Transcript The Credit Crunch and its Consequences

The Credit Crunch and its
Consequences
Howard Davies
Director, LSE
LSE Alumni Lecture Series – Inaugural Lecture
Wolfson Theatre, New Academic Building
19th February 2009
A Five Act Shakespearian Tragedy
Act One: Subprime
… real estate prices rise
Source: Tano Santos
The growth of securitised credit
Recent ABX BBB Price History
Price
Source: Markit Partners
Resecuritisation
Capital Structure Containing
Subprime Loans
Subprime Mezzanine CDO
Containing BBB Subprime Bonds
100%
100%
11%
SUPER
SENIOR
CUMULATIVE
LOSSES
AAA
AAA
8.6%
40%
AAA
28%
20%
11%
7%
0%
AA
AA
A
BBB
Residual/
Equity
A
11%
7%
BBB
7%
Equity
0%
Act Two: Liquidity
Financial market liquidity
Sources: Bank of England, Bloomberg, Chicago Board Options Exchange, Debt Management Office, London Stock
Exchange, Merrill Lynch, Thomson Datastream.
Act Three: Unravelling
-Bear Stearns, Indymac, Wa mu
-HBOS, RBS
-Fortis, Dexia etc.
Act Four: Meltdown
• Lehman’s failure leads to
– indiscriminate sell-off of financial stocks
– seizing-up of many markets
– generalised market panic
Act Five: Pumping
• additional liquidity facilities
• fiscal stimuli
• near-zero interest rates
• quantitative easing
The Credit Crisis: A Five-Act
Tragedy
Act One:
Subprime
Act Two:
Liquidity
Act Three:
Unravelling
Act Four:
Meltdown
Act Five:
Pumping
But what are the underlying
causes?
•global imbalances
•loose monetary policy, leading to
•mispricing of risk
•credit bubble
•‘excess’ growth of financial sector
•‘excess’ leverage, facilitated by procyclical
regulation
Global current account balances
China’s Growth Laggard
Personal Consumption as % of GDP
Source: China National Bureau of Statistics and Morgan Stanley
Household debt as a proportion of
GDP
Source: FSA, ONS, Federal Reserve, Eurodata, Datastream
UK Saving Rate
Source: ONS; Morgan Stanley Research
The growth of the financial sector
Source: FSA, Oliver Wyman
Major UK banks’ leverage
Source: FSA, Bank of England
“ Bank failures are caused by
depositors who don’t deposit
enough money to cover the
losses due to mismanagement”.
Dan Quayle
“ The owners of capital will stimulate the working
class to buy more and more of expensive goods,
houses, and mechanical products, pushing them
to take more and more expensive credits, until
their debt becomes unbearable The unpaid debt
will lead to bankruptcy of the banks, which will
have to be nationalised, and the state will have
to take the road which will eventually lead to
communism.”
Das Kapital
So what next?
• growth prospects have deteriorated
sharply, across the world
• Europe mired in recession
• long downturn the most likely outcome,
and (in the UK) anaemic recovery
Growth Rates: IMF Forecasts
4
3
2
1
0
-1
-2
-3
-4
Germany
France
US
UK
2007
2008
2009
2010
European Economic Forecast – April 2008
Source: www.ft.com
European Economic Forecast – January 2009
Source: www.ft.com
Larger than previous crises
UK recovery options:
• V-shaped: sharp contraction, quick
bounce-back
• U-shaped: longer trough, delayed but
strong recovery
• L-shaped: Japanese style stagnation
• Nike swoosh: sharp downturn, weak
recovery
Is London Reykjavik on Thames?
• Banks big, but not that big in relation to
GDP
• Fiscal position poor, pre-recession, but
stock of debt not excessive
• But needed fiscal tightening will mute the
recovery.
Sovereign five-year CDS
Source: Morgan Stanley (as at 21 January 2009)
General government debt rations in
OECD countries in 2008
Source: OECD, Economic Outlook No. 84, November 2008
UK gross issuance forecast
Source: Morgan Stanley
Discretionary policy change projected
in the PBR
Source: HM Treasury, Pre-Budget Report 2008
The Credit Crunch and its
Consequences
Howard Davies
Director, LSE
LSE Alumni Lecture Series – Inaugural Lecture
Wolfson Theatre, New Academic Building
19th February 2009