Transcript Auditing the financial crisis some afterthoughts

AUDITING THE FINANCIAL CRISIS:
SOME AFTERTHOUGHTS FROM
THE NETHERLANDS
BAS JACOBS
PROFESSOR OF ECONOMICS AND PUBLIC FINANCE
ERASMUS SCHOOL OF ECONOMICS
EUROSAI CONGRESS
NETHERLANDS COURT OF AUDIT
JUNE 18, 2014
THE CRISIS
 Not a public debt crisis!
 … except Greece
 Introduction of Euro caused a capital flow bonanza that
led to massive build up of private debt
 Risks exploded when US mortgage crisis ignited a
banking crisis in the EZ
 Sudden stop capital flows triggered systemic problems
in construction of EZ
 no crisis resolution insolvent sovereigns
 no lender of last resort illiquid sovereigns
 no banking union
CRISIS DUE TO PRIVATE DEBTS AND
CONSTRUCTION FAILURES EUROZONE
Source: Shambaugh (2012), BPEA
CRISIS FADED
 Draghi saved the Euro (so far):
 lender of last resort for solvent but illiquid sovereigns
 Rescue funds (EFSF/EFSM) ESM:
 restructure debts, reform economies
 Bankingunion
 supervision
 crisis resolution
 But, no real burden sharing and no EDGS
 ‘doom loop’ between banks and sovereigns not broken
 Debt write downs public debts Greece necessary
PUBLIC MISMANAGEMENT CRISIS
 Totally misguided focus on synchronized austerity
throughout EZ
 destroyed economic growth
 deepened banking crisis
 triggered public debt crisis despite austerity efforts
 Private debts hardly came down and still very high
 Public debts did not come down at all and keep on
rising
 Banks are still very weak: interventions 6 years too late
 Recovery? Secular stagnation and Japanese scenarios
are most likely for EZ
WHY DID THIS HAPPEN?
 Creditor countries played the blame game: crime and
punishment!
 Governments hijacked by financial sector
 Lack of knowledge of basic macro-economics:
 it’s not a morality tale
 not all sectors/countries can simultaneously deleverage
 Policy device: ‘austerity above all’
CONSEQUENCES MISGUIDED AUSTERITY
 Austerity policy does not pass social-cost benefit test for
all non-GIIPS EZ countries (DeLong and Summers,
2012)
 GDP NL in 2015 still below 2008
 Loss = 15% GDP relative to pre-crisis growth
 Loss = 10% GDP structurally
 Unemployment rate doubled to 9% (CBS) / 7,5% (ILO)
 10% structural GDP loss = fiscal gap increase of 5%
GDP
 austerity measures largely self-defeating
 2011-2015: 7,5% GDP austerity, 2,2% GDP deficit
reduction
PUBLIC BUDGETS ARE GOVERNED BY
ECONOMICALLY SILLY RULES
1. Static rules of GSP ignore that GBC is inherently
dynamic
2. Exclusive focus on liabilities ignore asset side
3. Off balance liabilities are ignored
STATIC RULES OF SGP
 Government budget constraint is dynamic
 Example: Netherlands has no long-run sustainability
problem in the public budget
 sustainability gap (fiscal gap) = approx. +1% of GDP
 Public finances sustainable due to
 raising retirement age
 reform mortgage rent deduction
 reforms long-term care
 NL embarked on a massive austerity program between
2011-2017: 9% GDP
 budget cuts: 5,5% GDP
 tax increases: 3,5% GDP
ASSETS MATTER FOR PUBLIC FINANCES
EXAMPLE: NL GOVERNMENT HAS NET ASSETS
Assets
 Public capital stock: 64%
bbp
 Financial assets: 27% bbp
 Gas stock: 22% bbp
Liabilities
 Gross debt: 74,5% bbp
Total assets: 112% bbp
Total liabilities: 74,5% bbp
 PM Tax claim future
pensions: approx. 63% bbp
 PM Latent liabilities (state
pensions, health care)
 PM guarantees
Source: CPB (2013) De naakte feiten over de Nederlandse overheidsschuld
GOVERNMENT AS A HEDGE FUND
 Private risks were socialized
 rescues banks and interbank markets
 country rescues
 Rescue operations required huge off-balance sheet
transactions Eurozone governments




deposit guarantee schemes
mortgage insurance
bank guarantees
guarantees for rescue funds (ESM etc)
 Arbitrage off-balance transactions public/private sector
SOMETIMES SOVEREIGN NEEDS TO
INTERVENE
 Correct market failure = social gain
 lacking liquidity banks/sovereigns
 lacking risk-bearing capital
 Bailing out insolvent banks or sovereigns = social cost
 insolvency banks: capital ratios SIFI’s way too low
 insolvency governments: public debts unsustainable
HOW TO CONTROL EXPOSURE SOVEREIGN TO
FINANCIAL RISK?
 Guarantees financial sector (DGS, mortgage insurance,
etc) are public liabilities
 need to be transparant
 need to be valued as liabilities on public balance sheets
 use market valuations as much as possible
 Valuation TBTF subsidies to banks as liability on public
balance sheet
 Reduce TBTF subsidies by increasing capital
requirements banks (Admati and Hellwig, 2013)
 (Also: remove tax advantages high leverage
 interest deductibility mortgage rent
 mortgage insurance
 interest deductibility corporate income tax)
LESSONS CRISIS FOR PUBLIC AUDITORS
 SGP rules should focus on long-term sustainability, not oneyear deficit measures
 true measure for sustainability: fiscal gap calculations
 theoretically superior, practically more difficult
 SGP rules should be based on all assets and liabilities,
explicit and implicit
 value all liabilities of financial sector for sovereign
 Higher deficits possible if
 larger assets
 lower implicit debts
 lower risk-exposure financial sector
LESSONS CRISIS FOR PUBLIC AUDITORS
 Control public liabilities financial sector




no longer off balance: value liabilities
higher bank capital
remove tax advantages debt
stop mortgage insurance