The G20 Summit: what to expect Howard Davies Director, LSE Director’s Circle Lecture Alumni Theatre, NAB 11 th March 2009

The phases of the crisis Rising US sub-prime mortgage arrears Losses and downgrades on related asset-backed securities (ABS) and other structured instruments Loss of confidence in the value of ABS globally Wider flight from risk in credit and other markets Risks flow back to banks’ balance sheets Money markets tighten as liquidity is hoarded Funding problems for some banks

Act One:Subprime Act Two:Liquidity Act Three:Unravelling Act Four:Meltdown Act Five:Pumping The Credit Crisis: A Five-Act Tragedy

global imbalances loose monetary policy, leading to mispricing of risk credit bubble ‘excess’ growth of financial sector ‘excess’ leverage, facilitated by procyclical regulation But what are the underlying causes?

Global current account balances

China’s Growth Laggard Personal Consumption as % of GDP Source: China National Bureau of Statistics and Morgan Stanley

Household debt as a proportion of GDP Source: FSA, ONS, Federal Reserve, Eurodata, Datastream

“ Bank failures are caused by depositors who don’t deposit enough money to cover the losses due to mismanagement”. Dan Quayle

“ The owners of capital will stimulate the working class to buy more and more of expensive goods, houses, and mechanical products, pushing them to take more and more expensive credits, until their debt becomes unbearable The unpaid debt will lead to bankruptcy of the banks, which will have to be nationalised, and the state will have to take the road which will eventually lead to communism. ” Das Kapital

So what next? growth prospects have deteriorated sharply, across the world Europe mired in recession long downturn the most likely outcome, and anaemic recovery

Growth Rates: IMF Forecasts

Source: European Economic Forecast – April 2008

Source: European Economic Forecast – January 2009

Larger than previous crises

Recovery options: V-shaped: sharp contraction, quick bounce-back U-shaped: longer trough, delayed but strong recovery L-shaped: Japanese style stagnation Nike swoosh: sharp downturn, weak recovery

The declared agenda stimulating global demand strengthening the international financial institutions reshaping the global financial and regulatory system putting the world economy on track for sustainable growth G20 Summit: 2 April

Stimulating global demand: the issues fiscal packages uncoordinated so far uneven scale of stimuli – Germany and Japan lagging financial protectionism

Strengthening the International Financial Institutions increasing the IMF’s resources to allow it to lend more strengthening the early warning and surveillance functions more trade credit support from Development banks, together with bank recapitalisation

Reshaping the global financial and regulatory system enhance corporate governance and risk management strengthen prudential regulation, but with a ‘managed transition’ to avoid exacerbating the downturn regulate financial activities according to their economic substance and ensure regulation is consistent in all jurisdictions

Global Committee Structure – A Regulator’s View G-7 (Gov’ts) Financial Stability Forum WTO OECD (Gov’ts) FATF (Money Laundering) IASB (Accounting IASC Bank for International Settlements (Central Banks) G-10 (Central Banks) CGFS CPSS Basel (Banking) IOSCO (Securities) Joint Forum IAIS (Insurance ) Monitoring Group IAASB (Audit) PIOB IMF World Bank (Gov’ts) IFIAR (Audit) Source: Adapted with permission from Sloan and Fitzpatrick in Chapter 13, The Structure of International Market Regulation, in Financial Markets and Exchanges Law, Oxford University Press, March 2007

Specific measures may include: enlarging and strengthening the Financial Stability Forum a new approach to capital: Basel 3? regulation of systemic hedge funds a tough approach to offshore centres more regulation of credit rating agencies supervisory colleges

Will it work? The omens are not good: financial protectionism on the rise little co-ordination of fiscal policies so far, even in Europe fundamental mismatch between global markets, global banks and domestic taxpayer-funded support

But: Monetary and fiscal stimulation on a massive scale ought to work in the end… though many businesses may not be there to see it.

The G20 Summit: what to expect Howard Davies Director, LSE Director’s Circle Lecture Alumni Theatre, NAB 11 th March 2009