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Lesson 2
Has the last crisis been
the last one ever?
Hopes and reality
• „Spain is not Greece“ Elena Salgado, Spanish minister of finance
2/2010
• „Portugal is not Greece“ The Economist 4/2010
• „Greece is not Ireland“ George Papaconstantinos, Greek minister of
finance, 11/2010
• „Ireland is not Greece„ Brian Lenihan, Irish minister of finance,
11/2010
• “Ireland is not Spain or Portugal” - Angel Gurria, general secretary
OECD, 11/2010
• “Spain is not Ireland or Portugal” - Elena Salgado, Spanish minister
of finance, 11/2010
• „Italy is not Spain” - Ed Parker, Fitch, 6/2012
• “Spain is not Uganda” – Mariano Rajoy, Spanish prime minister,
6/2012
• “Uganda does not intend to be like Spain” - Sam Kutesa, Ugandian
minister of foreign affairs, 6/2012
The past and the future …
• The Glass-Steagall Act from1933
consisted of 37 pages and has supported
the financial stability of the US economy
for over 70 years …
• The Dodd-Frank Act from 2010 consists of
848 pages, together with the related
implementation regulation it represents
several hundreds of documents with over
30 000 pages …
Few questions we are dealing with … these
are not minor issues, indeed
• Is the eurozone capable of surviving?
• If yes, at what cost – and how will these costs
distributed?
• What needs to be done (changed) for the euro to
survive (institutions, policies …)?
• Are the decisions, taken recently, sufficient?
• Short term vs long term effects of decisions …
• Do we really need to be scared of the consequences if
the euro collapses?
• If it does, how would that impact to global financial
system, economies …
• If the eurozone remains heterogeneous (and it
certainly does), who are the losers and who are the
winners (and why is that, how did it occur?)
Just a few questions we are
dealing with … ctd
• Are politicians ready to embark on genuine
changes?
• Most importantly, are voters ready to support
genuine changes? …
• … meaning: are voters willing (yet) to subscribe to
the principle of cross-boarder redistribution and
solidarity ( far beyond the current state of play…)
• Are we all ready for a fiscal union?
• Is an EU economic government THE solution .. If
yes, are we talking about a technocratic OR
democratic governmental platform? Question:
what is the difference between the two?
a few state
questions
are dealing
withmodel)
… ctd
• Is Just
the welfare
(EU – we
redistributive
- social
able to survive? In what form and with what content?
Just have a look around the globe and try to compare
…
• Actually, let's not be shy to ask even broader
questions: is this not the sun set of market economies
and is the future not linked to state interventionism?
Are we ready to go, once again, the same road
leading to the abyss? And why is it that some
politicians (ironically some of them the most powerful
in EU) are pushing towards the same mistakes,
committed already by others in the past??
• And, without willing to be provocative, what will now
happen in/to France? If Hollande suggests (as he
already did), that he wants a) the Eurobonds and b) to
give priority to fiscal growth stimuli, what
consequences may this lead to?
Just a few questions we are dealing with …
ctd
• Actually, is it not that the fiscal union has started to
emerge de facto (through transfers of debt (provide
example), interstate lending, fiscal rescue packages to
banks etc …?
• And, by the way, when we talk about fiscal union in the
eurozone (EU), what precisely do we have in mind? Is
it having harmonised taxes, or a centralised (federal)
budget with its own revenue and expenditure (on
what?) .. What is actually needed in the fiscal field for
the fiscal policy to be able to support the monetary
union?
• And is it not, that by adopting an extensive scheme of
redistribution, a harmonised welfare state across EU,
actually new divergences will emerge (or the present
ones will become more visible), implying even more
transfers (redistribution)?
And finally, a few questions (all implied by
the crisis) about ourselves and the euro
(EU) …
• Do we still see benefits of joining (which ones)?
• How valid is the argument that, actually, the
eurozone is (and has always been) a kind of
moving target?
• If it moves where it is supposed (and expected) to
move, why should we care (or care more than
before)?
• Can we ignore how open our economy is and how
integrated it is with the EU, eurozone and
Germany most specifically?
• Do we have the capacity to assess our own
situation objectively?
And, broadly considering …
• Are politicians (governments) ready to
make the move towards fiscal (and
political) union (= mutualising the costs)
• And, even more importantly, are voters
(taxpayers) ready to make that step??
