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Studium Generale
The costs of the crisis
prof. Dr. Tom van Veen
Maastricht University/Nyenrode Business Universiteit
Maastricht, 10 November 2011
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Agenda
1.
Intro and recap
2.
The costs of the crisis
3.
The real costs of the crisis
4.
Conclusions
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1. Intro and recap
Lecture 1: Joan Muysken
1. Causes of the crisis: global
imbalances
2. Rescue packages and
solutions
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Lecture 2: Bertrand Candelon
1.
What is a crisis? Typologies
2.
Contagion
3.
Policy responses
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Lecture 3: Bart Verspagen
1. Theory behind the global
imbalances: UIP and the
Impossibility Trinity
2. Emerging Asian economies and
Chimerica
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Lecture 4: Olaf Sleijpen
1.
The €-crisis and the role of
fiscal discipline
2.
The discussions about the
solutions
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So by now it is clear that the economic crisis
started with global imbalances and excessive
lending in the US
And spilled over to other countries, in
particular Europe because of the intimate
connections between the banks
Distrust in the behavior of banks and
governments/politicians and malfunctioning of
the governance in the EMU has extended the
crisis and this evolved in the current crisis in
Europe
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2. The costs of the crisis
Simple question: what have been
the costs of the crisis?
Not so easy to answer.
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What do we mean by costs? And for whom
are these “costs”?
Cost is an amount of money that has to be
paid to obtain something. This definition
does not seem appropriate here.
More appropriate seems: the value of all the
“losses” that have occurred in the economy.
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Direct costs
Indirect costs
Invisible costs
Lost opportunities
Not all costs have materialized yet because
these depend on the length of the crisis,
the development of the value of real and
financial assets
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1. Change in Wealth
Change in asset prices
• Houses
• Financial assets
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House prices: decrease by 2.5-3% on a
yearly basis after the crisis
In 2010: value of the houses in the
Netherlands € 1170 billion. The decrease
in prices is a “loss” of € 30-35 billion per
year, which comes down to 5 – 5.5% of
GDP.
Average house price is about €250.000.
The loss in value comes down to €7.500
per year
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Financial assets (stocks and bonds)
Stocks: over 2007-2010 the decrease in
the value of the stocks in the hands of
households was about €29 billion (€258
billion to €239 billion). This is on average
€12.000 per household that held stocks
(CBS, STAT-line).
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For bonds we see a similar picture
Value has decreased by €5.5 billion
(from €33.5 billion to €28 billion).
The number of households holding
stocks and bonds have decreased
Are this costs of the crisis?
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No because house prices have increased
dramatically over the past years; bubble?
No because aging would have led to a
decrease in house prices
No because the Dutch housing market has
become under pressure
No, because if you do not move/do not sell
the assets, what is the point?
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Yes, because investments of pension funds
decrease in value and this might have an
impact on premiums or retirement income.
Yes because the crisis has caused a lack of
confidence in the economic future and
hence a lack of demand for houses and
financial assets
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2. Changes in the interest rates
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17
Volatility in prices creates uncertainty
Low interest rates benefit borrowers
if……
• there are no credit constraints
• there are enough profitable
investment opportunities
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In addition low interest rates benefit
investors, because
• there is an inverse relation
between asset prices and the
interest rate
• low interest rates increases the
demand for real assets and for
stocks
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Bond, face value €1.000 r = 5%
(€50/year).
What happens if the interest rate on
new bonds decreases to 4%?
Holders of old bonds receive a rate of
return of 5%, holders of new bonds
receive a rate of return of 4%.
Price of old bonds will increase to
€1250 (€50/€1.250 = 4%)
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But, low interest rates also increases the
value of future commitments
If you need to pay €100 in one year and the
interest rate is 11%, then now set aside
€90,90 and in 1 year you will have €100.
We call €90,90 the present value of €100
to be paid in one year
But, if the interest rate decreases to 5%,
yet need to now set aside €95,24 to have
€100 in one year
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Hence, a decrease in the interest rate is
bad for companies that have future
commitments, like pension funds because it
increases the present value of their future
liabilities
Market value of the investments (>105%)
Present value of future liabilities
A change in the interest rate influences their
coverage ratio
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What is the influence of a decrease in
the interest rate on the coverage ratio?
