Economy & markets after the financial crisis What have we learned and where are we heading? Economics, UiO, March 7

1. Economy & marketsafter the financial crisisWhat have we learned and where are we heading?Economics, UiO, March 7 2011 Harald Magnus Andreassen hma@first.no

2. Today • On markets and our ability for forecast the future • ’After’ the Financial Crisis • What happened, and why? • The world economy • The Norwegian economy • What have we learned? • Implications for monetary, fiscal & regulatory policy

3. Some good advices • Read history • Read economic & financial history • Read history on economic theories • Never forget that economics is a social science • With no eternal truths • Do never underestimate the importance of (changing) institutions, created by human beings • Do not trust old truths nor old people, and even less new truths – and certainly not mine

4. First Securities ASA • Brokerage/investment bank/merchant bank • Equities, corporate • Merchant bank – with Swedbank, trading all sorts of int. rate/fixed income instruments, Private Bank, Investment Management +++ • 240 employees • 25 analysts (the best &…) • 7- 8% + of revenues on the Oslo Stock Exchange • We are better bean counters, than dreamers • We give goods advices • Our clients appreciate us • We hire business school graduates all the time, and economists from time to time. Our trainee-program works!

5. The real proof of the pudding: This should not have been possible!

6. Long term: Real fundamentals decide A Tobins q, calculated from the balance sheet

7. Still: A big swinger

8. A quite close connection

9. The stock market vs. actual earnings… Sic!

10. Take care, when you buy

11. Forward looking equity analysts?

12. .. But are economists any better?

13. Forward or backward looking?

14. For investors: The long end vs. the short end

15. Long term interest rates decided by today’s fundamentals

16. What am I looking at? • Demand cycles (”Keynes”) – debt cycles (“Minsky”) • C, I, G-T, X-M • Supply cycles (Real business cycles) • What’s most important? • Markets are mostly “Keynesian” (animal spirit, risk appetite, financial condition, monetary/fiscal policy impulses/responses) • Late follower of fashion? Or realistic, what works?

17. The financial crisis

18. Crisis, what crisis? It’s (still) a real one! • The hardest downturn in the world economy since ’45 • Millions of families are forced out of their homes • 1 out of 7 US mortgages in delinquency. New foreclosures 1:20, annual rate! • Unemployment sharply up almost everywhere • The banking system had to be guaranteed by the governments, more than ever • Zero Interest Rate Policy everywhere, for the first time • An unprecedentedfiscal stimulus, almost everywhere, record high deficits & high and rapid rising debt ratios • Will (some parts) of the system be changed? You bet..

19. What it is all about

20. Why did it happen? • Bad policy • Bad banking • Bad luck

21. Why did it happen? • A deregulated financial sector exploited too many new ways to boost profits, as always. The capital base eroded • Central banks looked another way and kept rates too low for too long • Many regulators did not understand what was going on, and others did not have the mandate to prop the party • The borrowers did not understand anything • The rating agencies did not see anything before it was too late • Asia and Opec saved more than others and could afford to borrow • A global, integrated financial system

23. This was a bubble

24. It was not totally invisible! And many warned: OECD, IMF, Shiller, BIS…

25. Tobin’s q (or P/B) works! An investment boom

26. More liquidity in the system

27. IMF: Housing busts not uncommon – but expesive

28. Banking crises: It’s not the first time Many more now 28 y, 17 countr.113 ”crises” A banking crises every 10th year We do not need CDOs and structured products. Just human beings

29. Does ’our’ model work? Well.. Banking crises and capital mobility Rogoff & Reinhart .

30. What have we learned? • That we have not learned too much.. • From time to time: We start dreaming… • .. At least not in finance, and we got the money • Markets do not always work as described in many textbooks • But many theories are based on situations where markets do not solve all problems: Keynes, Minsky, Shiller, Tversky, Kahneman, Kindleberger +++ • Banks are not as other businesses • And must be regulated in another ways • Monetary policy is more than inflation targeting

31. What did we already know? • “Over-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money” – Irving Fisher (1933)

32. These crazy Americans

33. Long-term risk: Imbalances in the household sector

35. China is responsible? Current accounts, USD 1997 and 2008

36. The financial crisis The economy The fiscal response

37. After financial crises: • Debt ratios back to where they came from (takes 5 – 10 y) • Slower growth than before the crisis • But usually not ’double dips’ • A lower activity level, higher unemployment • Property prices back to where they came from • Private deficits and debt transferred to the public sector

38. Something hit us…

39. What goes up, must come down. Credit/GDP Reinhart & Reinhart

40. This time is probably not different Reinhart & Reinhart

41. What’s driving the cycle? 1 Bad times 2 Soft landing 3 ’Happy’ days

42. An unprecedented increase in private savings The flip side of the coin: An unprecedented increase in public sector deficit – because the current account is quite stable short to medium term for rich countries in aggregate

43. Once upon the time – in 2007

44. And today!

45. Can you find the two outliers?

46. This is not sustainable But the problems are not the same everywhere

47. Public debt: Most are on the wrong side of the curve Maastricht criteria Still: Debt is not out of control yet (everywhere…)

48. Some has a job to do

49. Some have done it before Initial fiscal position vs. adjustment Adjustment % of GDP Underlying budget balance before consolidation OECD, 2010 85 episodes, 24 countries sice 1978. No one defaulted

50. Still, quite worrying A Greek debt restructuring not unlikely Irland is now asking for lower interst rates on EMU loans