What was the worst economic crisis of all time?

What was the worst economic crisis of all time?

I am interested in reading about the worst economic crisis of all time. By that I mean the largest reduction in GDP over a period of at least a year. The economic crisis should not have been caused by war nor natural catastrophe, but events that could arise arise in a stable society today, like a financial crisis, economic mismanagement or similar.

The Economist illustrated the History of World GDP by way of the intriguing graphic below.

The mismanagement of the Chinese Qing empire between the years of 1820 and 1913 is plain to see. Similarly, assuming that colonialism satisfies the OP's criteria, the difference in percentage GDP of (British) India between 1700 and 1940 is simply astounding.

Up front, imho GDP and "like a year" is not really suited for objective comparing of historic economic crises, which run on time scales of at least several years or a decade, smaller time scales are better called economic fluctuations. Comparing economic crises in different historical epochs, national and world-wide ones, by proportional (%) GDP reduction might turn out a bit tricky, due to incomplete data and different assessment basis.

But anyway, regarding economical, poltical mismanagment or faulty construction of economic system by pure better-known numbers, the biggest economic crisis was the Great Depression

In previous depressions, such as those of the 1870s and 1890s, real per capita gross domestic product (GDP)-the sum of all goods and services produced, weighted by market prices and adjusted for inflation-had returned to its original level within five years. In the Great Depression, real per capita GDP was still below its 1929 level a decade later.

Economic activity began to decline in the summer of 1929, and by 1933 real GDP fell more than 25 percent, erasing all of the economic growth of the previous quarter century. Industrial production was especially hard hit, falling some 50 percent. By comparison, industrial production had fallen 7 percent in the 1870s and 13 percent in the 1890s.

In the absence of government statistics, scholars have had to estimate unemployment rates for the 1930s. The sharp drop in GDP and the anecdotal evidence of millions of people standing in soup lines or wandering the land as hoboes suggest that these rates were unusually high. It is widely accepted that the unemployment rate peaked above 25 percent in 1933 and remained above 14 percent into the 1940s. Yet these figures may underestimate the true hardship of the times: those who became too discouraged to seek work would not have been counted as unemployed. Likewise, those who moved from the cities to the countryside in order to feed their families would not have been counted. Even those who had jobs tended to see their hours of work fall: the average work week, 47 to 49 hours in the 1920s, fell to 41.7 hours in 1934 and stayed between 42 and 45 until 1942.

(Source: Encyclopedia Britannica)

Austrian economist Kurt Richebacher states in a economic analysis of the Great Depression (the whole article is worth reading):

This view about the ultimate cause of the Great Depression predominated among economists around the world until the early 1960s. But one book, appearing in 1963, radically changed that view, at least among American economists. It was Friedman's and Schwartz's classic, Monetary History of the United States. This book categorically postulated that there had been neither inflation nor any money or credit excesses in the 1920s that could have caused the economy's collapse between 1929 and 1933. From this followed the conclusion that the Great Depression essentially had its crucial cause in policy faults that were made during these years.

To quote a decisive passage from the book, "The monetary collapse from 1929 to 1933 was not an inevitable consequence of what had gone before. It was the result of the policies followed during those years. As already noted, alternative policies that could have halted the monetary debacle were available throughout those years. Though the Reserve System proclaimed that it was following an easy-money policy, in fact it followed an exceedingly tight policy."

"Smaller/national" examples in 20th century would be:

  • Japanese asset price bubble, 1986-1990
  • Argentine inflation in the 80s & 90s

For crises before 20th century a look on these examples might be interesting:

  • Tulip Mania in Netherlands, 1637
  • Collapse of Easter Island Civilization (still a active research field in economics concerning ecological economics, sustainability and Malthusian catastrophe)
  • Collapse of Maya Civilization, again a non-sustainable managing of natural resources is ONE of the theories trying to explain its decline

The Great Depression of 1929-1933 showed a fall in real GDP in the United States of 38.1% according to this source. This was probably the greatest fall in real GDP in the independent history of the US, although the Panics of 1796 and 1819 could have been larger.

Beyond the US, Britain's biggest recession was the 25% fall following the end of the First World War, which exceeded the 5.8% fall experienced there in the Great Depression.

Some areas of the former Soviet Union experienced a 45% fall in GDP after the transition from planned and globally integrated economies to isolated and market oriented economies.

Going further back, the Great Depression of the 14th century in Europe led to a fall of up to 40% in some countries.

One of the hardest was possibly the crisis in Russia due to introduction of Capitalism, the breakup of the USSR in 1991 and pro-American policy of the Yeltsin's government.

This is the drop of GDP per captia:

This is graphic depicting the drop in industrial output in Russian Federation (blue) and Moscow (red), in per cents to the level of 1991:

This graphic shows index of machinery production of Russia, in percents to the level of 1991:

This graphic shows the GDP per captia of Russia (blue) and the constituents of the USSR (red) in 1950-2010 conpared to that of the USA in the same year (in purshasing parity prices).

2008 Financial Crisis

The 2008 financial crisis was the worst economic disaster since the Great Depression of 1929. It occurred despite the efforts of the Federal Reserve and the U.S. Department of the Treasury. The crisis led to the Great Recession, where housing prices dropped more than the price plunge during the Great Depression. Two years after the recession ended, unemployment was still above 9%. That doesn't count those discouraged workers who had given up looking for a job.    

5. Greece, Oct. 1944

Highest monthly inflation: 13,800%
Prices doubled every 4.3 days

In the fifth worst inflation situation of all time, Greece in 1944 saw prices double every 4.3 days. Hyperinflation in Greece technically began in October 1943, during the German occupation of the country in WWII. However, the most rapid inflation occurred when the Greek government in exile regained control of Athens in October 1944 prices rose by 13,800 percent that month and another 1,600 percent in November, according to a study by Gail Makinen.

In 1938, the Greeks held a drachma note for an average of 40 days before spending it, but by November 10th 1944, the average holding time shrunk to 4 hours. In 1942, the highest denomination of currency was 50,000 drachma, but by 1944 the highest denomination was a 100 trillion drachmai note. On Nov 11th, the government issued a redenomination of the currency, which converted old drachmai to new at a rate of 50 billion to one, although the populace continued using British Military Pounds as the de facto currency until mid-1945.

The stabilization efforts were relatively successful, with prices rising only 140 percent from January through May, and even seeing 36.8 percent deflation in June 1945 when prominent economist Kyriakos Varvaressos was brought in as economic czar. However, his plan of increasing foreign assistance, reviving domestic production and imposing controls on wages and prices through a redistribution of wealth worsened the country's budget deficit and Varvaressos resigned on September 1.

After the civil war of Jan-Dec. 1945/46, the British offered a plan to stabilize the country, which included increasing revenues through the sale of aid goods, an adjustment of specific tax rates, improved tax collection methods and the creation of the Currency Committee (composed of three Greek Cabinet Ministers, one Briton and one American) for fiscal responsibility. By the beginning of 1947, prices had stabilized, public confidence was restored and national income rose, bringing Greece out of the vortex of hyperinflation.

10 of the Worst Decisions Ever Made

Sometimes we make bad decisions about who we date or what movie to see -- and those shoes? Too late to return them now. But sometimes, we make really bad decisions.

For example, Thomas Austin didn't consider the consequence of introducing rabbits to Australia he just wanted a five-star meal. And NASA knew the Challenger had O-ring problems, but decided to launch the space shuttle anyway. And all 12 of the publishing firms that rejected J.K. Rowling's "Harry Potter and the Sorcerer's Stone"? Since their first printing in 1997, the Harry Potter books have broken publishing records they are now considered the fastest-selling books ever.

The next time you make a bad decision, remember: It probably could have been worse -- you could have accepted the Trojan Horse or tried to invade Russia. In no particular order, we've collected 10 of the worst decisions ever made. Hold on to your sweet tooth because we're starting with those little candies aliens just can't resist. No, not M&Ms.

10: Mars Turning Down the Chance to be in 'E.T.'

"Is he a pig? He sure eats like one," quipped Gertie when she first laid eyes on the small brown alien, E.T., in Steven Spielberg's 1982 blockbuster movie. E.T. may have had a sweet tooth, but those brown, orange and yellow candies he was snacking on weren't M&Ms.

It could have been M&Ms, but Mars passed on the chance to use their candy in "E.T., the Extra-Terrestrial" when Spielberg asked. Instead, Hershey smartly stepped in with Reese's Pieces when opportunity knocked. The good fortune for knowing when to say yes? Sales of Reese's Pieces jumped 65 percent in June 1982, the same month E.T. was released [source: Time, Conradt].

9: Decca Records Declining to Sign the Beatles

In 1962, Dick Rowe, an executive at Decca Records, thought guitar groups were falling out of favor. On New Year's Day that year, The Beatles – though at that time Pete Best was their drummer and they called themselves the Silver Beatles -- auditioned for Decca Records producer Tony Meehan. One month later, when Dick Rowe heard their audition tape -- 15 tracks on a 12-inch audio tape -- he passed on signing the band.

