Financial Crises and Debt Overhangs: Some Reflections

Transcription

1 Financial Crises and Debt Overhangs: Some Reflections Carmen M. Reinhart Peterson Institute for International Economics NBER and CEPR InterAmerican Development Bank April 18, 2012, Washington DC Reinhart 1

2 Outline: Variations on debt themes Most advanced economies Deleveraging, unemployment, double dips? The European risks From financial crash to debt crisis more restructurings Major emerging markets The capital inflow problem A global issue The return of financial repression? Reinhart 2

3 PART I. Key concerns in most advanced economies: Deleveraging, unemployment, double dips? After the Fall Reinhart and Reinhart (2010) Reinhart 3

4 Main results GDP growth and housing prices are significantly lower and unemployment higher in the ten-year window following the crisis when compared to the decade that preceded it. We present evidence that the decade of relative prosperity prior to the fall was importantly fueled by an expansion in credit and rising leverage that spans about 10 years; it is followed by a lengthy period of retrenchment that most often only begins after the crisis and lasts almost as long as the credit surge. Reinhart t 4

5 Real per capita GDP growth Real per capita GDP growth rates are significantly lower during the decade following severe financial crises and the synchronous world-wide shocks. The median post-financial crisis GDP growth decline in advanced economies is about 1 percent. Reinhart 5

6 Real Per Capita GDP Growth in the Decade Before and the Decade After Severe Financial Crises: Post-WWII, Advanced Economies Big five: Spain, 1977; Norway, 1987; Finland, 1991; Sweden, 1991, Japan 1992 t-10 to t-1 t+1 to t+10 median min max obs Post-crisis (t+1 to t+10) 10 Pre-crisis (t-10 to t-1) GDP growth, percent Reinhart t 6

7 The issue of double dips The role of external shocks Reinhart 7

8 Episodes of a slowdown or recession in 3rd or 4th year after the crisis Country Crisis year (beginning) Annual per capita GDP growth Lowest Magnitude growth rate of slowdown (high- low) Year(s) of slowdown External (or exogenous) shock(s) Spain High world interest rates; recession in advanced economies. The Latin American debt crisis gets underway. Chile Renewed weakness in commodity prices, which fall percent that year (depending on index used). Malaysia Philippines Thailand Colombia For the Asian economies concerns about the avian flu begin in earnest in May 2001; for all the recovering countries 9/11 poses a major blow to world trade. The trade volume of goods and services, which had risen by 12.2 percent in 2000 is flat in 2001, rising 0.2 percent. Memorandum item, a 5 th -6 th year recession Japan Asian crisis. Japanese banks had begun to lend aggressively to emerging Asia in early 1996; these are now hit with fresh losses. 2 Reinhart 8

9 In 7 of these 15 episodes there was a double dip The renewed weakness had external origins Reinhart 9

10 Unemployment rates In the ten-year window following severe financial crises, unemployment rates are significantly higher than in the decade that preceded the crisis. The rise in unemployment is most marked for the five advanced economies, where the median unemployment rate is about 5 percentage points higher. Reinhart Reinhart and Reinhart 10

11 Unemployment Rate in the Decade Before and the Decade After Severe Financial Crises: Post-WWII, Advanced Economies Probability density function, five advanced economies Pre-crisis, (t-10 to t-1) Post-crisis (t+1 to t+10) Big five: Spain, 1977; Norway, 1987; Finland, 1991; Sweden, 1991, Japan 1992 t-10 to t-1 t+1 to t+10 median min max obs Unemployment rate, percent Reinhart 11

12 In ten of the fifteen post-crisis episodes, unemployment has not fallen back to its pre-crisis level, not in the decade that followed Reinhart 12

13 Deleveraging Deleveraging is often delayed and is a lengthy process lasting about seven years. The decade that preceded the onset of the 2007 crisis fits the historic pattern. If deleveraging of private debt follows the tracks of previous crises, credit restraint will damp employment and growth for some time to come. Reinhart 13

