XX Financial and economic crisis 2008 -2009

XX. Financial and economic crisis 2008 -2009

XX. 1 The Crisis

What actually happened? (1) • Strong economic growth 2003 -2007 • Both short and long term consumption massively financed through debt – Consumer credits, mortgages, etc. • Sophisticated financial institutions (investment banks, hedge funds) securitized debt, i. e. combined debts of different qualities (i. e. with different quality of guarantees) into new debt instruments that were sold as allegedly safe investment – Well rated by rating agencies – Investors: commercial banks, insurance institutions, but also states, municipalities, pension funds, endowments and many others

What actually happened? (2) • Securitized debt instruments: derived from original, underlying debt (like mortgages) – derivatives – originally guaranteed, i. e. collateralized, by some tangible asset (houses, plots of land) or expected ability of consumers to repay, etc. ) – when combined into new, derived instrument – collateralized debt obligations, CDOs • Financial engineering – Complicated methods of CDOs valuation – Ability to issue new CDOs, collateralized by the existing one • CDOs of 2 nd, 3 rd, etc. order • Explosion of CDOs, speculation on their future values

What actually happened? (3) • The trigger of the problem: underlying value of the assets suddenly collapsed – Typical bubble on the housing market, nothing new in financial history • Why such a big impact? – Amount of CDOs issued – Poor valuation and rating of the rating agencies • Most of big financial institutions in US, UK and elsewhere in the world suddenly discovered that their investment might virtually ruin them • Threat of collapse of the financial, mainly banking system

Perrils • Systemic importance of large financial institutions • Potential consequences of the collapse: – Population would loose savings – Financial sector would stop to provide even basic financing – Huge impact on living standard – Deep and protracted recession • The ghost of Great Depression – Many banks almost stopped financing – „credit crunch“ – Fall of both domestic demand international trade – In some countries (USA, UK, IRL and others) deep impact on selected groups of the population

Immediate policy response • Governments and Central Banks guaranteed either restructuring of the debts or the debts as such – Exceptions: i. e. collapse of Lehman Brothers • Central Banks ready to purchase parts of commercial banks’ portfolio – Unprecedented increase of central banks’ balance sheets • Monetary easing • Fiscal stimulation • Consequences: unprecedented debts, future exit from monetary policies

Popular story today • Usual explanation: financial institutions as a main culprit – Liberalization of financial markets in past three decades – New financial products and financial engineering • Extreme profits and extreme bonuses – Poor regulation of the financial sector – Wrong system of incentives and „the greed“ • Financial sector and “bankers” as only cause of the crisis?

Broader roots of the crisis • Economic – overly accommodative policy of FED – Imbalances in global payments • Political: – Support to cheap credits and especially mortgages • Social: – Consumerism of the modern society

Failure of macroeconomics? • Some very unpleasant questions – Why so few were able and willing to issue warnings? – Why the most able institutions, responsible for macroeconomic policies (i. e. FED), performed wrong policies for such a long time? – Why macroeconomic theory does not explain the links between financial sector and real economy in a more elaborated way?

XX. 2 Impact on the real economy

Growth according IMF: World

Growth according IMF: Advanced Economies

Growth according IMF: Emerging Markets

Public finance deficit % GDP Source: IMF WEO Database, April 2010

Net debt % GDP Source: IMF WEO Database, April 2010

Other relevant data Global trade, %yoy Source: IMF WEO Database, April 2010

Main conclusions • The deepest recession since WWII – But data seem to imply that the growth has recently resumed • The growth rates for next years will not go back to pre-crisis levels – In Europe further slow-down due to the present uncertainty in Eurozone • Increase of debts and deficits in all advanced economies • Unemployment rate up and will not diminish even when the growth resumes

XX. 3 Year 2010: end of recession?

00 01 8 -D ec -2 00 20 8 -A pr -2 00 07 9 -S ep -2 00 26 9 -J an -2 01 0 8 00 -2 l-2 Ju 14 - 7 00 7 -2 7 00 -2 -2 00 ct eb -F 25 -O 08 ay M 21 - 01 -J an 02 -J an -2 24 00 -M 7 ay -2 11 00 -O 7 ct -2 04 00 -M 7 ar -2 00 24 8 -J ul -2 11 00 -D 8 ec -2 07 00 -M 8 ay -2 25 00 -S 9 ep -2 16 00 -F 9 eb -2 01 0 Stock markets: S&P Composite 1, 800 USA, S&P 500 350 300 250 200 150 100 1, 600 1, 400 EUR, S&P 350 1, 200 1, 000 800 600 EM, S&P BMI Source: S&P website Last observation: USA, EM 7. 5. 2010 EU 10. 5. 2010

Capital: losses and write-offs vs. newly raised bn. USD, cumulative since Q 3/2007 Source: Bloomberg, last observation 23. 3. 2010

Forex reserves, bn. USD Source: national statistical institutes

US Treasuries holdings bn. USD Source: US Treasury, end of January 2010

Current account of Bo. P bn. USD Source: IMF WEO, April 2010

Gross national savings % GDP Source: IMF WEO Database, April 2010, IIF, March 2010)

W option? • Stock markets rebounded, but volatility increased recently • Unclear if the banking sector problems resolved – Germany! • International imbalances, accumulated before the crisis, still persist • Strong vulnerability of - especially - European economy – Looming Greek crisis • Asia, especially China to the rescue?