As it turns out, Dick Rowe was mistaken. Guitar bands weren't cold, they were hot. The Beatles went on to sign with EMI, and released their first 8 albums through the Parlophone label. It's estimated that the band earned $38.5 million by the end of the summer of 1967. The Wall Street Journal estimated $50 million in record sales in the U.S. alone in 1964 [source: Beatle Money]. In 1968 they launched their own record label, Apple Records.

8: Thalidomide's Use as a Morning Sickness Treatment

Thalidomide was introduced in the early 1950s as a safe over-the-counter sedative, and went on to be prescribed to pregnant women as a morning sickness treatment during the 1950s and 1960s across 46 countries. By 1961, though, negative effects of the drug were becoming evident -- babies were born with severe deformities. Affected babies were often born with shortened arms or legs and with flipper-like hands and feet (a condition called phocomelia) some babies were born with other defects such as malformed eyes, ears, hearts and other organs [source: March of Dimes]. By the time the manufacturer finally pulled the drug, an estimated 100,000 pregnant women had taken it, and an estimated 40 percent of babies exposed to the drug died (either during the pregnancy or shortly after birth) [source: March of Dimes].

Thalidomide does have its uses, although always with the risk of severe birth defects or infant mortality. It's approved for use as a treatment for multiple myeloma, which is a blood and bone marrow cancer, as well as treatment for skin lesions associated with leprosy, and research is underway on its potential treatment for other cancers, HIV-related complications, and autoimmune conditions such as lupus and Crohn's disease.

7: The Titanic's Many Bad Choices

More than a century ago, the RMS Titanic set sail on her maiden voyage across the North Atlantic. But just five days into the trip from England to New York City, the luxury liner collided with an iceberg off the coast of Newfoundland consumed by damage she sank, killing more than 1,500 passengers and crew.

Multiple mistakes were made that collectively sent the Titanic to its tragic end in April 1912. First, there were no safety regulations in place for a ship as large as the Titanic. It didn't carry adequate safety equipment. For example, there were only 16 lifeboats, enough for only about one-third to one-half of the passengers on board, and crew members weren't prepared with binoculars or proper lighting. Additionally, the Titanic was untested. Sure, they'd reviewed the ship's equipment, but it was never test driven it was unproven. The crew was not fully up to speed on the liner, its equipment (such as the state-of-the-art Marconi wireless messaging system) and its emergency procedures.

Despite how unprepared the Titanic was operationally, it may have been a simple human error that ultimately caused the iceberg disaster. In 2010 it was revealed that the helmsman may have made a steering error when diverting the ship around the iceberg, and the turn wasn't corrected in time to avoid disaster. The iceberg was spotted just before midnight, and by 2:20 a.m. the Titanic had split and sunk.

6: Filling the Hindenburg With Hydrogen

In the 1930s, there was a dream of commercial airships ferrying passengers across the Atlantic in no time at all, just 60 hours. Commercial airship travel was gaining popularity, and the Hindenburg was the largest zeppelin ever built (in fact, it was the largest thing ever to fly). The airship was three times as long and double the height of a Boeing 747 of today, all wrapped up in a silver-painted fabric membrane [source: Hall]. It was just as luxurious as it was enormous -- it even had a specially designed lightweight baby grand piano on board, and, paradoxically, a smoking lounge.

In May 1937, during its attempt to dock, the luxury liner burst into flames above Lakehurst Naval Air Station in New Jersey. In 37 seconds the Hindenburg was destroyed by fire 36 of the 97 passengers and crew died. What went wrong? A few things. First and foremost, the Hindenburg was filled with hydrogen, a highly flammable gas, instead of a less-combustible alternative such as helium.

There have been differing theories about what caused the hydrogen to combust. Could the zeppelin have been struck by lightning? Or was the German Hindenburg -- Nazi-funded, with swastikas on its tail -- a political target, destroyed by a bomb, gun or sabotage? Or maybe, others thought, the powdered aluminum in the paint contributed to the explosion? Today's leading theory suggests the combination of leaking hydrogen gas, such as from a broken or malfunctioning valve or wire, and a build-up of electrostatic resulting from a thunderstorm may have sparked the fire when the crew dropped the ship's landing ropes, which may have grounded the zeppelin and discharged the electrostatic.

5: Napoleon Invading Russia

In June 1812, Napoleon invaded Russia with one of the largest armies ever assembled for battle, and was so confident of his impending victory he wagered the war wouldn't last more than 20 days [source: PBS]. It wasn't Russia Napoleon wanted, necessarily (although Napoleon and Czar Alexander I were at odds over trade with England) it was India. But due to lice infestations and subsequent typhus infections, food shortages, freezing temperatures and, eventually, Russian troops, the Grande Armee wouldn't make it beyond Moscow.

More than 600,000 men from Napoleon's empire marched toward Russia, but just a few more than 100,000 were left fighting by early September 1812, and in the end Napoleon was escorted by Russian troops back to France [source: Knight].

It was a battle of giants, and the largest military invasion of WWII: Nazi Germany against Communist Russia. But the war between Germany and Russia would be the first major land defeat for Hitler, and that defeat is considered the beginning of the decline of Nazi Germany.

In June 1941 Adolf Hitler broke the non-aggression pact signed in 1939 by Germany and the Soviet Union when he invaded Russia with an army of more than 3 million men, 7,000 artillery pieces, 3,000 tanks, and 2,500 aircraft [source: History]. Joseph Stalin, taken by surprise, found his military overwhelmed by the German onslaught. During the first week of the invasion there were 150,000 casualties among Soviet troops, and by October that year, German troops had taken 3 million Soviet prisoners of war [source: Rees]. German troops reached Moscow by December 1941, but the war was taking longer than anticipated -- clothing, food and medical supplies were wearing thin. When Soviet troops struck back hard to keep Moscow from falling, the Nazis failed to take Moscow.

3: Accepting the Trojan Horse

Legend has it that the Trojan War had been going on for a decade when the Greeks, unable to penetrate the walls of the city of Troy, decided to engage in a little subterfuge.

The Greeks planned to trick the Trojans into letting them behind those closed walls. They would leave a gift for the Trojans and pretend to retreat home. On orders from Odysseus, they built a horse, the Trojan Horse, and it was big enough to fit a few dozen soldiers inside. After they wheeled it to the city gates, the Greeks faked their departure, and the Trojans, convinced they'd just won the war, rolled the gift inside their walls. That night, the hidden soldiers opened the gates to additional troops, and Troy fell.

Stories of the Trojan War are told by Homer in "The Iliad" and "The Odyssey," and by Virgil in "The Aeneid," but is there truth to the Trojan Horse? Evidence suggests . maybe? Even historians don't agree on whether this war story is truth or tall tale.

In April 1846, a group of about 90 pioneers in about 20 wagons followed brothers Jacob and George Donner westward from Illinois to California. The California Gold Rush wouldn't be for another two years, and the Donner Party, inexperienced in the wilderness, was headed into uncharted territory. They began their journey on the California Trail, a known wagon-train route west, but decided to try a shorter, alternate route. Because of freezing temperatures and rough, mountainous terrain, the shortcut they'd hoped for turned out to be long and deadly.

The Donner Party is still well-known today, although we might not all know the specifics of their journey. What they're best known for, though, is the question of whether they engaged in cannibalism for survival while trapped in the snowy Sierra Nevada mountains.

In the 1920s, if you were "going to see a man about a dog," you weren't looking for a rescue pup you were in the mood for a tipple or two, preferably whiskey. Why so sly? During Prohibition in America, between January1920 when the 18th Amendment was signed until its repeal in 1933, it was illegal to manufacture, transport or sell alcohol (but it wasn't actually illegal to drink it).

Prohibition was considered the "noble experiment." It was supposed to lower crime levels and reduce the amount of money spent on prisons. It was supposed to clean us up socially, as well as improve our health and hygiene. What resulted instead was an explosion of alcohol-related crime, and eventually a corrupt law enforcement and political system willing to take bribes or look the other way. Prohibition didn't stop people from drinking it just changed the what and where of the equation. Because they were illegal, foot juice (slang for cheap wine around the speakeasy) and jag juice (for those who like something a little harder) were unregulated, and tainted alcohol killed an average of 1,000 during every dry year [source: Lerner]. Unexpected negative financial effects also fell on a country expecting an economic windfall. For example, states lost revenue previously gained from liquor sales.

Author's Note: 10 of the Worst Decisions Ever Made

I had just as much fun digging into each of these bad decisions as I did when I wrote another article, What are the odds? The two have become some of my favorites to both research and write. What are the odds of hitting that iceberg? As it turns out, the odds were pretty good. Also, if you learn nothing else from this article, remember: If you're thinking about invading Russia (any time, but especially in or near winter), you might want to brush up on a lot of history before committing to that decision.

Coronavirus: Worst economic crisis since 1930s depression, IMF says

Kristalina Georgieva said the world faced the worst economic crisis since the Great Depression of the 1930s.

