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- In “Making Housing Affordable”, the think tank propagates the use of Industrialised Building System (IBS) among homebuilders. Instead of constructing homes on-site, brick by brick, the IBS method fabricates components at a manufacturing facility and has been touted as speeding up the construction process while minimising costs.A faster turnaround helps property developers increase the supply of homes at a faster pace, said Charon Wardini. After that, simple economic dynamics — which is when supply outpaces demand — will take care of the pricing issue, he argued.
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- Economic literature points to the importance that tax composition plays for economic growth and suggests a ranking of the main categories of taxes with regards to growth, with taxes on immovable property being the least distortive to growth, followed by consumption taxes (including environmentally-related taxes) and, finally, income taxes (on personal and corporate income) being the most harmful….
- Increasing consumption, environmental and/or housing taxation could be a way to alleviate the high tax burden on labour, while enhancing the growth potential of the economy.
- There are a number of reasons why a well-diversified tax base which comprises taxation of the non-resource sector is a worthwhile policy goal. To start with, natural resources may not last forever, and building a reliable tax base and a culture of tax compliance takes time. Moreover, resource revenues tend to be highly volatile, and in the absence of an appropriate fiscal framework, this volatility is transmitted to the budget. Furthermore, there is ample evidence to suggest that countries with a heavy dependence on resource revenues are less democratic, suffer from the ‘resource curse’, experience higher levels of corruption, and have little incentive to strengthen their tax systems to mobilise revenues from non-resource sectors. Unless the population pays taxes, there is inadequate motivation for them to hold their government accountable.
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- The Swedish case makes an interesting case study for several reasons. First, the Swedish crisis management in the early 1990s is currently attracting international attention. It is regarded as a model for countries facing collapsing financial systems. Sweden is a well-developed welfare state with a large public sector, a tradition of good governance, and a high gross domestic product (GDP) per capita. The lessons from a financial crisis in such a society are likely to be of interest to other rich countries hit by the present global financial crisis
- A large part of the expanding volume of credit was channeled into property and share markets. House prices increased rapidly (Figure 2). The private sector utilized the rising value of real assets as collateral for additional borrowing. The process was fuelled by a rising rate of inflation, which peaked in 1990 (Figure 3). Inflation expectations followed the rise in the inflation rate. The real after-tax interest rate was negative for many investors due to the combination of high actual inflation, high inflation expectations and the rules of the tax system (Figure 4).
- The result was the creation of a financial bubble in the Swedish economy, built on excessive indebtedness within the private sector, and a corresponding overlending within the financial system. The credit boom was reflected within the real sector as well. Consumption became the driving force behind the overheating of the economy (Table 1). During the most intense part of the boom, households consumed more than their disposable income. Real income grew rapidly (Figure 5). Government finances improved during the overheating, since the sharp growth in consumption and income resulted in growing tax revenues from value added taxes (Figure 6). The budget showed a small surplus in the late 1980s, leading to a decline in the debt-to-GDP ratio. REF. Table 1
- Swedish real interest rates were forced upwards by international factors, in particular the reunification of Germany, which led the Bundesbank to raise German, and thus European, interest rates. The krona was subject to several speculative attacks due to the falling credibility of the policy of a pegged krona rate. The Riksbank had to defend the krona rate by raising interest rates in Sweden by more than rates in the rest of Europe.
- When the real rate of interest rose, the price of assets declined in a downward spiral. The fall in asset prices meant a reduction in wealth, since these had been financed through loans whose nominal value remained unchanged (Figure 2). The downturn was fuelled by expectations that asset prices would continue to fall.8 The number of bankruptcies increased dramatically. The massive loss in the balance sheet of the private sector created by the increase in the real rate of interest can be calculated in various ways. Söderström (1996: 174–79) estimated that the value of tangible assets in Sweden declined by about 30%. He also showed that the private sector tried to counteract this loss of wealth by increasing its financial savings by making repayments on its loans and thereby trying to rebuild its equity.9 Households adjusted their portfolios by increasing savings and by reducing consumption, primarily of durable consumer goods. The savings ratio rose from a negative level at the end of the 1980s to about 8% in 1993.10 This change in private savings was a significant feature of the crisis.
- At this point, it became apparent that the many years of regulated low interest rates had resulted in considerable overinvestment. The rise in the real rate of interest revealed excessive holdings of assets, mainly in the form of housing, at the beginning of the 1990s. Then this asset bubble burst. The revaluation of property and other assets brought with it an abrupt freeze in investment within the housing sector—a sector that had previously been considered a major engine of the Swedish economy.
