Esmond Birnie presentation at NICVA

What caused the financial crisis? Where do we go from here?

NICVA CEE Masterclass 21 October 2011Dr Esmond Birnie, Chief Economist, PwC

www.pwc.co.uk

PwC

Global growthTrends and prospects

Source: IMF, www.imf.org/external/pubind.htm (exchange rate weighted).

CEE Masterclass 21 October 20112

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

-2

-1

0

1

2

3

4

5

6

7

GD

P G

row

th (

% Y

-on-

Y)

Long-run average = 3.5%

World GDP growth(Although doubts over 2011 – 2013+ divergence “East” and “West”)

3PwC

Greedy, wicked bankers?

•9 February 2009 Vince Cable MP said the guillotine should be restored for bankers

•Rage against bankers may make us feel better in the short term,

but long term solution require a reasoned consideration of the full causes of the downturn

•Responsibility may be more widespread

21 October 2011CEE Masterclass

4PwC

Banking crisis- too much debt across the board

•By 2008 UK banks debts had risen to twice level of GDP (increases in some other economies but UK, and RoI (421%) and especially Iceland (580%), unusually high)

•Importantly, other debt/GDP also rose during the 2000s (in the UK from 150% in 1987 to about 300% in 2009)

•A moderately rapid increase until 2003 and then acceleration 2003-8

•But, in terms of banks, PwC analysis (2010) suggests spike in gross debts/income in UK 2008-09


5PwC

Banking crisis- complexity of derivatives

•Various financial instruments (CDOs) obscured , because made less direct, the connection between creditors and lenders

•Note, also, how far system internationalised-

US sub-prime becomes our problem

English/Scottish banks linked to RoI

French/German banks tied to Greece etc.


6PwC

Banking crisis of 2007-8 begins- sub-prime problems

•A long boom in US (and UK, RoI) house prices came to an end (1997-2006 US house prices up 124%, UK 97%)

•Interest rate rises provoking sub-prime mortgage defaults in US

•Transmission from sub-prime problems through to US banks, to wider (and international) capital markets

•February 2008 Northern Rock nationalised

•Bear Stearns rescued by Fed Reserve loan

•BUT when the next crippled bank came along, no appetite for bail out


7PwC

The banking crisis of 2007-8, continued…

•Lehmans failed 15 September 2008

•18 September 2008 money draining out (half Trillion$ in hours)

•Bail outs- AIG, 10 largest US banks, Chrysler, GM, RBS and HBOS

•Plus in US guarantees to Fannie Mae + Freddie Mac

RBS- thro. Acquisition of ABN Amro had acquired a lot of US“trailer parks”.

A.m. of 7 October 2008 shares plunged 30%

“This was once the conservative Scottish bank where I had opened my first account as a teenager. It was now on its knees. And what, its chairman asked were we going to do about it”, Alistair Darling


8PwC

Role of regulators- too little (or too much, or too ineffective)?

“We have been in a casino where the government was handing out free chips and the regulators were buying drinks and telling us which numbers to bet on”, Eamon Butler.

•Some critics say “not enough” regulation

•The regulation we had “missed” a lot– failing banks got through various stress tests/not allowing for sovereign default

•Unintended consequences- work to the limit, making banks more similar hence intensifying risk

•For sure, the regulators did not see 2007-8 coming 21 October 2011CEE Masterclass

9PwC

Central banks- Greenspan’s (Chairman US Federal Reserve) folly?

•Were US interest rates kept too low for too long in the 2000s?

OR, a reasonable response to a “glut” in global savings?

•The role of a central banker like the person at a party who has to take away the punch bowl before anyone too drunk?!

•Also criticism of Bank of England’s role

•For sure plenty of “hubris” about– assertions by Gordon Brown and others that the business cycle had more or less gone for good


10PwC

Governments’ response- support the banks at all costs

•Avoid repeat of 1930-32 (in the US thousands of high street banks fail, spending power collapses, output and jobs slump by 20%)

•Too big to fail?

21 October 2011CEE Materclass

11PwC

The triumph, or the limits of Keynesianism

Richard Lucas 2009 “I guess everyone is a Keynesian in the fox hole.”

