Financial turmoil Denis Besnard (D1) GFS/EDP course 2014 GFS/EDP course 2012 1/18/2019 Financial turmoil Denis Besnard (D1) GFS course ch. 13.5.15 GFS course ch. 13.5.15

Content What is the meaning of "Financial crisis"? GFS/EDP course 2012 GFS/EDP course 2014 1/18/2019 18/01/2019 Content What is the meaning of "Financial crisis"? What was the role of Central banks? How did governments intervene? What was the statistical impact? Conclusion Supplementary EDP table on the financial crisis GFS course ch. 13.5.15

What is the financial crisis? (1) GFS/EDP course 2012 GFS/EDP course 2014 1/18/2019 18/01/2019 What is the financial crisis? (1) "Official start" in August 2007 (valuation of some Investment funds in US ABS and then "trouble" on Euro Area interbank market) "Climax" in September 2008 (Lehman Brothers bankruptcy) As a result, dramatic fall in asset prices on markets, with effect on bank profitability (mark-to-market) Also, strong "market disruptions" raising refinancing shortfalls for financial institutions and financing corporations (high risk aversion) Some innovative instruments turned to be "toxic" "Flight to quality" to "so-called" riskless assets but not all so good In a first stage: common opinion that it is "just" a bank liquidity crisis GFS course ch. 13.5.15

What is the financial crisis? (2) GFS/EDP course 2012 GFS/EDP course 2014 1/18/2019 18/01/2019 What is the financial crisis? (2) …but in a second stage doubts on solvency of numerous banks In parallel, dramatic fall in real estate prices in countries where evident bubble (Ireland, Spain) String spill-over and contagion effects = systemic crisis / threats on financial stability Negative economic impact through wealth effects and "credit crunch" Some banks technically bankrupted and imperatively needed rescue by Authorities Need for Eurostat July 2009 decision + guidance notes in 2012-2013) EA sovereign crisis has other origins but double feed-back (nexus) banks support: government cost (not financeable under normal terms) and impact on banks of fall in government bonds prices GFS course ch. 13.5.15

Crucial role of central banks GFS/EDP course 2012 GFS/EDP course 2014 1/18/2019 18/01/2019 Crucial role of central banks Dramatic fall in intervention rates As usual, “lender in the last resort” for banks But “this time it’s different” : also “purchaser of assets in the last resort” Large use of “non-standard measures” (or "non-conventional"), such as "full/fixed" allocations, "quantitative easing", "VLTROs", enlargement of list of collaterals, etc. (See ECB website) Aim: providing liquidity at low cost over a long period ("forward guidance") Financial stability is now a clear objective of CBs But CBs cannot not fight (alone) insolvency… GFS course ch. 13.5.15

Thus, Governments had to intervene under various forms (1) GFS/EDP course 2012 GFS/EDP course 2013 1/18/2019 18/01/2019 Thus, Governments had to intervene under various forms (1) Guarantees for individual banks liabilities contingent assets except if evidence of call Direct lending: financial transaction if likely repayment Liquidity schemes (exchange of assets – government bonds versus “illiquid”): treated a securities lending but under both conditions: temporary and expected small losses Special bodies (for funding at better conditions with government guarantees): not in government sector if autonomy of decision, majority private owners, ex-ante risk rather small (notably if “good” collaterals) GFS course ch. 13.5.15

Thus, Governments had to intervene under various forms (2) GFS/EDP course 2012 GFS/EDP course 2014 1/18/2019 18/01/2019 Thus, Governments had to intervene under various forms (2) Direct recapitalisations: Basic analysis: coverage of accumulated losses? (restrictive notion of exceptional losses) Where ordinary shares, market price is crucial Where preference shares or “hybrid Tier 1”, fixed rate of return is key (but Special case of "Cocos" Special guarantees on deposits, other liabilities, assets: case by case (but basis: likelihood to be called) Nationalisations: usual rules Special bodies for equity injections: by definition within government sector GFS course ch. 13.5.15

Thus Governments had to intervene under various forms (3) GFS/EDP course 2012 GFS/EDP course 2014 1/18/2019 18/01/2019 Thus Governments had to intervene under various forms (3) Direct purchase of "bad" assets: Price paid is crucial and also possible resale price under a given period Government-owned "defeasance bodies" (“bad banks”) Always classified within the government sector Bank splitting into commercial "viable" unit/ ”liquidated unit" holding bad assets: Funds provided (to whom?) by government likely to be returned? Expected losses? “Resolution funds”: Autonomy of decision? Autopilot? Decisions on regular or exceptional resources? GFS course ch. 13.5.15

Conclusion Eurostat quite reactive. GFS/EDP course 2012 GFS/EDP course 2014 1/18/2019 18/01/2019 Conclusion Eurostat quite reactive. Eurostat priority: comparability of the impact on government accounts between MS. All decisions consistent with fundamental national accounts principle) But specific guidance for "exceptional measures in exceptional times" where no straightforward provisions (e.g. capital injections in banks not similar to capital injections in non-financial corporations) Eurostat analysis: “Substance over form” (it is in ESA!) Ad-hoc follow-up of the impact of the interventions: supplementary table provided with notification tables (annex 5) GFS course ch. 13.5.15

GFS/EDP course 2012 1/18/2019 GFS course ch. 13.5.15

Is the financial crisis over? GFS/EDP course 2012 GFS/EDP course 2014 1/18/2019 18/01/2019 Is the financial crisis over? If Yes, what does it mean? Thanks for your attention! Any Question? denis.besnard@ec.europa.eu GFS course ch. 13.5.15