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New Delhi: Markets regulator <keyword id="19901201" type="General" weightage="100" keywordseo="Sebi" source="keywords">Sebi</keyword> has proposed a minimum ticket size or <keyword id="21732014" type="General" weightage="20" keywordseo="investment-threshold" source="keywords">investment threshold</keyword> of Rs 1 crore for the RBI-regulated originators and unregulated entities engaged in securitisation activities. The proposal also introduced limitations on the number of investors in <keyword id="22496291" type="General" weightage="20" keywordseo="private-placements" source="keywords">private placements</keyword>, allowing <keyword id="23778966" type="General" weightage="20" keywordseo="securitized-debt-instruments" source="keywords">securitized debt instruments</keyword> (SDIs) issued privately to be offered to a maximum of 200 investors. If this limit is exceeded, the issuance must be classified as a public issue. <br /><br />Public offers should remain open for a minimum of three days and a maximum of 10 days, with advertisement requirements aligned with Sebi's regulations for non-convertible securities. <br /><br />Additionally, the regulator has suggested that all securitized debt instruments should be issued and transferred exclusively in demat form. <br /><br />SDIs are financial products created by pooling together various types of debt -- such as loans, mortgages, or receivables -- and then selling them as securities to investors. This process, known as securitisation, allows the originator (such as a bank) to convert illiquid assets into liquid ones, providing an alternative source of funding. <br /><br />Investors in these instruments receive returns based on the performance of the underlying debt pool, and the risk is spread across multiple assets, offering potentially attractive returns. <br /><br />The current framework is based on Sebi's 2008 regulations, with updates from the Reserve Bank of India's (<keyword id="19899808" type="General" weightage="20" keywordseo="RBI" source="keywords">RBI</keyword>) 2021 directions on securitising standard assets. <br /><br />The Securities and Exchange Board of India (Sebi) is now considering updates to the regulatory framework for securitized debt instruments and sought public comments till November 16 on the proposals. <br /><br />Regarding risk management, Sebi has proposed that originators retain a minimum risk retention of 10 per cent of the securitised pool or 5 per cent for receivables with a maturity of up to 24 months. <br /><br />A minimum holding period requirement will also be specified by Sebi for underlying receivables to ensure that originators maintain an interest in the underlying assets, the regulator said in a consultation paper. <br /><br />The regulator further suggested including an optional clean-up call for originators, allowing them to repurchase up to 10 per cent of the original value of the assets. This call is optional and intended to help manage the pool's longevity without mandating additional commitments from the originator. <br /><br />Liquidity facilities, essential to handle timing mismatches in cash flows, should either be provided directly by the originator or through an appointed third party. <br /><br />The updated definition of "debt/receivables" limits permissible underlying assets to listed debt securities, accepted trade receivables, rental incomes, and equipment leases while disallowing single-asset securitisation. <br /><br />The proposal establishes minimum track record requirements for both originators and obligors. Originators should have a minimum of three years of operating experience, while trade receivables specifically require at least two cycles of successful, default-free payments.

Sebi proposes Rs 1 crore minimum investment, mandatory demat form for securitized debt instruments

In a market defining move last month, Chinese Central Bank allowed the use of financial products that can potentially safeguard investors’ interest in the event of default of an underlying asset. In other words, the <keyword id="126380" type="UNKNOWN" weightage="100" keywordseo="credit-default-swaps">Credit Default Swaps</keyword> (CDS) can now be legally traded on the Chinese bourses. This move comes amidst increased stress around the <keyword id="1413899" type="UNKNOWN" weightage="100" keywordseo="Chinese-banking-system">Chinese banking system</keyword>, owing to exponential rise of public and private sector debt. As this debt mounts, and defaults rise to an unprecedented U.S. $4bn, this move signals the increased willingness of the Chinese government to let market forces deal with underlying defaults. It is noteworthy that in the wake of the 2008 credit crisis, China had introduced a lesser cousin of the CDS called Credit Risk Mitigation Agreement (CRMA), but the market never took off, largely because the state kept bailing out insolvent companies instead of letting them default, in the interests of financial and social stability.<br />
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India’s has had its share of frustrations with the growth of the corporate bond market – despite availability of instruments for investor risk hedging the debt market has failed to pick up. So really then, does the availability of hedging options like CDS drive an upswing in the investor sentiment by lowering riskiness of debt? If so, why hasn’t the debt market responded well in India, and why, despite having a robust corporate debt market, the CRMA market did not pick up in China? What is different this time around that China is expecting to achieve this time with CDS what it couldn’t with CRMA? It will be interesting to observe why such seemingly brilliant market moves have failed to gather mass in both India and China in the past. And what can India learn from this.<br />
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<strong>The <keyword id="1114678" type="UNKNOWN" weightage="100" keywordseo="Indian-debt-market">Indian debt market</keyword></strong><br />
To predict the emergence of CDS market in China and possibly draw learnings for India, it is interesting to follow the journey of similar products in comparable emerging markets. In India, the second largest growth market in the world currently, CDS was launched in mid-2011 keeping in view a then Rs 10 lakh crore corporate bond market signaling a huge potential for the development of a market for CDS. India’s rapid population growth needed (and still needs) significant investments in infrastructure. These needs were, and still continue to be, sufficed by either FIIs or bank financing, with money market instruments such as commercial papers and CDS providing short term funds only. The system desperately needed an efficient and vibrant corporate bond market for facilitating the financing needs of infrastructure projects. A provision of hedging the credit risk of the investors in the infrastructure sector could give a much-needed boost to the FIIs as investors. While RBI introduced two new instruments – Repo and CDS – it was expected that the corporate bond market would start booming, auguring well for the long term funding especially for infrastructure development in the country. But five years hence, the CDS market has turned out to be a stillborn. The development of the debt market is constrained by highly conservative and slow moving financial markets reform. Despite repeated policy changes introduced by RBI to push their usage, the corporate bond market has grown just 6.43% points in the last 5 years; the corresponding CDS growth is at best puny.<br />
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<strong>Learning from other <keyword id="116702" type="UNKNOWN" weightage="100" keywordseo="emerging-economies">emerging economies</keyword></strong><br /> Among other emerging nations, Brazil and Mexico have seen a robust growth in their bond markets after they focused efforts on improving their fiscal environment and macroeconomic factors. What is common across these economies is that the governments have put in place structured programs to rein inflation, open up the economies, provide stable fiscal program and set up a regulatory and governance framework. Closer home in Asia, South Korea and Malaysia have the strongest debt markets in Asia with Korea’s corporate bond market penetration of ~77% as compared to India’s ~16%. This, when Korea’s GDP is very similar to India’s. In stark contrast, Philippines have a much volatile <keyword id="34412" type="ORGANIZATION" weightage="100" keywordseo="economy">economy</keyword> and the corporate bond market is still underdeveloped and heavily dependent on government support.<br />
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<strong>So is CDS likely to succeed in China?</strong><br />
In the past, why China’s earlier experiment with CRMA failed was that every time a corporate bond tended to default, the Chinese government interfered to restructure debt and orchestrate a bail out, making investors very nervous in the process, and reducing the government’s ability to continue such act over a sustainably long period of time.<br />
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The corporate bond market in China has seen a surge in the last 2 years, largely due to easing of restrictions on bond issuance, corporate debt becoming cheaper, and government’s intervention in corporate debt restructuring. With this growth has come the risk of defaults, as not all issuers are now backed by a state guarantee. In the last two years, default rates have risen in line with overall growth in corporate debt. Many FIIs remain apprehensive of investing in the Chinese market, and the higher default rates have caused the bond market to become more expensive. At this point, the introduction of CDS can be a market defining move if the government lets market forces play out rather than repeating past mistakes of interference.<br />
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<strong>The name is Bond!</strong><br />
India’s need for investments in core sectors like infrastructure and education over the next two decades will far surpass the ability of equity markets to finance these needs. Eventually, corporate debt will need to play a larger role than it does today. Just having the right instruments like CDS will not provide the much needed impetus for growth of debt market in India; a look at rival China and other economies like Malaysia, Brazil, Mexico and Philippines teaches us many important lessons in what our next steps should be.<br />
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A slew of measures have been taken in the last 2 years to allow the Indian debt market to open up further. The primary shift in investor sentiment has come from the central government being led by a party that could garner majority votes after nearly two decades of hung parliament and indecisive leadership. This government has been able to shift focus to growth, and drive some key reforms. Alongside, many fiscal and economic policy decisions by the RBI are pushing economic reform one step further. Large investors like EPFO being allowed to invest in corporate debt, issuers being permitted to consolidate and reissue corporate debt, and FPI investments being allowed in corporate debt are all moves in the right direction. The government has also done a good job at reining in inflation and putting growth back in focus. As a next step, the country needs to learn from global best practices and invest in providing better settlement and reporting platforms, focus on investor education to invite broad based retail participation, and continue down the path of fiscal reform and providing impetus to securitization market. In the absence of a strong debt market, it is unlikely that the Indian banking sector could come true to providing the much needed boost for infrastructure development in this growth hungry economy.<br />
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<em>(<strong>About the Author:</strong> This article has been contributed by </em><em>Poornima Vasdev, Director, Program Management, </em><em>Sapient Global Markets.)</em><br />
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What Indian debt market can learn from other emerging economies?

