a very typical high risk. ‧. return scenario, which is accepted by the general market player.. Nat. y. Collateralized Debt. sit. obligation (CDOs) is an investment-grade security backed by a pool of bonds, loans and. n. al. er. io. other assets; do not specialize in one type of loans or bonds. CDOs are unique in that they. i Un. v. represent different types of debt and credit risk. In the case of CDOs, these different types. Ch. engchi. of debt sequence the payments from high risk to low risk categories. The low risk categories can always be the first one which receives a reply whenever the loan goes to liquidation. The issuer assumed that only a high percentage of home owners go to liquidation, otherwise the CDO will be less likely to default. In addition, this assumption was successful in convincing the Credit Rating agency to rate this kind of product as a good credit rating. With this good credit rating, CDO issuer can always find the market for either high ratio low risk investors. Shadow bank system (i.e. Hedge Funds) raise funds from the public and buy the high risk CDO product. The issuers were convinced to take this action because they believe the real estate price had a lesser chance of downturn in the near future. Even the 16.

(19) home owner would go to liquidation with their sub prime mortgage. They could always possibly to apply for another “home equity loan” in case they cannot refund the payment. Or the worst case is the loan agency will sell the real estate which should be higher than the original price. All of the above is based on one assumption which is the real estate price would be continuously increasing or the real estate price will be in a continuous growth. (Appendix 2). 3.4 The Problem of Credit Rating. 政治大. The major purpose of Credit ratings is used by investors, issuers, investment banks,. 立. broker-dealers, and governments. For investors, credit rating agencies increase the range of. ‧ 國. 學. investment alternatives and provide independencies, easy-to-use measurements of relative credit risk; this generally increases the efficiency of the market, lowering costs for both. ‧. borrowers and lenders. The above rating methodology is also adapted to the rating of. y. Nat. sit. structure finance. Credit rating agencies may also play a key role in structured financial. n. al. er. io. transactions. Different from traditional fixed income securities, which a borrower offers to. i Un. v. pay a certain return on a loan. Structured financial transactions may be viewed as either a. Ch. engchi. series of loans with different characteristics, or a number of small loan products with similar type of risk characteristics and bundled together into a series of buckets (or called "tranches"). Credit ratings often help to determine the interest rate or pricing which is endorsed by a particular tranche.. Company alliance with risk rating agency: Companies involved in structured financing arrangements often consult with credit rating agencies to help them determine how to structure the individual tranches.. Therefore, each receives a desired credit rating. For. example, a firm may wish to borrow a large sum of money by issuing debt securities.. 17.

(20) However, the amount is so large that the return investors may demand a single issuance which would be prohibitive. Instead, it decides to issue three separate bonds, with three separate credit ratings: A (medium low risk), BBB (medium risk), and BB (speculative) by using Standard & Poor's rating system. <2>. The firm expects the effective interest rate is paid on the A-rated bonds, which costs less than the rate that must be paid on the BB-rated bonds and thereafter.. With this. comprehensive calculation, the amount that must be paid for the total capital which. 治政 issue. In the above situation, the companies may consult大 with a CRA to see how it must 立. proposes will be less in compared with the companies who should pay for a single bond. structure each tranche, which means how they can put the minimum amount of assets to. ‧ 國. 學. secure the debt in each tranche, in order for that tranche to receive the desired rating when it. ‧. is issued. This is the exact same case of a player who plays the role of the judge.. er. io. sit. y. Nat 3.5 Dispute to the Credit aRating Agency (CRA). n. iv l C n hengchi U Is it same rating method which is applied on bond risk evaluation are the same with the rating method of the structure product? If they are not the same, why did the risk rating agency use the general acceptance rating method on bond or security and put it into a totally different structure product in terms of risk nature?. There has been a serious discussion in the credit rating on collateralized debt obligation market that occurred in large losses for the investors, even thought the CDO product had been assigned a top rating by the Credit risk Agencies (CRA). Losses on CDO issued by Credit Suisse Group added up to an amount of about $125 million at the end of year 2008,. 18.

