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Agenda Intro and recap The costs of the crisis The real costs of the crisis Conclusions

Studium Generale The costs of the crisis prof. Dr. Tom van Veen Maastricht University/Nyenrode Business Universiteit Maastricht, 10 November 2011. Agenda Intro and recap The costs of the crisis The real costs of the crisis Conclusions. Intro and recap Lecture 1: Joan Muysken

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Agenda Intro and recap The costs of the crisis The real costs of the crisis Conclusions

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  1. Studium Generale The costs of the crisisprof. Dr. Tom van VeenMaastricht University/Nyenrode Business UniversiteitMaastricht, 10 November 2011

  2. Agenda • Intro and recap • The costs of the crisis • The real costs of the crisis • Conclusions

  3. Intro and recap • Lecture 1: Joan Muysken • Causes of the crisis: global imbalances • Rescue packages and solutions

  4. Lecture 2: Bertrand Candelon 1. What is a crisis? Typologies 2. Contagion 3. Policy responses

  5. Lecture 3: Bart Verspagen • Theory behind the global imbalances: UIP and the Impossibility Trinity • Emerging Asian economies and Chimerica

  6. Lecture 4: Olaf Sleijpen 1. The €-crisis and the role of fiscal discipline 2. The discussions about the solutions

  7. So by now it is clear that the economic crisis started with global imbalances and excessive lending in the US And spilled over to other countries, in particular Europe because of the intimate connections between the banks Distrust in the behavior of banks and governments/politicians and malfunctioning of the governance in the EMU has extended the crisis and this evolved in the current crisis in Europe

  8. 2. The costs of the crisis Simple question: what have been the costs of the crisis? Not so easy to answer.

  9. What do we mean by costs? And for whom are these “costs”? Cost is an amount of money that has to be paid to obtain something. This definition does not seem appropriate here. More appropriate seems: the value of all the “losses” that have occurred in the economy.

  10. Direct costs Indirect costs Invisible costs Lost opportunities Not all costs have materialized yet because these depend on the length of the crisis, the development of the value of real and financial assets

  11. 1. Change in Wealth • Change in asset prices • Houses • Financial assets

  12. House prices: decrease by 2.5-3% on a yearly basis after the crisis In 2010: value of the houses in the Netherlands € 1170 billion. The decrease in prices is a “loss” of € 30-35 billion per year, which comes down to 5 – 5.5% of GDP. Average house price is about €250.000. The loss in value comes down to €7.500 per year

  13. Financial assets (stocks and bonds) Stocks: over 2007-2010 the decrease in the value of the stocks in the hands of households was about €29 billion (€258 billion to €239 billion). This is on average €12.000 per household that held stocks (CBS, STAT-line).

  14. For bonds we see a similar picture Value has decreased by €5.5 billion (from €33.5 billion to €28 billion). The number of households holding stocks and bonds have decreased Are this costs of the crisis?

  15. No because house prices have increased dramatically over the past years; bubble? No because aging would have led to a decrease in house prices No because the Dutch housing market has become under pressure No, because if you do not move/do not sell the assets, what is the point?

  16. Yes, because investments of pension funds decrease in value and this might have an impact on premiums or retirement income. Yes because the crisis has caused a lack of confidence in the economic future and hence a lack of demand for houses and financial assets

  17. 2. Changes in the interest rates

  18. Volatility in prices creates uncertainty • Low interest rates benefit borrowers if…… • there are no credit constraints • there are enough profitable investment opportunities

  19. In addition low interest rates benefit investors, because • there is an inverse relation between asset prices and the interest rate • low interest rates increases the demand for real assets and for stocks

  20. Bond, face value €1.000 r = 5% (€50/year). What happens if the interest rate on new bonds decreases to 4%? Holders of old bonds receive a rate of return of 5%, holders of new bonds receive a rate of return of 4%. Price of old bonds will increase to €1250 (€50/€1.250 = 4%)

  21. But, low interest rates also increases the value of future commitments If you need to pay €100 in one year and the interest rate is 11%, then now set aside €90,90 and in 1 year you will have €100. We call €90,90 the present value of €100 to be paid in one year But, if the interest rate decreases to 5%, yet need to now set aside €95,24 to have €100 in one year

  22. Hence, a decrease in the interest rate is bad for companies that have future commitments, like pension funds because it increases the present value of their future liabilities Market value of the investments (>105%) Present value of future liabilities A change in the interest rate influences their coverage ratio