XX. 4 The Impact on Central and Eastern Europe

Basic facts (1) External shock: slow-down of economic growth • Fall of demand for exports • Lower profits, lower wages: decline of consumption • General consequences of global financial crisis – uncertainty : investment decline (including sharp decline in FDIs) – Collapse of equity markets – Banking sector problems, „almost“ credit crunch – Unemployment, social consequences, etc. 1.

Basic facts (2) 2. Macroeconomic destabilization • Lack of confidence, danger of “sudden stop” of external financing : sustainability of (even short-term) debt • NPL share in domestic banks has dramatically increased (with notable exception of some countries, namely CZ): impact on large, Euro zone based banks • Dramatic decline of capital inflow in general • In some countries an outflow simultaneously • Global markets in 02 -03/09: unified view on the region – Not distinguishing enough among the countries – General view influenced by the worst performing country (“contagion” danger)

Spring 2009 • October 08 - March 09: speculation on destabilization of some CEE economies + unnecessary media hysteria with quite unfortunate consequences – Depreciation of all floated currencies in the region – Real economy adjustment more pronounced for economies with pegged currencies • Problems of some short-term sovereign bonds issues, increase of spreads – All this at quite low inflation • Slow pass-through into prices + decrease of commodity prices

Economic policy difficulties Contradictory requirements on economic policy • General impact of the crisis: – Monetary easing (including so called non-traditional steps) • Region's Central Banks could have - at the beginning - decreased interest rates disregarding the depreciations (on the contrary, some positive effects on exports) • Fiscal policy pressure (higher social expenditures, automatic stabilizators, calls for fiscal incentives) – Generally: anti-cyclical policies required • Short-term destabilization: – Very restricted space for increase of deficits, but even - at least within some period - for monetary easing as well

CEE: GDP growth, %yoy

CEE: GDP growth, %qoq

Other relevant data

VII-XII/2009 • Stabilization sui generis – Huge contraction of economic activity • Some countries - support from international institutions • Currencies and debt financing under control

XX. 5 Where are we today (2011)?

Global economy • Behind the worse times • In 2011: slight slow-down, in 2012 new acceleration • 2010 -2012: growth above trend level of past 20 years • 2011 -12: closing the growth gap between advanced (AE) and emerging economies (EM)

Global GDP growth, %yoy

Global economy: other basic data Inflation, Average consumer prices (%) General government net lending (%HDP) Unemployment (% of total labor force) General government gross debt (%HDP)

Production gap world, advanced and emerging economies

US economy: surprise on the upside? • In 2012: approaching 4% growth trajectory • Recent growth: subsiding fiscal stimulation and stock replenishment • Since 2011: final demand picking up – Lower pace of private sector deleveraging – Lower debt/income ratios – Improving credit quality – Declining financial balances

Emerging economies: barriers, inflation, but still solid growth • Faster growth than AE, but some slow-down • Brazil: from 7. 5% in 2010 to 4. 3% in 2012 • China and India: “stagnation” slightly bellow 10%, resp. 8% • Only Russia will generate faster growth, but from much lower base: 4. 0% in 2010, 5. 6% in 2012 • Closing the production gap completely during 2012 – Inflationary pressures

Europe (1) • Burdened by the crisis in the periphery countries … • … but it does not entail the crisis of the European economy • Whole EU 27: slight acceleration from 2. 0% growth in 2010 to 2. 2% both in 2011 -12 • Euro zone growth figures lower (1. 6% in 2011, 1. 4% in 2012)

Europe (2) • Deep differences behind aggregate figures • Very low growth of peripheral countries, Greece and Portugal around stagnation – Need for substantial deleveraging and structural changes • Return to normality in aggregate demand structure – Fiscal stimulation fading away, public expenditures decline – Recovery in some countries: increase of household demand in Germany and Scandinavia, also increase of private sector investment demand

Europe (3) • Benefiting from US and EM growth, but unequally – winners: exporters of capital goods (Germany, Scandinavia, northern Italy) + CEE manufacturing sub-suppliers (Poland, Czech Republic, Slovakia, to lesser extent Hungary) • . . and watch UK!

European growth

Euro zone: growth divergence

Europe: other basic data Inflation, Average consumer prices (%) General government net lending (%GDP) Unemployment (% of total labor force) General government gross debt (%HDP)

Central and Eastern Europe • Uneven recovery, differentiation centered around – Balance sheet strength – Domestic financial conditions • Two groups of countries 1. Strong balance sheet and easy financial conditions – outperforming countries: PL, CZ, SK, SLO 2. Balance sheet constraints (both public and private) and/or tight fiscal conditions – lagging behind: H, RO, BG, Baltic states

CEE: Economic growth

CEE: other basic data Inflation: CPI (%yoy) Net government lending (% GDP) Unemployment, % Gross debt (% GDP)

Current account (% GDP)

XX. 6 Conclusions • Largest depression since 1930 • Rescue policy operations prevented the catastrophe – Recapitalization and liquidity provisions to ailing banks • Succesfull in the short-term, moral hazard, longer term impact? – Monetary and fiscal stimulation of AD, mixd experience • Montary – clearly super-imporatnt, but again: moral hoazrd plus long term inflationary consequences • Fiscal – less clear impact, value of fiscal multipliers in different countries? , sharp increase of decidits and debts