14 Domestic Banking Credit/GDP Ten Years Before and Ten Years After Severe Financial Crises: Duration of Boom-Bust Credit Cycles in fifteen Post WWII Episodes Japan 1992 Korea 1997 secular debt increase Number of years Spain 1977 Finland 1991 Philippines 1997 Argentina 2001 Colombia 1998 Turkey 2001 Credit booms Norway 1987 Sweden 1991 Indonesia 1997 Malaysia 1997 Thailand 199 Chile 1981 Mexico 1994 Median 15 episodes Deleveraging -15 Reinhart 14

15 PART II. The European risks more restructurings? From Financial Crash to Debt Crisis Reinhart and Rogoff (2011) Reinhart 15

16 Historically, public debt buildups have often ended in sovereign debt crises There is a systematic link between debt/gdp and the incidence of default Reinhart 16

17 Sovereign Default, Total (domestic plus external) Public Debt, and Inflation Crises: World Aggregates, (debt % of GDP) Total public debt/gdp, world average (in percent, solid line, right axis) Percent of countries with annual inflation over 20% (dark bars, left axis) Percent of countries in default or restructuring (pale bars, left axis) Reinhart 20 17

18 PART III. Major emerging markets The capital inflow problem again? Capital Flow Bonanzas Reinhart and Reinhart (2009) Reinhart 18

19 Turning to emerging markets, and debt, capital flows, growth, and crises Reinhart 19

20 Sustained large capital inflows can be too much of a good thing Reinhart 20 20

21 Are capital flow bonanza episodes more crisis prone? Banking crises Lowest income Zimbabwe Zambia Nigeria Côte Thailand Peru Paraguay ElSalvado Colombia Bolivia Angola Algeria Venezuela Romania Mexico Hungary Chile Argentina Singapore Norway Finland Probabilities of a Banking Crisis: \ Unconditional Conditional on bonanza Highest income Percent Reinhart 21

22 Are capital flow bonanza episodes more crisis prone? Sovereign default Lowest income Zambia Nigeria Kenya Côted'Ivoir Tunisia Sri Lanka Philippines Guatemala Ecuador Bolivia Angola Algeria Turkey Mexico Costa Rica Chile Argentina Probabilities of External Default: Unconditional Conditional on bonanza Highest income Percent Reinhart 22

23 Are capital flow bonanza episodes more crisis prone? Inflation crises Lowest income Zimbabwe Zambia Nigeria Myanmar Peru Guatemala El Salvador Ecuador Colombia Angola Algeria Turkey Romania Poland Mexico Mauritius Hungary Costa Rica Chile Argentina Korea United Portugal Italy Greece Probabilities of an Inflation Crisis: Unconditional Conditional on bonanza Highest income Percent Reinhart 23

24 PART III. A global issue The return of financial repression? The Liquidation of Government Debt Reinhart and Sbrancia (2011)

25 Throughout history, debt/gdp ratios have been reduced by: (i) economic growth; (ii) fiscal adjustment/austerity; (iii) explicit default or restructuring; (iv) a sudden surprise burst in inflation; and (v) a steady dosage of financial repression that is accompanied by an equally steady dosage of inflation. (Options (iv) and (v) are only viable for domestic-currency debts). Reinhart 25

26 Financial repression includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks. It is a subtle type of debt restructuring Reinhart 26

27 Main results: In the heavily regulated financial markets of the Bretton Woods, restrictions facilitated a sharp and rapid reduction in public debt/gdp ratios from the late 1940s to the 1970s. Low nominal interest rates reduced debt servicing costs while a high incidence of negative real interest rates liquidated the real value of government debt. Reinhart 27

28 Main results: For the advanced economies in our sample, real interest rates were negative roughly ½ of the time during For the US and the UK our estimates of the annual liquidation of debt via negative real interest rates amounted on average from 3 to 4 percent of GDP a year. For Australia and Italy, which recorded higher inflation rates, the liquidation effect was larger (around 5 percent per annum). Reinhart 28