She forecast that 2021 would only see a partial recovery.

Lockdowns imposed by governments have forced many companies to close and lay off staff.

Earlier this week, a UN study said 81% of the world's workforce of 3.3 billion people had had their place of work fully or partly closed because of the outbreak.

Ms Georgieva, the IMF's managing director, made her bleak assessment in remarks ahead of next week's IMF and World Bank Spring Meetings.

Emerging markets and developing countries would be the hardest hit, she said, requiring hundreds of billions of dollars in foreign aid.

"Just three months ago, we expected positive per capita income growth in over 160 of our member countries in 2020," she said.

"Today, that number has been turned on its head: we now project that over 170 countries will experience negative per capita income growth this year."

She added: "In fact, we anticipate the worst economic fallout since the Great Depression."

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Ms Georgieva said that if the pandemic eased in the second half of 2020, the IMF expected to see a partial recovery next year. But she cautioned that the situation could also worsen.

"I stress there is tremendous uncertainty about the outlook. It could get worse depending on many variable factors, including the duration of the pandemic," she said.

Her comments came as the US reported that the number of Americans seeking unemployment benefits had surged for the third week by 6.6 million, bringing the total over that period to more than 16 million Americans.

The US Federal Reserve said it would unleash an additional $2.3tn in lending as restrictions on activity to help contain the coronavirus had forced many businesses to close and put about 95% of Americans on some form of lockdown.

Separately, UK-based charity organisation Oxfam warned that the economic fallout from the spread of Covid-19 could force more than half a billion more people into poverty.

By the time the pandemic is over, the charity said, half of the world's population of 7.8 billion people could be living in poverty.

On Thursday, following marathon talks, EU leaders agreed a €500bn (£440bn $546bn) economic support package for members of the bloc hit hardest by the lockdown measures.

The European Commission earlier said it aimed to co-ordinate a possible "roadmap" to move away from the restrictive measures.

Earlier this week, the International Labour Organization (ILO), a UN agency, warned that the pandemic posed "the most severe crisis" since World War Two.

It said the outbreak was expected to wipe out 6.7% of working hours across the world during the second quarter of 2020 - the equivalent of 195 million full-time workers losing their jobs.

Secretary general Angel Gurría said that economies were suffering a bigger shock than after the 9/11 terror attacks of 2001 or the 2008 financial crisis.

The rise of the stockmarket

During the worst phases of the crisis, Japanese and European stockmarket indices lost more than half of their value, as measured by the MSCI Japan and the MSCI Europe (excluding UK) indices. World, US and Asia (excluding Japan) indices all fell by more than 40%, while the UK lost over 35% of its value.

However, the knock-on effect of central bank attempts to stimulate economies has sent stockmarkets roaring back. US stocks have risen more than 260% since the crisis low in March 2009. UK, European and Asian stocks are all up more than 150% in the same period.

Low interest rates and the effect of money being pumped into the economy has benefited businesses and therefore the stockmarkets on which they are listed.

Low interest rates have enabled companies to restructure their balance sheets at lower costs because loans are cheap. And low rates have made shares, with relatively high dividend yield, more attractive. The UK stockmarket yields around 3.8% compared to 0.9% on a 10-year UK government bond.

Stockmarkets have provided decent returns since the crisis.

It is, of course, almost impossible to time the market. Those who sold their investments at the top in the autumn of 2007 and bought back at the low of spring 2009 would have done so more out of luck than judgement.

But as the chart below illustrates even if you had left your money in stocks at the pre crisis highs in 2007 you would still have made a healthy return, albeit having endured some nervous moments.

Between Q3 2007 and Q2 2017 US stocks returned more than 7% per year including dividends. UK and world stocks returned 4.9% and 4.3%, respectively.

Japan and Europe, which have seen some of the worst economic woes in the last decade, were the two main underperformers, although shares still returned more than bonds. The stockmarket indices for each indicate returns of 1.26% and 1.35% respectively.

How stockmarkets bounced back

Compound annual growth rate % (CAGR*)

*CAGR calculates the growth rate of your investment per year between two dates which helps smooth out periods of wild fluctuation.

Source: Schroders, Thomson Reuters Datastream as at 30 June 2017. Data is total returns including dividends for MSCI USA, MSCI UK, MSCI World, MSCI ASIA All Country ex-Japan, MSCI Europe ex-UK and MSCI Japan. For information purposes only. The material is not intended to provide advice of any kind. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Please remember that past performance is not a guide to future performance and may not be repeated.

Ben Bernanke: The 2008 Financial Crisis Was Worse Than The Great Depression

Ben Bernanke has just been revealed on record as insisting that the financial crash of 2008 was actually worse than the Great Depression itself. That's a statement that leads on to a very interesting indeed question: why on earth wasn't the fallout from that crash therefore worse than the Great Depression? The answer being, in short form, that Milton Friedman was right. In longer form, that the Federal Reserve itself followed the wrong policies back then and the right policies over the last few years: which is the same statement as saying that Milton Friedman was right. We can also go on to another point: which is that this time around has been worse in the periphery of the eurozone than the Great Depression was and that will lead us to the conclusion that the European Central Bank (ECB) has been following the wrong policies this time around as the Fed did 80 years ago.

Mr. Bernanke is quoted making the statement in a document filed on Aug. 22 with the U.S. Court of Federal Claims as part of a lawsuit linked to the 2008 government bailout of insurance giant American International Group Inc.

“September and October of 2008 was the worst financial crisis in global history, including the Great Depression,” Mr. Bernanke is quoted as saying in the document filed with the court. Of the 13 “most important financial institutions in the United States, 12 were at risk of failure within a period of a week or two.”


Asked why he thought it was essential for the government to rescue AIG, Bernanke said, “AIG’s demise would be a catastrophe” and “could have resulted in a 1930s-style global financial and economic meltdown, with catastrophic implications for production, income, and jobs.”

We might want to little teaspoon of sugar with that statement as it's all part of a lawsuit. But the general point is still worth making. Milton Friedman's point about the Great Depression was that it wasn't an inevitable result of the Great Crash of 1929. Rather, it was an avoidable consequence of the Fed's reaction to it. That Fed reaction being to let all the banks go bust, allow the money supply to shrink and if that's what you're going to allow to happen then you're going to get a precipitous fall in economic activity.

This time around of course the Fed didn't allow that to happen. They supported the banks (even if perhaps shareholders in them and possibly management of them should have lost a bit more than they did) and conducted QE to make sure that the wider measures of the money supply did not shrink as they did 80 years ago.

It's true that this doesn't leave all that much room for the effects of stimulus which will somewhere between disappoint and annoy Keynesians. But then there wasn't actually all that much stimulus either: the $800 billion splashed out at Federal level rather neatly offset the contraction of State and local governments.

And much the same was true on my side of the Pond. The Bank of England supported the banks, ran QE and made sure the money supply didn't shrink.

No one is going to say that either the US or the UK had an easy time over the past few years. But a deep recession that we're now recovering from is a great deal better than the 25 to 30% fall in GDP that happened during the Depression. The essential lesson here being that central banks learned from their mistakes last time around and didn't make the same mistakes this time.

Except, of course, for our friends at the ECB. They have protected the banks but they've just not been doing QE on anything like the scale required. And thus we have much of the eurozone just not recovering in the manner that the UK and US have been. And in the periphery the economic devastation has been just as bad as US Depression era unemployment and GDP falls were. For this very simple reason: the ECB didn't learn the lesson and hasn't been doing the right things to avert such events.

When the textbooks get written on the last few years we're going to hear it again and again. Milton Friedman was right, the Fed and the BoE listened and did the best possible under the circumstances. The ECB didn't and that's why Southern Europe is still mired in it and the UK and US are not.

