Rising national debt is fast emerging as perhaps the most worrying hangover from the recession. The latest warning comes from the IMF, which says sovereign debt risks triggering a new round of economic woes.
“If the legacy of the present crisis and emerging sovereign risks are not addressed, we run the real risk of undermining the recovery and extending the financial crisis to a new phase,” said Jose Vinals, director of the IMF’s monetary and capital markets department.
As noted previously on the blog, sovereign debts rose substantially during the crisis as government spent heavily to keep economies afloat. In the OECD area, government debt looks set to equal about 100% of GDP in 2011, up from about 70% before the crisis. That debt, along with government purchases of banks’ bad assets, means that in advanced economies “the biggest threats [to financial stability] have moved from the private to the public sectors”, says the IMF.
There is some good news in the Fund’s latest Global Financial Stability Report: Although banks and financial institutions remain in a “fragile” state, they are – says the IMF – “slowly regaining their health”.
The Special Investigation Commission released its report earlier this week. In more than 2,000 pages it paints a picture of reckless expansion in Iceland’s financial sector. It states that Iceland’s three main banks grew 20-fold in just seven years, a pace that “was not compatible with long-term interests of a strong bank”.
The report heavily criticises regulators and government, accusing them of “extreme negligence”, reports the Financial Times , while regulators were “in general understaffed and lacked experience”, adds the BBC .
But it also contains more than a suggestion of wrongdoing in the banks themselves: “According to all the loan-books from the banks, all the former owners of the three banks had inappropriate loans from the banks,” Sigridur Benediktsdottir, a member of the commission, told the FT.
Iceland wasn’t the only country whose financial sector ran into trouble. Many have wondered if the banks were “unlucky” – could they have avoided collapse if the financial crisis hadn’t hit? The report says no. In a “post mortem” annex , Mark Flannery of the University of Florida comments that the “sub-prime financial crisis surely added pressure on the banks … However, the banks had ignored repeated warnings that their size and rapid expansion exposed them to great risks. It seems likely that they would have come to grief eventually, even without a worldwide financial crisis.”
We reported last year that no less a figure than the UK’s Queen Elizabeth II had admitted to bafflement about the financial crisis. “ … She asked me: ‘How come nobody could foresee it?,” Professor Luis Garicano of the London School of Economics (LSE) told reporters back then.
The professor and his colleagues later wrote to the Queen to try to answer her question, blaming in part “a failure of the collective imagination of many bright people”. Now, they’ve sent another letter to Her Majesty, suggesting she could actually play a role in helping to avoid the next crisis.
The academics’ idea is that the Queen should request a monthly briefing on the state of the economy and – crucially – what may lie ahead. This would go beyond forecasting, which is an attempt to say what will happen; instead, the aim would be say what could happen under a variety of different possible outlooks – so-called horizon-scanning.
As The Guardian reports, the economists’ letter “explained the need for less complacency and more horizon-scanning, during which various scenarios are thought through, however unwelcome their outcomes might seem.”
Interestingly, this idea is not dissimilar to OECD proposals on financial reform, which include the idea that government figures and regulators in every OECD country –not just the UK – “should publish annual reports that give an overview of developments in the financial system, identify key risks and explain how they are addressing them.”
We asked Tim Besley, one of the signatories of the letter and a professor of economics at LSE, to explain a little bit more about the proposal, which came out of a forum organised by the British Academy.
“It’s difficult to get busy people, whether they’re ministers, senior civil servants or even academics to take their eyes off their desks, look into the future and say, ‘what are the bigger-picture issues we should be worrying about?’,” says Prof. Besley. But, he adds, if we’re to develop a proper system for spotting risks and vulnerabilities “we have to institutionalise this more long-run, horizon-scanning focus.”
Prof. Besley admits that creating such a committee would carry its own risks, including the danger of it getting stuck in a rut: “I think there’s a sort of tendency for people to get bogged down in their own thinking about their own issues,” he says. It would also be hard “to get anyone to take any notice of the output of this institutionalised committee.”
Which is where the Queen comes in: While providing a report to the head of state wouldn’t be the main function of the committee, it would, Prof. Besley believes, be a useful catalyst – focusing minds on the need to communicate clearly and to keep on thinking the unthinkable: “The idea would be to keep the thing fresh and really try to find the key issues every month.”
Useful links OECD
The OECD International Futures programme carries out horizon scanning
The OECD Horizon Scan was part of the Danish government’s Forsk2015 strategic planning exercise
OECD Insights: From Crisis to Recovery (forthcoming)
How much have governments committed for bailing out banks and financial institutions? $11.4 trillion, according to OECD estimates . That’s a lot of money – equivalent to the 2007 GDP of Japan, the United Kingdom, Germany and France combined. Or, as Dow Jones explains, about $1600 for every man, woman and child on the planet.
But that number needs to treated with a little caution. In effect, it represents a worst-case scenario for governments based on their current commitments.
$1600 for every man, woman and child on the planet
For example, it includes the cost of government guarantees, some of which will never be called on. It also includes the cost of purchasing assets and equity, the value of which may go up (or down). Because the job of supporting the banks is still a work in progress, the final cost won’t be known for years.
Of course, governments may still need to make fresh commitments in order to support banks. But assuming they don’t, the final bill could well be lower.
What – or who – caused the crisis? Slate offers not one but 15 answers to that question here. But if you’d like a more official response, you might like to keep an eye on the Financial Crisis Inquiry Commission (FCIC) in the United States, which is due to begin public hearings this week. The ten-member commission was set up by Congress with a sweeping mandate to investigate the causes of the crisis – everything from the possible role of fraud and abuse in the financial sector to the way bankers are paid.
There are precedents for this sort of probe. In the early 1930s, the U.S. Senate’s Pecora Commission investigated the causes of the Great Depression, and “unearthed a secret financial history of the 1920s, demystifying the assorted frauds, scams and abuses that culminated in the 1929 crash”, according to Ron Chernow. That investigation had a long-term impact on the U.S. financial sector, leading to the establishment of the Securities and Exchange Commission (SEC) and the separation of commercial and investigation banking.
Whether the FCIC will have the same impact remains to be seen, but its chairman, Phil Angelides, has made it clear that he wants the commission to ask – and answer – some tough questions. “You have millions of people unemployed, millions have lost their homes, and Wall Street is having a record year with record profits and record bonuses,” he told ABC News. “People want to understand why.” What questions should the commission ask? The New York Times and The Huffington Post have some suggestions.
The Commission is due to report by mid-December 2010, but members have indicated they plan to post important findings on their website (under construction) before then.