TOO MUCH DEBT, FINANCIAL SYSTEM STABILITY AND WIDER ECONOMIC IMPACTS

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1 TOO MUCH DEBT, FINANCIAL SYSTEM STABILITY AND WIDER ECONOMIC IMPACTS 16 th Annual Chicago Federal Reserve Bank International Banking Conference: Shadow Banking Within and Across National Borders 7 November 2013 Adair Turner Senior Fellow Park Avenue South - 5 th Floor New York, NY 10010

2 Two Recent Lectures: Credit, Money and Leverage: What Wicksell, Hayek and Fisher Knew and Modern Macro-Economics Forgot Stockholm School of Economics, September Securitisation, Shadow Banking and the Value of Financial Innovation. The Rostov Lecture on International Affairs School of Advanced International Studies (SAIS), John Hopkins University, Washington DC, April

3 $Tr $bn $Trn Measures of increasing financial intensity 300% 250% 200% 150% 100% 50% US debt as a % of GDP by borrower type Global issuance of asset-backed securities 10% Growth of interest rate derivatives values, ,100 1, FX Trading values & world GDP OTC interest rate contracts, notional amount outstanding Global nominal GDP, $bn Global FX turnover, annual, $bn Global exports, $bn 2

4 % of GDP Household deposits and loans: % 90% 80% 70% Securitisations and loan transfers Deposits Loans 60% 50% 40% 30% 20% 10% 0% Source: Bank of England, Tables A4.3, A4.1 3

5 Measures of increasing financial intensity US debt as a % of GDP by borrower type 300% 250% 200% 150% 100% 50% 10% 4

6 US financial sector assets 300% Banks GSE Issuers of ABS Security Broker-Dealer MMMFs Agency and GSE- Mortgage Pools Finance Companies Funding Corporation 250% 200% 150% 100% 50% 0%

7 NASDAQ index ,000 5,000 4,000 3,000 2,000 1, Source: Datastream 6

8 Categories of credit Loans to businesses / entrepreneurs to finance real investment projects Loans to businesses / speculators / investors to finance purchase of existing assets Mortgage loans to households to finance residential houses Loans to impatient / temporarily cash limited / poorer households to bring forward consumption 7

9 Categories of debt: UK, 2009 bn Other corporate Commercial real estate Primarily productive investment Some productive investment and some leveraged asset play Residential mortgage (including securitizations and loan transfers) 1235 Mainly purchase of existing assets Unsecured personal 227 Pure life-cycle consumption smoothing 8

10 Credit and asset price cycles Increased credit extended Increased lender supply of credit Increased borrower demand for credit Increased asset prices Expectation of future asset price increases Favourable assessments of credit risk Low credit losses: high bank profits Confidence reinforced Increased capital base 9

11 Lending to UK households Percentage changes on a year earlier Unsecured Secured Secured Households Households Source: Bank of England Trends in Lending 10

12 Sectoral financial surpluses/deficits as % of GDP: Japan % PNFCs Government Source: IMF, Bank of Japan Flow of Funds Accounts 11

13 % GDP Japanese government and corporate debt: Bank lending to non-financial corporates General Government debt Source: BoJ Flow of Funds Accounts, IMF WEO database (April 2011), FSA calculations 12

14 % GDP % GDP % GDP Shifting leverage: private and public debt-to-gdp 140 UK 120 US Q Q Q Q Q Q Q Q Q Q Household Public PNFCs Source: ONS Note: PNFC = private, non-financial corporates; Public = central and local government Spain 0 Q Q Q Q Q Q Q Q Q Q Household Public PNFCs Source: BEA Note: PNFC = private, non-financial businesses; Public = federal, state and local government Q Q Q Q Q Q Q Q Q Q Household Public PNFCs Source: ECB Note: PNFC = private, non-financial corporates; Public = central and local government 13

15 Private credit to GDP and growth Source: S. Cecchetti and E. Kharroubi, BIS Working Paper No. 381 "Reassessing the impact of finance and growth" 14

16 Dimensions of increasing complexity Securitisation Liquidity Market based pricing M-to-M accounting Improved risk management Secured finance VAR models M-to-M accounting Multi-step intermediation and maturity transformation Derivatives Interest rates Fx Credit Credit structuring and tranching Increased role for short-term wholesale funding Increased trading activity 15

17 Increasing complexity not just a parallel shadow system Securitisation Liquidity Market based pricing M-to-M accounting Improved risk management Secured finance VAR models M-to-M accounting Multi-step intermediation and maturity transformation Derivatives Interest rates Fx Credit Credit structuring and tranching Increased trading activity Increased role for short-term wholesale funding Increasing integration of commercial and investment banking Multiple bank to shadow bank links (SIVs, repo markets) Large expansion of banking trading books Increase in wholesale funding secured and unsecured Treasuries become profit centres Intra-financial system assets grow rapidly 16

18 Credit derivatives enhance the transparency of the markets collective view of credit risks [and thus] provide valuable information about broad credit constraints and increasingly set the marginal price of credit. IMF Global Financial Stability Report, April

19 Additional credit creation Securitisation is a good thing. If everything was on bank balance sheets, there would not be enough credit. Senior American Regulator, quoted in the Economist Special Report on Financial Innovation, February

20 Credit and asset prices: with securitised credit and mark-to-market accounting Increased credit extended Increased trading Increased shortterm liquidity Increased asset prices fewer defaults Decreased margin calls Decreased VAR Increased price of credit securities Mark-to-market accounting and VAR based risk management Bank profit and capital Required bank capital Bonuses and animal spirits 19

21 Irrational exuberance in equity and debt markets Financial firm CDS and share prices Source: Moody s KMV, FSA Calculations 20

22 WWII ends Housing bursts Private and public leverage cycles: US 250 Public and Private debt as a % of NGDP Financial Repression Source: McCulley and Pozsar 21

23 % of GDP China: total social finance to GDP

24 Non-financial private sector* credit outstanding, % GDP Brazil China India Hungary Indonesia Korea Mexico Russia South Africa Turkey Source: BIS, Citi Research *Households + corporates 23

25 Leaning against credit cycles: monetary or macro-prudential levers? Pros Monetary policy interest raises Gets into all the cracks Macro-Prudential levers Can address specific credit categories Cons Elasticity of response variable by category of credit Will stimulate innovation to avoid 24

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