  23. What is the influence of a decrease in the interest rate on the coverage ratio? In normal times, the market value of the investments increases and the present value of future liabilities increases. In general, the coverage ratio decreases

  24. In this crisis we have noticed • Decrease in the prices of the assets • Decrease in the interest rates • “Double” attack on the coverage ratio of the pension funds Market value of the investments Present value of future liabilities

  25. Evidence is given by the Bonenkamp and TerRele, CPB Memorandum 1/2009/01, Centraal Plan Bureau • A decrease in the interest rate by 1% causes a decrease in the coverage ratio by 14%-points (excluding the effects of the decrease in the interest rate on the price of assets) • Between December 2007 and February 2009, the average coverage ratio has decreased by 45%-points (from 140% to 95%). 40% is due to the change in the interest rates, 60% is due to the change in the asset prices.

  26. Coverage ratio Interest rate

  27. The consequences are clear • A large number of pension funds have a coverage ratio < 105% and have to act • Increase in premiums and/or decrease in pension benefits • But as important, the confidence in the once so solid pension funds decreases

  28. Thus low interest rates • Cause uncertainty • Have enforced the pension funds to act to the disadvantage of the participants • Have not triggered an increase in credits for investments

  29. 3. Direct bailouts by the governments Governments have supported the financial sector. Note that 90% of the support is via guarantees and loans. Hence the costs of this support are not clear yet.

  30. Public interventions in the banking sector

  31. HW Sinn (2010), Casino Capitalism, OUP, reveals that • Total approved package is €5 trillion • (€5.000.000.000.000) • 2. The big rescuers are US, UK and Germany (in total about 50% of the package). The Netherlands joined with 5% (€250.000.000.000, about 42% of GDP)

  32. 10.000$ 100x10.000 = 1.000.000$ 1$ 100x1.000.000 = 100.000.000$ 10x100.000.000 = 1.000.000.000$

  33. 1.000.000.000$ 1.000x1.000.000.000 = 1.000.000.000.000$ is 1 trillion$

  34. But, not all money has been “waisted” . Evidence for the Netherlands reveals Support to SNS, ING and Aegon via loans, €14 billion, against 8% and a premium of 50% on redemption. And the government guaranteed the pay back of US mortgages (€21 billion). ING has redeemed 70% and will redeem 30% in 2012 SNS Reaal has redeemed a large part. Aegon has redeemed all support. The rate of return on this was 18.5 %

  35. ABN AMRO was nationalized by the Dutch government: bought for €16.8 billion. Together with additional capital injections, we invested €30 billion in the bank. The market value is estimated at €20 billion in 2014 (when the bank might be sold). This results in a loss of €10 billion (€600 per Dutch citizen) Thus the loss because of the loans and so on have not been large. The loss of the guarantees still needs to be assessed however.

  36. To summarize: • For the Netherlands (GDP = €600 billion) • Change in asset prices: decrease in value of about €100 billion (2007-2010) • Change in the interest rates: average coverage ratio decreased from 140% to 95%. Consequences need to be assessed. • Costs of bailouts and guarantees: bailouts €10 billion. Substantial amount of guarantees still pending

  37. We have discussed monetary costs. But there is more. The real costs of this crisis are invisible

  38. 3. The real costs of the crisis Decrease and lack of trust and confidence in the economy and in the financial system Confidence in the future is measured by interviewing a sample of consumers/producers about their consumption and production plans in the next future and about their assessment of the economic and financial situation

  39. Source: CBS, de index van het consumentenvertrouwen in the series: Hoe doet het CBS dit nou?

  40. Consumers confidence: the Netherlands

  41. Consumers confidence index OECD

  42. Source: Ifo Business Survey, October 2011, CESifo Institute, Munich

  43. Lack of trust in general

  44. Delay in economic growth In the end, uncertainty, lack of confidence, lack of trust materializes in a slowdown of economic growth

  45. Source: The EEAG report on the European Economy 2012, CESifo Munich

  46. Source: The EEAG report on the European Economy 2012, CESifo Munich

  47. Annual growth of GDP, The Netherlands, 1970-2012 2007 1975 2002 2009 Source: MEV 2012, Main Economic Indicators for the Netherlands, CPB.

  48. Back of the envelope calculation for the Netherlands Average real economic growth over the period 1970-2007: 2.5% Average real economic growth over the period 2008-2010: 0.5% Hence, growth over the period 2008-2010 was 6% below the average or €36 billion in total. These are lost opportunities.

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