Table of Contents: Masthead Sticky<ul class="summary-list"><li>The <keyword id="121429" type="PERSON" weightage="60" keywordseo="great-recession">Great Recession</keyword>, one of the worst economic declines in US history, officially lasted from December 2007 to June 2009.</li><li>The collapse of the housing market - fueled by low interest rates, easy credit, insufficient regulation, and toxic <keyword id="981939" type="PERSON" weightage="60" keywordseo="subprime-mortgages">subprime mortgages</keyword> - led to the economic crisis.</li><li>The Great Recession's legacy includes new financial regulations and an activist Fed.</li></ul><p>Many factors contributed to the Great Recession of 2007 to 2009, the second-worst economic crisis in US history. </p><p>What caused this economic chaos? Economists cite as the main culprit the collapse of the subprime mortgage market - defaults on high-risk housing loans - which led to a credit crunch in the global banking system and a precipitous drop in bank lending. </p><p>But, in fact, the reasons are more complex. According to a <a href="https://www.govinfo.gov/content/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf" target="_blank" rel="noopener">2011 report</a> by the Financial Crisis Inquiry Commission, the Great Recession was an "avoidable" disaster caused by widespread failures, including in government regulation and risky behavior by Wall Street. </p><p>While the relative impact of each cause is still debated today, the Great Recession stands as a cautionary tale about risk, investing in what you know, and the dangers of putting full trust and faith in financial experts and institutions. </p><h2><strong>The Great Recession by the numbers<br /></strong></h2><ul><li>The downturn lasted 18 months</li><li>The net worth of US households declined, <a href="https://www.treasury.gov/resource-center/data-chart-center/Documents/20120413_FinancialCrisisResponse.pdf">erasing $19.2 trillion in wealth</a></li><li>Gross domestic product (<a href="https://www.businessinsider.com/what-is-real-gdp">GDP</a>) fell 4.3%, the largest decline in 60 years</li><li>The unemployment rate reached 10% in October 2009 - rates were even higher among Black and Hispanic households at about 15% and 12% respectively</li><li>The US lost <a href="https://www.pewtrusts.org/en/research-and-analysis/reports/2010/04/28/the-impact-of-the-september-2008-economic-collapse">$7.4 trillion in stock</a> wealth from July 2008 to March 2009</li><li>Home foreclosures skyrocketed, with nearly three million a year in 2009 and 2010</li></ul><h2><strong>1. Immoderate investments and deregulation</strong></h2><p>The two decades before the Great Recession were largely prosperous, with rises in GDP, low inflation, and two relatively mild <a href="https://www.businessinsider.com/what-is-a-recession">recessions</a>. </p><p>This period - from the mid-1980s up to 2007 - was optimistically called the <a href="https://www.federalreservehistory.org/essays/great-moderation">Great Moderation</a>. The name refers to the contemporary belief that the traditional boom-and-bust<a href="https://www.businessinsider.com/what-caused-the-great-depression"> business cycle</a> had been overcome in favor of middling but stable economic growth.</p><p>However, unbridled optimism led to immoderate spending, especially for risk-loving investors. Everyone from homeowners to bankers believed the economy would keep growing. This made traditionally risky behavior - like aggressive investment and leveraging strategies, plus taking on excessive debt - seem safe. </p><p>Assumptions about economic growth also contributed to a period of deregulation, most significantly the 1999 rollback of the Glass-Steagall Act, a <a href="https://www.businessinsider.com/what-caused-the-great-depression" target="_blank" rel="noopener">landmark Depression-era legislation</a> that separated commercial and investment banking. </p><p>Repealing key provisions of the Glass-Steagall Act <a href="https://www.federalreservehistory.org/essays/gramm-leach-bliley-act" target="_blank" rel="noopener">allowed banks and brokerages to become significantly larger</a>, and opened the floodgates for giant mergers. While just one contributing factor to the Great Recession, the changes to the Glass-Steagall Act brought a period of national expansion for corporations and the gobbling up of small, independent institutions, which created entities that were "too big to fail" - or so everyone thought. </p><h2><strong>2. Loose lending standards in the housing market</strong></h2><p>In the decade leading up to 2007, real estate and property values had been rising steadily, encouraging people to invest in property and buy homes.</p><p>By early to mid-2000s, the residential housing market was booming. To capitalize on the boom, mortgage lenders rushed to approve as many home loans as they could, including to borrowers with less-than-deal credit. </p><p>These risky loans, called subprime mortgages, would later become one of the main causes of the Great Recession. </p><p>A subprime mortgage is a type of loan issued to borrowers with low credit ratings. A prospective subprime borrower might have multiple dings on their credit history or dubious streams of income. In fact, the loan verification process was so lax at the time that it drew its own nickname: NINJA loans, which stands for "no income, no job, and no assets." </p><p>Because subprime mortgages were granted to people who previously couldn't qualify for <a href="https://www.businessinsider.com/personal-finance/what-is-a-mortgage" target="_blank" rel="noopener">conventional mortgages</a>, it opened the market to a flood of new homebuyers. Easy housing credit resulted in the higher demand for homes. This contributed to the run-up in housing prices, which led to the rapid formation (and eventual bursting) of the 2000s housing bubble. </p><p>While <a href="https://www.federalreserve.gov/boarddocs/press/general/2001/20011211/" target="_blank" rel="noopener">interest rates at the time were low</a>, subprime mortgages were adjustable-rate mortgages, which charged low, affordable payments initially, followed by higher payments in the years thereafter. The result? Borrowers who were already on shaky financial footing stood a good chance of not being able to make payments when the interest rate rose in the years following.</p><p>In the rush to take advantage of a hot market and low interest rates, many homebuyers took on loans without knowing the risks involved. But the common wisdom held that subprime loans were safe since real estate prices were sure to keep rising.</p><h2><strong>3. Risky Wall Street behavior </strong></h2><p>Along with issuing mortgages, lenders found another way to make money off of the real estate industry: By packaging subprime mortgage loans and reselling them in a process called securitization. </p><p>Through securitization, subprime lenders bundled loans together and sold them to investment banks, which, in turn, sold them to investors around the world as mortgage-backed securities (MBS). </p><p>Eventually, investment banks started repackaging and selling mortgage-backed securities on the secondary market as collateralized debt obligations (CDOs). These financial instruments combined multiple loans of varying quality into one product, divided into segments, or tranches, each with its own risk levels suitable for different types of investors.</p><p>The theory, backed by elaborate Wall Street mathematical models, was that the variety of different mortgages reduced the CDOs' risk. The reality, however, was that a lot of the tranches contained mortgages of poor quality, which would drag down returns of the entire portfolio. </p><p>Investment banks and institutional investors around the world borrowed significant sums at low short-term rates to buy CDOs. And because the financial markets seemed stable on the whole, investors felt secure about taking on more debt.</p><p>To make matters even more complicated, banks used credit default swaps (CDS), another financial derivative, to insure against defaults on CDOs. Banks and hedge funds started buying and selling swaps on CDOs in unregulated transactions. Also, because CDS transactions didn't show up on institutions' balance sheets, investors couldn't assess the actual risks these enterprises had assumed. </p><p><strong>Important:</strong> The convoluted jumble of financial products that included MBS, CDOs, and CDSs created a domino-like collapse of the housing market, and the main reason why the financial crisis was so widespread.</p><h2><strong>4. Weak watchdogs</strong></h2><p>Like corporate bonds and other forms of debt, MBS and CDOs required the blessing of credit rating agencies in order to be marketed. The "Big Three" credit rating agencies include Moody's, S&amp;P, and Fitch Group. </p><p>These agencies placed AAA ratings - usually reserved for the safest investments - on many securities, even though they contained a healthy share of risky mortgages. </p><p>It's worth noting that credit rating agencies are supposed to be independent. But an inherent conflict of interest seems to have existed since the banks issuing the securities were the ones paying the agencies to rate them.