Distressed Financial Markets:Navigating the Shoals of Liquidity Risk

249 Pages·2008·0.836 MB·English

by  Eric D Cruikshank, Eric D Cruikshank

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Distressed Financial Markets:
Navigating the Shoals of Liquidity Risk
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Distressed Financial Markets:
Navigating the Shoals of Liquidity Risk
Eric D. Cruikshank
E
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M O
O K
N S
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Published by
Euromoney Institutional Investor PLC
Nestor House, Playhouse Yard
London EC4V 5EX
United Kingdom
Tel: [phone] or USA 11 800 437 9997
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E-mail: [email protected]
Copyright © 2008 Euromoney Institutional Investor PLC
ISBN 978 1 84374 543 3
This publication is not included in the CLA Licence and must not be copied without the permission
of the publisher.
All rights reserved. No part of this publication may be reproduced or used in any form (graphic, elec-
tronic or mechanical, including photocopying, recording, taping or information storage and retrieval
systems) without permission by the publisher. This publication is designed to provide accurate and
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every effort has been made to offer the most current, correct and clearly expressed information possible.
The materials presented in this publication are for informational purposes only. They reflect the subjec-
tive views of authors and contributors and do not necessarily represent current or past practices or
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the editor or the publisher is engaged in rendering accounting, business, financial, investment, legal,
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The views expressed in this book are the views of the authors and contributors alone and do not reflect the views
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Typeset by Phoenix Photosetting, Chatham, Kent
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To Cleo
for your encouragement to write this book
and your love and support throughout
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Contents
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Chapter title
Contents
Foreword xi
About the author xiii
Introduction xv
Part 1 – The framework
1 Financial crises and their origins 3
Early examples 3
Boom–bust dynamics 7
Who to blame – external or internal causes, crowds or
policy-makers? 11
The problem with statistics and probabilities 14
2 Evolving characteristics of financial markets 17
The institutional importance of a financial market perspective 17
The role of legal frameworks 18
Macroeconomic preconditions 21
Intermediation and disintermediation – how banks and securities
markets handle risk 22
The functions of financial markets and their trade-offs 24
Liquidity – what does it mean? What does it matter? 26
The convergence of markets and institutions 28
Factors affecting the stability of financial markets 37
3 Systemic liquidity and financial market distress 40
The distinction between individual and systemic liquidity 40
Identifying financial market distress 42
Early warning signs of systemic financial distress 51
Macroeconomic and financial sector assessment and surveillance 54
4 Financial risk management and liquidity risk 57
Evolution of the markets for hedging products 57
The securitisation explosion and its influence on global financial
markets 72
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Contents
The symbiosis between risk markets and securities markets
(strengths and weaknesses) 76
The difficulty of hedging against sudden illiquidity 83
Best practices in institutional liquidity risk management 84
Part 2 – Country cases and global trends
5 Country case histories of financial market distress 89
Spain (1977) 89
Chile (1982) 91
United States Savings & Loan (1985) 95
United States Black Monday (1987) 99
Norway (1987) 102
Finland and Sweden (1991) 104
Japan (1992) 105
Mexico (1994) 108
South Korea and East Asia (1997) 112
Russia (1998) 115
Brazil (1999) 117
United States dot-com (2000) 118
Argentina (2001) 121
Lebanon (2002) 124
United States sub-prime (2007) 126
A practical typology for the country case histories 141
6 Financial globalisation – global trends and the new functions,
institutions and markets and their importance for financial
market distress 146
The migration of liquidity – how sustainable are emerging
capital markets? 146
Basel II and its ramifications 147
Banks and the end of entitlement 148
Financial institutional form follows function 148
Global imbalances and its mirror image: the rise of sovereign
wealth 149
The new institutional realities 150
Current developments in financial markets 158
Part 3 – Lessons for policy-makers and portfolio managers
7 Lessons from financial crises for policy-makers 163
Thoughts on contagion 163
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Contents
Thoughts on orthodox and heterodox economic policies 170
Sequencing economic liberalisation 175
Prescriptions for individual countries 178
When financial crisis crystallises 182
Macroeconomic policy lessons 182
Financial supervision and regulation 183
Global considerations 190
8 Lessons from financial crises for portfolio managers 193
The limits to hedging 193
The use of financial leverage 199
Asset allocation 200
Are sovereign ratings sufficient or should portfolio managers
develop their own country scorecards? 202
Active versus passive management and separating alpha and beta 203
Developing the institutional capacity to monitor and manage
liquidity risk 206
9 Conclusion 209
Annex 1 Treynor’s models of market bubbles 215
Annex 2 Securitisation and the market for structured finance products 219
Bibliography 224
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