More from IFR Special Report magazine

IFR 2000 issue Supplement

A man on a mission

IFR&rsquos 2000th special issue would be incomplete without recognising the achievements of Hans-Joerg Rudloff, the man at the centre of many of the key developments in the Euromarkets since the formation of IFR. He spoke to Keith Mullin. The Eurobond market owes its history of largely unbroken success to no single individual. The formative period of the 1960s and 1970s followed by the phase of explosive growth, globalisation and breathtaking innovation of the 1980s and 1990s have their hallowed lists of progenitors, progressive thinkers, inventors and pioneers. Few people have straddled both periods and can legitimately lay claim to having their name on both lists. Fewer still remain at the forefront of capital markets today, standing ready to help marshal the industry towards its next adventure. One man who can make those claims, though, is Hans-Joerg Rudloff, now chairman of Barclays&rsquo investment bank and senior adviser to Barclays&rsquo CIB executive committee. Rudloff&rsquos banking career spans almost 50 years yet he shows no signs of slowing down, continuing to exude passion and boundless energy. He doesn&rsquot focus on career high or low points. &ldquoI&rsquove always been happy,&rdquo he said simply. But he&rsquos also convinced that in his time the capital markets have done their job. &ldquoCapital markets have steered capital to all corners of this world and have lifted billions of people out of poverty,&rdquo he said. &ldquoWithout the pioneering spirit of the investment banks in the 1990s and at the beginning of this century, emerging markets would not have been able to finance their reforms and their growth. I think that&rsquos where investment banking was really tested and it proved its worth, just as it did in 19th century America.&rdquo Start of a journey Rudloff originally joined Credit Suisse in Geneva after graduating in 1965. In those very early days, he got to know the man who would become his mentor and watch over his career: Rainer Gut, undoubtedly Switzerland&rsquos foremost investment banker &ndash now in his 80s &ndash and honorary chairman of Credit Suisse. In 1968, Rudloff moved to New York and jumped ship to Kidder Peabody, one of Wall Street&rsquos largest investment banks, where he stayed for 11 years. Kidder had a small Eurobond department and Rudloff&rsquos moves to Zurich to head Kidder&rsquos Swiss operations and then to London as syndicate manager gave him the chance to observe the burgeoning market up close. Rising quickly through the ranks, Rudloff became chairman of Kidder Peabody International, and, in 1978, a board member of Kidder Peabody Inc. Of the very early days, Rudloff credits Stanley Ross, another market legend, for giving him his early vision. &ldquoStanley moved to Kidder from Strauss Turnbull, a typical London trading firm, trading everything under the sun, including international bond issues. I witnessed Stanley&rsquos passionate appeals, describing the extraordinary potential this new international capital market would offer,&rdquo Rudloff said. &ldquoHe had a vision of how it would develop and being a pretty young guy at that time, I was impassioned by his outlook that capital would once again flow freely across borders and would be a bridge into a more united and better world. &ldquo To realise his and the market&rsquos potential, though, Rudloff needed a bigger platform. Gut gave him the opportunity he needed. In 1971, Gut had joined Swiss-American Corporation (Credit Suisse&rsquos US investment banking and securities subsidiary) as president and CEO following three years as a general partner at Lazard Freres in New York. By the late 1970s, he had returned to his native Switzerland and was appointed chairman of Credit Suisse&rsquos executive board. He had observed Rudloff&rsquos impressive rise so it was not long before Gut had engineered a move for Rudloff to join CSFB in 1980. Michael von Clemm had recently taken over as chairman and

IFR 2000 issue Supplement

1977: US$100m deal for Bank of America: the first private-label MBS

The creation and growth of the private-label mortgage-backed securities origination and trading business on Wall Street in the late 1970s and early 1980s at Salomon Brothers in New York is legendary. It was also a critical turning point for Wall Street, ushering in a 30-year era where the bond market was king, bond traders became the most highly rewarded heroes of investment banking, and securitisation became one of the most lucrative and innovative pockets of finance. Of course, the “revolution” that took place at Salomon Brothers in the spring of 1978, when the very first mortgage finance department on Wall Street was formed, also arguably led, 30 years later, to the worst recession in the US since the Great Depression. How closely the two historical events are linked has been hotly debated. Lewis Ranieri, the “godfather of securitisation”, who led that very first Wall Street mortgage department, has gone on record in recent years as saying that it was not the concept of securitisation itself, but the new exotic mortgage loans, lack of liability, and growth of the subprime industry that ultimately sealed the fate of the pre-crisis housing/credit bubble. Either way, the invention of MBS without government backing was a seminal event in the history of Wall Street. Immortalised in the best-selling 1989 book “Liar’s Poker” by Michael Lewis, the story of MBS typically focuses on the brash Ranieri, a Brooklyn-born, hard-nosed utility-bond trader plucked from obscurity at Salomon to lead the brand new mortgage department because of his street smarts, drive, and aggression. Liar’s Poker focuses on the ascension of Ranieri’s powerhouse mortgage-finance business, whose profits accounted for more than half of Salomon’s overall profits by 1981. The creation of the first collateralised mortgage obligation in 1983, for Freddie Mac, only served to spread the wealth as other banks got in on the lucrative MBS industry. Salomon and First Boston completed that first deal. But while Ranieri is often given all of the credit for creating the mortgage “monster”, as some might say in hindsight, it was actually his original boss at Salomon, Robert Dall, who was the brainchild behind the very first private MBS. Dall, one of the few master-traders of Ginnie Mae MBS securities in the early 1970s, created the first private issue of mortgage securities (working with fellow trader of Ginnie Mae securities Stephen Joseph) for Bank of America in 1977, almost a year before Ranieri was even in the picture. The deal was for US$100m. That first private MBS deal was “something that just came out of my head and happened”, Dall told the New York Times in 1986. Ginnie Mae had been securitising government-guaranteed mortgages since 1970, but its bonds suffered from a serious flaw: an embedded prepayment option. Mortgages could be paid back in full at any time, leaving investors with a heap of cash to reinvest. Moreover, refinancing risk meant that investors would get their money back when interest rates were at their lowest – something investors were unhappy about. Dall and his peers begged Ginnie Mae to offer some type of protection to bond investors, but the GSE did not want to. The BofA deal of 1977 changed everything. It was the first that tried to address the prepayment issue – by introducing a nifty technique called “tranching”. The simple transaction had specific maturities and credit characteristics that would appeal to a much broader array of investors. However, the prepayment conundrum persisted throughout the initial years of the nascent MBS market, spawning MBS research and trading desks that sought to understand the complex mathematics behind predicting mortgage prepayments and taking bets on which maturities/credits to buy. With that initial 1977 private “pass-through” MBS deal, however – as simple as it was – Dall and Joseph for the first time persuaded insurance companies and pension funds to share some of the risk of American borrowers. That had ne

IFR 2000 issue Supplement

IFR: how it all began

Donald Last, the man who typed the first issues of what became IFR, remembers the foundation of what was then the Agefi Bondletter &ndash and the man who started it all. Every Friday evening Christian Hemain would come down to Sevenoaks with his Eurobond notes stuck in his pocket and catch a cab up to my small publishing office in the high street of this small town in Kent, southeast of London. After a cup of coffee and without further ado we would sit ourselves in front of an IBM &ldquogolf ball&rdquo correcting typewriter &ndash an essential and crucial piece of equipment given our time constraints and my typing &ndash and in his fractured Franglais Christian would dictate the week&rsquos Eurobond issues. &ldquoZe deal of ze week was IBM Eurodollar US$100m seven-year wiz ze cinq &hellip err &hellip 5% coopon, prix 99, lead banque Citi and ze selling group ABN AMRO, SocGen and Banque Lux. The issue sold &lsquoplus vite&rsquo. Rating Triple A. Terms: bearer bond, pari passu, &lsquolois Anglais&rsquo&hellip&rdquo And so we continued in those early days in March 1974 working through the night until sun-up &ndash with me converting the dialogue into a spare and compact English prose, a style that was the essence of my own business newsletter, the Transterra Brief, and that emulated that of my German backers and partners in Detmold, the Schmitt-Brief. Such was the parentage of Christian&rsquos Bondletter, a newsletter, by Sevenoaks out of Detmold, Germany &ndash a suitably &ldquoEuro&rdquo debut for what was to become the beacon of the Euromarkets. The notion behind the style was simply this: take any random newspaper story and a highlighter pen and go through colouring the key points and you probably end up with four or five lines &ndash the essence of the story. And that is how we wrote the Agefi Bondletter and that is why, after six months in Sevenoaks, Christian was ready and able to write his own copy in London. As he said himself, he didn&rsquot pretend to be Shakespeare, though he was certainly polished in French. Building on that base, Christian later expanded and enriched his English prose but in those early days simplicity was crucial. When finished, the waxed four pages of copy went down to the print room for the printer who came in around 6am to produce 200 four-page newsletters (a folded sheet of A3 paper), which he inserted into ready-stamped envelopes and took them to Sevenoaks&rsquo post office to arrive on readers&rsquo desks on Monday morning. Later, when there was a large Continental clientele, Christian used to hire a Mercedes to take copies to Paris for posting &ndash so there was also a free ride up for grabs to Paris for the weekend. Christian would pick up his copies and return to London and without pause would then use his Bondletter to dictate his weekly report on the Euromarkets for Agence Economique et Financiere in Paris. Hence the Bondletter&rsquos name, Agefi Bondletter, a title that puzzled and bemused quite a few Anglo-Saxon bankers in the City, who discovered for the first time that Paris produced a financial newspaper roughly equivalent to the Financial Times. This description, while accurate, flatters Agefi as much as it profanes the FT, for while the FT was typically replete with features, pundits, comment and editorials, Agefi was written and produced like a railway timetable. As such, it was admirably suited to its purpose: to keep investors throughout France, Belgium and Luxembourg fully informed each morning on French, Continental and world financial markets, plus forex, metal and commodity prices. Agefi was sent to bank branches throughout these countries and posted up in bank foyers each morning.Manna from heaven The newspaper was owned by the &ldquoPatronat&rdquo &ndash a group of top-tier French companies &ndash and the absence of editorial and a Lex-type column was for them Agefi&rsquos chief merit: there would never appear a comment on, for example, Mi