(21) despite being rated AAA or Aaa by the CRAs. The rating agencies responded that their advice constitutes only a "point in time" analysis, which means they never promise or guarantee a certain rating to a tranche, and also any change in circumstance regarding the risk factors of a particular tranche will invalidate their analysis and result in a different credit rating. In addition, some CRAs do not rate bond issuances upon which they have offered such advice on a more complicated product like CDO. The rating agencies illustrate that their ratings are opinions regarding the likelihood that a given debt security will fail to be serviced over a given period of time, and not an opinion on the volatility of that security. 政治大. and the judgment of investing in that security. Accordingly, the above statement breaks the. 立. concept of highly rated debt securities that are characterized as low volatility and high. ‧ 國. 學. liquidity. What is implied from their answer, the tradition kind of risk rating is no longer to able to properly evaluate the risk in the modern structure product or investors should not. ‧. have the same expectations on the same risk rating on different products for example. y. Nat. n. er. io. al. sit. Straight Bond versus Structure Notes.. 3.6. Bundling of Risk. Ch. engchi. i Un. v. However, where structured transactions that involves the bundling of hundreds or thousands of similar security which is similarly rated. The methodology of concentration on the similar risk security will eventually lead to an enormous effect on price, even a slight change on the default rate of a single product within that bundling security.. This means that even though a rating agency could be correct in its opinion that the chance of default in a structured product is very low, a slight change in the market's perception of the risk can have an excessive effect on the product's market price. As a result, a high rated 19.

(22) security can collapse in price without any faults. This raises a significant regulatory issue that the ratings in securities and banking regulation assume high ratings which correspond with low volatility and high liquidity. Under this circumstance, most of the investors solely or heavily rely on the CRA rating to make an investment decision without putting the companies specified or local specified risk adjustment on it.. 立. 政治大. ‧. ‧ 國. 學. n. er. io. sit. y. Nat. al. Ch. engchi. 20. i Un. v.

(23) 4. Enterprise response to the Financial Crisis More companies have their budget, sales or even expense forecasting for the coming year or years. In the past, forecasting was just a reference for the investor. Now a day, people use forecasting to monitor the performance and expectation of company growth which eventually affect the stock price. Did we ever think that risk should be one of an important indicator to show the value of the company? Is it necessary to be the same for two companies which have the same EPS but different risk forecast can have the same stock price expectation. Can we solely rely on the credit agency’s risk rating to make an. 政治大. investment decision? We will have more pages to discuss this.. 學. ‧ 國. 立 4.1 Balancing risk and profit. Decisions in managerial finance require the simultaneous evaluation of three primary. ‧. elements – profitability, both financial and accounting; liquidity; and risk. Time constraints. y. Nat. sit. are often present. The information availability is necessarily limited, imprecise, and often. n. al. er. io. lacking. The future must be projected but remains uncertain. Personal fallibility and internal politics are inescapable. <3>. Ch. engchi. i Un. v. Profitability: Financial profit is the excess of cash gain over cash outlay (the cash flows) for the project life. Discounted at the current cost of fund. The excess of the discounted cash over the current cash outlay is net present value also expressed as a percentage rate of return, or yield. Proposals to make investment projects must be carefully defined for cash flows, economic life, and tax effect. Financial profitability is the primary decision factor, but accounting profit must also be determined, based on company practices. They are different, often to a significant extent. The accounting results often show losses or very low profits in the first few years of project life. This reduces reported earnings and earnings per share 21.

(24) (EPS) with a possible adverse effect on market valuation.. Risk: Every investment project involves some degree of possible variation in the amount and timing of cash flows. Estimating the extent and probability of such variations provides a basis for better evaluation and for more effective communication among managers. The risk of loss or failure to earn the minimum profit is called the downside risk; the opportunity to do better is called the upside potential. The response of individuals to risk is highly subjective and is variable over time and as to types of risk and amounts. This is known as. 政治大. the utility function. Risk aversion and risk tolerance affect all decision to an unknown. 立. extent.. ‧ 國. 學. Liquidity: depends on the continuing inflow of cash, in amount and timing, sufficient to. ‧. meet all obligations for cash outlay. Variability of cash inflow that threatens liquidity can be. y. Nat. sit. guarded against by cash reserves, borrowing capacity, sale of stock, and disposal of assets.. n. al. er. io. The possibility of insolvency imposes a retain management freedom of action, which may. i Un. v. impair profitability, particularly in the long run. Investment proposals must be evaluated for. Ch. engchi. their effect on liquidity, as well as for profitability and risk. The required cash outlays are scheduled for the near term in predictable amounts, but the cash inflows extend into the future and may have a high degree of variability. Hence some profitable proposals may be foregone, or deferred, to preserve future liquidity.. 4.2 Identify Risk Systemic risk (market risk/ Non-diversifiable risk) From the risk point of view, companies will tend to identify the unsystematic Risk (or specific risk), which is the Company or industry specific risk that is inherent in each investment. 22.