</p><h2><strong>5. The <keyword id="415580" type="PERSON" weightage="60" keywordseo="subprime-mortgage-crisis">subprime mortgage crisis</keyword> </strong></h2><p><br />After staying low throughout the early 2000s, interest rates began to rise starting in 2004 in response to an overheating economy and fears of inflation. In mid-2004, the <a href="https://www.businessinsider.com/what-is-the-federal-funds-rate" target="_blank" rel="noopener">federal funds rate</a> was 1.25%. By mid-2006, the <a href="https://www.federalreserve.gov/monetarypolicy/openmarket.htm" target="_blank" rel="noopener">interest rate was 5.25%</a>.</p><p>The rate-hike could not have come at a worse time. </p><p>By mid-2006, home prices were peaking and the market was slowing down. When supply started to outpace demand, home prices spiraled. The combination of high interest rates and falling home prices made it extremely difficult for buyers to make payments on their homes. </p><p>As a result, defaults on subprime mortgages shot up. Loan after loan became worthless. In April 2007, New Century Financial, the largest independent provider of subprime mortgages, declared Chapter 11 bankruptcy. </p><p>The subprime mortgage crisis had begun. And because of CDOs, the collapse was soon felt  beyond the real estate industry.</p><p>The defaults meant big <keyword id="137561" type="ORGANIZATION" weightage="60" keywordseo="CDO">CDO</keyword> investors, like hedge fund managers, investment banks, and pension funds, saw the value of the investments nosedive. Since CDOs didn't trade on any exchanges, there was no way to get rid of them, so those holding them had to write off a substantial amount of their value. </p><p>Those who had committed heavily in CDOs saw their entire balance sheets decimated. One of the biggest: investment bank Bear Stearns. After the bank suffered massive CDO-based losses, it lost investors' confidence - and its ability to borrow money. In March 2008, to avoid bankruptcy, the venerable firm sold itself to JP. Morgan Chase for $10 per share.</p><h2><strong>6. The 2008 stock market crash</strong></h2><div type="image" title="Lehman" height="2000" width="3000" msid="84253734" hostid="261"></div><p>By the spring of 2008, the CDO debacle turned into a full-blown credit crisis. Since it was unclear where all these toxic securities were - given all the packaging and repackaging - and whose balance sheets were harboring them, banks started charging high interest rates to lend to other banks and institutions. </p><p>It was especially disastrous for investment bank Lehman Brothers. In fact, of the $600 billion in debt owed by the company, $400 billion was supposed to be covered by CDS. Unfortunately, by that point, the debt was worth almost nothing. </p><p>When Lehman collapsed, declaring bankruptcy on September 15, panicked banks stopped lending almost completely and the entire global banking system became short of funds. </p><p>The stock market reacted sharply. From September 19 to October 10, 2008, the<a href="https://www.businessinsider.com/what-is-dow-jones" target="_blank" rel="noopener"> Dow Jones Industrial Index</a> went into free-fall, declining 3,600 points. </p><p>During that time, big financial institutions started dropping: </p><ul><li>Bank of America (BAC) announced it was buying Merrill Lynch. </li><li>The FDIC seized Washington Mutual, the country's largest savings and loan, transferring its assets to JPMorgan Chase. </li><li>Goldman Sachs and Morgan Stanley, the last two of the major still-intact investment banks, converted to bank holding companies, the better to be able to obtain federal bailout funding.</li></ul><p>With the global economy declining, international trade and industrial production fell at an even a faster rate than during the Great Depression of the 1930s. As consumer and business confidence was shattered, companies started massive layoffs and unemployment skyrocketed globally. </p><p>The Great Recession was in full force.</p><h2><strong>Federal response to the Great Recession</strong></h2><p>Decisive action by the<a href="https://www.businessinsider.com/what-is-the-federal-reserve" target="_blank" rel="noopener"> Federal Reserve</a>, along with massive government spending, kept the US economy from total collapse. </p><p>Aiming to boost borrowing and capital investment, the Fed reduced interest rates to zero for the first time ever and launched a quantitative easing program, whereby it bought financial assets to add more money into the economy.</p><p>As for the federal government, it creating two key programs aimed to provide emergency assistance:</p><ul><li><strong>Troubled Asset Relief Program (TARP): </strong>This initiative helped stabilize the economy by having the government purchase up to $700 billion in toxic assets, with most of the money used to <a href="https://home.treasury.gov/data/troubled-assets-relief-program" target="_blank" rel="noopener">bail out troubled banks</a>. </li><li><strong>The American Recovery and Reinvestment Act (ARRA):</strong> A stimulus package enacted in 2009, ARRA implemented a series of tax cuts, government spending mandates, loan guarantees, and unemployment benefits to help kickstart the economy. </li></ul><p>These measures were effective, preventing the recession from developing into a decade-long affair, like the Great Depression. The stock market began to rebound in 2009. Still, other aspects of the economy took several years to recover - what economists <a href="https://www.businessinsider.com/recession-recovery-shapes" target="_blank" rel="noopener">characterize as an L-shaped recovery</a>.   </p><h2><strong>Aftermath of the Great Recession</strong></h2><div type="image" title="dodd frank" height="1944" width="3000" msid="84253736" hostid="261"></div><p>The Great Recession officially lasted through June 2009, but its effects have had a lasting impact. </p><ul><li>GDP didn't regain its pre-recession strength until 2011.</li><li>Unemployment remained above 5% until 2015.</li><li>Real household income didn't increase until 2016.</li></ul><p>The policies, reforms, programs and impact of the Great Recession are still with us today. Among the Great Recession's legacy:</p><h3><strong>Financial regulation and reform</strong></h3><p>In 2010, President Obama signed the <a href="https://www.cftc.gov/LawRegulation/DoddFrankAct/index.htm">Dodd-Frank Act</a> into law, which aimed at reforming regulation of the financial industry. Some highlights include the ability for the government to take control of banks seen to be fiscally unsound, regulation of the over-the-counter derivatives market, including credit default swaps, and a requirement for banks to set aside more capital reserves as a cushion. It also included the Volcker Rule, which curbed banks proprietary trading for their own accounts and limited their dealings with hedge funds and private equity funds, among other steps. </p><h3><strong>An activist Fed</strong></h3><p>Interest rates were at 5.25% in 2007. But by the end of 2008, the Fed slashed them to zero. Those low interest rates and swift, strong action to keep the economy moving are still hallmarks of the Fed today. For example, it moved quickly to lower interest rates in response to the economic turmoil caused by the COVID-19 crisis.</p><h3><strong>Hobbling of a generation</strong></h3><p>The generation that came of age at the worst of the crisis, <a href="https://www.pewresearch.org/politics/2011/11/03/section-5-generations-and-the-great-recession/">Millennials still feel the effects of the Great Recession</a>. They have decreased savings and heavy student loan debt. They have a reluctance to buy homes and overall less wealth than previous generations at a comparable age. A 2019 Country Financial survey<a href="https://www.countryfinancial.com/en/about-us/newsroom/year2019/millennials-feeling-less-financially-secure-in-2019.html"> revealed that half (50%) of Millennials rate their level of financial security</a> as fair or poor, compared to 44% of Americans overall.</p><h2><strong>The financial takeaway</strong></h2><p>The Great Recession stands as one of the worst economic meltdowns in US history. Although the subprime mortgage crisis was the immediate cause, multiple interconnected financial factors  caused the specialized-industry bubble burst to ripple out, bankrupting firms, crashing the stock market, and hobbling the whole economy.</p><a data-type="5fe4ae0364795006b83cf8c3">What is a stock market crash? Understanding its causes and consequences can help investors prepare for a sudden, severe drop in share prices</a><a data-type="5fd3f367628b9a440f246bda">8 of the biggest stock market crashes in history - and how they changed our financial lives</a><a data-type="5fd15b49fe994d2fe9680ea4">The different shapes of recovery: Understanding how quickly and strongly an economy can bounce back after a recession</a><a data-type="5ff74f0cf01d6901535af175">What is inflation? Why the cost of goods rise over time and what it means for the value of your money</a>

