The Global Financial Crisis and Post-Crisis Challenges

Jon FrostFinancial Stability DivisionDe Nederlandsche Bank

(Central Bank of the Netherlands)

TEIMUN ConferenceECOSOC

The Hague, 12 July 2011

Outline

I. DNB and its role in financial stability

II. Origins and chronology of the global financial crisis

III. The crisis and emerging and developing countries

IV. Global and national policy responses

V. The post-crisis recovery: new challenges

DNB and its role in financial stability

• DNB is an integrated central bank and supervisor of the Dutch financial sector – banks, insurers and pension funds

• “Everything in the service of financial stability”: • monetary policy (ESCB)• payments• prudential supervision• economic advice

• Financial Stability Division active since 2004:• signals risks to the financial system• writes semi-annual “Overview of

Financial Stability”• active in policy formation on financial

stability-related issues

Outline

I. DNB and its role in financial stability

II. Origins and chronology of the global financial crisis

III. The crisis and emerging and developing countries

IV. Global and national policy responses

V. The post-crisis recovery: new challenges

The global financial crisis:An overview

• Since 2007, extraordinary stress in global financial markets

• Financial crisis has caused major economic dislocations, including global recession of 2009 (worst since the Great Depression)

• Origins lay in the US housing market bubble, but also in much deeper economic and financial factors

• Since 2009, also sovereign debt crisis in Europe

• Emerging and developing countries not at heart of the crisis, but also heavily impacted

• Major impact on global employment, welfare and attainment of development objectives (e.g. Millennium Development Goals)

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1993-2002

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2016World Advanced economies Emerging and developing economies

Chart: GDP Growth by regionIn %, actual and projected, 1993-2012

Source: IMF World Economic Outlook (April 2011)

Chronology of the crisis (selected)

Jun. 18 2007: Two hedge funds owned by Bear Stearns forced to close due to sub-prime losses (US)

Sep. 14 2007: Bank run on Northern Rock (UK)

May 2 2010: IMF/EU announce €110 bn program for Greece (EU)

Sep. 15 2008: Request for Chapter 11 protection by Lehman Brothers (US)

Nov 28 2010: IMF/EU announce €85 bn program for Ireland (EU)

Oct. 7-9 2008: Icelandic banks Glitnir, Landsbanki and Kaupthing enter receivership (IS)

May 20 2011: IMF/EU announce €78 bn program for Portugal (EU)

Sep.-Dec. 2008: Major losses in assets markets worldwide; capital outflows from emerging markets

Nov. 26 2009: Debt Standstill at Dubai World (UAE)

Apr. 2 2009: London G20 Summit; world leaders announce package of measures to respond to financial crisis

Origins of the Global Financial Crisis: direct causes

• Huge housing bubble in US in early years of past decade (through 2007)

• Huge extension of “sub-prime” mortgages to (generally low-income) borrowers with limited or impaired credit history

• As house prices fell, wave of defaults, bursting of US housing bubble

• IMF estimate: over $1 trillion in losses from sub-prime assets, total bank losses of $2.8 trillion (2010)

• Period of uncertainty about distribution of losses (2007-8)

• “Hot phase” of the crisis, with bank runs and freezing of interbank market after default of US investment bank Lehman Brothers (September 2008)

Origins of the Global Financial Crisis: underlying causes (I)

• “Great moderation”: between 1980’s and 2007 – growth was robust and inflation was in control in many advanced (and increasingly emerging) economies

• Under the surface, growing “global imbalances”• “Exorbitant privilege” – role of US

dollar as reserve currency, ability of US to run persistent current account deficits

• “Global savings glut” – high savings especially in emerging Asia

• 2002-2007: growing “search for yield”, compression of risk premia

• Demand for USD assets• Very low USD interest

rates from 2003-5

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10121416

1970 1975 1980 1985 1990 1995 2000 2005 2010

Chart 1: Consumer price index (CPI) inflation in the United StatesIn %, average, 1970-2010

Source: US Dept of Labor Bureau of Labor Statistics

Chart 2: Current account balances of selected economiesIn billions of USD, 1990-2008

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1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

CEE

Euro area

United States

Japan

China

Oil exporters

Other Asiancountries Latin America

Figure 1.Current account balancesIn billions of US dollars

Source: IMF, WEO Spring 2009

Origins of the Global Financial Crisis: underlying causes (II)

• De-regulation of the financial sector• Financial innovation – e.g. asset-

backed securities (ABS), credit default swaps (CDS), collateralized debt obligations (CDO’s), structured investment vehicles (SIV’s), etc.

