AFTER THE AFTER THE SUBPRIME SUBPRIME
MORTGAGE CRISIS: MORTGAGE CRISIS: WHAT STRATEGY WHAT STRATEGY
FOR EUROPE?FOR EUROPE? Robert BOYER
PSE (Paris-Jourdan Sciences Économiques)
Babbot Room, The Octagon, Amherst College, March 26, 2008
INTRODUCTIONINTRODUCTION• Entering a new and quite uncertain Entering a new and quite uncertain
epoch:epoch:
What will be the consequences for the What will be the consequences for the US of the sub-prime mortgage crisis?US of the sub-prime mortgage crisis?
How interdependent is the world with How interdependent is the world with respect to the American economy?respect to the American economy?
Is a finance-led growth regime a fatality?Is a finance-led growth regime a fatality?
How should new regulations How should new regulations restore the structural stability of restore the structural stability of such a regime?such a regime?
Will Europe be drastically affected Will Europe be drastically affected by the sub-prime mortgage crisis?by the sub-prime mortgage crisis?
What alternative strategies for the What alternative strategies for the European Union?European Union?
• The strategy of this presentationThe strategy of this presentation
An institutional analysis of the origins of An institutional analysis of the origins of financializationfinancialization
A simple macro model of finance-led growthA simple macro model of finance-led growth
An interpretation of the origins of financial An interpretation of the origins of financial crisescrises
Diversity and legacy of European institutional Diversity and legacy of European institutional configurations: an alternative to configurations: an alternative to financializationfinancialization
SYNOPSIS OF SYNOPSIS OF PRESENTATIONPRESENTATION
I.I. The pressures towards a The pressures towards a finance-led regime.finance-led regime.
II.II. The homeland of The homeland of financialization is the US…but financialization is the US…but potential macro-economic potential macro-economic instability.instability.
III.III.From the Internet bubble to From the Internet bubble to the sub-prime mortgage crisis.the sub-prime mortgage crisis.
IV.IV. How Europe will be How Europe will be affected?affected?
V.V. The European Union: the The European Union: the search for alternative search for alternative models.models.
VI.VI. ConclusionsConclusions
I. THE PRESSURES I. THE PRESSURES TOWARDS A FINANCE-TOWARDS A FINANCE-
LED REGIMELED REGIMEBack to social historyBack to social historyThe 60s: a The 60s: a de facto de facto compromise compromise
between managers and wage earnersbetween managers and wage earnersConsumers
Patient financial market
Managers Permissive international regime
Wage-earners
Strong links Weak links Direction of influence
The 80s: An international The 80s: An international competition led regime weakens the competition led regime weakens the bargaining power of wage earnersbargaining power of wage earners
Consumers
Gain from trade Managers More
international competition
Discipline
Erosion of past compromise
Wage-earners
Strong links Weak links Direction of influence
The 90s: The The 90s: The ex postex post alliance of investors and managers alliance of investors and managers
Consumers
Transparency
Managers Large and powerful financial markets
Share holder value More risk Financialisation of
income and pensions Wage-earners
Strong links Weak links Direction of influence
The 2000s: The emerging tensions within the The 2000s: The emerging tensions within the finance industry and the rise of the lawyerfinance industry and the rise of the lawyer
State,
as the last resort
THE LAWYER