- Domestic developments—a growing financial crisis, falling industrial output and rising unemployment—undermined the credibility of the pegged krona rate. The authorities were trapped in a situation where external conditions (the currency crisis) required contractionary measures, while domestic considerations (the banking crisis) demanded an expansionary policy. The more the Riksbank tried to defend the pegged krona rate by raising interest rates, the deeper the domestic crisis became. With the European currency markets facing unrest in September 1992, the Riksbank defended the krona by significantly raising its overnight rates. For a very short period, the marginal interest rate—the overnight rate—was 500%. The government and the opposition party, the Social Democrats, agreed in September to jointly back two austerity packages to avoid a devaluation of the krona. However, the defense of the krona broke down in November 1992 when it came under massive speculative attack. A floating exchange rate was introduced on 19 November 1992, amounting to a considerable depreciation of the Swedish currency (Figure 8).
- The depreciation of the krona in November 1992 marked the culmination of the crisis and the beginning of the recovery in Sweden. Because the krona was floating, interest rates were gradually lowered. The turnaround and the recovery started in 1993. Economic growth turned positive in 1993 and remained strong throughout the rest of the 1990s, apart from a short downturn in 1996/97 (Figure 5). Almost all indicators of economic activity showed positive numbers after 1993–94. Exports were the major driving force behind the recovery, increasing as a share of GDP. Exports for 1992 amounted to 28% of GDP. By the end of the decade the number was over 45% (Figure 9)—a remarkable development within less than a decade.
- Several factors contributed to this sharp expansion in exports. First, the large and persistent depreciation of the krona after November 1992 increased the competitiveness of Swedish goods. Wage moderation and improvements in productivity facilitated the growth of exports. Exports were also favorably affected by Sweden's entry into the European Union in 1995, which fostered trade both directly and indirectly by promoting foreign direct investment, not least in the rapidly growing information communication technology sector. The rise in domestic demand during the recovery phase was markedly lower. Both private and public consumption grew more slowly than GDP in the years following the crisis. At the same time, the household savings rate remained at a higher level than before the crisis, indicating a continued improvement of the balance sheets of the private sector.
- The effects of the crisis on employment were more prolonged. Unemployment rates in the 1990s never dropped back to the level that prevailed during the 1980s. Open unemployment began to decline from the high level of around 8–10% by the end of 1997 (Figure 7). The high and persistent rate of unemployment contributed to wage moderation in the 1990s and well into the new century.
- Differentiated resolution policy - The general strategy was to divide the banks into three categories, depending on whether the statutory capital adequacy ratio would be breached and, if so, whether this breach was temporary. The first category included those banks that might deteriorate towards the capital adequacy limit, but would subsequently be able to achieve enhanced solvency on their own; the second category covered those that might fall below the limit for a time, but would eventually recover; and the third category was for those that were expected not to recover. Each of these three categories was treated differently by the Bankstödsnämnd. Two bank asset management corporations (AMC) were set up to manage the bad debt (nonperforming loans) of two financial institutions, Securum as AMC for Nordbanken and Retriva as AMC for Gotabanken, as part of the resolution policy, as had been the case in other countries. A novel approach was adopted which involved splitting the assets of an ailing bank into "good" and "bad" assets, and then transferring the "bad" assets to the AMC, principally to Securum.22 In addition, when assets were placed under the administration of Securum and Retriva, they were assigned low market values in the due diligence process, effectively setting a floor for asset values. Because market participants did not expect prices to fall below this level, trading was maintained
- Sweden, being a small open economy with a pegged exchange rate when the crisis peaked, was able to abandon the pegged rate in November 1992, thus obtaining a lasting depreciation of its currency that contributed to a prolonged recovery. This option of an export-oriented growth strategy out of the crisis is currently not open to the world, because the present crisis is a global one. An individual country can no longer rely on the rest of the world to maintain aggregate demand for its exports, as Sweden was able to do in the 1990s. The small size of the Swedish financial system in the 1990s facilitated the bank resolution policy. Policymakers had to deal with a limited number of banks—only six major banks, in fact—in a global environment of trust in the banking system and in financial markets (except for the Nordics). The Swedish system was also bank-based, with few major financial actors outside the banking system. This is in sharp contrast to the US today, for example, where there are a large number of banks of different types and many nonbank financial actors and where public trust in the financial system and its actors (“Wall Street”) is extremely low.33 The Swedish bank resolution policy was also confronted by a financial system that was much less sophisticated and much less globalized than the financial system of today.
- Indeed, on this score, the ongoing crisis has been difficult for the authorities to manage, in part because some traditional central banking tools—particularly in the United Kingdom and the US—are not well suited, either legally or architecturally, to provide liquidity for the institutions most in need, including investment banks and insurance companies. By contrast, the Swedish blanket guarantee of September 1992 immediately created trust; one reason for this was the comparatively simple set of instruments available compared to the present case.