• Rise of “shadow banking” – activities outside purview of supervision

• Increase in leverage in the banking sector (ratio of debt financing to equity – see chart)

• Increasing cross-border financial integration increased contagion channels between countries

• …

Current Sovereign Debt Crisis: underlying causes

• Persistent government deficits (borrowing) led to high public debt in many advanced economies before crisis

• In euro area, Maastricht criteria (limit of 3% of GDP deficit, 60% public debt) not adequately fulfilled

• Crisis hit both public revenue (taxes) and expenditures (e.g. unemployment insurance, bank recapitalization, etc.)

• Large fiscal stimulus in some countries

• Worries about sustainability of public debt, especially in Greece, Ireland and Portugal (but potentially in other countries)

Chart 3: Gross public debt by country groupingsIn % of GDP, 2001-2015

Public debt and budget deficits: an overview

World

United StatesFranceGermany

Italy

China

MexicoSouth Africa

Spain

United KingdomCanada

India

Russia

Brazil

Greece

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120

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0 2 4 6 8 10 12 14Budget deficit

Publ

ic d

ebt

Chart 2: Public debt and defict of selected economiesIn 2010, in % of GDP

Source: IMF

Japan

Ireland 34%

220%

Outline

I. DNB and its role in financial stability

II. Origins and chronology of the global financial crisis

III. The crisis and emerging and developing countries

IV. Global and national policy responses

V. The post-crisis recovery: new challenges

Emerging and developing countries before the crisis

• Strong growth and relative macro-economic stability in many countries in 2002-7 period

• After crises in late 1990’s, declining public debt levels and increasing reserves (see chart)

• Especially rapid growth in Developing Asia (11.4% in 2007) and CIS (9%)

• Sub-Saharan Africa, Latin America, oil exporters also see strong growth, partly led by commodity exports (e.g. due to growing demand from China)

• Other economies negatively affected by rising oil and food prices, especially in 2007-8

The impact of the 2007-8 food (and oil) crisis

• Food prices began rising rapidly in 2007 – rise of 140% through April 2008

• Especially heavy impact on least developed countries and the most poor, who spend a relatively large share of income on food

• Oil prices peaked at $145 per barrel (WTI) in July 2008; collapsed to $30 only 6 months later in December

• Asymmetric impact on emerging and developing countries: oil exporters experience windfall, while others see huge pressures on balance of payments and government finances

Global investment flows have run a rollercoaster ride during the crisis

Net Capital Inflows – All emerging market countriesIn $ billions, 4-quarter moving sum

Source: IMF, “Recent Experiences in Managing Capital Inflows—Cross-Cutting Themes and Possible Policy Framework”, February 2011

60

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100

120

Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10

Brazil China India Indonesia MexicoKorea Czech Republic Russia Turkey TaiwanThailand Philippines Poland

Real effective exchange rates of selected EMEsIn %, jan 2008=100

Source: Datastream,

…with significant impact on economies, financial markets and (real) exchange

rates

Source: Datastream, DNB

Paul Krugman: “the mother of all currency crises”

(26 October 2008)

The crisis had a heavy toll on growth for some regions

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1993-2002 2009Central and Eastern Europe (CEE) Commonwealth of Independent States (CIS)Developing Asia Latin America and the CaribbeanMiddle East and North Africa Sub-Saharan Africa

Chart: GDP Growth by region - emerging and developing worldIn %, actual and projected, 1993-2002 and 2009

Source: IMF World Economic Outlook (April 2011)

