World financial crisis: reasons, trends, responses and perspectives

1
World financial crisis reasons, trends,
responses and perspectives

• Mojmir Mrak
• University of Ljubljana
• 2009

2
The structure of the presentation

• I. Intensification of systemic risks in
  international finance
• II. Immediate reasons for development and
  outbreak of the financial crisis
• III. Key phases of the financial crisis
• IV. Responses to the financial crisis
• V. The impact of the financial crisis on the
  countries of Central and South-east Europe
• VI. How to proceed?

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I. Intensification of systemic risks in
international finance

• Instability of exchange rates
• According to the BW system, we live in a system
  of flexible exchange rates, where coordination of
  exchange rate policies is of extreme importance
• Coordination of exchange rate policies was
  conceptually recognized, but it is not
  operational in practice (the rising BP imbalances
  confirm this)
• Strong US and EU pressure on the Chinese exchange
  rate policy
• Oil countries and their exchange rate policies
• Recent movements of exchange rates

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I. Intensification of systemic risks in
international finance (II)

• Large balance of payments imbalances
• During the last years, the BP imbalances have
  increased significantly
• US have a huge BP deficit, Asia a great BP
  surplus, euro zones BP is around zero

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I. Intensification of systemic risks in
international finance (III)

• Difficulties in providing international liquidity
• Extremely strong trend of liberalization of
  capital flows in the last two decades
• Balance of payments imbalances have been mainly
  financed by private capital marginalization of
  official capital flows
• Frequent financial crisis, especially in EE, but
  also in some developed countries have disclosed
  problems

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II. Immediate reasons for development and
outbreak of the financial crisis

• Long-term upward trend of real estate prices in
  the US

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II. Immediate reasons for development and
outbreak of the financial crisis (II)

• Large liquidity in the world

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II. Immediate reasons for development and
outbreak of the financial crisis (III)

• Problematic role of rating agencies in assessing
  the creditworthiness of complex financial
  instruments
• Weaknesses in the supervision of some parts of
  the financial system
• Agressive leadership model of financial
  institutions governance / management

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III. Phases of the financial crisis

• Outbreak of the crisis in the summer of 2007
• The financial crisis breaks out as a result of
  macroeconomic factors (such as the crises in
  1980s and 1990s), or for reasons arising in the
  financial sector
• The current crisis has occurred because of
  problems in the financial sector, specifically
  due to the plummeting of real estate prices (that
  hindered the servicing of debt)
• The crisis began on the "sub-prime" segment of
  the US real estate market

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III. Phases of the financial crisis (II)

• Expansion of the crisis in the first period
  (autumn 2007 - August 2008)
• Step one Transfer of the crisis from the US to
  investors around the world
• Step two Transfer of the crisis from
  institutional investors to the interbank market
• Step three Crisis starts spreading from the
  financial sector to the real economy
• Deepening of the crisis in the second period
  (from September 2008 onwards)
• Systemic risk increased with Lehman Brothers
• Stock markets plunge in all countries
• Strong tightening of inter-bank market

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IV. Responses to the financial crisis

• Responses to the crisis in the first period
  (autumn 2007 August 2008)
• Providing liquidity by central banks and
  selectively reducing interest rates
• Very limited and case-by-case usage of public
  funds for resolving the crisis
• Short-term measures of regulators
• Reporting banks / financial institutions losses
  
• Deleveraging of banks / financial intermediaries
• New business models in the financial sector
• Self-regulation of certain subjects, such as
  rating agencies, sovereign funds

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IV. Responses to the financial crisis (II)

• General responses to the crisis in the second
  period (from September 2008 onwards)
• Coordinated lowering of interest rates by key
  central banks
• A more systemic approach of tackling the problem
  of financial institutions with public funds
• Ensuring the solvency of banks by nationalization
  (partial / comprehensive, capitalization and
  forced mergers of banks in trouble and healthy
  banks, with the participation of public funds)
• Guarantees to unblock the interbank market
• Guarantees to deposits (first limited, then
  overall)

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IV. Responses to the financial crisis (III)

