But a BIS paper suggests that some of the main crisis-affected economies will return to their pre-crisis level of GDP by the second half of 2010.
Excerpted from Financial Crises and Economic Activity by Stephen G Cecchetti, Marion Kohler and Christian Upper
Financial crises are more frequent than most people think, and they lead to losses that are much larger than one would hope. On average, there have been between three and four systemic banking crises per year for the past quarter century. Not all of these have had visible real costs, but most have. In the restricted sample of 40 financial crises that we study, fully one fourth resulted in cumulative output losses of more than 25 per cent of pre-crisis GDP. And one third of the crisis-related contractions lasted for three years or more.
Banking crises are also quite diverse. In fact, those that we study appear to be practically unique in their evolution. In an important sense, the average crisis does not exist. In 16 cases, countries had a positive shift in the level and in 6 cases countries had a negative shift in both the level and the trend.
Nevertheless, by directing a battery of statistical tools at the historical data, we are able to use the variation across crises to learn a number of things that can provide insights into the likely progression of the current crisis. We find that when a banking crisis is accompanied by a currency crisis, it is nearly six quarters longer, and the trough in output is (on average) 6 percentage points lower. And when it comes along with a sovereign debt default, the financial crisis is less severe – one and a half years shorter and 6 percentage points of precrisis GDP less deep.
Furthermore, we show that if the crisis is preceded by low growth – possibly because it is induced by a recession – it tends to be more severe. For each percentage point that GDP growth is lower, the contraction is longer by one quarter and the trough in activity is 1 percentage point lower.
We find that many systemic banking crises have had lasting negative effects on the level of GDP. And even in those cases in which trend growth was higher after the crisis than it had been before, making up for the output loss resulting from the crisis itself took years.
By altering attitudes towards risk, as well as increasing the level of government debt and the size of central banks’ balance sheets, systemic crises have the potential to raise real and nominal interest rates and consequently depress investment and lower the productive capacity of the economy in the long run. We looked for evidence of these effects and found that a number of crises had lasting, negative impacts on GDP. In some countries this was a result of an immediate, crisis-induced drop in the level of real output combined with a permanent decline in trend growth. In other cases, we find that the growth trend increased following the crisis but that the immediate drop was severe enough that it took years for the economy to make up for the crisis-related output loss.
Finally, we were able to find a robust statistical model that can explain a large share of variation in contraction length across past crises. This model predicts that for the current episode, some of the main crisis-affected economies will return to their pre-crisis level of GDP by the second half of 2010.
Technorati Tags: banking-system, economic-policy, financial crisis, GDP, recession, recovery
A new working paper from the IMF finds that stimulus measures can be effective in speeding economic recovery, especially if applied early. But it also finds that banking-crisis-related recoveries are more sluggish than other recoveries.
Excerpts from International Evidence on Recovery from Recessions by Valerie Cerra, Ugo Panizza, and Sweta C. Saxena
Although negative shocks have persistent effects on output on average, this paper shows that macroeconomic policies and the structure of the economy can influence the speed of recovery and mitigate the persistence of the shock. Indeed, monetary and fiscal stimulus and foreign aid can spur a rebound, with impacts that are asymmetrically stronger than in nonrecovery years. Real depreciation and the exchange rate regime also have asymmetric growth effects in a recovery year relative to other years of expansion. Recoveries are more sluggish in open economies, partly because fiscal policy is less effective than in closed economies.
- Fiscal and monetary stimulus and foreign aid can be more effective to boost a rebound from recession relative to the effect of these policies on growth in other stages of the business cycle.
- Real appreciation, fixed and intermediate exchange rate regimes, and trade openness are associated with lackluster recoveries.
Of particular note, we find that fiscal policy is less effective in lifting recovery growth in more open economies.
- In open economies, fiscal stimulus may spill over to higher growth in partner countries by increasing demand for imported foreign goods and services. This finding suggests the need for more coordination in fiscal stimulus across countries, so that the spillover to other countries is offset by equivalent increases in foreign demand fordomestic goods and services.