In normal times, the market value of
the investments increases and the
present value of future liabilities
increases.
In general, the coverage ratio
decreases
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In this crisis we have noticed
1. Decrease in the prices of the assets
2. Decrease in the interest rates
“Double” attack on the coverage ratio of
the pension funds
Market value of the investments
Present value of future liabilities
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Evidence is given by the Bonenkamp and Ter Rele, CPB
Memorandum 1/2009/01, Centraal Plan Bureau
1.
A decrease in the interest rate by 1% causes a
decrease in the coverage ratio by 14%-points
(excluding the effects of the decrease in the interest
rate on the price of assets)
2.
Between December 2007 and February 2009, the
average coverage ratio has decreased by 45%points (from 140% to 95%). 40% is due to the
change in the interest rates, 60% is due to the
change in the asset prices.
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Coverage ratio
Interest rate
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The consequences are clear
A large number of pension funds have
a coverage ratio < 105% and have to
act
1. Increase in premiums and/or
decrease in pension benefits
2. But as important, the confidence in
the once so solid pension funds
decreases
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Thus low interest rates
1. Cause uncertainty
2. Have enforced the pension funds to
act to the disadvantage of the
participants
3. Have not triggered an increase in
credits for investments
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3. Direct bailouts by the governments
Governments have supported the financial
sector. Note that 90% of the support is via
guarantees and loans. Hence the costs of
this support are not clear yet.
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Public Interventions in the Banking Sector, in Percent of
GDP
Capital injections
Approved
Effective
Guarantees on bank
liabilities
Approved
Effective
Relief of impaired assets
Approved
Effective
Austria
5,0
1,7
27,3
5,1
0,4
0,4
Belgium
4,2
5,7
70,8
16,3
5,7
5,0
Denmark
6,1
0,3
Finland
Liquidity and bank
funding support
Approved
Effective
8,7
74,6
35,3
253,0
243,8
0,5
27,7
27,7
1,2
0,8
16,6
3,1
2,3
0,3
Germany
4,2
1,6
18,6
7,3
3,6
0,4
Greece
2,0
6,1
0,4
Hungary
1,1
0,1
5,9
Ireland
5,1
2,1
225,2
Italy
1,3
Latvia
1,4
Luxembourg
6,9
7,9
12,4
7,9
7,9
34,3
5,7
12,5
3,0
3,3
1,5
Approved
60,0
France
27,3
Effective
Total
1,7
225,2
20,1
4,2
26,4
6,3
11,4
2,1
7,0
0,1
230,3
227,3
1,3
10,9
2,8
10,9
6,1
23,2
8,9
19,3
18,5
42,2
24,3
14,9
3,0
Malta
Netherlands
4,9
5,8
Poland
Portugal
2,4
Slovenia
32,8
Spain
32,8
9,3
2,8
2,8
Sweden
1,6
0,2
48,5
8,8
0,1
United Kingdom
3,5
2,6
21,7
9,5
25,1
1,8
18,7
12,1
4,6
50,2
9,0
50,3
30,8
Empty cells: Data not
available.
Source: European Commission (2009), Economic Crises in Europe: Causes, Consequences and Responses, European Economy 7/2009, accessed
at http://ec.europa.eu/economy_finance/publications/publication15887_en.pdf on 12 April 2010.
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Public interventions in the banking sector
Total (% of GDP)
Ireland
Belgium
Direct Support
Recovery
Net Support
40.6
2.6
38
5.7
0.3
5.4
UK
6.7
1.1
5.7
NL
14.0
8.8
5.1
Germany
13.2
0.8
12.4
3.0
0.9
2.1
Spain
USA
5.0
3.0
3.1
Average
6.8
1.8
4.9
1,722
452
1,270
US$ Billion
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32
HW Sinn (2010), Casino Capitalism, OUP,
reveals that
1. Total approved package is €5 trillion
(€5.000.000.000.000)
2. The big rescuers are US, UK and Germany
(in total about 50% of the package). The
Netherlands joined with 5%
(€250.000.000.000, about 42% of GDP)
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1$
100x1.000.000 =
100.000.000$
10.000$
100x10.000 =
1.000.000$
10x100.000.000 = 1.000.000.000$
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1.000.000.000$
1.000x1.000.000.000 = 1.000.000.000.000$ is 1 trillion$
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But, not all money has been “waisted” .
