The Financial Crisis: Some Facts, Some Responsibilities, Some Ways Out?

The financial crisis: some facts, some responsibilities, some ways out? Ignazio Visco Banca d’Italia NFA, Firenze 30 June 2009

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Some facts  Structural changes  Integration of economies and markets  Technological and financial innovation  Demographic trends

 Macro framework  High rates of growth of the world economy  Low inflation rates

 Imbalances  Saving rates, current accounts, net foreign positions  Global liquidity, asset prices, volatility

 Financial framework  Financial intermediaries, securitization, structured products  Investment strategies, risk management 2

3

4

5

6

National savings and investment of selected countries and country groups (in percent of GDP) Euro area

United States

National Saving

19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08

20 08

5

6 20 07

4

20 0

20 0

3

20 0

20 0

19 9

19 9

20 02

19

20 01

12 20 00

20

19 99

14

6

21

7 19 98

16

19 95

22

19 94

18

19 93

23

19 92

20

19 91

24

19 90

22

National Saving

National Investment

National Investment

Japan

China

36

60

34

55

32 50 30 45 28 40

26

35

24

National Saving

08

07

20

20

05

06 20

04

20

03

02

National Saving

National Investment

20

20

20

00

01 20

98

99

20

19

97

19

96

19

95

19

19

93

94 19

92

19

19

91

90

19

19

08

07

20

20

06

05

20

20

04 20

03 20

02 20

01 20

00

98

99

20

19

19

97 19

96 19

95 19

94 19

93 19

92 19

91

30 19

19

90

22

National Investment

Oil exporters

Em. Asia exc. China 34

40

32 35

30 30

28 25

26 20

24

National Investment

National Saving

07

08 20

20

06 20

05

04

20

20

02

03 20

20

00

99

01 20

20

19

98 19

97 19

95

96 19

19

94 19

93

92

19

19

91 19

19

20 08

20 07

20 06

20 05

20 04

20 03

20 02

20 01

20 00

19 99

19 98

19 97

19 96

95 19

19 94

19 92

19 91

19 93

National Saving

90

15

22 19 90

Source: IMF, World economic outlook, April 2009.

National Investment

7

8

9

10

11

12

13

14

15

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Some responsibilities  Economic agents: wrong incentives?  Budget constraints  Planning horizons

 Policymakers: political cycles and ideology?  Macroeconomic (MP and FIT; Fiscal policy)  Regulatory and supervision (Light touch; Basel 1 and 2)

 Economic theories and models: rational behaviour?  Macro: nmc, rbc, nke (DSGE)  Finance: apt, risk (mark to market, rating)

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Ways out?  Macro-policies  Monetary policy, liquidity “mopping out”  Fiscal policy, exit from “public debts”  Macro-prudential policy?  Global macro surveillance (G-20, IMF: IMS?)  Financial regulation  FSB (perimeter, markets, products, intermediaries)  Basel process  Economics  Behavioural theories?  Econometric models…

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Further details Post-Lehman Forecasting Policy responses Open Issues

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Stages of the crisis: pre and post Lehman Onset of the crisis (9 August 2007)

Default of Lehman Brothers: confidence crisis 15 September 2008

Before Lehman

After Lehman

 Liquidity risk

 Credit risks

 Inflation risk

 Deflation risks

 Recourse to markets,

 Government interventions

 Advanced economies

 Emerging economies crisis

central banks crisis

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Some relevant facts: a confidence crisis (1) Interest rate spread between three-month interbank loans with and without collateral

Large banks: Losses and recapitalizations (billion dollars)

400

400

450

350

350

400

300

350

300 250

Euro US Dollar

250

British Pound

200

150

150

150

100

100

100

50

50

0

0 Dec-2007

Dec-2008

Dec-2009

stock issues

250

200

Dec-2006

losses

300 200

50 0 2007 Q3 2007 Q4 2008 Q1 2008 Q2 2008 Q3 2008 Q4 2009 Q1 or earlier

Source: Bloomberg. 21

Some relevant facts: a confidence crisis (2)

Banks: CDS premia (1)

Banks: stock price indices

(basis points)

(end of June 2007=100)

350

US

300 250 Switz

200

UK Italy

150

France

100 50 0 Dec-07

Mar-08

Jun-08

Sep-08

Dec-08

Mar-09

Source: Bloomberg. (1) Simple averages. Investment banks not included.

110 100 90 80 70 60 50 40 30 20 10 0

US Euro area

Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09

Source: Datastream.