- We also investigate whether recovery from banking crises is different from other recoveries and find strong evidence in this direction. Banking crisis-related recoveries are more sluggish than other recoveries. However, some policies may be more effective for these situations. Fiscal policy, foreign aid, trade and capital account openness, and the exchange rate regime have disparate impacts on recovery from banking crises relative to other recessions.
Technorati Tags: economic-policy, fiscal-policy, monetary-policy, recession, recovery, stimulus
RT @RetailTraffic CMBS Deliquencies Drop for First Time in Almost a Year http://bit.ly/125wvs
RT @alacra1 New Post by Integrity Research: Why Does Debt Research Differ from Equity? http://bit.ly/p0NRR
Confidence among UK business professionals sees the biggest rise for two years, suggesting the recession is at an end. http://bit.ly/1Rf7Xk
RT @FTAlphaville Up to five UK building societies could be pushed into mergers over the next couple of years: KPMG http://tinyurl.com/kpya2p
Why venture capital needs more regulation – by Georges van Hoegaerden of the Venture Company (h/t DJ Venture wire) http://bit.ly/45XOIG
Global downward trend in top rates of personal tax about to reverse: KPMG study http://bit.ly/HQpKx
RT @OECDtweet RT @soyroberto: How many weekly hours workers in OECD countries put in. Korea top at 44 vs low at 27 http://bit.ly/26QU1
RT @planetmoney A new kind of Big Mac index – how much time it takes to earn a burger http://bit.ly/X4Fii The Economist via @andyzilch
RT @zerohedge Cash for Clunkers: A welfare program where we borrow from China to buy cars we can’t afford and ship profits to Japan.
RT @StructuredFin Rating Agencies Look to Make Ratings More Transparent with New Tool http://bit.ly/L8Q4V
U, V or W for recovery: The world economy has stopped shrinking. That’s the end of the good news (The Economist) http://bit.ly/pkzlC
Philly Fed survey points to manufacturing rebound (via CreditWritedowns) http://bit.ly/G0JqD
RT @FTAlphaville The shape of things to come is probably not ‘V’: So say Bank of America Merrill Lynch economists http://tinyurl.com/lxejdg
The Blatant Opacity of Banks’ Balance Sheets (The Motley Fool) $BAC $WFC $RF $STI $KEY http://shar.es/FVby
Technorati Tags: banks, building societies, business confidence, CMBS, economic indicators, investment-research, recession, tax-policy, venture-capital
Count Oxford Analytica among those anticipating an economic recovery in the US by the fourth quarter.
OxAn says the four key determinants of recovery by the fourth quarter are moving in the right direction: housing market activity, household savings, financial markets and the beginning of the main tranche of fiscal spending. “However, a continued surge in long-term bond yields, or a savings rate overshoot, would substantially delay recovery.”
OxAn says the timing and size of US recovery now depends upon four main factors:
1. Housing bottoming out. Housing prices must hit bottom. They do not need to rise again to restore consumer confidence, but they do need to stop declining. The Case-Shiller housing price index shows that prices in many major metropolitan areas are still down 15-20% in the past year. However, rising sales volumes in many markets — including Los Angeles, Las Vegas, Phoenix and Miami — suggest that substantial market clearing is occurring and that housing prices are approaching cyclical lows. Nationally, it appears plausible that prices will hit bottom by the fourth quarter.
2. Savings rate stabilisation. The savings rate must stabilise. Historically, the US household saving rate has averaged 7% of income. During the economic boom of 2003-07, it dropped to 0% and even went negative in several quarters. A normal corrective process that occurs in virtually all recessions is that households cut spending and replenish savings. As of April, the saving rate had rebounded to 5.7%, and is likely to return to the 7.0% range. This could happen as early as the third quarter.
3. Credit restoration. Credit flows must be restored. The ‘Ted spread’ — the difference between the interbank rate and the Treasury bill rate (both at three-month maturity) — usually averages approximately 50 basis points, but during the Lehman Brothers crisis it soared to 450 basis points. With the Federal Reserve’s balance sheet actions to flood the credit markets with funds, the Ted spread has nearly returned to its historical range, suggesting that normal functioning is returning. Loan volumes are low, but this is due as much to weak cyclical demand as to constricted supply. If a recovery is to begin by late 2009, the major banks that were ’stress tested’ in May will need to raise more capital and shift some of their balance sheet assets out of government bonds and into loans.
