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
1
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)
United States Euro area
22 24
20 23
18 22
16 21
14 20
12 19
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
90
91
92
93
90
91
92
93
94
95
98
99
00
01
02
07
08
6
6
9
19
19
19
19
19
19
19
20
20
20
20
20
20
20
20
20
19
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
19
19
20
20
20
20
National Saving National Investment National Saving National Investment
Japan China
36 60
34
55
32
50
30
45
28
40
26
24 35
22 30
93
90
91
92
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
93
98
00
05
90
91
92
94
95
96
97
99
01
02
03
04
06
07
08
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
20
20
20
20
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
20
20
20
20
Em. Asia exc. China Oil exporters
34
40
32
35
30
30
28
25
26
20
24
Source: IMF, World economic 22 15
outlook, April 2009.

90
97
98
91
95
96
02
03
99
00
01
06
07
08
92
93
94
04
05
90
91
92
96
97
98
99
04
05
95
93
94
00
01
02
03
06
07
08
19
20
20
20
20
20
19
19
19
19
19
19
19
19
19
20
20
20
20
19
19
19
19
19
19
19
19
20
20
19
19
20
20
20
20
20
20
20
7
8
9
10
11
12
13
14
15
16
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)
17
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…
18
Further details
Post-Lehman
Forecasting
Policy responses
Open Issues
19
Stages of the crisis: pre and post Lehman
Onset of the crisis Default of Lehman Brothers: confidence

(9 August 2007) crisis
15 September 2008
Before Lehman After Lehman
 Liquidity risk  Credit risks
 Inflation risk  Deflation risks

 Recourse to markets,  Government interventions
central banks
 Advanced economies  Emerging economies crisis
crisis
20
Some relevant facts: a confidence crisis (1)
Interest rate spread Large banks:

between three-month interbank Losses and recapitalizations
loans with and without collateral (billion dollars)
400 400
450
350 350 400
300 Euro 300 350 losses stock issues

US Dollar 300
250 250
British Pound
250
200 200
200
150 150 150
100 100 100
50
50 50
0
0 0
2007 Q3 2007 Q4 2008 Q1 2008 Q2 2008 Q3 2008 Q4 2009 Q1
Dec-2006 Dec-2007 Dec-2008 Dec-2009
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)
350 110
US
300 100 US
90 Euro area
250 80
Switz 70
200
UK 60
Italy
150 50
France
40
100 30
50 20
10
0 0
Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09
Source: Bloomberg. Source: Datastream.

(1) Simple averages. Investment banks not included.
22
Some relevant facts:
transmission to the real economy (1)
GDP growth forecasts for the US, UK and Japan
United States Japan United Kingdom
average range average 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).
23
Some relevant facts:
transmission to the real economy (2)
GDP growth forecasts for the euro area
€-coin Consensus Forecasts
Source: Consensus Forecasts

Source: Banca d’Italia
24
Some relevant facts: repercussions on
inflation
Consumer price inflation forecasts
United States Euro Area

3
2.5
1.5 1 year ahead inflation forecast
10 years ahead inflation forecast
1
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Source: Survey of Professional Forecasters Source: Consensus Forecasts.
25
A credit crunch?
Lending standards
United States (1) Euro Area (2)
(loans to firms)
100 75
large and middle-market firms
small firms 65
80
households (credit cards) 55
60 households (other than credit card)
45
40 35
25
20 15
0 5
-5
-20 -15
-40 -25
Q2 2000
Q4 2000
Q2 2001
Q4 2001
Q3 2002
Q1 2003
Q2 2003
Q3 2003
Q4 2003
Q2 2004
Q1 2005
Q3 2005
Q1 2006
Q3 2006
Q2 2007
Q4 2007
Q2 2008
Q4 2008
Q1 2009
Q2 2009
Q1 2000
Q3 2000
Q1 2001
Q3 2001
Q1 2002
Q2 2002
Q4 2002
Q3 2004
Q2 2005
Q4 2005
Q2 2006
Q4 2006
Q1 2007
Q3 2007
Q1 2008
Q3 2008
Q1 2004
Q4 2004
02Q4
03Q3
04Q2
05Q1
05Q4
06Q3
07Q2
08Q1
08Q4
03Q2
04Q1
04Q4
05Q3
06Q2
07Q1
07Q4
08Q3
03Q1
03Q4
04Q3
05Q2
06Q1
06Q4
07Q3
08Q2
09Q1
Source: Federal Reserve 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)
27
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 ?
28
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)
29
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
31
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?
32
33

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

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The financial crisis: some facts, some

responsibilities, some ways out?

Em. Asia exc. China Oil exporters

Source: IMF, World economic 22 15

outlook, April 2009.

National Saving National Investment National Saving National Investment

 Economic agents: wrong incentives?

 Policymakers: political cycles and ideology?

 Regulatory and supervision (Light touch; Basel 1 and 2)

 Economic theories and models: rational behaviour?

 Finance: apt, risk (mark to market, rating)

Onset of the crisis Default of Lehman Brothers: confidence

Before Lehman After Lehman

 Liquidity risk  Credit risks

 Inflation risk  Deflation risks

Interest rate spread Large banks:

300 Euro 300 350 losses stock issues

Banks: CDS premia (1) Banks: stock price indices

Source: Bloomberg. Source: Datastream.

GDP growth forecasts for the US, UK and Japan

United States Japan United Kingdom

average range average 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).

GDP growth forecasts for the euro area

€-coin Consensus Forecasts

Source: Consensus Forecasts

United States Euro Area

1.5 1 year ahead inflation forecast

10 years ahead inflation forecast

Source: Survey of Professional Forecasters Source: Consensus Forecasts.

 The policy process - timeline

 Stabilization of financial markets

 Stimulus packages and credit supply

 Expansion of the scope of regulation to include all

 Strengthening international cooperation

 The future of regulation

 Finance and the real economy

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