IFR 2000 issue Supplement

The deals: 1974 to 1983

1974: Citicorp/First National City Bank’s US$650m FRN – first floating-rate note in the US As many innovations are, the US$650m floating-rate note issue for First National City Bank (through holding company Citicorp) was controversial when it arrived in July 1974. US laws at the time banned banks from paying more than 7.5% on long-term deposits and more than 5.5% on passbook accounts. Rival banks, worried that the new structure would divert funds that would otherwise be deposited with them, argued vehemently that the new issue violated those laws. The issuer, and its underwriter First Boston, countered that issuing through the holding company meant that the deal didn’t violate the law. After rival lobbying efforts, the latter view prevailed. The interest rate on the notes floated at one percentage point above US Treasury bills after an initial period when they were guaranteed to pay 9.7%. As Associated Press reported at the time, the concept was designed to offer small investors a high yield, but with an assurance that the yield would increase when rates rose. Investors loved the issue, snapping up the paper on the morning they became available for sale. The impact was immediate, with New York Bank of Savings immediately following suit. The scene was set for all the floating-rate bond issues that followed.1976: New York City Pension Fund US$1bn block trade – then largest ECM deal It was by far the largest block trade in history. When the New York City Pension Fund decided in January 1976 that it wanted to sell US$500m of stocks and purchase another US$500m to create what was in effect an index fund, it turned to the only firm that could execute the trade: Goldman Sachs. As detailed in “The Partnership”, Charles Ellis’s history of the bank, Goldman was asked to bid a single price to buy the existing portfolio and to create the new portfolio specified by the pension fund. And it had to do the whole thing “on-risk”, which meant a total exposure of US$500m. Head of block trades Bob Mnuchin prepared to get approval from the firm’s management committee. He expected a barrage of questions. “They only asked five questions,” he later told Ellis. “And each question was laser-like in its focus on a key trading factor. We answered the five questions and there was a moment of silence and then everyone agreed. It was a go!” Acting in great secrecy, Mnuchin’s team executed myriad trades, but ended up charging the pension fund just US$2.9m – for transactions totaling US$1bn. It was a remarkable result, properly reflecting Goldman’s prowess in the block business.1977: US$100m deal for Bank of America: the first private-label MBS The creation and growth of the private-label mortgage-backed securities origination and trading business on Wall Street in the late 1970s and early 1980s at Salomon Brothers in New York is legendary. It was also a critical turning point for Wall Street, ushering in a 30-year era where the bond market was king, bond traders became the most highly rewarded heroes of investment banking, and securitisation became one of the most lucrative and innovative pockets of finance. Of course, the “revolution” that took place at Salomon Brothers in the spring of 1978, when the very first mortgage finance department on Wall Street was formed, also arguably led, 30 years later, to the worst recession in the US since the Great Depression. How closely the two historical events are linked has been hotly debated. Lewis Ranieri, the “godfather of securitisation”, who led that very first Wall Street mortgage department, has gone on record in recent years as saying that it was not the concept of securitisation itself, but the new exotic mortgage loans, lack of liability, and growth of the subprime industry that ultimately sealed the fate of the pre-crisis housing/credit bubble. Either way, the invention of MBS without government backing was a seminal event in the history of Wall Street. Immortalised in the best-selling 1989 book “Liar’s Pok

IFR 2000 issue Supplement

1986: Canada’s US$1bn 9% due February 1996 – 'The Nines'

&lsquoA special deal&rsquo - Not many bond issues enjoy such iconic status as to warrant a party to mark their redemption. But that is exactly what happened when the &ldquoCanada Nines&rdquo matured in February 1996 after a 10-year lifespan that had seen it become easily the most liquid Eurobond. Not many bond issues enjoy such iconic status as to warrant a party to mark their redemption. But that is exactly what happened when the &ldquoCanada Nines&rdquo matured in February 1996 after a 10-year lifespan that had seen it become easily the most liquid Eurobond. The event was hosted by ScotiaMcLeod, although Deutsche Bank had been lead manager on the deal. Such was the syndication process in pre-pot 1986, however, that a myriad co-leads, co-managers, sub-underwriters and selling group members felt they had equal reason to celebrate the bond&rsquos passing, as did a swathe of traders and investors for whom it had become a quintessential part of their day-to-day business. &ldquoIt became obvious pretty early on that it was a special deal,&rdquo said Stuart Young, who was head of trading at Deutsche when it was launched. &ldquoThe sales people were going crazy, with demand coming in globally in a way we had never seen before.&rdquo &ldquoIt was an extraordinary thing. Sometimes deals just work, everything clicks,&rdquo said Robert Stheeman, now chief executive of the UK Debt Management Office, but then on the syndicate desk at Deutsche in Frankfurt. Such was the weight of early orders that the issue, originally launched as a US$750m offering, was upsized to US$1bn &ndash at the time a significant increase. &ldquoIt was a US$1bn deal in the context of a US$250m&ndash$300m market, maybe US$500m,&rdquo said Martin Egan, global head of primary markets and origination at BNP Paribas, who was then trading the paper at UBS. &ldquoThe US$250m upsize would in itself have constituted a decent-sized issue on its own in those days,&rdquo said Stheeman. Many in the market had an inkling that something momentous was in the air. &ldquoWe were told to get in early that day, just like you would for your own new issue,&rdquo said Kevin O&rsquoNeill, currently executive director of debt syndicate at Daiwa Securities, who was then head of syndicate at CSFB, a co-lead manager on the deal. &ldquoSo, up we turned, and out it came &ndash the rest is history.&rdquo But if the primary experience was notable, it was the secondary performance that made the Canada Nines the most talked about Eurobond issue ever. &ldquoIt injected new adrenalin into a market that had been developing at a steady pace,&rdquo said Egan. &ldquoIt marked the beginning of a new benchmark market &ndash we had never seen anything like it as far as liquidity was concerned.&rdquo &ldquoIt remained liquid way beyond what you would have expected for a Eurobond, in time becoming the five-year, then the three-year benchmark,&rdquo said Stheeman. Most bonds end up being so tightly held that liquidity drains away. However, this was not the case with the Nines, which maintained its exalted position throughout its life. &ldquoIt was just so easy to trade. It became the Eurobond benchmark and a Treasury equivalent, indeed a Treasury proxy to a large degree,&rdquo said Young. Back in 1986, the prevailing trading convention was still on a cash price basis, even though some had begun using Treasuries to hedge positions. The Nines not only persuaded more to think about spreads but also offered a ready-made, liquid, globally traded hedging instrument in itself. According to IFR data from the time, the paper came at a 15bp spread over Treasuries, tightening to 4bp as it outperformed, before drifting back out again. &ldquoIt took the market to a completely different level: it traded on a tight bid/offer spread 24/7,&rdquo said Egan. &ldquoAnd that was across the globe traders in Europe, the US and Asia all loved it. Investors had to have it and traders had to have

IFR 2000 issue Supplement

The global financial system: my part in its downfall

IFR columnist Anthony Peters recalls his time at the heart of the structured credit boom. What did it have to do with proper lending? Not a lot. But it is wrong to dismiss the value of structuring entirely, he writes. I have enjoyed a long and modestly successful career in the City. Had it been unsuccessful, I would have been spat out long ago and would now probably be teaching either economics or modern languages at a minor public school. Had it been highly successful, I would probably be retired due to excess wealth. In the event, I am neither, and therefore have been hanging around the street corners of EC1 from the rise of the Eurobond market to the disintegration of the structured credit market and beyond. How that I, who cannot add two and two, should have ended up working in structured credit during its boom years was a mystery. But my superiors at the US investment bank I turned out for probably never grasped the level of my innumeracy and so I found myself removed from the credit world I felt comfortable in and was cast as a hot-shot salesman in what was known as GSP &ndash or Global Structured Products. As a trained corporate lender who had turned to banking in the late 1970s because I wasn&rsquot good enough to get a proper job with BP, Nestle or Kodak, I was something of a fish out of water among the quants with PhDs in maths and physics and MScs in banking and finance who had fought to gain one of those highly valued graduate positions on Wall Street or in the Square Mile. I could never admit that the squiggles, arrows and integration formulae on meeting room white boards could have been Arabic as far as I was concerned. I certainly struggled to see what all this had to do with the lending process, which is what I thought banking to be about. In the fullness of time, I was proved right on that one &ndash and all those clever chaps turned out to be wrong. They demanded and were paid millions. I didn&rsquot and wasn&rsquot. Who&rsquos the fool? And yet, the notion that structuring credit products is downright stupid (and that the lousy reputation with which they exited the credit crisis of 2007&ndash08 was fully deserved) is highly oversimplified and subsequently quite wrong. Old as the hills The process of abstracting credit risk from the underlying loan is as old as the Code of Hammurabi (a Babylonian law code, dating back to about 1772 BCE) and can be found in any old textbook on banking and finance under the title of &ldquoLoan Guarantee&rdquo. That the process of guaranteeing loans had to be &ldquogenerecised&rdquo and packed into a 100-page document before re-emerging as a credit default swap is nobody&rsquos fault in particular. Likewise, the truest of structured credit products &ndash the collateralised loan obligation &ndash is a shuffling of credit risk within a portfolio of loans that is, in my humble opinion, a creation of genius. Let me explain. Assume you have a portfolio of 100 Double B rated loans. Each one of them is imbued with X default probability over a period Y years. If X occurs as predicted, then, very simply put, 100 &ndash (X x Y) will not default and that collective will therefore be rated higher than Double B. Looked at another way, imagine a field with a number of landmines spread across it and a fair probability that you&rsquoll tread on one. The structuring process engineers a concentration of all the landmines in one corner of the field. The risks in that corner rise dramatically but the rest of the field is suddenly relatively safe. So long as someone is prepared to take the risk of navigating the dangerous corner of the field &ndash for a substantial reward &ndash then others can gambol about in the knowledge that they are fairly safe. Such ideas were fine and dandy until interest rates fell so low in the post-9/11 world that defaults melted into insignificance in all areas of the credit curve. With the need for yield hugely increased at the same time, the makings