• General responses to the crisis in the second
  period (from September 2008 onwards) (cont.)
• Spreading of the crisis from the Wall Street to
  the Main Street
• Economic growth in the world was drastically
  reduced in autumn
• Forecasts for 2009 are bad (recession in US and
  EU) and only a bit better for 2010
• It has become more and more obvious that measures
  aimed solving financial sector would not be
  sufficient what is also needed are fiscal
  packages aimed at increasing economic growth

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IV. Responses to the financial crisis (IV)

• EU specifics in responding to the crisis in the
  second period (from September 2008 onwards)
• Some basic problems of the EU in responding to
  the financial and economic crisis
• Institutional specifics of the EU vs USA
• EU does not have a serious budget at the EU level
• EU has strongly decentralised supervision of its
  financial sector
• Until September 2008 EU member stated had
  responded to the crisis exclusively at a national
  level
• Broadening of the crisis has forced EU member
  states and especially euro zone countries for
  more coordination
• Irish precedence concerning deposit guarantees
• European Commission considers today the state aid
  much more generously than only half a year ago

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IV. Responses to the financial crisis (V)

• EU specifics in responding to the crisis in the
  second period (from September 2008 onwards)
• Key elements of the package adopted by the
  European Commission the set of proposed measures
  included
• Fiscal impetus at a member states level
  equivalent to EUR 170 bn
• Increase of targeted investment
• Increase the guarantee potential for bank
  financing
• Increase of safety net expenditures
• Temporary reduction of certain taxes
• Temporary reduction of contributions
• Fiscal impetus at the EU level
• EIB loans equivalent to EUR 30bn
• Increase of advance payment for EU cohesion funds

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IV. Responses to the financial crisis (V)

• Implications of the crisis on EU economy (from
  September 2008 onwards)
• Deficits in majority of EU member states will be
  over 3 of GDP (over SGP treshhold) ratings of
  several eurozone members downgraded
• Problems with raising funds on the international
  financial markets
• Spreads over reference interest rates widened for
  many eurozone countries (discussion about union
  bonds)
• Aceess limited to sovereign borrowers and
  borrowers with sovereign guarantees
• Is it possible that an eurozone state defaults?
• Real test for the euro
• Increasing fear of protectionism (car industry)

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IV. Responses to the financial crisis (VI)
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V. Financial crisis and Central and South-east
Europe

• Why are the CE and SEE countries more hurt by the
  crisis than other emerging country regions
• Characteristics of the financial systems of the
  CE and SEE countries
• High dependence of domestic banks of the
  interbank market
• A significant number of foreign banks and thus
  much financing from abroad parent - daughter
  relations
• Great credit expansion in the years before the
  outbreak of the crisis, much invested in real
  estate (due to cheap money and low indebtedness
  of population)
• First signs of tightening conditions seen this
  spring due to liquidity problems of mother banks
• It meant reduced access to capital for domestic
  banks and a significant increase of its price
• Additional problem was the price erosion of real
  estate

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V. Financial crisis and Central and South-east
Europe (II)

• Why are the CE and SEE countries more hurt by the
  crisis than other emerging country regions
  (cont.)
• The region has well defended itself against the
  financial crisis until September, despite
• Higher price of money
• Falling economic growth in partner countries
  especially EU
• Deepening of the crisis after the collapse of
  Lehman Brothers the region got affected more than
  other regions because of
• Partner EU countries enteres into a strong
  recession
• Significant dependence on the interbank market
  which is blocked
• Parent banks evaluate how to allocate available
  funds to its daughters (higher influence of
  country risk)

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V. Financial crisis and Central and South-east
Europe (III)

• Impact of the crisis on different groups of
  countries in the region Iceland has deepened the
  differenciation among countries in the region
• The most affected are the countries with large
  balance of payment deficits and significant needs
  for foreign borrowing (the Baltic states,
  Hungary, Ukraine, Kazakhstan and Turkey and some
  of the SEE countries, especially Bulgaria and
  Romania)
• Less risky are Central European countries, except
  Hungary, which are characterized by relatively
  lower dependence on the foreign interbank market
  (they have relatively more domestic deposits)

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V. Financial crisis and Central and South-east
Europe (IV)
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V. Financial crisis and Central and South-east
Europe (V)
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V. Financial crisis and Central and South-east
Europe (VI)
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V. Financial crisis and Central and South-east
Europe (VII)