But let's take it from the beginning
• A crisis is a more or less drastic correction of imbalances,
created in previous times …
• In most cases, a crisis is generated by an overheating of the
economy, apparent through „bubbles“ on various markets
• Unsustainable deviations are misinterpreted as trends
• But, at the end of the day, the disciplining role (power) of the
market can hardly be avoided …
• Although crises may be of a diverse nature (monetary,
banking, debt), they have all one thing in common: risks are
being underestimated, old truth is being (intentionally)
overlooked, prudential behaviour weakened
The roots of crisis are always found in „good times“,
when the world looks pretty and sweet
The recent episode …
• A prolonged period of low inflation, implying low profit returns on
investment all around the world, combined with an unprecented
surge in free liquidity Explain why
↓
- Investors ready to search for and accept higher risk
- Creativity in new and complex investment products, offering higher
returns (and distributing – hiding – (excessive) risks
- Enormous diversification of financial intermediary, an extremely
robust surge of the non-banking intermediary (partially in response
to ever increasing limitation imposed by regulators
- In an environment of unshakable trust in an ever growing global
economy, driven by new global players (mostly the BRICs) showing
an unlimited hunger for growth
- The psychology of investors „if they can make it, we have to make it
as well, if they succeeded, we will as well“
- Expectations and instructions of bank shareholders to managements
– pressure on profits, shortening of investment horizons
The recent episode … ctd
-
-
-
-
Expectation of small investors, depositors, shareholders: all of them
willing to „be there, get their own part“ – lesson of human
psychology: would anyone resist to become rich, if risks seem to
have evaporated from the scene?
Regulation got relaxed (example: the Glass-Steagall Act terminated)
Supervisors felt asleep, overlooked syndromes of forthcoming
trouble – assets bubbles etc)
Mistakes of central bankers, overlooking the bubbles (and the
message these bubbles were sending to policy makers), a
misinterpretation of the long period of low inflation …
Unfortunate (fiscal) decisions by governments, very populist and
difficult to take back (as we see it today in the streets of Athens,
Madrid, Rome, Paris and even Prague): „debt can be resolved by
economic growth“ (now we know – again – that this is not true)
However, caution is needed today: more regulation should not be
(once again) assimilated to better regulation
The financial causes:
• Development of a „shadow“ (or parallel) banking, various special
purpose vehicles (SPVs), investment banks (detached from primary
deposits and with huge leverage ratios), investment funds, hedge
funds
• A failure to properly supervise the credit process: the mortgage
provider would, for instance, sell, within the six months, the risk to a
third party: thus, his motives to assess the creditworthiness of clients
went severely weakened
• This third party would, for instance, wrap the mortgage risk into
packages, together with other risks to make them look better (risk
diversification…), than they would contract an agency to get a rating
of the package (in most cases very good) and they would sell the
package further down the road
• At the end of the day, some investors would buy non transparent,
but still well rated instruments, and would even make a hell lot of
money out of it
Please note: the risk has not disappeared, it merely got hidden
(became thus even more like a time bomb)
VK about the roots …
• The western civilisation has made, in the last
couple of decades, a fatal mistake: it has created
a model, which does not put on top the economic
output (from which everything else should be
derived), but, instead, puts on the top various and
autonomous claims of individuals, interested or
social groups, and even entire states. This a
radical reversal of the key sequence …
• … which led to a situation when resources and
needs were detached, as were revenues and
expenditures
• It was all supported by the fact, that governments
(at least some of them) seemed to have an almost
unlimited capacity to borrow …
The igniter …
• These were the mortgages: supported widely by governments,
which articulated policies to promote access to housing even to subprime clients (US is the most striking example): subsidies, benefits,
weakening the supervision requirements etc …
• Leading to almost no assessment of creditworthiness of clients,
lending even more than 100% value of the property, progressive
interest rates (lower at the start to attract clients) with instalments
often, at the beginning, even below the due interest payment etc
• The mortgage brokers were only interested to sell as many contracts
as they could
• Value appraisals got systemically overshot (everyone down the
chain interested in achieving the higher price possible)
• Rating agencies: got on board as well …
Just before the crisis, the mortgage sector has almost entirely ignored
all prudential principles: the focus on (quick) profit prevailed on
everything else, the main focus was no longer on the capacity of the
borrower to repay but on the ability of the creditor to sell the risk
„ Securitization was based on the premise that a
fool was born every minute“.