IFR 2000 issue Supplement

Forty years at the heart of international markets

Thierry Naudin, a former associate editor of IFR, recalls the early days of the journal that became IFR &ndash and the phenomenon that was founder Christian Hemain. Probably the best accolade IFR received over the course of its first four decades took the form of a casual remark by a Paris-based bond dealer, who thought IFR was the official gazette of what was then known as the Euromarket, instead of a profit-making publication compiled by professional journalists. The bond dealer&rsquos fantasy about some sort of governmental &ldquoinvisible hand&rdquo points to the core raison d&rsquoetre of IFR, which has endured to this very day: publicising the cost of money on the international market, whatever the currency, the instrument (loan, bond, etc), the borrower or the maturity, and based on the most reliable sources. Forty years on one could be forgiven for taking this basic rationale for granted. But building on it did take some vision &ndash the rare mix of acumen and deep, broad-sweeping intelligence that characterised IFR founder Christian Hemain. Why did it fall to a French correspondent with a Paris-based daily financial newspaper to set up in London a publication that, initially, focused on a market that was the purview of the then-almighty US dollar? The short answer is: that&rsquos the transnational Euromarket for you. The fact is that on top of his enterprising spirit and superb professional connections, Hemain kept an eye on broader trends in the financial sphere. The US dollar had become the world currency even before the lifting of post-war currency market restrictions in Europe in the late 1950s. The Continent became flush with greenbacks, not just because increasing numbers of large US industrial groups set up subsidiaries there. Rather, much as everyone around the world was keen to hold claims on the US (the world&rsquos supreme economic powerhouse at the time), not everyone was as inclined to put their trust in Uncle Sam. Weary as they were of the potential for their US dollar assets to be too closely monitored for comfort or frozen in New York or even London, Communist countries instead stored them on the Continent, in Paris for the main part, or in Geneva. A similar pattern emerged with African commodity-exporting countries after 1960, and with Arab oil-producing countries a decade or so later. The Eurodollar was born. Now, what about a market for it? The problem with any government is that it can be heavy-handed, too. For all the efforts deployed by US bank branches in Paris and their major local counterparts at the turn of the 1960s and 1970s, French authorities denied the fully fledged liberalisation that the UK government, however grudgingly, came to concede for foreign exchange transactions. London&rsquos luck France&rsquos mistake was London&rsquos luck. The big offshore-dollar game has hardly changed since then, with borrowers and investors alike ever happy for fresh opportunities to diversify, with fee-reaping banks in the middle. Those countries with massive claims on the US today keep looking for ways to on-lend those dollars as profitably as they can (with the pursuit of ever-higher yields posing the threat of speculative bubbles, but that is another story). For the sake of its own geo-strategic security, Uncle Sam has from the start taken a benign view of what, in effect, amounts to the recycling of its own perennial external deficit as long as the process remains largely in the hands of American banks. And London, with its privileged location, stood in the middle, and has remained largely there to this day. As London correspondent for the Paris-based Agefi (short for Agence Economique et Financiere) and its Swiss, Belgian and Luxembourg offshoots, Hemain understood the game early on. The price of money on national markets was publicised in national media, including official gazettes as in France. In this set-up, and by definition, offshore transactions fell in the middle of nowhere, an

IFR 2000 issue Supplement

The birth (and troubled life) of CDS

If some interpretations of the events of the past few years were to be believed, an alternative headline for this story would be &ldquosomething wicked this way comes&rdquo. But the truth about CDS is more complicated, writes Christopher Whittall. Towards the end of the 1980s, one large lender approached Bankers Trust with a thorny problem. The bank in question was extending a multi-billion dollar lending facility to one of its most important blue-chip customers and was going to struggle to warehouse the entire loan. There was a catch, too: it didn&rsquot want to syndicate the loan to other banks, but instead keep it on its balance sheet and sell on the exposure synthetically. This was music to the ears of the nascent swaps desk at Bankers Trust, which was then housed in a no-man&rsquos land between trading and banking, trying to convince clients of the exciting potential of derivatives. &ldquoFor me, that was the start of the credit derivatives market,&rdquo said Gay Huey-Evans, a member of that team, who later went on to chair ISDA and head the UK FSA&rsquos markets division. &ldquoThat transaction never took off, but it got people thinking.&rdquo It was a familiar problem after all. Internal limits curbed banks&rsquo ability to lend to companies, spurring a search for ways to free up capital without damaging relationships with key clients. Moreover, the Bankers Trust swaps team had spotted a natural client-base for these exposures. In the days before monetary union, large US companies were deterred from tapping European capital markets due to the fragmentation of currencies across the Continent. For their part, European institutional investors balked at the notion of holding US dollar-denominated assets, but were frustrated that they couldn&rsquot gain any real exposure to high quality US companies. This presented a great business opportunity for investment banks: lend money to high-grade US corporates, then sell slices of the credit exposure in synthetic format to European investors in their own currency. &ldquoEuropean investors wanted more exposure to these American firms, so we syndicated a bit of a loan synthetically. This reduced the credit exposure to that specific corporate name, which would enable us to maintain an ongoing relationship with the corporate, and extend more credit when necessary,&rdquo said Huey-Evans. At this stage the documentation was very basic. The concept of default was not even included in most contracts given the high creditworthiness of the underlying companies &ndash pay out events were linked to ratings downgrades instead. But the building blocks were all there for what would later morph into the credit default swap market. Bankers Trust had created a synthetic exposure to an underlying credit that could be sold on to investors as an alternative to holding the physical securities. &ldquoIt wasn&rsquot known as CDS &ndash it was just a structured transaction. We&rsquod ask investors what credit they&rsquod like, and they&rsquod say: &lsquoWhat credits do you have?&rsquo It was very specific,&rdquo said Huey-Evans. The next year Bankers Trust began originating baskets of credits and also introduced financial underlyings, which were more liquid and therefore easier to hedge. John Crystal, who later switched to Credit Suisse Financial Products, took the reins of the new business, seeing the potential to build a tradable market. Enter JP Morgan He was not the only one. In 1994, a group of derivatives bankers from JP Morgan congregated in Boca Raton, Florida, to bounce ideas off one another about derivatives and how to better manage the firm&rsquos credit exposure. Shortly afterwards, Blythe Masters and Bill Demchak, two rising stars based in the firm&rsquos New York offices, began sketching out these ideas into a firmer structure, which eventually became the Bistro (see related story). Meanwhile, in the firm&rsquos London offices, Bill Winters went about establishing a

