Global crisis2011

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REMARKS ON GLOBAL CRISIS

İKT 438

JANUARY 2011

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ECONOMIC CRISES: SOME COMMON ASPECTS

Before the crisis: Resistance to reform in a high growth environmentProblems are well known but somewhat …

Crisis: Wrong and superficial assessment of what went wrong before

Central Bank policy rates, before the crisis either too low or too highCentral Bank operations, before and during the crisis, too early or too late

Government policy reaction almost always too lateLeave it to central banks, liquidity etc …When it’s not enough, too late: Expectations deteriorated already

Systemic risk vs liquidity ? Policy reaction not well coordinated among governments and institutions

Thin lines of responsibility: It’s always others’ job to deal with problems. Attacks on banks by politicians that lead nowhere Even if it’s not a banking crisis: Why ? What does Niall Ferguson say about it ?

Is it justified ? Who spoiled the banks in the first place ?

Communication policy failures further deteriorating expectations

It’s always the same: So much time wasted Crisis deepens, lasts longer

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WHY THIS GLOBAL CRISIS ANYWAY ? Fedreserve rates up to 2004 too low ? Excess dollar

liquidity ? XA central bank aims at …The cost of higher policy rates to deal with asset prices:

Lower outputBernanke: Policy rates are not to blame

Asset prices ? ~Irrational exuberance (1992)Inflation baskets vs asset prices: Unresolved, so far …Blanchard et al. : Policy rates cannot deal with excess

leverage, excessive risk-taking

Imprudent banking: Subprimes Not much to do with 21st century or globalization

Information asymmetry Lack of transparency, lack of uniformity in

accounting systemsBlame it on the complex

derivatives ?Off-balance sheet itemsIs marked to market valuation a problem ?

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Authorities/shareholders tolerance towards excessive risk taking, over-leveraging Reinhart, Rogoff

What do textbooks say about it ?

Acemoğlu : Free markets # unregulated markets

Acemoğlu : Greed is neither good or bad

Checked competition, innovation growth

Unchecked too much risk failures

↓

Regulation / supervision necessary Evolution of economic policies

1929 : Liberal

1929 : Protectionism; rise of the fiscal policy

1970 : Interventionist policies fail

1980 : Globalisation, liberalism again

2008 : Interventionism again

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Problems in the institutional set-up of the regulation/ supervision of financial systems Eight federal regulators in US Can’t see the whole map

One regulator in UK Can’t see what ?

Are banking bonuses at the core of the problem? XIs “too-big-to-fail” the problem ? X

US: %10 limit on deposits was already in forceCrisis didn’t come from deposits

Are financial conglomerates a problem ? ~1933: Glass-Steagall; 1999 Gramm-Leach-Bliley

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Areas, institutions outside supervision maps

Competition with offshores push onshores towards risky

investments

Hedge funds, investment banks

Ineffective cooperation between central banks and regulatory/supervisory authorities

Not much noticed, but …

The thin line, again: The Turkish experience

Credit rating agencies Iceland AAA ? Turkey Single B 1996-2006 ?

Always late; analysis capacity debated

Who should pay for it ? Lenders or investors ?

Global imbalances: US in trouble … China too

Currency wars Trade wars ?

Exchange rate : Easy to blame others

Long-run equilibrium value of the exchange rate C/A 2007

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GreeceSpain

AustraliaTurkeyIreland

United StatesPoland

United KingdomItaly

FranceIndia

MexicoBrazil

South KoreaDenmark

CanadaBelgium

IndonesiaAustriaFinland

JapanRussia

NetherlandsGermany

SwedenSwitzerland

ChinaNorway

-20 0 20 40 60 80 100 120

22 16-6

Savings, Investments and Current Account (as of GDP, 2007)

Total gross investment*

Gross national savings rate

Current-account balance

Source: EIU

* Total gross investment: Gross fixed investment expenditure and stockbuilding at current market prices, as a percentage of GDP.

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Failure of international coordination

Global markets vs national governments/institutions

EU

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The European Union Deep problems before the global crisis

• Fast pace of enlargement in the last 3 decades Greece : diverged, not converged Eastern Europe : fear or setback in the USSR

• Economic : Preference for social cohesion vs. Economic efficiency Loss of competitive edge against the US

• Problems with the institutional set-up Something wrong with the decision-making process (2002)

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• Establishment of The ECB Monetary discipline will bring fiscal discipline

But fiscal policies remained national :

Stability and Growth Pact : Only Luxemburg and Finland > Divergence in the general level of interest rates Lessons out of the Turkish experience

• Lack of transparency in financial systems Stress tests lacked credıbılıty from the very begınnıng ECB ok : “BRSA’S” ? Does the EUROSTAT govern ?

