A ringside view of the economic crisis David

A ringside view of the economic crisis David Fenton, Senior Economist March 2012

Was the Greenspan “put” a shot in the foot? Policy rates, UK and US Source: Datastream Slide 2

Goodbye dot-com bubble, hello housing bubble Equity prices, house prices Source: Datastream Slide 3

(Taylor) rules are made to be broken? Federal funds rate (%) Housing starts (millions of units) Source: “Housing and monetary policy”, Jackson Hole conference 2007 Slide 4

Signs of a property bubble – difficult to miss Commercial property and gilt yields, % 9. 0 8. 0 Comm prop yield 7. 0 6. 0 5. 0 4. 0 3. 0 10 y gilt yield 2. 0 1. 0 0. 0 2000 Normal Nuts Nasty! (c 200 bps) (inverted!) (c 400 bps) 2001 2002 Source: Datastream, IPD 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Slide 5

The Great Moderation made us complacent GDP % growth, standard deviation Source: Datastream, RBS calcs Slide 6

The price of risk fell sharply RBS net interest margin (%) Source: Bloomberg Slide 7

The loan to deposit ratio shot up RBS loan to deposit ratio (%) Source: Bloomberg Slide 8

We saw it coming. . . sort of “Unlike previous scenarios, the main source of the economic downturn is in the banking system. . . it is the resultant ‘credit crunch’ that propagates this initial shock, and turns recession into depression. ” RBS stress scenario, July 2006 Slide 9

Strange things afoot in the inter-bank market Spread between 3 m LIBOR and bank rate (bps) Source: Datastream Slide 10

Did we really think Greece was like Germany? 10 y bond yields (%) Source: Datastream Slide 11

Where do we from here? Strong demand Goldilocks Returns “V” Return of macro instability “W” Not much spare capacity Lots of spare capacity Slow Grind Higher “U” Deflation “L” Weak demand Slide 12

The long road to recovery Slide 13

Fiscal rebalancing: a good start, but still far to go Net borrowing, % GDP Source: HM Treasury Slide 14

“Plan A” requires a private sector response Net financial surplus/deficit, % GDP (flow of funds) Source: Datastream, RBS calcs Slide 15

Rates expectations fade into the distance UK policy rate 7 6 5 4 3 2 Feb-10 Feb-11 Aug-11 Nov-11 1 Feb-12 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Datastream, Bank of England Slide 16

Are we turning Japanese? Market expectations of policy rate (%) 1996 1998 Actual Source: Fathom Slide 17

Drastic times? Increase demand (symptom) Reduce debt (cause) n Massive fiscal stimulus n (Big) “bad bank” n QE max n Debt forgiveness n Liquidity unbounded n Financial repression n “Use it or lose it” deposit tax n Monetise debt n PFI v 2. 0 n Raise interest rates n Beg to China n Outright default Slide 18

The darkest hour is just before the dawn? “Initial projections for a V-shaped recovery are subsequently revised to a U-shaped recovery and eventually to an L-shape just as the recovery arrives. ” Blanchflower, Feb 2009 Slide 19

Keep in touch! Internet www. rbs. com/economics E-mail www. rbs. com/economics/registration Social media @rbs_economics Slide 20

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