(25) Certainly, the amount of unsystematic risk can be reduced through appropriate diversification or insurance to moderate the risk.. Total risk is equal to unsystematic risk plus the systematic. risk; interest rates, recession and war are all represent the sources of systematic risk because they affect the entire market and cannot be avoided through diversification. In fact, a portfolio of well-diversified assets cannot escape all risk, which means companies can diversify their unsystematic risk by increasing their target market.. Non-Systemic risk (diversifiable risk) is company-specific, and can be reduced by holding. 政治大. a portfolio with a large number of obligations. Risk is everywhere. Success in business. 立. often comes down to recognizing and managing possible risks associated with potential. ‧ 國. 學. opportunities and returns. The types of risks faced in most businesses are quite varied and far ranging. Risks typically include both financial and physical categories. Types of risk. ‧. include sometimes apparent hazards, such as safety and health risks associated with. y. Nat. sit. operations, as well as financial risks from exposures to market price volatility, counter party. n. al. er. io. credit defaults, and legal liabilities. Some risks are intuitively obvious; unfortunately, many. i Un. v. are not. Risk categories include: Market, Credit, Legal, Regulatory, Political, Operational,. Ch. engchi. Strategic, Reputational, Event, Country and Model Risks.. 4.3 Enterprise Risk Management The purpose of minimizing risk: A corporation is accountable and responsible to a variety of stakeholders, particularly its equity investors. Investors who supply equity risk capital demand an appropriate return on their capital, and directors and managers, as their agents, must strive to provide the greatest possible return within the mandate of the firm’s business. A company’s share price, which we consider to be a reflection of the discounted value of future risky cash flows of the firm, is one measure of value. Maximizing enterprise value in 23.

(26) order to provide investors with the highest possible share price often becomes an overarching corporate goal. Naturally, different claimholders have different values at stake and different attitudes toward risk; value maximization accounts for the risk costs imposed on all corporate claimholders, not just shareholders.. Maximize enterprise value a firm pursues projects in which the rate of return is greater than the firm’s cost of capital. From a practical perspective, management will seek to maximize the discounted future net cash flows of the firm. Maximizing net cash flows. 政治大. generally infers minimizing expected losses. In fact, most of the firm is seeking to minimize. 立. losses to protect the capitalized value of future earnings. In effect, the process involves a. ‧ 國. 學. decision by a firm to commit current resources to generate future value. It also involves minimizing the volatility of expected losses, as less volatile earnings can lead to a lower. ‧. cost of capital. Indeed, many academic studies strongly support the benefits of using risk. y. Nat. sit. management products to boost cash flows and lower expected loss volatility <4>. Although. n. al. er. io. value maximization is the ideal goal a firm strives at a minimum, to avoid financial distress. i Un. v. and the costs associated with a weakened financial position; it must understand loss events. Ch. engchi. that can damage its financial performance and creditworthiness, and within the confines of rational cost/ benefit behavior.. Value creation centers on the actual returns that can be obtained from corporate assets, less the cost of capital needed to support those assets. Value is created when the net return is positive, and the focus is on what assets earn, how much it costs to refund them, and the amount of leverage involved. For instance, and insurance company creates value when the net return from underwriting and investment activities is greater than thee cost of capital. Actions that are taken to lower the cost of capital can create even more value. Through 24.

(27) diversification and reinsurance an insurer can lower the volatility of underwriting results and the cost of capital, and raise enterprise value assuming that the cost of diversification and reinsurance are not so great that they offset the gains generated from lower volatility of underwriting results.. Cost and Benefit A company can be exposed to a range of financial and operating risks. These risks can impact enterprise value by affecting expected Net cash flow through size, timing and. 政治大. variability. Fundamentally, a firm must consider the cost of risk the implicit or explicit price. 立. paid to manage risk exposures when it is creating a risk management strategy, since the cost. ‧ 國. 學. of risk directly affects enterprise value. The cost of risk comprises various theoretical components.. The ultimate goal of any value-maximizing firm must be minimization of the. ‧. cost of risk. This, as we shall see, is not necessarily the same as minimizing risk.. y. Nat. sit. Therefore, if the expected cost of risk management techniques is greater than the benefit. n. al. er. io. obtained from a reduction in the cost of capital, then hedging, diversifying or otherwise. i Un. v. protecting expected net cash flow may not increase enterprise value. vice versa. (Appendix 3 and Appendix 4). Ch. engchi. 4.4 Diversification strategy A company might wish to purchase insurance to reduce Net Cash Flow variability. If the expected cost of the loss-financing protection is less than the estimated future Net Cash flow, then it is sensible to acquire protection and eliminate uncertainty. However if the company believes that the cost of insurance is too high, It may proceed unprotected by retaining the uncertainty. If it has sufficient cash on hand to cover any losses arising from a future event it must then decide whether to use internal funds to cover the loss when it 25.