•Government deficits and borrowing rose to wartime levels (without a world war)

•Does the experience of the US and UK represent “antibiotic resistance” given previous doses of the Keynesian “medicine”?


12PwC

The nightmare continues

•The global financial crisis of 2007+ did not really end in 2009-10

•In fact, mutated

•The issue has become not just the solvency of banks but the solvency of states and governments too


PwC

Euro crisis- a flawed project?

•Two bail outs of Greece (even now its debt/GDP ratio almost certainly unsustainable)

•The bail outs of RoI and Portugal

•Spain and Italy may be waiting in the wings (“too big” for current EU rescue funds)

•When the euro started in the early 2000s many economists questioned its wisdom as constituted– was continental Europe really a “natural currency area”?

•Design flaws:

- When “PIIGS” competitiveness moved out of line with Germany- no ready adjustment

- monetary union without fiscal union

21 October 2011CEE MasterclassSlide 13

PwC

Fixing the euro?- unpalatable alternatives

•PIGS try to work (i.e. grow) their way out of debt--- is this feasible/austerity very painful and maybe counterproductive?

•Some/all of the weaker economies leave (be pushed out) of the euro -they could then achieve a devaluation (at huge cost ,default… Argentina in Europe, although is the Latin American precedent actually favourable [NEXT SLIDE]?)

•A debt write off---- may well be “necessary” but burden on Germany

•Share the defence of “sovereign debt” e.g. through eurobonds---- might restore some market confidence but, again, a heavy demand on Germany

21 October 2011CEE MasterclassSlide 14

PwC

Don’t cry for me Argentina: after default, a bounce?

2 3 4 5 6 7 8 9 10

11

12

13

-6

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-4

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-2

-1

0

1

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Argentina and Greece

Q3 1993, ArgentinaQ2 2003, Greece

Years since Argentinian currency board and Greece joining the euro

Period beginning:

GDP, growth rate compared to previ-ous quarter, sea-sonally adjusted.

Source: World Bank, National accounts:

PwC

Economic outlook still brightest in BRICs, stormiest in Europe (forecast GDP growth for 2011)

16

* CEE Masterclass 21 October 2011

Russia

Germany

UK

US

Brazil

India*

China

Spain

Canada

Mexico

South Africa

Australia

Japan

Italy

Greece

Source: PwC main scenario for GDP growth in 2011

Ireland

France

2.7

1.6

4.3

4.4

0.6

1.8

1.0

1.2

3.0

0.9

3.2

8.0

-3.8

2.8

9.5

-0.5

4.2

17PwC

Global economic outlook- what next?

•Double dip- not inevitable, but possible. Vulnerable because weaknesses in each of the US, Japan + eurozone

•Confidence (or lack of) is the key– like the 1930s but this need not imply that the same solution would work this time

•“Balance sheet and de-leveraging issues”, Ben Bernanke

•Hence, real danger of lost decades scenario- like Japan in 1990s

•Over the long run 2010-2030 rapid growth in emerging economies should continue (subject to Russia is problematic, India and China may have their own credit bubble + supply side difficulties)


PwC

Where this “rebalancing” could take us- The World Economy by 2050

Source: PwC forecasts.* BRICs+Indonesia+Turkey+Mexico,compared to US+Japan+Germany+UK+France+Italy+Canada.

Total E7 GDP (PPP) as% of total G7

2007 c. 60

2010 c. 75

2020 100

2050 200

Compare the total size of the seven biggest emerging economies to the seven largest “Western” economies(the G7)*GDP per capita in Shanghai in 2010 already

similar to that in some northern English counties

PwC

A sign of changeFalling behind China

19PwC

GDP per capita in Shanghai in 2010 already similar to that in most of NI (allowing for cost of living– purchasing power parity)

PwC

If we can think about growth

UK Growth Review (Cable+Osborne) November 2010+...

• Planning

• De-regulation

• Competition

• Skills

• Infrastructure

• SMEs

• Rural economy

• Open data

Preliminary to the NI Executive Economic Strategy – identified strategic aims for Executive...

• Innovation

• Employability

• Competitiveness

• Business growth

• Infrastructure

THIS FRAMEWORK GOOD BUT THREATS:

- Too much focus on short term (employment vs productivity)?