4. Fiscal stimulus. The largest volumes of spending from the 787 billion dollar federal stimulus package are likely in the last two quarters of 2009 and the first two quarters of 2010. That is, the bulk of these funds have not kicked in yet, but they are just about to make a major entrance. It is already apparent that tens of thousands of state and municipal workers are not being laid off because of supplementary federal funds.
On balance, it appears that the building blocks are in place for a US recovery by the fourth quarter.
However, there are two key risks that could delay recovery:
- Interest rates. Long-term interest rates are a critical risk. The prospect of a 1.8 trillion dollar budget deficit in fiscal year 2009 (13% of GDP) followed by deficits that remain in the trillion dollar range for several years, has spooked the bond market. Treasury bond yields have jumped by about 100 basis points and mortgage rates, which are based in part on these yields, are up nearly 130 basis points. Higher yields could impede a housing recovery and handicap a rebound in business investment spending.
- Savings rate ‘overshoot’. If consumers turn pessimistic, perhaps because of an acceleration of job losses, the savings rate could ‘overshoot’ to 8-10% or more — implying continuing declines in consumer spending for another 2-3 quarters. This would be consistent with prolonged ‘L’ or ‘W-shaped’ recessions.
Technorati Tags: economic-data, economic-forecast, recession, stimulus, US-economy
Global economic activity is expected to contract 2.6 percent this year after expanding 2.1 percent in 2008, the United Nations now forecasts in its mid-year World Economic Situation and Prospects update. The new forecast is much worse than the U.N.’s January prediction for a decline of 0.5 percent in global GDP.
The U.N. report says the global economy could rebound in 2010 but that there are significant risks to that outlook:
If financial markets do not unclog soon and if the fiscal stimuli do not gain sufficient traction, the recession would prolong in most countries with the global economy stagnating at lower welfare levels well into 2010.
Under a more optimistic scenario, in which the financial and credit markets are completely healed in 2009, the U.N. said world GDP could rise 2.3 percent in 2010.
Technorati Tags: credit-crisis, global-economy, recession, UN
Deterioration in the creditworthiness of Japanese corporations and financial institutions continued unabated in the first quarter of 2009, with rating downgrades outnumbering upgrades by a whopping 24-to-1.
Worse, Standard and Poor’s Credit Research said there is little to suggest any turnaround in the near future:
Given the uncertain prospects facing Japanese and global economies, we believe that the downward trend in the credit quality of Japanese corporations and financial institutions may continue for some time.
Japan’s corporations were on an upswing from 2004 until mid-2008. In the third quarter of 2008, credit conditions began deteriorating and have been on a downward slide since, S & P said.
S & P downgraded 10 Japanese in the first quarter, while none were upgraded. An additional 14 corporations saw their outlooks slashed to negative.
In “Weakening of Credit Quality Among Japanese Corporate and Financial Institutions More Pronounced in Q1 2009,” S&P details its downgrades of 14 banks, insurance and securities firms, and its move to a negative outlook on 12 others.
Technorati Tags: corporate downgrades, credit-crisis, japan, Japanese banks, recession
CreditSights expects a long and slow recovery when US consumers emerge from the current recession, with as much as $2.8 trillion of excess leverage remaining to be unwound.
“It is not just the current recession that poses such risks for investors, it is the likely lackluster nature of the subsequent recovery,” CreditSights notes in The US Consumer Conundrum. “A defining factor in that recovery will be the strength of consumer expenditure. We are not expecting a strong rebound despite the rapid drop off in economic growth.”
The individual pieces add up to a picture of a consumer that is challenged on multiple fronts and, we believe, is in the midst of a secular deleveraging that will take many months, if not years, to play out.
“Although it is hard to estimate how far this trend can extend the adjacent chart that plots total household liabilities as a percentage of GDP suggests that the current level of 100% is approximately 20% above the prevailing long term trend level indicated by the red line. That suggests there is still a substantial amount of wood to chop even if there is no overshooting that is typical in big cyclical shifts, liabilities would need to fall by $2.8 trillion to be 80% of current GDP levels.“
Technorati Tags: Consumer-spending, deleveraging, economic-data, recession
Despite protectionist and economic pressures, the European Union is not likely to suffer political ruptures and could even emerge from the recession stronger than before, according to Oxford Analytica.