(28) occurs, or borrow against expected future cash flows and use funds on hand to invest in an alternative project. The cost/ benefit tradeoff decision surfaces once again; if the project has a positive NPV and outweighs securities issuance or bank-borrowing fees, it may be optimal from an enterprise on hand and lacks loss financing protection is in a lightly different position; it can borrow against future cash flows in order to cover today’s losses, or it can declare bankruptcy. Supposedly, if a company is able to diversify away risk; investors should demand a lower required rate of return. The question is whether a company can do this diversification efficiently. Risk can be divided in to two components: diversifiable risk. 政治大. and non diversifiable risk. Below figure highlights these relationships.. 立. ‧ 國. 學. The more a company spends on its cost of risk, the more variability it eliminates from expected NCFs, but the more it reduces its operating income. All other things being equal, a. ‧. firm with lower expected NCFs reduces its probability of insolvency. However, at some. y. Nat. sit. point the marginal cost of loss control, loss financing and risk reduction will be greater than. n. al. er. io. the reduction in expected losses; when this occurs the firm’s risk elimination, diversification. i Un. v. and control techniques no longer serve to maximize enterprise value. This brings us back to. Ch. engchi. our earlier point: it is possible to create a completely risk-free company, but the endeavor is unlikely to yield an enterprise with maximized value.. Let us consider a simple framework. to illustrate several key points of the concept. To begin, we assume that maximizing enterprise value means maximizing the present value expected probability of earning $70 in one year, the expected NCF one year from now 97. Discounting back at a 5% rate yields a present value of expected NCF of 92.38. This is the enterprise value today, before the firm undertakes any risk management activities.. 26.

(29) 4.5 Risk management for banking operation Banking History: Banks were built for people who want to safely store valuable asset like custody or safekeeping. Bankers noticed that they can earn money by receiving the deposit and lending the borrower with higher interest rates (spread). Now a day, banking regulation is approaching perfection thought the previous experience of financial incident or crisis by having local banking regulation or global banking regulation like the Basel Accord.. Glass-Steagall Act: An act passed by Congress in 1933 and officially named the Banking. 政治大. Act of 1933, introduced the separation of bank types according to their business. 立. (commercial and investment banking); it was found that the Federal Deposit Insurance. ‧ 國. 學. Corporation was insuring bank deposits. Commercial bank had a strong regulation on risk control that prohibited them from collaborating with full-service brokerage firms or. ‧. participating in investment banking activities. But at the same time, they were more easily. y. Nat. sit. able to get credit support form the Fed. The Glass-Steagall Act was enacted during the. n. al. er. io. Great Depression. It protected bank depositors from the additional risks associated with. i Un. v. security transactions. However, the act was dismantled in 1999 <5>. Consequently, the. Ch. engchi. distinction between commercial banks and brokerage firms had been blurred; many banks own brokerage firms and provide investment service to the public.. The Major responsibility of Bank and investment banks Investment banks, commercial banks, and universal or integrated banks are focused primarily on originating and managing financial risks. Similar to insurers, they have very specific duties and functions, which they perform to varying degree (depending on regulatory rules, specific expertise, and corporate strategy). These can include originating credit facilities and loans; providing wealth management, risk management, and corporate 27.

(30) finance advice; underwriting capital market securities (e.g. equities, bonds) on a primary basis; trading assets (equities, bonds, loans, derivatives, foreign exchange) on a secondary basis; developing structured products and other synthetic asset (via cash products and derivatives).. Corporate Bank function in detail (banks step in to the insurance company): Most banks have considerable expertise in designing products and pricing and trading multi-year, bundled risks (e.g. credit, market, liquidity). While that remains their core business, the. 政治大. most innovative have expanded into the insurance world and regularly assume. 立. insurance-related risks. As with insurers, financial institutions are searching for. ‧ 國. 學. opportunities to expand and diversity revenues in uncorrelated areas, including insurance and risk transfer market. For instance, several large investment and universal banks have. ‧. been at the forefront of insurance-related capital market issues, and various others have. y. Nat. sit. actively sought to transfer capital markets risks to the reinsurance market through their own. n. al. er. io. dedicated reinsurance subsidiaries. Some have also become involved in trading insurance. i Un. v. related-derivatives. More generally, some of the world’s largest banks own insurance. Ch. engchi. subsidiaries that permit them to underwrite certain types of life and annuity covers for their clients. In addition to revenue diversification, financial institutions may be active in “risk transfer” for internal risk management purposes.. Expand Risky Business: Many banks are eager to transfer their risks in order to lower capital charges and write new business. In many cases risks that they originate, particularly in the credit markets, are passed to the insurance sector, who may have some comparative advantage in assuming exposure as a result of unique regulations and diversification, pricing, and risk management policies. In fact, banks have actively worked with insurers in 28.