- When will we get the Economic Strategy, PfG, decisions on Corp. Tax and SFA?


PwC

Corporation Tax reduction?Headline observations

• Need to re-balance NI economy

• Long term (25 yr) project

• To extent CT reductions lead to greater competitiveness and hence more investment, jobs and growth– hence welcome UK wide reductions

• But what about lower NI specific rate?

• Experience of ROI suggests slow burn and/or one of a number of factors

• The powers to vary tax more widely (in addition to Corporation Tax) are of particular interest

• The cost of cutting Corporation Tax must be borne by the Executive

IN SHORT, CT REDUCTION WOULD WORK BEST AS PART OF A PACKAGE OF FISCAL INCENTIVES (e.g. TAX CREDITS, APD, AVOID THE ENGLISH SYSTEM OF ELECTRICITY PRICING, ALCOHOL EXCISE)


PwC

PwC

Going for growth(continued)

Goals identified for UK economy by McKinsey (2010), these apply also to NI

• Improve productivity (not just in manufacturing but services too)

• Become an excellent location for FDI

• Get transport and energy infrastructure right

• Maximise opportunities to earn export revenues from health and educational sectors

• Innovate through clustering

• Devolution below the regional government level (i.e. to dynamic cities and local government)

• Minimise the economic negatives of an ageing population and take the economic opportunities

23PwC

Banking reform proposals in the UK- the Vickers’ Commission plan

•Not total separation of high street from investment banks, but firewalls and extra safety cushions

•Goes against grain of international banking development over several decades (but reminiscent of US Glass-Steagall Act of 1930s)

•“The proposals will damage London’s competitive position”, Martin Jacomb FT

•OR “…old fashioned principles- better capitalised, less leveraged and focused on the needs of customers..”, Sarah Brooks Consumer Focus Head of Financial Services

•Higher capital requirements

•Cost to banks £5-10 bn p.a., social cost of £1-3 bn but p.a. cost of a bail out/downswing c £ 40bn


24PwC

This time really is different or back to the Hungry Thirties?


“Now”, 2007+ “Then”, Great Depression 1929-30s

Decline in output UK GDP down 7.1% RoI GDP down c. 15% most of Western c.5-6% decline

UK GDP down 5.7%“RoI” GDP flatUS, Germany c.20% decline

Decline in employment

US down 5.3% US down 20.5%

Absolute living standards

UK,US real GDP per head about 4-5 times higher

World trade By 2011 back to 2007 peak

By 1932 30% down in volume

25PwC

This time is different or back to the Hungry Thirties?

“Now” 2007+ “Then”, Great Depression 1929-30s

Inflation > B of England’s 2% target but still “moderate”

UK deflationOther countries, e.g. US, Germany severe deflation

Bank failures c. 100 worldwide 1000s (espec. US including high street)

Exchange rates Extent of $, £, euro, Yen volatility limitedMost of EU locked in euroUndervalued Yuan

Great volatility/beggar my neighbourUK advantage of early exit from gold standard

Global econ leader US being passed by China

30 year hiatus UK to US


26PwC

Some lessons from 2007-11 global crisis

•General failure of markets or of a particular market (finance)?

•Governments also failed (e.g. regulation, lax monetary policy)?

•The failure to see the crisis coming was pretty widespread (naïve belief business cycle had been banished)

•We now criticise financial innovation but, sometimes, it contributes to growth

•Globalisation may have reduced the frequency of “minor” downswings but also ensured when we get a crisis it is a big one!


27PwC

Be “G-local”: the impact of the world crisis on your sector

•Less (private) cash about

•Less public funding (and less EU too)

•NI has hitherto had a very large community and voluntary sector with many individual organisations

•Moving into a world of retrenchment, consolidation with a premium on capacity building and management


Thank you, any questions?

This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

© 2011 PricewaterhouseCoopers LLP. All rights reserved. In this document, “PwC” refers to PricewaterhouseCoopers LLP (a limited liability partnership in the United Kingdom) which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.

Esmond BirniePwC | Chief EconomistDirect: +44 (0)2890415808 | Mobile: +44 (0)7850907892Email: [email protected]

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Esmond Birnie presentation at NICVA

Economy & Finance