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Some relevant facts: transmission to the real economy (1) GDP growth forecasts for the US, UK and Japan

United States average

Japan

range average

United Kingdom range

average

range

2009

-2.9

[-3.9;-2.1]

-6.1

[-8.1;-1.2]

-3.8

[-4.5;-3.1]

2010

1.8

[-0.3;3.8]

1.3

[-0.1;4.2]

0.3

[-1.0;2.0]

Source: Consensus Forecasts (May 11, 2009).

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Some relevant facts: transmission to the real economy (2)

GDP growth forecasts for the euro area €-coin

Source: Banca d’Italia

Consensus Forecasts

Source: Consensus Forecasts

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Some relevant facts: repercussions on inflation Consumer price inflation forecasts United States

Euro Area

3

2.5

2

1.5

1 year ahead inflation forecast 10 years ahead inflation forecast

1 2000

2001

2002

2003

2004

2005

2006

2007

Source: Survey of Professional Forecasters

2008

2009

Source: Consensus Forecasts.

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A credit crunch? Lending standards United States (1)

Euro Area (2) (loans to firms)

100 80 60

large and middle-market firms small firms households (credit cards) households (other than credit card)

75 65 55 45 35

40

25 20

15

0

5 -5

-40

-25

Source: Federal Reserve

02Q4 03Q1 03Q2 03Q3 03Q4 04Q1 04Q2 04Q3 04Q4 05Q1 05Q2 05Q3 05Q4 06Q1 06Q2 06Q3 06Q4 07Q1 07Q2 07Q3 07Q4 08Q1 08Q2 08Q3 08Q4 09Q1

-15 Q1 2000 Q2 2000 Q3 2000 Q4 2000 Q1 2001 Q2 2001 Q3 2001 Q4 2001 Q1 2002 Q2 2002 Q3 2002 Q4 2002 Q1 2003 Q2 2003 Q3 2003 Q4 2003 Q1 2004 Q2 2004 Q3 2004 Q4 2004 Q1 2005 Q2 2005 Q3 2005 Q4 2005 Q1 2006 Q2 2006 Q3 2006 Q4 2006 Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009

-20

Source: European Central Bank

(1) Percentage of banks reporting tightening of credit standards (2) Difference, in percentage points, between banks reporting tightening of credit standards and banks reporting easing of credit standards 26

The policy response in the short run  The policy process - timeline  Stabilization of financial markets  Liquidity support  Broadening of collateral accepted by central banks (in Italy: MIC)  Interest rate cuts

 Stimulus packages and credit supply  Easy monetary policy (and non conventional measures)  Expansionary fiscal policy (TTT vs. PPP)  Stabilization of systemically relevant institutions

− liabilities (deposit insurance and bonds issued by banks) − equity (recapitalization and nationalization) − assets (asset relief for toxic, impaired, legacy assets)

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Medium term actions: coordinated and comprehensive reforms to strengthen the global financial system (1)  Expansion of the scope of regulation to include all

systemically important institutions, markets, instruments  A macro-prudential oversight to supplement the micro-

prudential framework against the build-up of systemic risk  International capital standards and oversight  Capital requirements (quantity and quality), and countercyclical capital buffers  Enhanced liquidity buffers, leverage caps  Other measures  Dynamic provisioning ?  Ring fencing ?

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Medium term actions: coordinated and comprehensive reforms to strengthen the global financial system (2)

 Macroprudential supervision  Early identification of potential system-wide risks and

vulnerabilities (forward-looking approach)  Endogeneity of systemic risk (from collective behaviour of financial institutions and their interaction in financial markets)  Real-financial linkages, asset price misalignments

 Strengthening international cooperation  Supervision of cross-border groups (supervisory colleges)  Financial Stability Forum: expansion and broader mandate

(Financial Stability Board)  IMF and FSB collaboration for the assessment of global vulnerabilities (Early Warning Exercises)  The regulatory framework in Europe (“de Larosière” Report)

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Open issues (1)  The future of the financial system  Less leverage, less risk, less complexity => less profits  Return to traditional lending relationships, higher quality (of loans

and of products)  Risk: probability vs. frequency, tail risk, ergodicity, APT and GE…

 The future of regulation  Reduction of grey areas, more pervasive supervision, more

international cooperation: more rules vs. better rules

 Finance and government  Impact on future generations of the cost of bank bailouts  Governments as bank shareholders: how to get out ? An industrial

policy for the financial sector ?  In the medium run, need to absorb the liquidity generated to sustain financial markets 30

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Open issues (2)  Finance and the real economy  How to finance innovation and growth (by definition risky

business)  How to help households finance consumption and retirement  How to preserve the benefits of intertemporal and international risk sharing

 Global imbalances  Will savings pick up in the United States?  Will Asian countries increase public spending?  A new monetary system?

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