The global crisis has fomented disagreement among EU states over the handling of the economy, trade and protectionism, leading some to predict political crisis for the union. Among the concerns:
- The “one size fits all” unified currency has hamstrung individual European nations in their efforts to combat the credit crisis.
- There isn’t sufficient political unity behind the monetary union, evidenced by the German-led rejection of a Hungarian proposal to bail out Eastern European nations.
- European Parliament elections to be held in June have fostered political uncertainty about the future path of the European Commission.
- Nationalist trade measures, e.g. protectionism, threaten to usher in another era of 1970’s-style “Euro-sclerosis,” where European states turn inward and growth stagnates.
But Oxford Analytica, in “Integration Will Survive Economic Test,” argues the fears are exaggerated.
Though European integration is set for a period stasis while the crisis endures, measures agreed so far — and the fact that the EU was expected to act even where it had limited powers – suggest that it could emerge strengthened when the crisis comes to an end.
Self-interest argues for preserving the union, given the tragic outcome for Iceland, a small country on the fringe of the EU.
Oxford Analytica points out that Iceland has a renewed interest in joining the EU, and Eastern European countries are trying to accelerate their admission to the union.
Technorati Tags: credit-crisis, eastern europe, EU, euro, European Union, protectionism, recession
Executives at American International Group aren’t the only ones being asked to adjust to a new “normal” in executive compensation.
A survey of 227 U.S. companies in February by accounting firm Grant Thornton LLP found that half the firms have frozen executive base pay and 15 percent have cut salaries. Think your bonus will make up for that? Think again.
- For 69 percent of the companies surveyed, payouts on 2008 bonuses are below targeted levels.
- For 27 percent of the companies, no bonuses are being rewarded at all for 2008.
- 2009 bonus budgets are the same or lower than 2008, the companies said.
- More than half the companies reported that 75 percent of their stock options were “under water,” and half have reduced the number of options granted in the first two months of 2009.
Companies are expecting 2009 to be a challenging year for business growth and financial stability. As they recast business plans for leaner times, this is impacting executive compensation programs dramatically.
Interestingly, public companies and private companies are approaching the problem differently, Grant Thornton found. About one-third of private companies versus one-fifth of public companies are paying no bonuses for 2008, for example.
The full report is available free at the Grant Thornton Web site.
Technorati Tags: (AIG), 2008 bonuses, bonus, corporations, executive compensation, executive-pay, Grant Thornton, recession, salaries, salary freeze
Revenues across European consumer food, beverage and tobacco companies are expected to be flat in 2009, but profits could be under further pressure due to the weakening of the euro, and despite the decline in most commodity prices in the second half of 2008, according to Standard & Poor’s Credit Research.
Among the trends noted in S&P’s just-released Industry Report Card on the sector:
- Retailers ran down inventories in the fourth quarter of 2008.
- The volume declines were the worst for products with longer shelf lives, suggesting that retailers ran down inventories to preserve cash — not a good sign for early 2009 trends.
- Central and Eastern Europe bore the brunt of the volume declines.
- For the most diversified consumer goods manufacturers, volume declines were offset by product mix and “positive pricing.”
- Gross margins are likely to remain under pressure in spite of commodity price drops.
The consumer goods sector remains sharply polarized in terms of liquidity and investment funding: While the nondurable and relatively noncyclical food, beverage, tobacco, and personal/household goods manufacturers retain preferential access to funding, durable consumer goods manufacturers remain vulnerable and show widespread signs of financial distress.
As the following chart from S&P shows, downgrades have been more prevalent in the non-investment-grade area and the default rate was 20 percent among the 20 junk-rated European companies.
Among developments that are positive for credit ratings in this sector, S&P cited the widespread suspension of share buyback programs.
Technorati Tags: consumer goods, credit-crisis, European corporates, recession, retail, S&P Credit, S&P Industry Report Card