29 Real Interest Rates Frequency Distributions: 35 Advanced Economies, Real interest rates Share of observations at or below percent percent percent Reinhart 29

30 Share of Outside Marketable U.S. Treasury Securities plus Government Sponsored Enterprises (GSEs) Securities: End-of-period, Share of "Outside" Treasury Securities Share of "Outside" Treasury Securities plus GSEs Reinhart 30

31 Domestic Bank Holdings of General Government Debt: Greece, Ireland, Portugal, and UK, , end-of-period (as a percent of gross general government debt) Ireland Greece Portugal UK 31

32 The Re-emergence of Financial Repression, France, December 2010: Liquidation of Fonds de Reserve Pour Les Retraites (FFR) The French government changed the law to shift the 37bn FFR from providing long-term financial support to the French PAYG pension system after 2020 to instead pay an annual 2.1bn to the Caisse d Amortissement de la Dette Sociale (CADES) from 2011 to 2024 and at that point transfer all remaining assets to the CADES in one lump-sum payment. This shift in FFR s investment horizon has meant a radical shift in asset allocation from longer-term diversified riskier assets to a short-term LDI-strategy dominated by liability matching short-term French government bonds. For the duration of its lifespan the FRR has consequently been transformed into a large captive buyer of French government bonds. Ireland, 2010: Use of the National Pension Reserve Fund to Recapitalize Banks As a result of the banking crisis, Ireland National Pension Reserve Fund (NPRF) may have to contribute up to 17.5bn to recapitalize Ireland s banks. The NPRF was originally set up in 2001 to help finance the long-term costs of Ireland's social welfare and public service pensions from 2025 onwards. However, a 2010 law directed the NPRF to invest in Irish government securities and provides the legal authority for the Irish government to fund capital expenditure from the NPRF from April 2011: Levy on pension funds. The Irish government has further recently suggested to fund job creation schemes through a special 0.5% levy on private pension funds. Japan, March 2010: Reversal of Post Privatization and Raising of Deposit Ceiling The new DPJ government reversed the 2007 plan to privatize Japan Post, the world s largest financial conglomerate with more than 300tr in assets. Crucially, the DPJ government with the new law also doubled the deposit cap at Japan Post Bank to 20mn and raised the life insurance coverage limit at Japan Post Insurance Co. from 13mn to 25mn. Given Japan Post s traditional roughly 75 percent asset allocation to JGBs, and under the assumption that consumers will transfer deposits to a company certain to enjoy a government guarantee, the reversal of the Japan Post privatization provides additional incentives to a captive customer of Japanese government debt. Reinhart 32

33 Portugal, 2010: The transfer of the previously privatized Portugal Telecom pension scheme back to the Portuguese government, which in the process immediately booked 2.8bn (1.6% of GDP) in extra revenues. This enabled the Portuguese government to improve its budget deficit in 2010 sufficiently to cosmetically appear to be in line with annual EU deficit reduction targets. Spain, April 2010: Interest rate ceilings on deposits. The Ministry of Finance (MoF) requires that institutions offering deposit interest rates that are considered to be above market rates (determined by MoF) double their contributions to the Fondo de Garantía de Depósitos. UK, October 2009, UK Financial Services Authority (FSA) puts a global regulatory liquidity marker. The proposal by the FSA requires UK banks, investment banks, and subsidiaries or branches of foreign banks operating in the London market to hold more high quality government securities at least around 110 billion more (at that time), and cut their reliance on short-term funding by 20 percent in the first year alone. 2011? Royal Mail privatization, which will see an expected 23.5bn in assets transferred to the UK treasury ahead of privatization (as well as an expected 29.5bn in liabilities). Reinhart 33

34 Banking crises and capital mobility, High Share of Countries in Banking Crisis, 3-year Sum (right scale) Index Capital Mobility (left scale) 15 Percent Low Reinhart 34