(31) recent years in transferring credit risks. As noted above, insurers provide a variety of covers on pools of corporate credit risk and also act as investors in a range of trances. Banks routinely create customized trading desk CDOs and portfolio default swaps for insurances, who essentially sell them the required protection.. Mergers and acquisitions make it more complicated: Various mergers and acquisitions have occurred within the banking universe in recent years as firms attempt to create greater operating efficiency, financial strength and broader business and distribution networks.. 政治大. National and cross-border consolidations within the investment banking and commercial. 立. banking sectors have occurred regularly since the mid-1990s. It is also worth nothing that in. ‧ 國. 學. some instances financial institutions and insurance companies have merged their operations, creating very broad-based financial conglomerates that can offer insurance, reinsurance, and. ‧. banking products. These firms are arguably well positioned to offer integrated insurance/. y. Nat. sit. banking products and solutions. This cost sell channel is actually making control to the. n. al. er. io. financial sector even harder.. Shadow banking system:. Ch. engchi. i Un. v. Auction rate security is a typical example for the Shadow. Banking System <6>. The first Auction rate security was invented by Lehman Brothers in 1984 which was referred to a debt instrument with a long-term nominal maturity for which the interest rate is regularly reset through an auction. As bank loans became more expensive, the auction market became increasingly attractive to issuers who were seeking the lowest costs and flexibility of variable rate debt. Therefore, buyers received a slightly higher interest and an apparent assurance of liquidity through the auction process. It appears to be a good deal, since Auction rate security provides a better interest return than commercial banks.. Also Auction rate security is not monitored by FED, since they were launched by 29.

(32) an investment bank.. Even though, they are actually doing the same as the commercial. bank which is lending money by using the deposit from the shareholder. The Auction rate security had its highest transaction volume at 200 billion <7>. Since February 2008, most auctions have failed, and the auction market has been largely frozen. In late 2008, investment banks that had marketed and distributed auction rate securities agreed to repurchase most of them at par. Shadow banks are getting more important as the transaction volume is growing so fast from year to year. The five major investment banks (Shadow bank) were growing so fast as they were selling products including structured investment. 政治大. vehicles, tender option bond, and variable rate demand notes tri-party repo. The total asset. 立. value for these big five investment banks accounted for US four trillion in the beginning of. ‧ 國. 學. 2007. At the same time, the total asset value for these top five commercial banks was USD six trillion, which means almost 40% of lending activity, was not properly regulated by FED.. ‧. In February 2008, the auction market failed, and most auction rate securities have been. y. Nat. sit. frozen since then, with holders unable to dispose of their securities. Investment banks that. n. al. er. io. participated in the distribution and marketing have agreed to repurchase approximately $50. i Un. v. billion in securities from investors<8>, under duress of investigations by the U.S. state. Ch. engchi. attorney general and auction rate security has become history.. 30.

(33) 5. Governments response to the financial crisis 5.1 Repairing the Financial system: Most Economists agree that restoring the basis functions of the financial system intermediating deposits as loans to businesses and households as efficiently as possible is one of the highest priorities. There is much less agreement on the best way to accomplish this goal. Broadly speaking, three types of policies are being considered and implemented to various degrees.. 5.2 Purchases of “Toxic” assets: one factor limiting lending by banks is that they have. 政治大. significant quantities of troubled assets on their balance sheets. These are securities whose. 立. values are greatly reduced but also uncertain because the usual markets in which they trade. ‧ 國. 學. have dried up.. Mortgage-backed securities are a typical example from this financial crisis.. The idea in the original Troubled Asset Relief Program (TARP) was that the government. ‧. would purchase many of these assets from financial institutions. The difficulty is that what. y. Nat. er. io. a. sit. price the purchase should be made.. n. 5.3 Capital Injections into financial institutions. If thei vmain problem with lending is l. n U i e h n g capital c directly into the banks may be useful. that banks are undercapitalized, then injecting. Ch. This is what the original Troubled Asset Relief Program (TARP) actually ended up doing. The government invested $25 million in each of many large financial institutions and took equity stakes in these firms. By some estimates, however, losses in the financial sector may be measured in the trillions of dollars, much larger than the equity injections that have taken place so far. Because of leverage, each dollar of equity can in principle be turned into $10 of loans, which is part of the appeal of this option. On February 17, 2009, US President Obama signed into law the American Recovery and Reinvestment Act of 2009, a $787 billion package designed to stimulate aggregate demand in 31.