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Problems yes, but were’nt there benefits from the common currency ?

• Strong economies : Banks lend to weaker ones in higher i

• Weak economies : Banks & corporates borrow in common, credible currency ; at lower i ; avoid the problem of “original sin”

Then… the global crisis : crises always reveal inherent weaknesses

• No mechanisms to deal with member states’ national problems

• Discussion : rescue them (moral hazard), or leave them alone ? (French, German banks ?)

• Discussion : ecb should deal wıth problems alone ?• Discussion : IMF or EMF ?

Before the crisis, after the crisis..

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Then… the bail-out comes…

• Bail-out simply aimed at putting a new iron curtain between the north and south, or the core and the periphery

• Country-specific measures, not EU-wide

↓• Greece : rescue came at a cost; IMF loan lower i but…

Nobody believed the problem was over

At the end, some weak countries’ secondary market i ’s so high public debt perceived as unsustainable ↓

• Bail-out again simply saved time for politicians who know very well what needs to be done, but they are scared of the political cost

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Where do we go from here ?

• Increase in EFSF resources, in spite German resistance• Lower i in rescue packages, e-bonds to replace

domestic bonds• EU guarantee for public debt to avoid contagion

+• EU-wide measures, not country specific :o Strong economies’ leadership in a new fiscal pact

If not, and only the current rescue efforts are continued, sooner or later the weaker economies are out of the euro-zone : Remember, 90 % of Germans want DM!

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o European banking regulatory & supervisory agency

Remember, it’s not only weak countries at the periphery Who are at risk, it’s also French and German banks ! o Restructuring of the debt Greece, Portugal, Ireland Spain : bail-out may work Italy, Belgium : good savings, good budget no bail-out necessary

Damage of the global crisis

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DAMAGE OF THE GLOBAL CRISIS Though not as bad as 1929 …

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GROWTH RATES (Realized GDP (%), annual)2007 2008 2009

TURKEY 4,7 0,9 -4,7World 5,2 3,0 -0,6Advanced Economies 2,7 0,6 -3,4United States 2,1 0,4 -2,6Euro Area 2,7 0,7 -4,1European Union 3,1 1,0 -4,1Japan 2,3 -0,7 -6,3Emerging Economies 8,3 6,0 2,1Newly Industrialized Asian Economies 5,7 1,5 -0,9Central and eastern Europe 5,5 3,0 -3,6Commonwealth of Independent States 8,6 5,5 -6,5Russia 8,1 5,6 -7,9

Developing Asia 10,6 7,6 7,0China 13,0 9,0 9,2India 9,4 7,3 5,7ASEAN-5* 6,3 4,8 1,7Western Hemisphere 5,7 4,2 -1,8Brazil 5,7 5,1 -0,6Mexico 3,3 1,3 -6,1*Indonesia, Malaysia, Phillippines, Thailand, Vietnam

Source: IMF (World Economic Outlook)

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UNEMPLOYMENT RATES (Realized ,%)2007 2008 2009

TURKEY 10,3 11,0 14,05

United States 4,6 5,8 9,28Euro Area 7,7 7,7 9,5European Union 7,4 7,2 9,0Japan 3,8 4,0 5,07Russia 6,1 6,4 8,38

China 9,2 9,2 6,30

India 9,8 10,4 10,7ASEAN 6,3 6,0 6,0Brazil 9,3 7,9 8,08Mexico 3,7 4,0 5,47

Source : Economist Intelligence Unit

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Tayland

Norveç

Güney Kore

Hollanda

Avusturya

Hong Kong

Avustralya

Filipinler

İngiltere

İzlanda

Peru

Finlandiya

İsveç

Yunanistan

Slovenya

Şili

Polonya

İrlanda

Türkiye

Estonya

İspanya

1.91.9

3.23.53.73.7

4.95.15.15.15.25.55.65.9

7.57.67.67.98.08.18.18.18.28.48.58.6

8.99.19.29.3

10.010.0

11.011.411.6

12.014.0514.3

15.016.6

18.225.0

Unemployment in 2009

Source :Economist Intelligence Unit

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Çin

Vietnam

Endonezya

Polonya

Filipinler

Peru

Kolombiya

Brezilya

Yeni Zelanda

İsviçre

Singapur

Kanada

ABD

Yunanistan

Venezüella

Avusturya

Tayvan

Lüksemburg

Çek Cumhuriyeti

Türkiye

İngiltere

Almanya

Japonya

İzlanda

İrlanda

Slovenya

Litvanya

Ukrayna

Source : Economist Intelligence Unit

Growth in 2009

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OUTLOOK

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GROWTH RATES (Expected GDP (%), annual)2010 2011 2012