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- Honkapohja (2009) cites deregulation of the financial system in the 1980s as the root of both the economic downturn and the financial crisis.3 Around 1980, attractive interest rates amplified inflows of capital; in these deregulated markets, credit expanded according to market forces. Honkapohja notes that this “led to uncontrolled credit expansion” and “soaring indebtedness in the private sector” and furthermore that the rules and practices of 1969 were left unchanged when banking was deregulated and financial instruments evolved. The result was an increase in information asymmetry—the now all-too-familiar historical precursor to financial crises—amplified by international capital inflows. If international investors enter a country with complete information, and if their confidence in the country does not change, then that country’s economy may be able to function well with a relatively high level of international debt. However, if investors enter a country with imperfect information, or if the rate of growth changes, they may seek to withdraw capital.
- seek private solutions, including mergers and acquisitions; avoid liquidations when possible. Third, be very transparent regarding support actions. In the Nordic case, public confidence was sustained and bank runs avoided (absent government deposit insurance) through a highly visible public government guarantee for the obligations of banks, including both deposits and borrowings.5 While debt holders were protected, equity holders suffered decreases in value but were not automatically wiped out when the governments provided support.An additional element of the Nordic resolution was openness, “refraining from concealing both the extent and nature of the problem.
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- The Swedish banking market crashed in the early 1990s after a spate of deregulation caused a sudden credit expansion which subsequently triggered a collapse in real estate prices.
- Today, Nordic banks’ “compensation structure, approach to client services and focus on basic banking services -- consumer and industrial lending -- as well as knowing your markets very well and using your capital market function as a value-enhancer to your basic banking business”
- Swedish regulators, drawing on lessons from the 1990s, have been quick to respond and have pushed through tighter capital standards than those set elsewhere. Its four biggest banks must hold a core Tier 1 ratio of at least 12 percent of risk-weighted assets by 2015, a ratio they all already exceed.
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The question being discussed at the G-20 is whether it is desirable and feasible to provide a positive fiscal stimulus in 2016 and 2017 rather than a neutral fiscal policy, though coordinated fiscal stimulus anywhere near the scale of what was done in 2009 is not in the cards. With much higher government debt-to-GDP ratios today than before the Great Recession, particularly in the advanced economies, space for fiscal stimulus is more limited and less needed, given that growth remains positive in most economies. The cost of government borrowing has declined, partly owing to quantitative easing—itself a policy that will not last forever—thus helping the sustainability of public finances. But the rate of economic growth is also likely to have declined in a lasting manner compared with pre-crisis rates.
For those countries that retain fiscal space—notably Canada and Germany—additional fiscal stimulus is appropriate. In most countries, tilting the composition of spending toward infrastructure is also desirable and likely to help improve public finances in the long run. In Europe, additional spending to ensure that refugees are quickly integrated and become productive should also be viewed as an investment. Globally, however, a major fiscal stimulus is unlikely and would be premature at this time.
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- The central bank says the biggest threat to Canada’s financial system would be a severe recession that leads to a spike in unemployment and causes many homeowners to default on their mortgages. If that happens, Mr. Schembri said, the share of borrowers behind on loan payments would more than quadruple to 1.8 per cent from 0.4 per cent now.Mr. Schembri also pointed out that excessive borrowing has become increasingly concentrated in a clutch of households with extremely high debt-to-income ratios. As the Bank of Canada pointed out in its most recent Financial System Review, there are roughly 720,000 Canadian households with debts equal to more than 3 1/2 times what they earn every year. They hold about a fifth of all household debt, or $400-billion.The share of these highly indebted households has jumped to 8 per cent from 4 per cent before the financial crisis.The bank said these borrowers are at the greatest risk of defaulting on their loans because they tend to be younger, earn less money and live in the provinces where house prices have climbed the most in recent years: Ontario, B.C. and Alberta.
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- Most other central banks charging negative rates do so on lenders’ deposits. The rate charged usually applies only to a portion of reserves that lenders park at the central bank. This portion is usually dubbed as “excess” reserves as it is the level above the minimum central banks require lenders to hold in their coffers.
- Policymakers might not admit it, but one of the reasons they like negative rates is that they have proved quite an effective way to weaken currencies. Why hold euros if the central bank is sending out a message that it wants to punish you for saving in their currency?A weaker currency helps central banks to meet their inflation targets by raising the cost of imported goods. With the fall in oil prices and sluggish global demand invoking the spectre of deflation, anything to lift price pressures is welcome.But negative nominal rates have never been tried before, and the policy now seems to have some side effects.Like the falls in banks’ shares?Exactly.