(34) the economy<9>. The final plan includes more than $250 billion in tax cuts and more than $500 billion in new government spending on unemployment benefits, infrastructure, education, health care, and aid to state and local governments. According to the Congressional Budget Office, about $185 billion of the stimulus will occur in 2009, with another $400 billion coming in 2010. Given the macroeconomic situation, many economists support some kind of fiscal stimulus. With the fed funds rate at zero, short-run output turning sharply negative, and deflation a possibility, a large fiscal stimulus seems prudent. The main areas of disagreement among economists concern the types of. 政治大. spending and the relative weight on tax cuts versus new spending.. 立. The Congressional Budget Office (CBO) provides estimates of the impact of the fiscal. ‧ 國. 學. stimulus package on the macroeconomic. These estimates come in the form of forecasts for short-run output and the unemployment rate. In the absence of a stimulus package, the. ‧. Congressional Budget Office forecasts are troubling, with short run output reaching -7.4% in. y. Nat. sit. 2009 and the unemployment rate peaking at 9.0%. <10> The Congressional Budget Office. n. al. er. io. then provides two forecasts including the impact of the stimulus, a “low estimate” based on. i Un. v. pessimistic assumptions about the effects of the package and a “high estimate” based on. Ch. engchi. optimistic assumptions. Notice that even in the best case scenario, the recession is long and deep, with output staying below potential until around 2013. The fiscal stimulus effect had been adopted by Japanese government following its financial crisis and deflation in the 1990s. The ratio of government debt to GDP rose from about 13% in 1991 to 90% in 2006, as government spending exploded sharply to stimulate the economy. On the surface, Japan’s slow growth in the 1990s might be taken as evidence of little payoff from its fiscal stimulus. On the other hand, Japan did not experience a depression in the 1990s despite enormous collapses in the stock market and the housing market. This could be caused by timely applying the fiscal stimulus and thus preventing the situation from becoming even worse. 32.

(35) 5.4 Reorganizations of financial institutions. A standard remedy when liabilities exceed assets in a firm is for the firm to file for bankruptcy. The government steps in and reorganizes the firm if possible so that it can resume its business. The essential way the reorganization works is as follows. Equity (net worth) is already zero or even negative, so the stockholders have lost their entire investment. Debt is then reorganized in to new equity claims. That is, debt is written down to zero and the former debt holders are given equity claims in the newly reorganized firm. Essentially, the value of the debt at the time of bankruptcy becomes the new equity in the new firm. In the context of the financial crisis,. 政治大. this last option has a number of appealing features. First, the stockholders and bondholders. 立. in the financial firms that have magnified the crisis bear the brunt of the cost of putting the. ‧ 國. 學. financial institutions back on their feet; there is no cost to taxpayers. Second, the banks are recapitalized and should emerge with willingness an ability to lend.. ‧ y. Nat. sit. 5.5 Government Control on the Credit Agencies. n. al. er. io. Why does the credit rating system exist? It arose in the 1970s when the SEC looked for a. i Un. v. way to ensure that the brokers it regulated had enough capital. It was much easier for the. Ch. engchi. commission to accept the opinions of a few agencies than to research every single bond itself, and it also saved money (and regulatory risk) for the brokers the act was known as Nationally Recognized Statistical Rating Organizations, or NRSROs. At the same time, those rating agencies have earned huge sums in the past ten years offering opinions on the creditworthiness of an alphabet soup of mortgage-related securities created by over-eager banks. As the market blossomed, so did the agencies’ profits. Moody’s net income rose from $289m in 2002 to $754m last year <11>.. 33.

(36) “The events of recent months have had a profound effect on our economy and our markets, and they have galvanized regulators and policymakers not only in this country but around the world to re-examine every aspect of the regulatory framework governing credit rating agencies,” said SEC Chairman Christopher Cox.. The agencies feel harmed at the criticism. S&P says it has downgraded just 1% of subprime residential mortgage-backed securities, and that none of those downgrades affected the triple-A bonds. So far, defaults have hit only three of the mortgage tranches it has rated. Of. 治政大 just 1% of securities by value (*13). 立. more complex products, collateralized-debt obligations (CDOs) downgrades have affected. ‧ 國. 學. Analyst might retort that the agencies are behind the times; market prices for subprime-related bonds suggest many are in deep trouble. But the agencies argue that their. ‧. ratings are designed to measure the probability of default, not to recommend the purchase of. y. Nat. sit. individual securities or to predict market prices. And they say their long-term record is good;. n. al. er. io. the average five-year default rate for investment grade (BBB and above) structured. i Un. v. securities is less than 1%. Which implied that their rating will still be accurate only if no. Ch. engchi. crisis will be happen in the future. Which is a question no one can be sure about the answer.. Any set of rules creates incentives for participants to game the system. And that seems to have happened with ratings. After all, CDOs repackage existing securities and charge hefty fees for doing so. There must be a substantial exception in the system to make such activities worthwhile; the most likely source is the way ratings are treated.. Critics allege that the rating agencies suffered from conflicts of interest, as they were paid by investment banks and other firms that organize and sell structured securities to investors. On 11 June 2008, the SEC proposed rules designed to mitigate perceived conflicts of 34.

