Transcript Austerity Politics, Then and Now Harold James, November 2010

Two Generations of Asset Price Bubbles:
From 1990 Japan to 2007 U.S.
Eric Rashi
What are Asset Price Bubbles?
0 An upward price movement over a period of time, unexplainable
based on fundamentals, and which eventually implodes
0 Implosion associated to widespread socio-economic distress
0 Not a new phenomenon:
0 Irrationality: mania
0 Human psychology
0 Market manipulation
New More Modern Causes
Globalization
1
2
3
New Financial Architecture
Policy Mistakes
The Current Problem
0 “Greenspan” principle: policy-makers should not intervene in the
markets to prevent bubbles, only clean up the mess once they burst
BUT…
0 Bubbles are very dangerous: history of leading to banking crises
0 Japan 1985-1990  “Lost Decades”
0 U.S. 2003-2007  Global Financial Crisis
Japan: From Asian Miracle to “Lost Decades”
10%
8%
6%
4%
2%
0%
1980
-2%
1985
1990
1995
2000
-4%
-6%
-8%
Real GDP Growth
Inflation
2005
2010
Japan Real Estate Bust…
Rebased:
1980 = 100
300
250
200
150
100
50
0
1980
1985
1990
1995
Nominal GDP
2000
2005
2010
Land Prices
0 1990 real estate bust put pressure on banks’ balance sheets
Coupled with Equities Bust
40,000
30,000
20,000
Nikkei 225
10,000
0
1980
1985
1990
1995
2000
2005
2010
0 Full-blown banking crisis:
0 1992-1998: 21 Big Banks write of ¥42.02 trillion of bad loans
0 Peak capital base during time period was only ¥22.15 trillion in 1994
Causes of Japan’s Financial Bubbles
Banking liberalization
• From controlled to competitive market-based system
Financial innovation
• Financial engineering (zaitech) enabled speculation
Prolonged monetary easing
• Cheap credit and high liquidity
Japanese Government Response
0 Underestimated crisis: too little, too late:
Fiscal Balance (% of GDP)
Central Bank Interest Rate
4%
10%
2%
8%
0%
1990
-2%
6%
4%
-4%
2%
0%
1980
1995
-6%
1985
1990
1995
2000
2005
2010
-8%
0 Long-term measure: provide subsidies to failing banks
2000
2008 U.S. Crisis : Similar Story?
Rebased:
1995 = 100
250
Nominal GDP
200
150
S&P Case-Shiller
Home Price Index
100
50
0
1995
2000
2005
2010
1,600
1,200
800
S&P 500
400
0
2002
2004
2006
2008
2010
2012
Spread to Real Economy
0 Full-blown banking crisis: heavily exposed banks are acquired or collapse
12%
10%
8%
6%
4%
2%
0%
2000
-2%
2002
2004
2006
2008
-4%
-6%
Real GDP Growth
Unemployment rate
2010
Causes of U.S. Housing Bubble
Banking liberalization
• Greenspan led deregulation: Gramm-Leach-Bliley Act 1999
Financial innovation
• Mortgage market securitisation: tranching, CDOs, MBS, …
Prolonged monetary easing
• Cheap credit and high liquidity after 2001 dot-com bust
U.S. Government Response
0 Immediate and aggressive
0 Pushed for “private sector solution” amongst banks
Fed Interest Rate
Fiscal Balance (% of GDP)
8%
0%
2001
6%
-2%
4%
-4%
2%
-6%
0%
1995
2000
2005
2010
-8%
2003
2005
2007
2009
2011
Main Takeaways
1) The Japanese and U.S. episodes are strikingly similar
2) Bubbles, particularly in real estate, can pose a serious
threat to the real economy
3) “Greenspan principle” seems outdated:
Policy-makers need to contain spillovers (ex-post)
Also need to act proactively (ex-ante)
Preventing Future Asset Price Bubbles
Re-regulation
• Continue with efforts: Basel III and U.S. Dodd-Frank Act
Keep up with financial innovation
• Understand complex products and reduce systemic risks
Conservative monetary policy
• Monitor real estate prices and avoid low interest rates
Response to Future Asset Price Bubbles
0 U.S. response was more successful in containing damage
from housing collapse and in returning economy to
growth:
0 Must act quickly and aggressively
0 Must protect banks
Difficulties to Overcome
0 Preventing and reacting to bubbles is not an easy task:
Bubbles are difficult to establish ex-ante
2) Reputational difficulties for policy-makers
1)
0 But… given the threat, these difficulties must be overcome...
Questions?
Bubbles: difficult to establish ex-ante
Rebased to
1998 = 100
Chinese Property Price-to-Earnings Ratio
400
300
National Average
Property Price
200
Urban Household
Disposable Income
per Capita
100
0
1998
2000
2002
2004
2006
2008
2010
U.S. Loan Delinquency Rate (% of total)
U.S. Gross Public Debt (% of GDP)
120%
100%
80%
60%
40%
20%
0%
2000
2002
2004
2006
2008
2010
2012
Japan Public Debt (% of GDP)
250%
200%
150%
100%
50%
0%
1980
1985
1990
1995
2000
2005
2010