What caused the Great Recession? Understanding the key factors that led to one of the worst economic downturns in US history

<p><div class="KonaFilter image-container display-table lead-image-large"><div><div class="image on-image"><p class="source"><span>Aberdeen Standard Investments</span></p><p class="caption">Martin Gilbert.</p></div><p></p></div></div></p><ul class="summary-list"><li>Collateralized debt obligations, or CDOs, were a major financial casualty of the 2008 crisis.</li><li>Many sounded the alarm on these instruments, including Martin Gilbert, the co-CEO of Aberdeen Standard Investments, which oversees $736 billion in assets and is the UK's largest active manager.</li><li>In an interview with Business Insider for the 10th anniversary of the collapse of <a href="https://www.businessinsider.com/category/lehman-brothers">Lehman Brothers</a>, Gilbert shared the class of financial product he's wary about now.</li></ul><p>Martin Gilbert can claim bragging rights as one of the people who called the 2008 financial crisis - or at least an important part of it.</p><p>In a 2007 conference in Monaco, he warned about Wall Street's affinity to collateralized debt obligations, or CDOs, the complex financial instruments that went down with the mortgage market.</p><p>Ten years after the financial crisis, the co-CEO of Standard Life Aberdeen, a $736 billion asset manager and one of Europe's largest, is flagging another debt instrument.</p><p>It's covenant-lite loans, which lenders are increasingly issuing out to companies that seek less-restrictive financing terms. In these arrangements, lenders waive or water down certain so-called covenants, such as whether a company can pay dividends. Breaching these would normally give lenders the option to redeem the loan early.</p><p>Companies with weaker credit ratings are taking on more risk with covenant-lite loans and their investors could face a greater downside during the next downturn, according to <a href="https://www.moodys.com/research/Moodys-Lax-covenant-protections-position-companies-to-add-risk-during--PR_380397">Moody's</a>.</p><p>Gilbert shared with Business Insider, via email, why he's wary of these loans, and other reflections on the anniversary of the collapse of Lehman Brothers.</p><p><div class="KonaFilter image-container display-table"><div><div class="image on-image"><p class="source"><span>Mario Tama/Getty</span></p><p class="caption">Lehman Brothers headquarters seen September 15, 2008.</p></div><p></p></div></div></p><p><strong>Business Insider:</strong> You steered Aberdeen clear of the market for collateralized debt obligations ahead of the crisis. What similar instruments are you wary of now?</p><p><strong>Martin Gilbert:</strong> Yes, we steered clear of CDOs. I was pretty vocal about the risk they posed when speaking at a conference in Monaco in 2007. I viewed them as financially engineered vehicles that enabled misallocation of capital. We avoided getting involved with them.</p><p>Currently, I'm wary of covenant-lite debt paper for a variety of reasons, a good example of which are certain weaker covenants, which allow borrowers to essentially strip assets away from the restricted group. This has found its way into some high-yield documentation recently and became topical during the J.Crew restructuring in the US. The market has, however, managed to get this language removed in a number of cases but it's nevertheless indicative of a wider trend.</p><p><strong>BI: </strong>Where were you and what you were doing during <a href="https://www.businessinsider.com/financial-crisis-scariest-moments-2015-9"><em>that</em> weekend</a> in September, and when you heard Lehman Brothers had finally filed for bankruptcy on Monday?</p><p><strong>Gilbert:</strong> I was in London that weekend and the following week. There was a lot of panic that weekend because many people had assumed the US Treasury simply would not let an institution as big as Lehman go. The bank's problems were no mystery at the time, but it was the fact that they were allowed to fail that was a watershed moment. It was when investors realized there was a limit to what the US authorities would bear.</p><p>The following week was a maelstrom in markets and I spent the entire week working with colleagues to analyze how the event would impact us as the dominoes kept on falling. I have to say though, the atmosphere in the office was not one of panic. Everyone had a clear sense of purpose and was trying to find practical solutions to the issues that markets were throwing up. It was stressful and intense, but it was all about keeping a cool head in those days and weeks in the immediate aftermath.</p><p><strong>BI: </strong>What are some of the biggest lessons from the crisis and ensuing market crash, especially for younger investors who want to learn from history?</p><p><strong>Gilbert:</strong> Don't sell at the point of maximum pain. The scale of the great financial crisis was really something else but there are common threads running through all crises. Markets have a habit of bouncing back and you have to do whatever you can to take a step back.</p><p>Another lesson is to stick to the basics. Invest in what you understand, spread your risk and know that if something looks too good to be true, it almost certainly is. The products that the banks were churning out in the run-up to the crisis were ever more complex and built on even shakier fundamentals.</p><p>This relates to another lesson, and that is that the nature of a globalized economy makes neatly apportioning blame very hard.</p><p>Banks have rightly taken a lot of the blame for the crisis, but it was a failing at all levels by governments, regulators, investors, rating agencies, and the banks. When the crisis hit, each party spent quite some time pointing the finger at everyone else. No one party was to blame, but they were all culpable.</p><p><strong>BI:</strong> What could regulators have done differently post-crisis?</p><p><strong>Gilbert:</strong> Regulators did a pretty decent job in their immediate response to the crisis.</p><p>One of the problems with financial markets is that they act a bit like water running down a hill. If something, like regulation, tries to block a certain route, the market tends to find a way around it sooner or later. This unfortunately means that we might not understand the shortcomings of the post-crisis regulation until it is really tested in the next crisis.</p><p>It could be desirable to see more support for securitization. Regulators rightly came down on securitization hard after the crisis because it played a big part in what happened. Securitization is a brilliant tool to match risk and return profiles to appropriate investors. When it is misused to create or obscure unnecessary layers of leverage, though, the crisis shows that it can be extremely harmful.</p><p>What I find encouraging is that, on the whole, regulation has been pragmatic. I'm a big believer in working with regulators. They have a tough job and the task of avoiding a repeat of 2008 is not solely theirs.</p><p><strong>BI:</strong> If there's another 2008-style crunch, what should the balance between government and private-sector intervention be, given that bailouts to Wall Street remain a grievance?</p><p><strong>Gilbert:</strong> It's inevitable that in periods of major crisis governments get involved. The degree to which their responses will be coordinated globally is an open question.</p><p>The political environment has changed significantly since 2008, so governments may not unite and work together. In many countries, the "too big to fail" mindset is history and governments feel less inclined to intervene and individual companies will be left to sink, swim, or be rescued (acquired) by a competitor.</p><p>That said, governments are very sensitive to public opinion so may well act in situations if the private sector doesn't. They also recognize that the financial sector oils the wheels of the economy to get growth going again.</p><p><strong>BI:</strong> What might the next 2008-style crisis be?</p><p><strong>Gilbert:</strong> That's the $1 billion question, or the $650 billion question given by how much the US economy shrank from September 2008 to the end of 2009. Unfortunately, as Nassim Nicholas Taleb has argued, black swan events that trigger financial crises come from left field and are difficult to predict.</p><p>As we experienced 10 years ago, the global financial system is so interconnected that even a relatively small part, such as sub-prime mortgages, can cause a domino-like effect.</p><p><strong>BI: </strong>What risks should investors be watching to avert another crisis like that?</p><p><strong>Gilbert: </strong>I'm not sure investors can avert a future crisis if seeds have been sown and problems have grown. What investors can watch for are signs of complacency, greed, and overt risk-taking within the financial system. Leverage and illiquidity are also the normal ingredients for more systemic-style crises.</p><p>If investors see signs of these emerging then they should perhaps prepare for the worst and hope for the best, in terms of diversifying their portfolios.</p>    <div class="margin-top">        <h3>NOW WATCH: <a href="https://www.businessinsider.com/woke-up-430-am-like-navy-seal-exercise-discipline-2018-7">I woke up at 4:30 a.m. for a week like a Navy SEAL</a></h3>        <div>                    </div>    </div>