(37) interest between rating agencies and issuers of structured securities. On 3 December 2008, the SEC approved measures to strengthen oversight of credit rating agencies, following a ten-month investigation that found “significant weaknesses in ratings practices,” including conflicts of interest <12>.. The regulatory program established by Congress through the Credit Rating Agency Reform Act allows the SEC to promulgate rules regarding public disclosure, recordkeeping and financial reporting, and substantive requirements designed to ensure their activities with. 治政 implemented by the Commission under the Act in June 大 2007. The detail regulatory program 立 integrity and impartiality. These additional proposed rules supplement initial rules. is summarized as below.. ‧ 國. 學. Create more agencies: A view that partly inspired the Credit Rating Agency Reform Act. ‧. passed by Congress at 2008. The negative is, perhaps the existence of more agencies would. y. Nat. sit. encourage issuers to shop around for the firm with the weakest standards.. Although the. n. al. er. io. agencies’ models make it clear what rating they will give a bond on issue, it is less clear what will cause them to downgrade it later on.. Ch. engchi. i Un. v. Make the agencies legally liable for their views. The courts may do this of their own volition. The negative is the potential damage claim for making a rating would be so large that agencies might either be driven out of business or made excessively cautious by the threat of legal action.. Perhaps the best approach would be to make the regulations less dependent on ratings, and market values could be used instead. However, prices can be very volatile, as they have been in recent weeks; that might require banks to hold more reserves as a cushion against. 35.

(38) price moves, an inefficient use of their capital which is the price we have to pay for the change. Improve investor understanding of credit rating: There was a new proposal from SEC in regard to the Credit agency issue for the recent financial crisis. The aims of the act are to enhance disclosure of NRSRO methods and performance data, and to promote investor confidence in credit ratings by minimizing the gap. The Commission’s rule proposal summarized as below:. Maintain the independency. Prohibit a credit rating agency from issuing a rating on a. 治政大products that they rate. Attack Constrain credit rating agencies from structuring the same 立 structured product unless information on assets underlying the product was available.. the practice of buying favorable ratings by prohibiting anyone who participates in. ‧ 國. 學. determining a credit rating from negotiating the fee that the issuer pays for it.. ‧. All information should be announced and can be easily compared through a. y. Nat. sit. standardized platform. Require credit rating agencies to make all of their ratings and. n. al. er. io. subsequent rating actions publicly available. This data would be required to be provided in a. i Un. v. way that will facilitate comparisons of each credit rating agency’s performance.. Ch. engchi. Disclose the methodology and risk composition in detail: Require disclosure by the rating agencies of the way they rely on the due diligence of others to verify the assets underlying a structured product. Require disclosure of how frequently credit ratings are reviewed; whether different models are used for ratings surveillance than for initial ratings; and whether changes made to models are applied retroactively to existing ratings.. Require. credit rating agencies to make an annual report of the number of ratings actions they took in each ratings class, and require the maintenance of an XBRL database of all rating actions on the rating agency’s Web site. That would permit easy analysis of both initial ratings and. 36.

(39) ratings change data. Require the public disclosure of the information a credit rating agency uses to determine a rating on a structured product, including information on the underlying assets. That would permit broad market scrutiny, as well as competitive analysis by other rating agencies that are not paid by the issuer to rate the product.. Differentiate the rating across product type. Require credit rating agencies to differentiate the ratings they issue on structured products from those they issue on bonds, either through the use of different symbols, such as attaching an identifier to the rating, or. 政治大. by issuing a report disclosing the differences between ratings of structured products and other securities.. 立. ‧ 國. 學. Declaration of the track record of Credit agency performance: require credit rating agencies to publish performance statistics for 1, 3, and 10 years within each rating category,. ‧. in a way that facilitates comparison with their competitors in the industry.. sit. y. Nat. io. n. al. er. 5.6 Balance of Advantage. Ch. i Un. v. Bigger is not necessarily to be better. To a degree, the financial crisis is responsible. It has. engchi. devastated the venture-capital market, the lifeblood of many young firms. Governments have been rescuing companies they consider too big to fail, such as Citigroup and general motors. Recession is squeezing out smaller and less well connected firms. But there are other reasons too, which are giving big companies a self-confidence they have not displayed for decades. A health economic ecosystem should be contained a variety of big and small companies. The return of the giants could well be a boon for the world economy-but only if business people and policymakers avoid certain pitfalls. Business should not largely focus on the company size, and thereafter to diversifying into a lot of unrelated areas. The most successful big firms should focus on their core businesses. 37.