TURKEY 7,8 3,6 3,7World 5,0 4,4 4,5Advanced Economies 3,0 2,5 2,5United States 2,8 3,0 2,7Euro Area 1,8 1,5 1,7European Union 1,8 1,7 2,0Japan 4,3 1,6 1,8Emerging Economies 7,1 6,5 6,5Newly Industrialized Asian Economies 8,2 4,7 4,3Central and eastern Europe 4,2 3,6 4,0Commonwealth of Independent States 4,2 4,7 4,6Russia 3,7 4,5 4,4Developing Asia 9,3 8,4 8,4China 10,3 9,6 9,5India 9,7 8,4 8,0ASEAN-5* 6,7 5,5 5,7Western Hemisphere 5,9 4,3 4,1Brazil 7,5 4,5 4,1Mexico 5,2 4,2 4,8

*Malaysia, Philippines, Indonesia, Thailand, Vietnam Source : IMF, WEO

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UNEMPLOYMENT RATES (Expected, %)2010 2011 2012

TURKEY 11,00 10,66 10,32

United States 9,7 9,2 8,6

Euro Area 10,10 9,8 9,6

European Union 9,6 9,4 9,1

Japan 4,9 5,0 4,7

Russia 7,5 6,8 6,2

China 6,1 6,5 6,4

India 10,8 10,6 10,6

ASEAN 5,5 5,2 5,1

Brazil 7,1 6,3 6,2

Mexico 5,4 5,7 5,4

Source : Economist Intelligence Unit

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OUTLOOK 1st and 2nd derivatives, market indicators OK, but not enough

Watch: Gold, long term interest rates

Gold : Hedge against inflation ; lazck of confidence in national

currencies

EM’s recover faster : Global crisis turns into regional crises. Only when contraction in housing markets in US is over

Easy to detect

Only when contraction in financial systems is over

Liquidity Loans or Public Debt ? Why tax the banks ?

Are losses still on balance sheets ?

Recovery in capital markets may take a long time Problems, delays in the reform process Expectations’ improvement far from being satisfactory Politicians, recession and the reform process. Watch out! Are there strong governments ?

Solutions, at last

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WHAT TO DO ?

Asset bubbles: Dangerous only when leveraged (Mishkin)

Amending the Taylor Rule; Walsh

Solution probably lies elsewhere: Regulation / Supervision

Information asymmetry

Solution: New accounting standards

To be more clear, universal

Off-balance sheet items

Problems with mark-to-market rules ?

Accounting rules are not to be blamed for enormous losses:

Accounting’s objective is to provide a reliable description of the

picture at a given time in the prevailing environment

What if GDP, BOP valued at prices other than market’s ?

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If liquidity problems distort prices, liquidity risk should be taken into

a/c

Credit spreads reflect not only credit but also liquidity risk

Fair value , also alternative valuation methods to see actual and

estimated values.

Carry only some items on accrual basis: Long term loans,

simple debt

Standard setters independence should not be compromised

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Solutions for the regulation/supervision of the financial systems

Re-assessment of liquidity, reserve requirements

Minimum liquidity requirements ↑;

Net stable funding: Promote long term liabilities

Basel II a problem ?

Flaws: Banks’ own internal risk models, role of credit rating agencies But, it took so long to enforce it …

Solution: More authority to BIS; Financial Stability

Board

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BASEL IIIFINANCIAL STABILITY BOARD• Capital adequacy ↑ (4-year transition)

Counter-cyclical capital• Transparency of transactions, capital

Enhancement of capital base (tiers)• Separate regulation for “too-big-to-fail”• Support for “too-little”• Limits on leveraging (debt/capital)• Contingency capital• Transparency for derivatives, centralized monitoring . . .

• Addresses international banks

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US Regulatory Reform• Protection of consumers

Deposit insurance $ 250.000 Mortgage : Down payments ↑ Raise consumer awareness

• Investors Standards for financial intermediaries

• Financial institutions Rigid capital rules Loan segmentation Measures against speculation Walls between deposit takers / others Group liability

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• Derivatives Centralized processing Adequate reporting Revision of capital and margin requirements

• Government Split big banks Fed Insurance Office etc.. Other views ?