• Impact of the crisis on Western European banks
  and their states
• Western banks have some 1,300 bn EUR of claims in
  the region the most exposed Austria, followed by
  Belgium and Sweden
• Banks have problems raising funds on the market
  Moodys recently downgraded some of them
• CE in SEE countries have to repay or roll over
  for some 400 bn EUR of credits in 2009
• Due to the crisis, EBRD expects that some 10 of
  loans will become non-performing
• High exposure of banks and states to the crisis
  

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V. Financial crisis and Central and South-east
Europe (VIII)
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V. Financial crisis and Central and South-east
Europe (IX)
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V. Financial crisis and Central and South-east
Europe (X)
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V. Financial crisis and Central and South-east
Europe (XI)
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V. Financial crisis and Central and South-east
Europe (XII)
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V. Financial crisis and Central and South-east
Europe (XIII)

• Management of the crisis for the region
• In the early stage (by the end of 2008)
  case-by-case approach with arrangements done for
  Hungary, Latvia, Serbia and Ukraine key role of
  the IMF in these arrangements
• Later on (since January 2009) more talks about a
  rescue package for the region and for the western
  banks amount between 150 250 bn EUR
• Austrian proposal for an EU sponsore package
• Proposal for an EIB sponsored package
• Proposal for increasing the funding potential of
  the IMF
• 24 bn EUR package by EBRD, EIB and WB

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VI. How to proceed?

• Complexity of the current crisis asks for complex
  answers as in the following two directions
• Macroeconomic policy measures
• Measures within the financial sector
• Macroeconomic policy measures how to make the
  crisis as short and shallow as possible
• Monetary - further lowering of interest rates
  (FED vs. ECB) and maintaining liquidity
  (mistrust)
• Fiscal - in addition to financial, also fiscal
  measures, to prevent the collapse of the "Main
  Street" and possibly of the "Wall Street" in the
  future
• Price of these measures (worse fiscal position
  and less favourable ratings pressure to make
  the GSP softer pressure on ECB's independence)

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IV. How to proceed? (II)

• Measures within the financial sector how to
  reestablish a healthy development "lifeblood"
• Short-term to extinguish the fire and to
  stabilize the sector
• Measures to reestablish confidence (in terms of
  deposit savers, and interbank business European
  specifics problems with implementation)
• Measures to ensure the solvency of banks
  (potentially negative impact to the real sector
  moral hazard problem)
• More complete disclosure of information about the
  complex financial instruments (to systematically
  tackle the problem, it is necessary to know its
  exact scope)
• Assisting emerging" countries without their own
  financial packages (pulled in the crisis, this
  time not by their own fault IMF vs others)

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IV . How to proceed? (III)

• Measures within the financial sector (cont.)
• Long-term for systematic rehabilitation of
  national and international financial systems
  (globalization requires a new approach of global
  governance) two basic approaches
• Idealistic establishment of a new
  international financial architecture in an
  multilateral world
• A thorough institutional reform of the IMF with a
  substantially greater weight to emerging
  countries in its decision making (elimination of
  the US veto power and one voice for the euro
  zone countries)
• Establishment of a framework for effective
  coordination of exchange rates and elimination of
  balance of payments imbalances (the role of
  countries with large balance of payments
  surpluses - "sovereign wealth funds")

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IV. How to proceed? (IV)

• Measures within the financial sector (cont.)
• Long-term for systematic rehabilitation of the
  system
• Realistic approach that is based on a national
  / regional level and strengthened cooperation
  between national institutions
• To substantially strengthen the regulation and
  control over the entire financial industry (end
  of "shadow banking cooperation of national
  structures, particularly in the EU, centralized
  control of large banks central areas of
  regulation will be capital adequacy, liquidity,
  rewards danger of too much regulation)
• Harmonization of differences in accounting
  standards for banks, regarding the valuation of
  securities
• Improvement of risk management in banks and
  elimination of conflict of interests between
  individual banking products
• The reform of rating agencies (the elimination of
  conflict of interests different views regarding
  regulation between the U.S. and EU)