(40) The best use of the government’s energies is to remove the barriers which prevent entrepreneurs from starting businesses and turning small companies into big ones, instead of making a big company to be the future giant.. 立. 政治大. ‧. ‧ 國. 學. n. er. io. sit. y. Nat. al. Ch. engchi. 38. i Un. v.

(41) 6. Consumer response to the financial crisis. Understand your investment As talk on the above page, investors should be able to identify the possible risk on your target investment before you step in the market. Of course consultation with a professional is always the best way to capture more information that we can get from ourselves. But we are the only person who makes the investment decision. Your financial consultant will not responsible for your living if you are not their customer.. 政治大. Don’t be fooled by the product name. 立. There is no free lunch in the world, at least in the investment world. Even a large financial. ‧ 國. 學. institute, they launched products like “Premium Deposit” but they are actually not 100% deposit. The most common way will be to use the interest piece or part of your principle to. ‧. link with the derivative product. Some of them are principle product, some of them are not.. y. Nat. n. al. Personal Financial Crisis. Ch. engchi. er. io. could be difference from what they going to sell.. sit. Make sure you fully understand the terms and conditions of the product. The product name. i Un. v. The best way to avoid a financial crisis is to spend less than you earn. You'll be better prepared for unexpected expenses or life-changing events that might dramatically reduce your income or increase your expenses. It also enables you to have the freedom to make personal choices about your job, where you live, and in many other areas of your life. Recognizing the causes of financial crisis will help you know what to avoid. Below is a list of major circumstances that could put you deeply in debt. When one or more of these happens, it can be overwhelming. If you plan for the unexpected, you will be in a much better financial situation. Part of the reason of the current financial situation is some people 39.

(42) pay more mortgage payment than they can actually afford. The worst things is that the bank supports this kind of mortgage loan application.. Education We are facing the most severe economic crisis since the Great Depression. There is plenty of blame to go around. But as suppliers of ideas and talent to the business community, schools education needs to accept some responsibility. Exotic financial instruments, poorly designed compensation plans, models of corporate leadership that value leaders’ charisma. 政治大. over substance. Maybe it is the time for the school faculties to make the most of this. 立. opportunity to consider how they can contribute to the creation of a business culture that. ‧ 國. 學. better serves the American economy and society. We must define business leadership in terms of value creation, not value extraction. This would be an important first step toward. ‧. restoring society’s faith in our future business leaders.. n. er. io. sit. y. Nat. al. Ch. engchi. 40. i Un. v.

(43) 7. Conclusion The current recession is different. It is now in global scope. The advanced countries like Japan, Germany, the U.K., and France are all in or headed for a deep recession. I can say that it is a balance sheet crisis; both on the firm side and on the household side want to take advantage of the risk transfer market and leverage to get the most fortune out of the market. The investment is a zero sum game; no one can get an extra one dollar from the market. Someone will ask the question, where has money gone. The answer is simple, the investor who uses the leverage and the money is from the bank. They can earn many times return from the original. 政治大. investment, which depends on your bargaining power to get the fund. At the same time, when. 立. the market goes down, investors will loss many times the original investment which depends. ‧ 國. 學. on the leverage level. In the normal situation, investors will absorb the loss until they go bankrupt. The bank will take over the loss until the bank goes bankrupt. Then, the. ‧. government/ Central bank will take over the loss. If the government takes over too much toxic. y. Nat. sit. asset like Iceland. They will go bankrupts too. Macroeconomic performance over the next. n. al. er. io. few years is very challenge. The Great Depression was extraordinary by all measures, with. i Un. v. unemployment peaking in 1933 at an astounding rate of 25%<13>. No economist expects an. Ch. engchi. outcome that even approaches this magnitude. But an unemployment rate of half that amount is a distinct possibility, something no economist would have expected just two years ago. Also, there will be some drawback for the government action to purchase toxic assets or direct injection to the financial institute as we can see on the current financial market. These policies can lead financial institutions to undertake excessively risky investments in the future. This is no doubt that this is a valid concern and a cost of intervention. The government’s position is that the costs of intervention thus far have been significantly lower that the cost of not intervening which would cause an even more serious financial crisis that could happen in the future. 41.