Public Lecture: 'Lessons from the Credit and Liquidity Crisis'

The Department of Finance at LSE is pleased to announce that Dr. Josef Ackermann, CEO of Deutsche Bank, has joined the Department as a Visiting Professor. To mark his appointment Dr. Ackermann gave a public lecture at LSE on Monday 14 January 2008:

'Lessons from the Credit and Liquidity Crisis'

Dr. Josef Ackermann held a lecture on January 14, 2008, entitled 'Lessons from the Credit and Liquidity Crisis'. The lecture outlined the history of events that have unfolded in the credit market during the past eight months, and gave an overview of how these events could occur within a nexus of modern banks.

The speaker opened the presentation with remarks on the changing role of banks in financial markets and on the objective and state of risk management at modern banks. This was the background to an outline of the recent events in the credit markets. The lecture was concluded with lessons to be drawn for public and private institutions from the credit and liquidity crisis.

The past decades have seen a sweeping change of banks' business models. Banks have moved from being simple entities taking deposits and giving loans to being vehicles for origination and through securitisations transformation of risk. This development has lead to a high turnover of banks' balance sheets, and through the rise of alternative investor classes to increased demand for credit products. In parallel, progress in the IT field has increased computing power and facilitated the implementation of more and more sophisticated risk management models. Modern risk management is based on scenario analysis and takes a holistic view of risk, which allows different types of risk to be interdependent.

The history of the current credit market turmoil can be split broadly into 5 phases, starting with the initial emergence of the sub-prime problem. This had knock-on effects on leveraged loans and led to a spill-over into interbank markets. A short period of calm with the restoration of nearly normal market conditions preceded the current phase of the crisis which is characterised by large write-downs. Large off balance sheet liquidity commitments, a lack of transparency and the absence of a reliable price discovery mechanism for many structured products were offered as explanations for the observed meltdown of the credit markets.

Turning to the regulatory lessons to be drawn from the crisis, the speaker noted the potential benefit of increased disclosure on structured products and their performance drivers. This would enhance transparency and facilitate accurate pricing and better risk management. Greater transparency is perceived as a prerequisite for a functioning and stable credit market. On the lessons for private institutions, the speaker noted the need to perform realistic stress tests and emphasized how important it was for market participants to appreciate that even low probability events would materialise at some point. The speaker made it clear that understanding the macro-economic and regulatory environment was important for risk managers in order to evaluate the output of quantitative risk management models.