The CEO of a $736 billion asset manager that sidestepped the most toxic casualty of the financial crisis warns of the big risk in markets right now

<p><div class="KonaFilter image-container display-table"><div><div class="image on-image"><p class="source"><span>Reuters/Toby Melville</span></p></div><p></p></div></div></p><ul><li><strong>"We no longer recommend any US equity exposure above an investor's benchmark," said a team of equity strategists at Morgan Stanley led by Andrew Sheets. </strong></li><li><strong>They have shifted to a neutral weight and are adding to a corner of the credit market instead. </strong></li><li><strong>They also outlined the conditions that would move them to an underweight position in stocks. </strong></li></ul><p>Morgan Stanley is going to zero on US stocks - relative to its benchmark. </p><p>A team led by Andrew Sheets, the chief cross-asset strategist, has shifted to a neutral weight on stocks amid doubt the market can extend its rally from here. </p><p>"While our cycle models remain in 'expansion', a phase that has historically seen valuation overshoots, we are increasingly concerned that the bulk of this tailwind is already behind us," Sheets said in a note on Monday.</p><p>"We no longer recommend any US equity exposure above an investor's benchmark."</p><p>The S&amp;P 500 has already zoomed past Morgan Stanley's year-end target of 2,750, and it now faces "outright downside" risk, Sheets said. </p><p>This recent rally isn't a sufficient reason on its own for investors to shed stocks, and so Sheets offered a few other reasons for caution. </p><p>First is an unusual gap between how US stocks and risky assets elsewhere are performing. The "extreme divergence," according to Sheets, is notable in the face of the weakness in emerging markets, credit, copper prices (a gauge of global economic growth) among others. </p><p>According to Bank of America Merrill Lynch, non-US equities have underperformed the US by the <a href="https://www.businessinsider.com/stock-market-divergence-between-us-and-em-2018-8">most since the recession</a>, and investors must make a call on whether they think global growth can lead to a turnaround.</p><p>Sheets listed nearly a dozen material events this year that could answer that question, from potential US tariffs on $200 billion of Chinese imports to the US midterm elections.</p><p>Beyond these headlines, earnings growth matters most to stocks. On that front, Sheets says companies are approaching their peak, judging by the consensus expectation for a top in the third quarter. </p><p><div class="KonaFilter image-container display-table click-to-enlarge"><div><div class="image on-image"><a title_source="Morgan Stanley" title_caption="" class="zoomin" href="https://static-ssl.businessinsider.com/image/5b8eaf250ce5f594208b4c8d-960/screen shot 2018-09-04 at 121253 pm.png"><span class="sprites click-to-enlarge-icon" title="Click to enlarge"></span></a><p class="source"><span>Morgan Stanley</span></p></div><p></p></div></div></p><p>In the place of stocks, Morgan Stanley's strategists have added to securitized credit: pools of consumer debt that are packaged into assets investors can buy. </p><p>It goes without saying that these kinds of bundles - specifically of subprime mortgages - were instrumental to causing the 2008 financial crisis. However, Morgan Stanley is skewed towards the high-quality end of this market in three ways: </p><ul><li>Senior tranches of collateralized loan obligations (CLOs) offer materially higher all-in yields relative to recent history, thanks to wider spreads and higher Libor.</li><li>Consumer asset-backed securities (ABS) and non-agency residential mortgage-backed securities (RMBS) benefit from relatively healthy consumer balance sheets (which stand in stark contrast to high corporate gearing).</li><li>Spreads on agency mortgage-backed securities (MBS) have also seen material widening for a high-quality market.</li></ul><p>Sheets is the first to acknowledge that this swing away from equities and into securitized credit could go wrong. In fact, he noted that Morgan Stanley was largely wrong on its <a href="https://www.businessinsider.com/stock-market-investors-complacent-ahead-of-likely-correction-morgan-stanley-says-2018-8">earlier call that volatility would rise</a> during the summer. </p><p>However, the strategists are also ready to go from a neutral weighting in stocks to an outright underweight if a number of conditions are fulfilled. These include worsening labor markets and consumer confidence, tighter financial conditions, and signs of a bigger earnings slowdown than is currently expected.  </p>    <div class="margin-top">        <h3>NOW WATCH: <a href="https://www.businessinsider.com/kaman-kmax-helicopter-intermeshing-dual-crossing-rotors-2018-8">An aerospace company reintroduced its precision helicopter with two crossing motors</a></h3>        <div>                    </div>    </div>