IFR 2000 issue Supplement

Warrants and stock bubbles: when Japan ruled the world

Keith Mullin looks back on the era when Japanese banks surveyed the international markets from a position of apparently unassailable strength. Take a look at any broad yardstick of international investment banking achievement today. Four of the Japanese Big Five CIBs and investment banks &ndash Mitsubishi UFJ, Sumitomo Mitsui, Mizuho, Nomura and Daiwa &ndash are in the top 20 of global fee earners. Yet at the same time, it is probably fair to conclude that their positions in M&A as well as debt and equity underwriting are modest relative to their size and stature. Their combined market share is just 5% of the global IB wallet and that includes their domestic market exploits. But it was not always thus. During Japan&rsquos modern-day financial Golden Era, whose zenith was between 1987 and 1990, the country&rsquos Big Four securities firms (Nomura, Daiwa, Nikko and Yamaichi) came to dominate the combined Eurobond and Euroconvertible business. And they used the huge revenue streams they derived from their presence in Japan-related primary and secondary markets to build out their capital markets origination, distribution and trading platforms, and to broaden their product coverage outside of Japan after the asset-inflation bubble burst. In the years leading up to the real estate and stock market crash of 1989&ndash90 and before the &ldquolost decade&rdquo of economic stagnation and decline, the Japanese had the look of unstoppable world-beaters. During that period of rapid growth, their presence in London reflected their new-found stature: the Japanese houses became patrons of the arts, sponsoring high-profile classical music events, opera and theatre productions, museums and art galleries moving and shaking with City glitterati and rubbing shoulders with its leaders in the corridors of City power and influence. In short, the Japanese had arrived. But one particular arrival that was to become very significant in cementing the rise and influence of the Japanese in London in those days went largely unnoticed. &ldquoI arrived in London on New Year&rsquos Eve 1987. It was a very strange day nobody was working and the only restaurants that were open were Chinese,&rdquo recalled Takumi Shibata, chairman of Nikko Asset Management since July 2013 but before that a 36-year Nomura veteran and until last year chairman and CEO of the firm&rsquos wholesale division and COO of Nomura Holdings. &ldquoPrior to my arrival in London, I&rsquod been working in Tokyo as head of the American desk. That was the worst job you can imagine as Tokyo is in a completely different time zone and I didn&rsquot really get much time to sleep. London was the perfect environment in which to operate an international business. It was like being in an amusement park. With the exception of the quality of restaurants, London was a globally diverse place so you could arrive as a foreigner and be accepted,&rdquo he said. Shibata did two stints in London for Nomura, the market powerhouse. During his first, he stayed for six years, initially running debt and equity new issues &ndash keeping Nomura at the top of the Eurobond league table for four years &ndash before gaining a broader role as head of investment banking. &ldquoMy predecessor Hiroshi Toda had told me: &lsquoHey, Shibata, you need to belong to the boy&rsquos club&rsquo, which wasn&rsquot a problem for me as I felt I was a fit from day one. But I asked myself: &lsquoDo I want to be a part of a club or do I want to form the club?&rsquo I went for the latter and was one of the founders of a group originally called G7. We used to have dinner in Brown&rsquos Hotel, where we would eat, drink lots of wine and criticise each other&rsquos deals. We were a group of naughty boys. That&rsquos when I realised that capital markets boys were by no means true gentlemen,&rdquo he joked. Typical of the environment of the time was Morgan Stanley&rsquos ski weekends. &ldquoAt Friday lunchtime, I

IFR 2000 issue Supplement

World leader: the borrower that shaped the bond markets

The World Bank has always been at the forefront of the global debt markets, not just in terms of issuance but also in the leadership it has shown and its commitment to innovation, says John Geddie. Some 25 years ago a newly-recruited funding officer at the World Bank sat down and started to pen a note to its board of directors explaining how the bank had been trying to improve bond offerings for investors. For an entity whose main fiduciary responsibility was simply to get the best possible funding rates for its government shareholders, this may have seemed a somewhat extraneous exercise. But it was one that stuck with that funding officer through the years. &ldquoWhen I look back, this is what we have been doing all along and it is the foundation of our borrowing strategy,&rdquo said Doris Herrera-Pol, who is now head of capital markets at the bank. It has been the World Bank&rsquos constant desire to find new and innovative ways to grow and service its investor base that, as a byproduct, has ensured it has always had access to the most diverse and competitive funding sources. It is its conscientious approach to a pioneering vision that has allowed it to shape the capital markets as we know them today, and will continue to break new boundaries for many years to come. The World Bank, as its name suggests, has always had a global outlook. Its first bond offering in 1947 was in US dollars, its second in Swiss francs in 1948, and by 1950 it had issued in sterling, Canadian dollars and Dutch guilders. Today, the World Bank has issued in 56 different currencies. But the one thing it has never taken for granted is market access, and its experiences from as far back as the 1960s have served it well. Under pressure Its commitment to funding diversity was not solely altruistic, though. With the balance of payments problems making the US government particularly nervous about World Bank raising and exporting US dollars out of the country, the bank was under huge pressure to diversify. The broadening of its funding sources was paramount to maintaining its growing loan commitments to developing countries, and Gene Rotberg was the man brought in to find a solution. &ldquoIt wasn&rsquot rocket science,&rdquo said Rotberg, who took up the position of treasurer in 1968 and is now retired. &ldquoWe recognised early on that there were a lot of other central banks, outside of the US, beginning to accumulate dollar reserves, and they seemed eager to diversify outside of US government obligations,&rdquo he said. &ldquoWe first went to Japan, which was booming because of its export market. With the consent of the government, we became the first foreign entity to borrow from the Bank of Japan.&rdquo This set the wheels in motion, and the World Bank started to tap into the savings of the country&rsquos trust banks, commercial banks and eventually insurance companies. It then rolled out the same model in Germany, the Netherlands, Belgium, Canada and Austria, while also tapping the central banks of OPEC countries such as Iran, Saudi Arabia, Venezuela and Kuwait. &ldquoWe were in a very favourable position because governments wanted to expand the investment opportunities for their citizens, and there was no better place than the World Bank,&rdquo said Rotberg. &ldquoIt got institutions throughout the world, particularly in Western Europe, used to the idea of holding debt instruments other than those of their own government or industrials.&rdquo This attitude sowed the seeds for the expansion of the Euromarket from London, which would eventually allow the bank to issue its first Eurobond in 1980. Mutual respect But despite the rapid expansion of its borrowing programme, the World Bank always kept investor relations at the forefront of its strategy. Rotberg remembers one particular example of the World Bank&rsquos good faith that involved a private placement with Societe Generale de Belgique, a five-year deal denominated in Belgian francs.

IFR 2000 issue Supplement

1987: ਷.2bn BP privatisation: the deal that defied Black Monday

For some, memories of the Thatcherite 1980s are dominated by football hooliganism, the cavernous North-South divide and the ascent of Welsh miners to the surface and straight on to the dole queue. Among Thatcher&rsquos many champions &ndash more for economic achievements than social &ndash are students of the equity capital markets for it was through her privatisation programme that global ECM took on its current form. &ldquoThe British privatisations really set the stage for the globalisation of the equity markets,&rdquo said Eric Dobkin, founder of the ECM group at Goldman Sachs and acknowledged as the father of modern ECM. &ldquoThey occurred in the immediate aftermath of &lsquoBig Bang&rsquo in the UK, at a time when investors were starting to pursue more global equity investment strategies.&rdquo The UK government&rsquos sales repeatedly broke records for the largest equity transactions ever, forcing the internationalisation of ECM and the development of new issuance structures. This provided a way in for US investment banks that could offer access to capital across the Atlantic. Each trade was a benchmark in its time &ndash Britoil&rsquos £627m IPO that went largely unsold in 1982, the £3.9bn float of British Telecom that nearly doubled on its debut in 1984, and the £4.3bn British Gas float in 1986, which came complete with a £28m-plus ad campaign. But it was an external factor &ndash Black Monday &ndash that made the £7.2bn selldown in British Petroleum the defining deal of its time. Voters &ndash more specifically taxpayers &ndash were a focus of all privatisations, so deals were highly publicised, slow-moving and priced well in advance. It was in March 1987 when the planned £7.2bn BP follow-on was announced &ndash but the deal wasn&rsquot due to close until October. As usual, pricing was set upfront to give retail investors certainty, but because BP was already listed, underwriters had to guarantee pricing for two weeks. They couldn&rsquot have picked a worse time. &ldquoBy malign coincidence, the world&rsquos largest ever share sale collided with the world&rsquos most dramatic stock-market crash,&rdquo wrote Nigel Lawson, then the UK&rsquos Chancellor of the Exchequer, in his memoirs. The government was not looking to give shares away, so, with underwriters and sub-underwriters already signed up, pricing was set at 330p per share on October 14 versus a trading level of around 350p. Then Black Monday hit. That day, October 19, saw the worst ever single-day drop in both London and New York stock indices. Over October 19&ndash20 London markets fell by more than 20%, leaving underwriters staring at heavy losses &ndash with the ongoing BP trade the biggest contributor. By October 27, BP was trading at 262p, versus the 330p offer price. Fees of just 18bp did little to cushion the blow. For UK banks and brokers the pain was bearable as the process of sub-underwriting meant the risk was shared among more than 400 firms. Size and BP&rsquos desire to increase North American representation on its shareholder register, however, meant the US and Canadian allocations were substantial and held entirely by the lead banks. Goldman Sachs, Salomon Brothers, Morgan Stanley and Shearson Lehman Brothers as US underwriters were on the hook for 22% of the deal. The prized mandate of sole lead in Canada went to Wood Gundy, which went out of business as a result. Bankers met at Rothschild&rsquos offices on Friday, October 23 and discussed triggering the force majeure clause but could not reach agreement. Back at Rothschild&rsquos after the weekend the view had hardened and UK banks &ndash foreign firms were present but had no vote &ndash sought to exercise the clause. The move was rejected, but the Bank of England did offer to buy partly-paid stock at 70p (versus the 120p initial payment) to avoid the apocalyptic events outlined by US underwriters &ndash which cited an inabil

Causes of the crisis

Although the exact causes of the financial crisis are a matter of dispute among economists, there is general agreement regarding the factors that played a role (experts disagree about their relative importance).