Globalization meant that there was a global
landscape on which they could search for
those fools..
And they found them everywhere“.
J. Stiglitz
Role of institutions (governments, regulators,
supervisors): far from being innocent
• Community Reinvestment Act (1977, J. Carter): support
access to housing
• Fannie Mae and Freddie Mac (government sponsored
enterprises, purpose: access to housing for low income
people)
• Commodity Futures Modernisation Act (2000): derivates
exempted from regulatory requirements and supervision
and minimum reserve requirements
• 2002: FED terminates supervision of mortgage
companies
• 2004: Securities and Exchange Commission grants an
exemption from the required debt-to-net capital ratio to
Goldman Sachs, Merrill Lynch, Lehman Brothers, Bear
Sterns, Morgan Stanley (the allowed leverage ratio
increased from 12 to 40)
And than, the party was over …
• When Lehman collapsed, no one new precisely,
where the risk would emerge from and how it
would hit the financial accounts of market
players
• Confidence amongst market participants was
gone …
• And so was liquidity from the market …
• Consequently, the ability (and willingness) to
lend money to corporates was gone as well …
• Producing second round negative effects on
financial institutions
Actions of authorities
• Since Lehman, everything authorities were
trying was aimed at:
–
–
–
–
restoring confidence on the markets,
substitute the missing liquidity,
stimulate the financing of the economy
and thus limit the economic and social damages
What do you think: did they succeed in that?
Examples of intervention after 2008 …
Governments:
• Purchase of problem assets (essentially securities linked to subprime
mortgages) by government funds
• Recapitalisation (entry into capital) of systemically important banks
• Deposit guarantee schemes reinforced Question: what is your view of that?
What arguments support this and what risks does it create?
• Writing-off parts of claims (or pushing third parties to do that: refer to the
Greek case)
• And regulatory tsunami (Basel 3, CRD IV)+ further recapitalisation of banks
+ FTT + Resolution and Recovery (including the Bail-in) schemes, Vickers,
Volker, Liikanen …
Central Banks:
- Pumping liquidity into the system
- Reducing interest rates
- QE
- Dealing on the secondary bond market
Chronology of events: how is the crisis
passing through the economy
• Mortgage sector → financial intermediary
• Financial intermediary → real economy
• Real economy → a) financial intermediary (secondary effects)
→ b) public finance + debt crisis
• Debt crisis
→ a) financial intermediary
→ b) real economy → financial intermediary
Questions:
• V or VV or VVVV … ?
• Is there an escape to this vicious circle at all?
• How to socialize the future costs of consolidation of financial
entities?
The debt crisis
• This phase of the crisis became visible in 2010 and 2011, though
the fiscal trouble would emerge, sooner or later, in all circumstances
• 2012: situation getting even more dramatic
• It has various reasons (compare Greece and Ireland)
• It has severe implications
– From the market prospective, government bonds are no longer seen as
safe, low-risk and low yield, investment instrument: this has severe
repercussions on the quality of the bank's balance sheets and risk
management
– Governments are loosing (a preferred) instrument of economic
intervention (this has to be seen in conjunction with the failure of market
supervision), or, at least …
– … intervention by an authority that has lost part of its own credibility
may not restore market confidence as efficiently as it would be needed
– Efficiency horizons of such interventions are shortened
– They have severe negative side effects (on taxpayers, benefit
recipients, market participants – banks etc)
The special case of Europe (eurozone)
• The current institutional framework has failed to perform as needed
and the new has not become effective as yet … that is not helping
credibility of both national governments and the EU institutions …
• Attempts to shift debt „upstairs“ (like issuing Eurobonds) have hit a
kind of political barrier Explain why and discuss the underlying
arguments …
• … and attempts to confine the costs to the private sector only
proved to be risky (threatening the stability of the financial sector, its
capacity to find capital on the market and, ultimately, jeopardizing
the financing of the economic recovery) …
• … while elements of a fiscal union have emerged anyway as a byproduct of events (cross boarder transfers of cash, guarantees, debt
- new intervention entities with massive „firepower“ such as ESFS,
Euroval) …
• …and while, at the national level, structural reforms of finance are
taking place at a very different pace …
• …and while there are signs of a kind of „austerity fatigue“ …
Greece, France …
Examples of policy/supervisory reaction:
Banking Union
Single EU
supervisor
Single EU
deposit
guarantee
scheme
Common
resolution
authority
and fund
Single
rule book
Single Supervisory Mechanism
 Two Commission's proposals for the regulation
presented on 12th September 2012:
 Regulation establishing ECB as the Single Supervisor;
 Proposal amending provisions in the EBA regulation.