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•Blanchard et al., again: Cyclical regulatory toolsIf leverage ↑ Capital ↑ ; If liquidity ↓

Liquidity ratios ↑If housing prices ↑ Loan-to-value-ratio ↓If stock prices ↑ Margin requirements ↑

•Contingent Convertible Capital (Coco)Debt that converts into equity if bank in troubleEx: Core capital < 4% of risk-adjusted assets

coupon payments stop bond converted into equityCoco bonds yield higher

•Special resolution regimes: Living willsBail-in instead of bail-out: Recap rules in case of

failure

•Liabilities guarantee: Only for deposits•Corporate governance

Reshaping of the boardsexperts versus independent members; large

vs small boardsFurther separation of trading, risk teamsEnhancement of risk management

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Dangers of the new regulatory framework

Too many rules may overlap with each other regulatory arbitrage

Recall: Regulatory arbitrage behind complex instruments, hedge funds

Capital is like water, will flow around obstacles

Financial institutions’ profitability ↓ move to capital markets

An efficient financial system is a must for economic growth

Criterion: Benefits of regulation > losses as market efficiency ↓ (Ersel)

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Ineffective cooperation between CBs and regulatory/

supervisory authorities

Solution: Macro prudential regulation of systemic risks

Cure to the asset bubble problem..

Systemic risk premiums, capital requirements, insurance

CB’s: Do price stability and financial stability objectives clash in the

long run ?

CBT’s Financial Stability Report, recent measures

The previous trend to separate authorities in charge of price stability

and financial stability may be reversed (Blanchard et al.)

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Credit rating agencies

• Solution: More accountability; legal liabilities

Investors’ losses, court cases against rating

To be subject to regulation and supervision

Expected to be more transparent in rating methodology,

procedures

• Ratings to be based on publicly available data

Solution: Competition needed

Eliminate their officially “nationally recognized” status

Better quality staff

Solution: Who should pay the agencies ?

Investors or borrowers ?

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Global imbalances: US in trouble … China too Solution: No easy solution: Correction lower growth ? Tobin tax: Circumvention Effect on exchange rate not proved Increases costs of capital Negative effect on growth Yuan revaluation, dollar devaluation ? Failure of international coordination

G20; IMF; EU institutions

Better international coordination needed Faster pace in the assessment of financial systems in developed economies needed

Faster pace in structural reforms crucial

Fiscal policies to become more countercyclical in the futureNew automatic stabilizers: Cyclical invesment taxTemporary transfers to low income economic agents

Blanchard at al. again

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IMF’s changing role

•Change of stance : Now addressing the global crisis

G-20 and the IMF; increasing sources

•Counteract capital flight from EM countries

•New facilities for EM countriesFlexible credit line; more flexible St-by; better cost/maturity

structure Ex-ante vs ex-post approaches

•Contingency lines of creditAccess limits ↑

•Changing quotas

•Are governments ready to give up authority ?

Government to government bilateral funding

As recovery of capital flows may take a long time

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FINAL WORD …TIMING OF REFORMS ESSENTIAL

Avoid overreaction to the past: 1933, 1999, 2011 ?

The more we see recovery, the less will be the chance for reforms

Policymakers will only be successful if and when they are ahead of markets with positive surprises (EU)

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FINAL WORD …EXIT STRATEGY

Previous crises cast a shadow on US

If exit from policy stimulus too early… US 1937-1938 ; Japan 1990’s

If exit too late … high public debt slower growth

Blanchard et al.: Timing

Tactics Cut budget deficits or raise policy rates ?

Technique How will central banks diminish the size of their balance sheets ?

Is it a problem anyway ?

Countries with large budget deficits may have to tighten earlier

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FINAL WORD …CRISES OFFER GOLDEN OPPORTUNITIES… IF YOU SEIZE THEM

Turkish experience: CB Independence Banking reform

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REFERENCES “Rethinking Macroeconomic Policy” Olivier Blanchard,Giovanni Dell’Ariccia, and Paolo Mauro (IMF staff Position Note)

“Should Financial Stability Be An Explicit Central Bank Objective? “ Roger W. Ferguson, Jr

“This time is different: Eight Centuries of Financial Folly” Carmen M. Reinhart, Kenneth S. Rogoff

“How Should We Respond to Asset Price Bubbles? “ Frederic S. Mishkin