First, the Federal Reserve (Fed), the central bank of the United States, having anticipated a mild recession that began in 2001, reduced the federal funds rate (the interest rate that banks charge each other for overnight loans of federal funds—i.e., balances held at a Federal Reserve bank) 11 times between May 2000 and December 2001, from 6.5 percent to 1.75 percent. That significant decrease enabled banks to extend consumer credit at a lower prime rate (the interest rate that banks charge to their “prime,” or low-risk, customers, generally three percentage points above the federal funds rate) and encouraged them to lend even to “subprime,” or high-risk, customers, though at higher interest rates (see subprime lending). Consumers took advantage of the cheap credit to purchase durable goods such as appliances, automobiles, and especially houses. The result was the creation in the late 1990s of a “housing bubble” (a rapid increase in home prices to levels well beyond their fundamental, or intrinsic, value, driven by excessive speculation).

Second, owing to changes in banking laws beginning in the 1980s, banks were able to offer to subprime customers mortgage loans that were structured with balloon payments (unusually large payments that are due at or near the end of a loan period) or adjustable interest rates (rates that remain fixed at relatively low levels for an initial period and float, generally with the federal funds rate, thereafter). As long as home prices continued to increase, subprime borrowers could protect themselves against high mortgage payments by refinancing, borrowing against the increased value of their homes, or selling their homes at a profit and paying off their mortgages. In the case of default, banks could repossess the property and sell it for more than the amount of the original loan. Subprime lending thus represented a lucrative investment for many banks. Accordingly, many banks aggressively marketed subprime loans to customers with poor credit or few assets, knowing that those borrowers could not afford to repay the loans and often misleading them about the risks involved. As a result, the share of subprime mortgages among all home loans increased from about 2.5 percent to nearly 15 percent per year from the late 1990s to 2004–07.

Third, contributing to the growth of subprime lending was the widespread practice of securitization, whereby banks bundled together hundreds or even thousands of subprime mortgages and other, less-risky forms of consumer debt and sold them (or pieces of them) in capital markets as securities (bonds) to other banks and investors, including hedge funds and pension funds. Bonds consisting primarily of mortgages became known as mortgage-backed securities, or MBSs, which entitled their purchasers to a share of the interest and principal payments on the underlying loans. Selling subprime mortgages as MBSs was considered a good way for banks to increase their liquidity and reduce their exposure to risky loans, while purchasing MBSs was viewed as a good way for banks and investors to diversify their portfolios and earn money. As home prices continued their meteoric rise through the early 2000s, MBSs became widely popular, and their prices in capital markets increased accordingly.

1929-33: The big one

Until the eve of the 1929 slump—the worst America has ever faced—things were rosy. Cars and construction thrived in the roaring 1920s, and solid jobs in both industries helped lift wages and consumption. Ford was making 9,000 of its Model T cars a day, and spending on new-build homes hit $5 billion in 1925. There were bumps along the way (1923 and 1926 saw slowdowns) but momentum was strong.

Banks looked good, too. By 1929 the combined balance-sheets of America’s 25,000 lenders stood at $60 billion. The assets they held seemed prudent: just 60% were loans, with 15% held as cash. Even the 20% made up by investment securities seemed sensible: the lion’s share of holdings were bonds, with ultra-safe government bonds making up more than half. With assets of such high quality the banks allowed the capital buffers that protected them from losses to dwindle.

But as the 1920s wore on the young Federal Reserve faced a conundrum: share prices and prices in the shops started to move in opposite directions. Markets were booming, with the shares of firms exploiting new technologies—radios, aluminium and aeroplanes—particularly popular. But few of these new outfits had any record of dividend payments, and investors piled into their shares in the hope that they would continue to increase in value. At the same time established businesses were looking weaker as consumer prices fell. For a time the puzzle—whether to raise rates to slow markets, or cut them to help the economy—paralysed the Fed. In the end the market-watchers won and the central bank raised rates in 1928.

It was a catastrophic error. The increase, from 3.5% to 5%, was too small to blunt the market rally: share prices soared until September 1929, with the Dow Jones index hitting a high of 381. But it hurt America’s flagging industries. By late summer industrial production was falling at an annualised rate of 45%. Adding to the domestic woes came bad news from abroad. In September the London Stock Exchange crashed when Clarence Hatry, a fraudulent financier, was arrested. A sell-off was coming. It was huge: over just two days, October 28th and 29th, the Dow lost close to 25%. By November 13th it was at 198, down 45% in two months.

Worse was to come. Bank failures came in waves. The first, in 1930, began with bank runs in agricultural states such as Arkansas, Illinois and Missouri. A total of 1,350 banks failed that year. Then a second wave hit Chicago, Cleveland and Philadelphia in April 1931. External pressure worsened the domestic worries. As Britain dumped the Gold Standard its exchange rate dropped, putting pressure on American exporters. There were banking panics in Austria and Germany. As public confidence evaporated, Americans again began to hoard currency. A bond-buying campaign by the Federal Reserve brought only temporary respite, because the surviving banks were in such bad shape.

This became clear in February 1933. A final panic, this time national, began to force more emergency bank holidays, with lenders in Nevada, Iowa, Louisiana and Michigan the first to shut their doors. The inland banks called in inter-bank deposits placed with New York lenders, stripping them of $760m in February 1933 alone. Naturally the city bankers turned to their new backstop, the Federal Reserve. But the unthinkable happened. On March 4th the central bank did exactly what it had been set up to prevent. It refused to lend and shut its doors. In its mission to act as a source of funds in all emergencies, the Federal Reserve had failed. A week-long bank holiday was called across the nation.

It was the blackest week in the darkest period of American finance. Regulators examined banks’ books, and more than 2,000 banks that closed that week never opened again. After this low, things started to improve. Nearly 11,000 banks had failed between 1929 and 1933, and the money supply dropped by over 30%. Unemployment, just 3.2% on the eve of the crisis, rose to more than 25% it would not return to its previous lows until the early 1940s. It took more than 25 years for the Dow to reclaim its peak in 1929.

Reform was clearly needed. The first step was to de-risk the system. In the short term this was done through a massive injection of publicly supplied capital. The $1 billion boost—a third of the system’s existing equity—went to more than 6,000 of the remaining 14,000 banks. Future risks were to be neutralised by new legislation, the Glass-Steagall rules that separated stockmarket operations from more mundane lending and gave the Fed new powers to regulate banks whose customers used credit for investment.

A new government body was set up to deal with bank runs once and for all: the Federal Deposit Insurance Commission (FDIC), established on January 1st 1934. By protecting $2,500 of deposits per customer it aimed to reduce the costs of bank failure. Limiting depositor losses would protect income, the money supply and buying power. And because depositors could trust the FDIC, they would not queue up at banks at the slightest financial wobble.

In a way, it worked brilliantly. Banks quickly started advertising the fact that they were FDIC insured, and customers came to see deposits as risk-free. For 70 years, bank runs became a thing of the past. Banks were able to reduce costly liquidity and equity buffers, which fell year on year. An inefficient system of self-insurance fell away, replaced by low-cost risk-sharing, with central banks and deposit insurance as the backstop.

Yet this was not at all what Hamilton had hoped for. He wanted a financial system that made government more stable, and banks and markets that supported public debt to allow infrastructure and military spending at low rates of interest. By 1934 the opposite system had been created: it was now the state’s job to ensure that the financial system was stable, rather than vice versa. By loading risk onto the taxpayer, the evolution of finance had created a distorting subsidy at the heart of capitalism.

The recent fate of the largest banks in America and Britain shows the true cost of these subsidies. In 2008 Citigroup and RBS Group were enormous, with combined assets of nearly $6 trillion, greater than the combined GDP of the world’s 150 smallest countries. Their capital buffers were tiny. When they ran out of capital, the bail-out ran to over $100 billion. The overall cost of the banking crisis is even greater—in the form of slower growth, higher debt and poorer employment prospects that may last decades in some countries.

But the bail-outs were not a mistake: letting banks of this size fail would have been even more costly. The problem is not what the state does, but that its hand is forced. Knowing that governments must bail out banks means parts of finance have become a one-way bet. Banks’ debt is a prime example. The IMF recently estimated that the world’s largest banks benefited from implicit government subsidies worth a total of $630 billion in the year 2011-12. This makes debt cheap, and promotes leverage. In America, meanwhile, there are proposals for the government to act as a backstop for the mortgage market, covering 90% of losses in a crisis. Again, this pins risk on the public purse. It is the same old pattern.

To solve this problem means putting risk back into the private sector. That will require tough choices. Removing the subsidies banks enjoy will make their debt more expensive, meaning equity holders will lose out on dividends and the cost of credit could rise. Cutting excessive deposit insurance means credulous investors who put their nest-eggs into dodgy banks could see big losses.

As regulators implement a new round of reforms in the wake of the latest crisis, they have an opportunity to reverse the trend towards ever-greater entrenchment of the state’s role in finance. But weaning the industry off government support will not be easy. As the stories of these crises show, hundreds of years of financial history have been pushing in the other direction.