- So far banks have taken the hit for negative rates and have not passed on most of the cost of the cuts to their customers. That has eroded their interest rate margins.This is partly the intention of negative rates: The policy is supposed to encourage banks to seek out riskier lending opportunities by squeezing margins. Lending to riskier ventures should spur growth in weaker parts of the economy, so the theory goes.In practice, profiting from this so-called “portfolio rebalancing” effect is tricky at present.Banks borrow short and lend long. Yet other extreme monetary policies, such as the purchase of government bonds under quantitative easing, have lowered longer-term interest rates for businesses and households. That limits opportunities for banks to charge higher rates to their customers, or build their profits by buying riskier assets. The short-term benefits that can be expected from negative rates, such as falls in loan defaults, are increasingly countered by the impact on profitability it seems.Cuts such as the Riksbank’s are fuelling suspicions that central banks are engaging in “currency wars” that will trigger a race to the bottom on negative rates. That in turn is sparking sharp falls in bank stocks as investors becoming increasingly concerned about whether lenders, particularly those still weak from the financial crisis, can stomach the hit.So, if bank stocks and bonds are plunging, where are investors putting their money?Investors are selling equities and corporate bonds and buying sovereign debt that still sports a positive yield. This week alone, we have seen dramatic rallies in US and UK bond prices, pushing their 10-year yields below 1.60 per cent and 1.3 per cent respectively.But there is a declining stock of these bonds available.Some $6tn of government debt sold by Japan and Europe now yields below zero. Roughly two-thirds of Japanese government bonds are negative-yielding while in Germany the 10-year Bund yields just 0.16 per cent.Why buy a negative-yielding bond?Call it the “greater fool” theory of investing. Buying negative-yielding bonds entails a guaranteed loss if held to maturity, but a trader can still make a profit by selling their holdings at a higher price and a lower yield. As long as someone else thinks central banks will keep pushing further below zero.
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in terms of their expected value, stocks are not overpriced today. - what matters for the valuation of stocks is the relation between future growth and future interest rates. Put another way, the equity premium, the difference between the expected rate of return on stocks and the expected rate of return on bonds, has if anything increased relative to where it was before the crisis.
- A popular alternative measure proposed by Robert Shiller of Yale University uses a 10-year average of past earnings (adjusted for inflation) in order to smooth out temporary fluctuations (the solid line in figure 1). The Shiller P/E measure eliminates the massive spike in 2009 and allows the fall in stock prices that year to show through. Although the two P/E measures were often close to each other in the past, the Shiller measure has been consistently higher than the standard measure since 2010.1 The Shiller P/E ratio reached 26 late last year and is currently around 24, compared with a 60-year average of 20. This elevated Shiller P/E measure is commonly cited as an indicator that stocks may be overpriced, including by Shiller himself.
- But suppose that we see them as significant, that we believe they indicate the expected return on stocks is unusually low relative to history. Is it low with respect to the expected return on other assets? A central aspect of the crisis has been the decrease in the interest rate on bonds, short and long. According to the yield curve, interest rates are expected to remain quite low for the foreseeable future. The expected return on stocks may be lower than it used to be, but so is the expected return on bonds.
- The first measure is the earnings-price (E/P) ratio, i.e., the reciprocal of the P/E ratio. E/P reflects the real, or inflation-adjusted, rate of return an investor can expect on holding stocks over a long period of time under the assumptions that (1) stock prices rise with overall inflation (reflecting the “real” nature of corporate assets) plus any earnings that are not passed on to investors as dividends, and (2) earnings grow in proportion to the value of corporate assets.2
- If anything, the evidence from 150 years of data is that the equity premium tends to be high after a financial crisis, and then to slowly decline over the following decades, presumably as memories of the crisis gradually dissipate. If this is the case, then stocks look quite attractive for the long run.
- in terms of their expected value, stocks are not overpriced today.
- We note that anyone who bought stocks in 2005 and held them to 2015 would have earned an average annual return more than 3 percentage points higher than that on holding a 10-year nominal bond.
- There is evidence that the Federal Reserve’s bond-buying programs have lowered term premiums in bonds, but not so much as to lower expected returns in long-term bonds below those of short-term bonds. (This estimate of the 10-year term premium is close to zero.) The Fed plans to reduce its bond holdings slowly over many years, so any future rise in term premiums is likely to be gradual.
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- Regulations that once forced companies to go public after surpassing a certain number of investors have changed. Meantime, the private markets became awash in cash with the entry of new players alongside traditional venture capitalists. Investors, including mutual funds and hedge funds, began to buy private deals to obtain larger chunks of companies and better returns prospects by investing earlier in a company’s life cycle.
- He expects to see fewer and bigger deals because companies are more mature when they list.
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