…but the recovery is much stronger than in advanced economies

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2011 2016Central and Eastern Europe (CEE) Commonwealth of Independent States (CIS)Developing Asia Latin America and the CaribbeanMiddle East and North Africa Sub-Saharan AfricaAdvanced economies

Chart: GDP Growth by region - emerging/developing vs. advancedIn %, actual and projected, 2011 and 2016

Source: IMF World Economic Outlook (April 2011)

Outline

I. DNB and its role in financial stability

II. Origins and chronology of the global financial crisis

III. The crisis and emerging and developing countries

IV. Global and national policy responses

V. The post-crisis recovery: new challenges

Global policy responses (selected)• Establishment of G20 as key policy forum for global economic issues• Increased role of the IMF:

• USD 250 billion allocation of Special Drawing Rights (SDR), USD 500 billion for New Arrangements to Borrow (London Summit, April 2009)

• Enhanced role in surveillance• Key role in programs for euro area countries

• Financial Stability Board replaces Financial Stability Forum to coordinate work on issues of financial regulation and supervision

• Supervisory policy coordination: • Basel III capital accord for banks (Basel Committee of Bank

Supervisors)• Solvency II introduced for insurers

• Sovereign debt crisis:• Establishment of €440 billion European Financial Stability Facility

(EFSF), used to co-finance EU/IMF programs for struggling euro area member states

National policy responses (selected)

• Monetary policy: • major cuts to policy rates around the world• unconventional monetary policy (Quantitative Easing, full allotment)

• Fiscal policy:• automatic stabilizers and fiscal stimulus programs• since sovereign debt crisis, much more impact on consolidation

• Financial stability policy: • emergency recapitalization of banks and other financial institutions• liquidity assistance (e.g. through government guarantees, etc.)• establishment of permanent funds for recapitalization or deposit

insurance• major reforms to supervisory frameworks – establishment of financial

stability committees and reorganizations of supervisory bodies

Outline

I. DNB and its role in financial stability

II. Origins and chronology of the global financial crisis

III. The crisis and emerging and developing countries

IV. Global and national policy responses

V. The post-crisis recovery: new challenges

Global imbalances: increasing again?

Since mid-2009, a major rebound in net capital inflows to (many) EMEs

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2009Q1 2009Q2 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3 2010Q4 2011Q10

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Poland: Financial account, CDS and EMBI spreads In $ million (left axis) and basis points (right axis)

Bron: JP Morgan, Datastream, IMF

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2009Q1 2009Q2 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3 2010Q4 2011Q10

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FDI Portfolio Other CDS (r-as)

Grafiek # CDS en kapitaalstroomIn basispunten, mln USD respectievelijk

Bron: JP Morgan, Datastream, IMF

Financial account, CDS and EMBI spreadsIn $ millions (left axis) and basis points (right axis)

Brazil Turkey

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Brazil: Financial account, CDS and EMBI spreads In $ million (left axis) and basis points (right axis)

Bron: JP Morgan, Datastream, IMF

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Turkey: Financial account, CDS and EMBI spreads In $ million (left axis) and basis points (right axis)

Bron: JP Morgan, Datastream, IM FPoland Romania

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2009Q1 2009Q2 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3 2010Q4 2011Q10

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FDI Portfolio Other CDS (r-as) EMBI (r-as)

Poland: Financial account, CDS and EMBI spreads In $ million (left axis) and basis points (right axis)

Bron: JP Morgan, Datastream, IMFSource: JP Morgan, Datastream, IMF, DNB

Indicators of vulnerability?

Varying signals from

different indicators, but some recurring (country)

names

Source: IMF, Global Financial Stability Report, April 2011

Global recovery brings new challenges

• IMF warns of risks from “two-speed global recovery”:“The recovery is gaining strength, but unemployment remains high in advanced economies, and new macroeconomic risks are building in emerging market economies.”

• Low interest rates and heavy global liquidity could be funding new “search for yield”, contributing to overheating in emerging markets

• Commodity prices again rising, putting pressure on most poor and vulnerable

• Need for “exit strategies” from policies enacted during the crisis

• Importance of reforms to financial supervision and regulation

Questions?