Institutional Investors
Managers Auditors
Rating Agencies Financial Analysts
Fund Mangers
Pension funds
Flow of information Financial flow Intermediation of conflicts and related income
Financialization is part of a long term Financialization is part of a long term structural transformation of contemporary structural transformation of contemporary capitalism, after the crisis of Fordismcapitalism, after the crisis of Fordism
International opening
Regained power of managers
Demand addressed to managers =
shareholder value
Surge of CEO compensation
Erosion of wage-earners bargaining
power
Acceptance of pension funds
Inflow on the stock market
Financial bubble
Crisis of the Fordist growth
regime
Conservative backlash
Financial deregulation
Multiple innovation in
finance
II.II.THE HOMELAND OF THE HOMELAND OF FINANCE LED GROWTH: FINANCE LED GROWTH:
THE US… THE US…
An accumulation regime at odds with An accumulation regime at odds with Fordism: the centrality of the stock marketFordism: the centrality of the stock market
+
Dividends and
Pension funds
+ High stock market price
+ Easy access to
credit
+
Profit
+
Consumption Production
+
+
Employment Diffusion of
Financial norms - Careful management
of investment
+
Globalised Financial
regime
Shareholder value as a new form of competition
and governance mode
Highly reactive wage labour
nexus
The multiple channels of financializationThe multiple channels of financialization
+ Monetary policy,
Financial market stabiliser
+
Limitation of
public borrowing
-
Public
expenditure
+
Stock Market
prices
G F
Credibility of Government ac-
tions
E Tax system favour-able to the most mobile factors
+
+
+
Industrial specialisa-tions, Financial con-
centration
Raising the required rate
of return
- Productive investment
+ Profit
A
+ + -
FINANCIAL SYSTEM
Management of firms for sharehold-
ers
B Labour con-tract flexibil-
ity
+ Productive capacity
Effective de-mand
Employment, wages
- +
+
+ “Patrimonial” Eq-uity based Household
behaviour
C
Wealth effect on Sav-
ings/Consumption Allocation
+ Current con-sumption
+
+
Privatisation of elements
of social security
D Pensions via stock market
Purchase of housing and
durable goods
+
+
+
+ Secured bor-rowing
A simple A simple macroeconomic macroeconomic
modelmodel
Various Various regimesregimes
A finance-led regime is A finance-led regime is possible if: possible if:
– The financial wealth / income ratio The financial wealth / income ratio is highis high
– The investment is profit ledThe investment is profit ledThis regime is structurally stable if:This regime is structurally stable if:
Wage formation is not too much Wage formation is not too much competitivecompetitiveThe rate of return required by The rate of return required by shareholders is not too highshareholders is not too high
The Central Bank has to react The Central Bank has to react quickly to financial bubblesquickly to financial bubbles
Testing the model for some OECD Testing the model for some OECD countriescountries
The US: the only finance-led The US: the only finance-led regimeregime
……..BUT A POTENTIAL ..BUT A POTENTIAL MACROECONOMIC MACROECONOMIC
INSTABILITYINSTABILITYThe development of financial market The development of financial market
first extends the likelihood of a first extends the likelihood of a finance-led regime…finance-led regime…
But up to some threshold, the But up to some threshold, the economy enter into a zone of economy enter into a zone of structural instability.structural instability.
III.III. FROM THE FROM THE INTERNET BUBBLE TO INTERNET BUBBLE TO
THE SUB-PRIME THE SUB-PRIME MORTGAGE CRISIS.MORTGAGE CRISIS.