'Reducing US stocks to +0%': Here's why Morgan Stanley just made a major tweak to its portfolio, and what it's buying instead

<p><div class="KonaFilter image-container display-table float_right"><div><div class="image on-image"><p class="source"><span>Jaap Buitendijk/Paramount</span></p></div><p></p></div></div>A lot has changed since the housing- and global-financial crisis that roiled the world economy from 2007 to 2009 (and still impacts it now).</p><p>One thing that has not evidently changed, however, is public opinion of mortgage-backed securities (MBS).</p><p>Wall Street's use of MBS, which are financial instruments that bundle together several underlying mortgages into a single tradable asset, was <a href="http://www.businessinsider.com/here-is-what-really-went-wrong-with-mortgage-backed-securities-2009-7">cited as one of the main culprits</a> that brought down the financial system during the crisis.</p><p>The assets again had a spotlight shone on them in <a href="http://www.businessinsider.com/next-big-short-doesnt-make-sense-2016-2">2015's film version of Michael Lewis' book "The Big Short."</a></p><p>Despite this negative reputation, however, Gershon Distenfeld, SVP and director of high-yield and investment-grade credit at AllianceBernstein, said that MBS is actually a great investment right now.</p><p>"One thing that we're overweight on and I really like are mortgage-backed securities," Distenfeld told Business Insider. "People don't think about MBS that much, but we think that they're a strong asset to be in."</p><p>One of the biggest issues with the MBS that caused the financial crisis was the quality of the underlying mortgages. Since MBS assets are packaged home loans, the risky and downright dangerous mortgages that they were based on made them toxic. Nowadays, according to Distenfeld, the mortgages being packaged are in much better shape.</p><p>"Totally, the quality is much better," said Distenfeld. "The underlying mortgages aren't going to people that shouldn't be getting a mortgage in the first place. It's much different than it was during the crisis."</p><p>It is true - the credit of people receiving mortgages is <a href="http://www.businessinsider.com/us-mortgage-standards-tightening-2015-10">much better than it was leading up to the crisis</a>. Thus, it would make sense that the securitized products based on those loans would also be safer.</p><p>One issue with the market is that MBS get a bad rap from their role in the financial crisis, and investors are unwilling to take them on as part of a portfolio. Basically, it's a tough sell to get mom-and-pop investors to agree to put money into an asset that helped bring down the global economy.</p><p>According to Distenfeld, this has led to very few people owning MBS, which helps makes the asset look worse than it is.</p><p>"There aren't necessarily buyers in the market right now," said Distenfeld. "This lowers liquidity and makes the market look tougher than it maybe is."</p><p>MBS so far this year, however, has been pretty strong. S&amp;P's MBS index has registered a 3.6% return for 2016:</p><p><div class="KonaFilter image-container display-table click-to-enlarge"><div><div class="image on-image"><a title_source="Andy Kiersz/Business Insider; data from S&amp;P Indices" title_caption="" class="zoomin" href="https://static-ssl.businessinsider.com/image/57d30f48077dcc6b138b493b-960/mbs-index.png"><span class="sprites click-to-enlarge-icon" title="Click to enlarge"></span></a><p class="source"><span>Andy Kiersz/Business Insider; data from S&amp;P Indices</span></p></div><p></p></div></div></p><p>If people get over the fear, however, it appears that the assets could actually be a strong investment, according to Distenfeld.</p><p>"I mean basically you've got a bond-like security that yields as much as a high-yield bond with good quality," Distenfeld told us. "There's opportunity there for a pretty good return."</p>     <div class="margin-top">        <h3>NOW WATCH: <a href="http://www.businessinsider.com/student-debt-crisis-worse-than-mortgages-2014-11">Here's What's Truly Frightening About The Student Debt Bubble</a></h3>        <div>            <div>        <div class="ooyala-video-player" data-video-autoplay="false" data-video-id="NsdTFscTrGMo0BFPnun6mdZ9nmiJYVBe" data-player-variable="ooyalapopvideo" id="ooyalaplayer_popvideo" style="width:1280px;height:720px"></div>        </div>        </div>            </div>

The toxic asset made famous by 'The Big Short' might actually be a good investment