Evidence for the Netherlands reveals
Support to SNS, ING and Aegon via loans,
€14 billion, against 8% and a premium of
50% on redemption. And the government
guaranteed the pay back of US mortgages
(€21 billion).
ING has redeemed 70% and will redeem 30%
in 2012
SNS Reaal has redeemed a large part.
Aegon has redeemed all support. The rate of
return on this was 18.5 %
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ABN AMRO was nationalized by the Dutch
government: bought for €16.8 billion. Together
with additional capital injections, we invested
€30 billion in the bank.
The market value is estimated at €20 billion in
2014 (when the bank might be sold).
This results in a loss of €10 billion (€600 per
Dutch citizen)
Thus the loss because of the loans and so on
have not been large. The loss of the guarantees
still needs to be assessed however.
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To summarize:
For the Netherlands (GDP = €600 billion)
1. Change in asset prices: decrease in value of
about €100 billion (2007-2010)
2. Change in the interest rates: average
coverage ratio decreased from 140% to
95%. Consequences need to be assessed.
3. Costs of bailouts and guarantees: bailouts
€10 billion. Substantial amount of
guarantees still pending
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We have discussed monetary costs.
But there is more.
The real costs of this crisis are
invisible
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3. The real costs of the crisis
Decrease and lack of trust and confidence
in the economy and in the financial system
Confidence in the future is measured by
interviewing a sample of
consumers/producers about their
consumption and production plans in the
next future and about their assessment of
the economic and financial situation
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Source: CBS, de index van het consumentenvertrouwen in the series: Hoe doet het
CBS dit nou?
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Consumers confidence: the
Netherlands
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Consumers confidence index OECD
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Source: Ifo Business Survey, October 2011, CESifo Institute, Munich
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Lack of trust in general
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Delay in economic growth
In the end, uncertainty, lack of
confidence, lack of trust
materializes in a slowdown of
economic growth
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Source: The EEAG report on the European Economy 2012, CESifo Munich
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Source: The EEAG report on the European Economy 2012, CESifo Munich
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Annual growth of GDP, The Netherlands,
1970-2012
6,0
5,0
2007
4,0
3,0
2,0
1,0
1975
2002
0,0
-1,0
1
3
5
7
9
11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43
-2,0
-3,0
2009
-4,0
Source: MEV 2012, Main Economic Indicators for the Netherlands, CPB.
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Back of the envelope calculation for
the Netherlands
Average real economic growth over
the period 1970-2007: 2.5%
Average real economic growth over
the period 2008-2010: 0.5%
Hence, growth over the period 20082010 was 6% below the average or
€36 billion in total. These are lost
opportunities.
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Is a slowdown of economic
growth bad?
•
Pollution decreases?
•
Income per capita decreases
•
Tax income decreases and less
spending on public goods
•
Unemployment increases
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6,0
5,0
4,0
3,0
% change in
real GDP
2,0
1,0
0,0
-1,0
1
3
5
7
9
11
13
15
17
19
21
23
25
27
29
31
33
35
37
39
41
43
-2,0
-3,0
-4,0
9,0
8,0
7,0
6,0
5,0
4,0
unemployment
3,0
2,0
1,0
0,0
1
4
7
10
13
16
19
22
25
28
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31
34
37
40
43
Source: MEV
2012, Main
Economic
Indicators for the
Netherlands, CPB.
Source: The EEAG report on the European Economy 2012, CESifo Munich
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Summary: the costs of the crisis
1. Direct costs including wealth
decreases: €110 billion (20% of GDP)
2. Indirect costs: increase in
premiums/decrease in pension
entitlements (no price indexation would
imply about 2% decrease in real
income for pensioners, this is about
€400 per pensioner. In total max. €1
billion in 2011)
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3.
Invisible costs and lost
opportunities: at least €36
billion (value of below average
growth)
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