 Ambitious time schedule - entering into force
on 1st January 2013 – speed vs. quality?
 Task Force on the Future of Banking Supervision
meeting
on 28th September 2012
 EBF Position to be approved by ExCo meeting
on 25th October 2012
ECB as the Single Supervisor
 All banks in the Euro area – Is it manageable and
practical?
 Non-Euro Member States can opt-in
 Fair balance between obligations and powers?
 Perception of banks supervised by ECB and banks
supervised
by national supervisors?
 ECB to carry out the tasks in close cooperation with
national supervisors – Any bright line or overlaps, double
requirements?
 Separation between the supervisory function and
monetary policy functions of ECB through the
Liikanen report (published on October
1.
2.
3.
4.
5.
the 2nd)
Legal separation of certain particularly risky financial
activities from deposit taking banks
Role of Recovery and Resolution frameworks further
increased (= wider separation as in 1) if required by
the resolution authority)
Amendments to provide more clarity to the bail-in
instruments
More robust risk weights for the determination of
capital requirements on trading assets and real estate
related loans
Further corporate governance reforms
Liikanen report (initial assessment)
1.
2.
3.
4.
5.
Ring fencing of risky activities: probably not an issue
for us (quantitative thresholds sufficient)
Additional ring fence dtto
Bail-in instruments: might have an impact on the cost
of funding (differentiated across our region)
Impact likely, will need further evaluation
Corporate governance reforms: probably not the
central issue for us given the business models applied
in our region
So, what have we learned?
•
•
•
•
The power of conflict of interest …
The power of moral hazard …
The power of black passengers …
That the distribution of risks and risk
assessment will never be the same as
before
• That safe may no longer be safe
• There might no longer be a rescue of last
resort …
And what about the Czechs?
•
•
•
•
•
•
•
•
•
•
•
•
How were we affected by the crisis in 2008-2009?
What about monetary, fiscal developments?
Our economy is very much open: what role does this play?
Spill over effects: how are they (would they) affecting/affect our
economy?
How important is our link to Germany?
What role was played by banks?
Is our conservative banking model an advantage?
What is the situation of our corporates?
Do we have a competitive institutional and regulatory environment?
What about the structural characteristics of our economy: are they
playing to our advantage?
Back to the beginning: is Euro a topic for us? If not today, then when
will it be?
Why are we not growing (unlike others in the neighbourhood)???
Share of interest expenditure on general
budget revenue (%)
Greece
Romania
Ireland
Malta
UK
Latvia
Hungary
Spain
France
Poland
Estonia
Lithuania
Portugal
Italy
Slovakia
Slovenia
CR
Austria
Belgium
2008
EU27, 2008
SGP, 3%
Netherlands
Germany
Bulgaria
Cyprus
-14
Luxembourg
-10
-12
Denmark
Sweden
Finland
General Government Deficits
(in % of GDP, EDP methodology)
Czech R: -2.1% of GDP in 2008 and -6.6% of GDP in 2009
6
4
2
0
-2
-4
-6
-8
2009
EU27, 2009
Public debt to GDP ratio
… increasing fast
EU17
Greece
Italy
2007
66,2
105,4
103,6
68,3
36,1
25,0
2008
69,9
110,7
106,3
71,6
39,8
44,4
2009
79,3
127,1
116,1
83,0
53,3
65,6
2010
85,4
142,8
119,0
93,0
60,1
96,2
136,2%
166,5%
384,8%
2010/2007 129,0% 135,5% 114,9%
Portugal
Spain
Ireland
Exposures of banking sectors
to PIIG countries ( bil. USD)
•
•
•
•
•
France
Germany
UK
NL
Spain
• USA
646
533
347
151
127
25%
16,1%
15,4%
19,2%
9%
GDP
GDP
GDP
GDP
GDP
147
1%
GDP