• This regime is generating This regime is generating speculative bubblesspeculative bubbles that burst out… that burst out…
• ……But are cured by an But are cured by an activeactive monetary policy… monetary policy…
• ……And the positive impact of And the positive impact of financial innovationsfinancial innovations……
• ……For instance the For instance the securitisationsecuritisation first prevents the fragility of banks first prevents the fragility of banks A strong paradox: an unstable accumulation regime rescued by the deepening of financial innovations
• ……But But private innovationsprivate innovations, such as , such as subprimesubprime loans, exploit this opportunity to shift the risk… loans, exploit this opportunity to shift the risk…
• ……The boom of this market reaches its limits, the reversal of The boom of this market reaches its limits, the reversal of confidence confidence challenges challenges macroeconomic stabilitymacroeconomic stability……
• ……And again the And again the Central BankCentral Bank is the rescuer of last resort in order to preserve the is the rescuer of last resort in order to preserve the viability of the financial viability of the financial systemsystem
Figure 1 – A typical sequencing of
financial crises
Private innovatio
n
Success /
High profit
Rapid adoption
Entry in the zone
of financial fragility
Lender as a last resort
No public intervention: collapse
of the innovation
Regulation by the
government
Viability of the regulated
innovation New
cycle
Figure 2 – A first example: energy derivatives
and the ENRON collapse
Energy derivatives
Unprecedented profit
Creative accounti
ng
Bankruptcy
New rules of accountability for CEO and CFO
Prevention from any
public control by lobbying
But not any reform of
accountability principles
A structural weakness
Potential for new crisis
Figure 3 – A second example: rise and collapse of Northern Rock
Financing by bonds of mortgage
loans
High profit / Rapid
capture of market shares
No reaction
of Financial Service Agency
More bonds issued
Banking run
Initially, Bank of England did not bail out
Worsening of the crisis
Systemic crisis
Conflict between Bank of England,
Treasury, FSA
Search for self
regulation
A failed innovation
Nationalization of
Northern Rock
Figure 4 – A third example: the sub-prime mortgage
Sub-prime mortgage
New and growing market
Absence of public regulatio
n
Securitization shift the risk
Reversal of the
housing
market
Melting down of the sub-prime
market
Limited FED
intervention
Diffusion of Non
Performing Assets (NPA)
A creepin
g banking
crisis
Searching for new
regulations
Recapitalization by
sovereign funds
Mergers among banks
Unlimited access to
liquidity from FEDA systemic
financial crisis
IV.IV.HOW EUROPE WILL HOW EUROPE WILL BE AFFECTED?BE AFFECTED?
The financial led regime is not observed in The financial led regime is not observed in EuropeEurope
COUNTRIESPARAMETERS
United States
Great Britain
Canada Japan Germany France
1.Average propensity to consume (1996)
0.95 0.926 0.956 0.869 0.884 0.908
2. Wealth in shares/ disposable income (1997) %
145 75 95 30 25 20
3. Extent of capital gains /disposable income (%)
35.5 15 11 - 7 7 5
4. Proportion of shares and bonds in households’ financial assets
28.4 52.4 n.a. 25.3 21.3 14.5
1.Monetary market rate 5.34 7.38 5.20 0.32 3.5 3.46
1.Return on bonds 6.51 5.59 7.30 1.06 3.97 4.23
1.Reference profitability 12%-16% 12%-16% 12 - 16% 5% 6% -7% 9%
Actually, in other OECD countries Actually, in other OECD countries alternative alliancesalternative alliances may exist and may exist and govern govern different different accumulation regimesaccumulation regimes
Managerial
expertise
THE
AMERICAN FIRM
Governance under
shareholder value
The firm as a bundle of
competences
THE JAPANESE
FIRM
Financial
capital Firm specific
competences
ESOP
Employee ownership/
co-management
THE GERMAN FIRM
The different channels of the The different channels of the diffusion of American financial diffusion of American financial crisiscrisis
Many European financial institutions Many European financial institutions have non performing sub-prime loans have non performing sub-prime loans or derivatives: how important are they?or derivatives: how important are they?
The impact of the American recession The impact of the American recession upon world trade…possibly upon world trade…possibly compensated by Asian dynamism.compensated by Asian dynamism.
The negative impact of the The negative impact of the appreciation of the euro upon growth appreciation of the euro upon growth and employment in Europe.and employment in Europe.
A long lasting revaluation of A long lasting revaluation of financial risk, as a source of credit financial risk, as a source of credit crunch.crunch.
The imperfection of the European The imperfection of the European policy mix (a single monetary policy policy mix (a single monetary policy but contrasted national budgetary but contrasted national budgetary policies): a clear limitation to the policies): a clear limitation to the reactivity of the EuropeanUnion.reactivity of the EuropeanUnion.