<p><div class="KonaFilter image-container float_right"><div class="image on-image"><p class="source">REUTERS/Aly Song</p></div><p></p></div>The Shanghai Composite fell 1% on Thursday, with Chinese brokerages taking the biggest hit.</p>
<p>Citic Securities, <keyword id="1334" type="COUNTRY" weightage="60" keywordseo="China">China</keyword>'s largest brokerage, was down 3.7%. </p>
<p>This comes on news that the government wants banks to <a href="http://www.businessinsider.com/chart-chinese-wealth-management-product-2013-1">unwind the controversial wealth management products (WMPs)</a> and switch to asset management plans (AMPs).</p>
<p>WMPs make up the <a href="http://www.businessinsider.com/chart-chinese-wealth-management-product-2013-1">$2 trillion powder keg</a> at the heart of China's banking system.</p>
<p>In a quest for higher returns, tons of people have been pouring their wealth into WMPs, which are sold as high yielding,  low-risk investments offering "expected" instead of "guaranteed or promised returns." This flood of deposits is key reason behind the surge in social financing and banks' fee income in recent years.</p>
<p>WMP holders largely view these as "investments as deposits" according to Bank of America's David Cui, while in reality they take the hit if the investments go bad. And it is "this perception mismatch" that "prompts banks to seek undue risks when <keyword id="35175" type="UNKNOWN" weightage="60" keywordseo="investing">investing</keyword> 'other people's money he writes.</p>
<p>This has obviously been unsustainable.</p>
<p>In late 2012, we saw investors take to the streets when WMPs they <a href="http://www.businessinsider.com/investors-protest-chinese-wmps-2012-12">bought from Huaxia Bank</a> soured.</p>
<p>AMPs on the other hand will only provide investors with a "possible range of returns," and they are open-ended. Initially they will only be allowed to invest in direct debt financing instruments (DDFIs) like securitized bank loans and other such assets, that can be traded on China's interbank market.</p>
<p>So what's the rationale for switching to AMPs?</p>
<p>"The key change is to remove an implicit guarantee of principle and yield, in the form of 'expected return,' by WMPs," writes Cui.</p>
<p>For now, 11 banks are testing out AMPs, but if these are successful, they could have bigger implications on China's financial market. Cui argues that consumers stand to gain while financial institutions stand to lose. This is largely because investors will become more aware of the risks that come with these products, and will therefore be less likely to place their money there. From Cui:</p>
<p style="padding-left: 30px;">"This probably means that total social financing growth will slow down and hurt investment. Banks' fee income should also suffer: with WMPs, they took a spread between what they pay investors and what they get; with AMPs, they may only be able to book a management fee. The new rules may also eliminate the banks' needs to use other financial intermediates to structure off balance sheet products to satisfy regulatory requirements."</p>
<p>This would also have broader implications for the economy as credit growth would slow, and this would trickle over to sectors that rely on investment.</p>
<p>Of course the success of AMPs is far from certain, as banks are unlikely to be too enthusiastic about this new investment product.</p>

China's Latest Move To Unwind A $2 Trillion Investment Product Is Bad News For Chinese Banks