V. THE EUROPEAN UNION: V. THE EUROPEAN UNION: THE SEARCH FOR THE SEARCH FOR
ALTERNATIVE MODELSALTERNATIVE MODELS A change of epoch: from the primacy of the wage labor nexus to the
omnipresence of a financial logic
The European treaties codify this swing in the hierarchy of the economic institutions
Figure 1 – The hierarchy of the European procedures: the primacy of the monetary
regime
Any growth strategy has to take into account the shift in the conception of economic policy
Source : Freely inspired of EC/DGE "Reinforcement of mechanisms for economic policy
coordination", July 28, 1999.
A survey of alternative A survey of alternative strategiesstrategies
S1 – Promote a better policy mix in order to rejuvenate S1 – Promote a better policy mix in order to rejuvenate growthgrowth
S2 - Convert Information and Communication Technologies S2 - Convert Information and Communication Technologies (ICT) into a knowledge based economy (KBE)(ICT) into a knowledge based economy (KBE)
S3 - Gender equality and the response to ageing as sources S3 - Gender equality and the response to ageing as sources of a welfare / services driven growthof a welfare / services driven growth
S4 - S4 - A recurring temptation of some member states riding A recurring temptation of some member states riding the financial globalisation the financial globalisation
Figure 2 – First strategy: A pragmatic coordination of monetary and fiscal
policies in order to promote growth and creation of jobs.
Table 2 – Institutional conditions of this first strategy
Figure 3 – Second strategy: convert Information and Communication Technologies (ICT) into a knowledge based economy (KBE)
Table 3 – Institutional conditions of this first strategy
Figure 4 – A third strategy: gender equality and the response to ageing as sources of a
welfare / services driven growth
Figure 5 – Strategy four : Riding the financial globalisation, as a recurring temptation of
some member states
Table 2- What growth regime for the early 21st century?
CONCLUSIONCONCLUSIONC1 -C1 - The US is the first economy The US is the first economy
to experience the to experience the benefits and benefits and the risksthe risks of a finance-led of a finance-led regime.regime.
C2 -C2 - The recurrence of powerful The recurrence of powerful financial innovationsfinancial innovations is at the is at the origin of most financial crises origin of most financial crises in the US, but their in the US, but their macroeconomic consequences macroeconomic consequences differ drastically.differ drastically.
C3 -C3 - The collapse of the The collapse of the sub-sub-prime prime mortgage is the last mortgage is the last one and the one and the most severemost severe since since WWII. It sheds a crude light WWII. It sheds a crude light upon the danger of a bold upon the danger of a bold financial liberalizationfinancial liberalization
C4 -C4 - This is an incentive to This is an incentive to reassess the role of reassess the role of financial financial re-regulationre-regulation, in order to try , in order to try to reduce the instability to reduce the instability potentially associated to potentially associated to intense financial innovations.intense financial innovations.
C5 –C5 – With the possible exception With the possible exception of UK, of UK, no European economyno European economy is following the American is following the American trajectory. This reduces the trajectory. This reduces the risk of an equivalent melting risk of an equivalent melting down, but down, but many channelsmany channels will will diffuse the American diffuse the American recession to the rest of the recession to the rest of the world.world.
C6 -C6 - A priori, financialization A priori, financialization may well be may well be detrimental detrimental to to most non US economies. most non US economies. Consequently they should Consequently they should resist to further financial resist to further financial liberalization.liberalization.
C7 –C7 – The mission of European The mission of European Union should be to contribute Union should be to contribute to the to the discipliningdisciplining of the of the international finance and the international finance and the promotion of promotion of welfare welfare enhancingenhancing growth strategies. growth strategies.
MANY THANKS FOR YOUR MANY THANKS FOR YOUR ATTENTIONATTENTION
Robert BOYERCNRS (PSE- Paris Jourdan Sciences Economiques),
EHESS, CEPREMAP48, Boulevard Jourdan 75014 PARIS
+ 33 (0)0 43 13 62 56 [email protected]
Site WEB : http://www.jourdan.ens.fr/~boyer/