<p><div class="KonaFilter image-container display-table float_right"><div><div class="image on-image"></div><p></p></div></div>Janet Yellen spoke at the IMF on Wednesday about financial stability. </p><p>Here's the full text of Yellen's prepared remarks. </p><p style="padding-left: 60px;"><strong>Finance and Society</strong></p><p style="padding-left: 60px;">Let me begin by thanking the organizers for inviting me to participate in this important dialogue on the role of finance in society. The financial sector is vital to the economy. A well-functioning financial sector promotes job creation, innovation, and inclusive economic growth. But when the incentives facing financial firms are distorted, these firms may act in ways that can harm society. Appropriate regulation, coupled with vigilant supervision, is essential to address these issues.</p><p style="padding-left: 60px;">Unfortunately, in the years preceding the financial crisis, all too many firms took on risks they could neither measure nor manage. Leverage, interconnectedness, and maturity and liquidity transformation escalated to dangerous levels across the financial system. The result was the most severe financial crisis and economic downturn since the Great Depression. Almost 9 million Americans lost their jobs, roughly twice as many lost their homes, and all too many households ended up underwater on their mortgages and overburdened with debt. To be sure, some individuals and families borrowed unwisely, but too often financial institutions encouraged the behavior that resulted in such excessive debt.</p><p style="padding-left: 60px;">In my remarks today I will discuss some important reasons why the incentives facing financial institutions were distorted and the steps that regulators are taking to realign those incentives.</p><p style="padding-left: 60px;"><strong><span style="line-height: 1.5em;">The Important Role of the Financial Sector</span></strong></p><p style="padding-left: 60px;">Before discussing the incentives that contributed to the buildup of risk at financial institutions, I would like to highlight the important contributions that the financial sector makes to the economy and society. First and foremost, financial institutions channel society's scarce savings to productive investments, thereby promoting business formation and job creation. Access to capital is important for all firms, but it is particularly vital for startups and young firms, which often lack a sufficient stream of earnings to increase employment and internally finance capital spending. Indeed, research shows that more highly developed financial systems disproportionately benefit entrepreneurship.1</p><p style="padding-left: 60px;">The financial sector also helps households save for retirement, purchase homes and cars, and weather unexpected developments. Many financial innovations, such as the increased availability of low-cost mutual funds, have improved opportunities for households to participate in asset markets and diversify their holdings.2 Expanded credit access has helped households maintain living standards when suffering job loss, illness, or other unexpected contingencies.3 Technological innovations have increased the ease and convenience with which individuals make and receive payments.4</p><p style="padding-left: 60px;">The contribution of the financial sector to household risk management and business investment, as well as the significant contribution of financial-sector development to economic growth, has been documented in many studies.5 Such research shows that, across countries and over time, financial development, up to a point, has disproportionately benefited the poor and served to alleviate economic inequality.6</p><p style="padding-left: 60px;"><strong>Distorted Incentives in the Financial Sector</strong></p><p style="padding-left: 60px;">Despite these benefits, as we have seen, actions by financial institutions have the potential to inflict harm on society. Instead of promoting financial security through prudent mortgage underwriting, the financial sector prior to the crisis facilitated a bubble in the housing market and too often encouraged households to take on mortgages they neither understood nor could afford. Recent research has raised important questions about the benefits and costs of the rapid growth of the financial services industry in the United States over the past 40 years.7</p><p style="padding-left: 60px;">A combination of responses to distorted incentives by players throughout the financial system created an environment conducive to a crisis. Excessive leverage placed institutions at great risk of insolvency in the event that severe, albeit low-probability, problems materialized. Overreliance on fragile short-term funding by many institutions left the system vulnerable to runs. And excessive risk-taking increased the probability that severe problems would, in fact, materialize. Moreover, regulators--and the structure of the regulatory system itself--did not keep up with changes in the financial sector and were insufficiently attuned to systemic risks. Once concerns began to develop about escalating losses at large firms, insufficient liquidity and capital interacted in an adverse feedback loop. Funding pressures contributed to "fire sales" of financial assets and losses, reducing capital levels and heightening liquidity pressures--culminating in the near collapse of the financial system in late 2008.</p><p style="padding-left: 60px;"><strong>Capital and liquidity</strong></p><p style="padding-left: 60px;">Several factors encouraged excessive leverage, including market perceptions that some institutions were "too big to fail."8 Financial institutions also had an incentive to engage in regulatory arbitrage, moving assets to undercapitalized off-balance-sheet vehicles. The complexity of the largest banking organizations also may have impeded market discipline. In addition, financial intermediation outside of the traditional banking sector grew rapidly in the years up to 2007, leaving gaps in the regulatory umbrella. And conflicts in the incentives facing managers, shareholders, and creditors may have induced banks to increase leverage.9</p><p style="padding-left: 60px;">To strengthen banks' resilience, the Federal Reserve and the other banking agencies have substantially increased capital requirements. Regulatory minimums for capital relative to risk-weighted assets are significantly higher, and capital requirements now focus on the highest-quality capital, such as common equity. In addition to risk-based standards, bank holding companies and depositories face a leverage ratio requirement. Also, significantly higher capital standards--both risk-weighted and leverage ratios--are being applied to the most systemically important banking organizations. Such surcharges are appropriate because of the substantial harm that the failure of a systemic institution would inflict on the financial system and the economy. Higher capital standards provide large, complex institutions with an incentive to reduce their systemic footprint. We are also employing annual stress tests to gauge large institutions' ability to weather a very severe downturn and distress of counterparties and, importantly, continue lending to households and businesses. Firms that do not meet these standards face restrictions on dividends and share buybacks. As a result of these changes, for the largest banks, Tier 1 common equity--the highest-quality form of capital--has more than doubled since the financial crisis.</p><p style="padding-left: 60px;">New liquidity regulations will also improve incentives in the financial system. Prior to the crisis, institutions' incentives to rely on short-term borrowing to fund investments in riskier or less liquid instruments were distorted in two important ways. First, many investors were willing to accept a very low interest rate on short-term liabilities of financial institutions or on securitizations without demanding adequate compensation for severe-but-unlikely risks, such as a temporary loss of market liquidity. Perhaps these firms expected government support or simply considered illiquidity a very remote possibility. Second, institutions' attempts to shift their holdings once concerns about credit or liquidity risk arose created a fire-sale dynamic that amplified declines in market values, causing unanticipated spillovers onto other institutions and across markets.10</p><p style="padding-left: 60px;">Recently implemented regulations aim to strengthen liquidity. For example, a new liquidity coverage ratio requires internationally active banking organizations to hold sufficient high-quality liquid assets to meet their projected net cash outflows during a 30-day stress period. A new process--the Comprehensive Liquidity Analysis and Review--sets supervisory expectations for liquidity-risk management and evaluates institutions' practices against these benchmarks. A proposal for a net stable funding ratio would require better liquidity management at horizons beyond that covered by the liquidity coverage ratio. A proposed capital surcharge for the largest firms would discourage overreliance on short-term wholesale funding. Also, the Securities and Exchange Commission has adopted changes in regulations that may help avoid future runs on prime money market mutual funds (that is, money funds that invest primarily in corporate debt securities). And reforms in the triparty repo market have reduced risks associated with intraday exposures.</p><p style="padding-left: 60px;"><strong>Large, complex institutions and too big to fail</strong></p><p style="padding-left: 60px;">In the aftermath of the crisis, the Congress tasked the banking regulators with challenging and changing the perception that any financial institution is too big to fail by ensuring that even very large banking organizations can be resolved without harming financial stability. Steps are under way to achieve this objective. In particular, banking organizations are required to prepare "living wills"--plans for their rapid and orderly resolution in the event of insolvency. Regulators are considering requiring that bank holding companies have sufficient total loss-absorbing capacity, including long-term debt, to enable them to be wound down without government support.11 In addition, the Federal Deposit Insurance Corporation has designed a strategy that it could deploy (known as Single Point of Entry) to resolve a systemically important institution in an orderly manner.</p><p style="padding-left: 60px;">The crisis also revealed that risk management at large, complex financial institutions was insufficient to handle the risks that some firms had taken. Compensation systems all too frequently failed to appropriately account for longer-term risks undertaken by employees. And lax controls in some cases contributed to unethical and illegal behavior by banking organizations and their employees. The Federal Reserve has made improving risk management and internal controls a top priority. For example, the Comprehensive Capital Analysis and Review, which includes the stress tests that I mentioned, also involves an evaluation to ensure firms have a sound process in place for measuring and monitoring the risks they are taking and for matching their capital levels to those risks. Also, supervisors from the Fed and other agencies have pressed firms to improve their internal controls and to make their boards of directors more directly responsible for compensation decisions and employee conduct.</p><p style="padding-left: 60px;"><strong>Changes to Regulatory and Supervisory Focus</strong></p><p style="padding-left: 60px;">As I noted, the financial crisis revealed weaknesses in our nation's system for supervising and regulating the financial industry. Prior to the crisis, regulatory agencies, including the Federal Reserve, focused on the safety and soundness of individual firms--as required by their legislative mandate at the time--rather than the stability of the financial system as a whole. Our regulatory system did not provide any supervisory watchdog with responsibility for identifying and addressing risks associated with activities and institutions that were outside the regulatory perimeter. The rapid growth of the "shadow" nonbank financial sector left significant gaps in regulation.</p><p style="padding-left: 60px;">In response, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) expanded the mandate and authority of the Federal Reserve to allow it to consider risks to financial stability in supervising financial firms under its charge. Within the Federal Reserve System, we have reorganized our supervision of the most systemically important institutions to emphasize what we call a "horizontal perspective," which examines institutions as a group and in comparative terms, focusing on their interaction with the broader financial system. We also created a new office within the Fed to identify emerging risks to stability in the broader financial system--both the bank and nonbank financial sectors--and to develop policies to mitigate systemic risk. The Dodd-Frank Act created the interagency Financial Stability Oversight Council, chaired by the Treasury Secretary, and the Federal Reserve is a member. It is charged with identifying systemically important financial institutions and systemically risky activities that are not subject to consolidated supervision and designating those institutions and activities for appropriate supervision. And it is charged with encouraging greater information sharing and policy coordination across financial regulatory agencies.</p><p style="padding-left: 60px;"><strong>Where We Stand</strong></p><p style="padding-left: 60px;">My topic is broad, and my time is short. Let me end with three thoughts. First, I believe that we and other supervisory agencies have made significant progress in addressing incentive problems within the financial sector, especially within the banking sector. Second, policymakers, including those of us at the Federal Reserve, remain watchful for areas in need of further action or in which the steps taken to date need to be adjusted. And, third, engagement with the broader public is crucial to ensuring that any future steps move our financial system closer to where it should be. Active debate and discussion of these issues at this conference and in other forums is important to improve our understanding of the challenges that remain.</p>    <div class="margin-top">        <h3>NOW WATCH: <a href="http://www.businessinsider.com/how-floyd-mayweather-spends-his-money-boxing-2015-4">Here's how Floyd Mayweather spends his millions</a></h3>        <div>            <div>        <div class="ooyala-video-player" data-video-autoplay="false" data-video-id="NiaGVpdDqdBR4NCmtjL5odLe14N1R4Hp" data-player-variable="ooyalapopvideo" id="ooyalaplayer_popvideo" style="width:1280px;height:720px"></div>        </div>        </div>            </div>

You Searched For "securitized debt instruments" and got 8 results

Sebi proposes Rs 1 crore minimum investment, mandatory demat form for securitized debt instruments

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What Indian debt market can learn from other emerging economies?

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What caused the Great Recession? Understanding the key factors that led to one of the worst economic downturns in US history

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The CEO of a $736 billion asset manager that sidestepped the most toxic casualty of the financial crisis warns of the big risk in markets right now

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'Reducing US stocks to +0%': Here's why Morgan Stanley just made a major tweak to its portfolio, and what it's buying instead

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The toxic asset made famous by 'The Big Short' might actually be a good investment

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China's Latest Move To Unwind A $2 Trillion Investment Product Is Bad News For Chinese Banks

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Here's Janet Yellen's speech at the IMF on financial stability

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