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Is it time to grasp the debt restructuring nettle?
Patience, we’re constantly told, is what’s needed to get through this painfully slow recovery. Sir Mervyn King and George Osborne make the point so often you need the patience of a saint just to keep listening.
Writing down £60bn of unrecognised private sector losses in the UK may lead to a lot of short-term pain but it could prevent other people who didn't make bad decisions in the run-up to the financial crisis from suffering as well. Photo: Rex
By Philip Aldrick
11:47AM GMT 26 Jan 2013
23 Comments
Everyone’s fed up with waiting, though. Unemployment may be coming down but it hardly feels like a recovery. It’s been almost five years since the end of the boom. The economy has flat-lined since mid-2011. GDP per head - according to Citi’s Michael Saunders - is now 6.7pc below the pre-crisis peak, worse even than Japan’s “lost decade”. And the pound in your wage packet really won’t be worth as much tomorrow.
Vincent Reinhart, Morgan Stanley’s chief economist who was a senior US Federal Reserve official and is the author of seminal papers on post-financial crisis responses, thinks there is an alternative, though. That there is a quicker way back to prosperity.
“A financial crisis is really about an enormous loss of wealth,” he told me at the Word Economic Forum in Davos. “And it’s only when you recognise that loss of wealth that you can set about rebuilding.”
What he was talking about was writing down private sector debt – that of over-borrowed households, companies and banks. According to the Bank of England, there may be as much as £60bn of unrecognised losses in the UK.
Writing down that amount of debt would normally lead to an awful lot of pain – with some families losing their homes and jobs lost as companies go bust. But if the debts aren’t written down, the rest suffer too.
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A little bit of honesty here from the political classes would go a long way, Mr Reinhart reckons.
In the wake of a major financial crisis, he said, the authorities have two options: denial - letting banks, companies and households pretend they can service their debts and sparing them short-term pain.
Or forcing writedowns upfront. Individuals would suffer and unemployment would almost inevitably rise, but the country would get over the hump quicker.
“How long would those laid off be out of a job, though,” Mr Reinhart said optimistically. Effectively, his second option prescription is classic economic “creative destruction”.
Mr Reinhart is not some misguided hairshirt ideologue, though. He has studied in detail the 15 biggest financial crises since the Second World War, and worked on the issue with the world’s foremost authorities – his wife Carmen and Harvard economist Ken Rogoff.
According to his research, the “more successful economies were the ones where you recognise losses, take writedowns and get over it early”.
“The incomplete recognition of losses means a prolonged period of below par growth. You never really grow your way out of a debt problem, you limp out.
If that’s the case, you have to do QE1, QE2, QE infinity,” he said.
QE brings its own problems by distorting market behaviour and perpetuating the problem of “zombie banks, zombie companies, and zombie households”. “The attrition can last a really, really long time,” Mr Reinhart said, citing Japan’s two “lost decades”.
So where does that leave the UK? First, his argument suggests policymakers are not being entirely honest with the public. Patience is not the only option.
Aggressive debt restructuring is another.
The problem is, as Mr Reinhart pointed out, that the taxpayer would almost certainly have to step in – to recapitalise the banks as they wrote off billions of pounds of bad lending, or to protect households by capping their maximum loss. The US stepped into help householders in the 1930s under President Roosevelt, and the idea has been recently endorsed by the International Monetary Fund no less..
According to Mr Reinhart, the instruction for banks to write down their assets would have to come from the financial regulator – in the UK in future, the Bank of England. But the decision would need to be made politically. Taxpayers, after all, would probably be coughing up.
Ideally, this would be when to use quantitative easing. The economy would suffer a brief shock as a result of the hurt households were feeling and as unviable businesses went bust. Low rates and cheap money would be the cushion to ease the blow.
Instead, Mr Reinhart reckons, QE is being used because politicians are failing to take the big decisions: “Of the – say - 15 things that need to be done, QE is number 15. It’s just that the other 14 aren’t happening.”
“I think of it like one of the old service comedies. The commander asks his troops to volunteer for a dangerous but vital mission and they all take a step back except one guy – the hapless hero. That’s the central bank. Because of the failure of politicians to address the real issues, you’re left with the hapless hero trying to do the right thing.”
There is some evidence the UK is trying to grasp the debt restructuring nettle. The Bank of England is currently forcing banks to declare their hidden losses. But, the Treasury has made it crystal clear that the taxpayer will not be forking out a penny more, which will limit the policy’s effectiveness.
As much as £100bn of mortgage debt in the UK is in forbearance, where borrowers are struggling to keep up with their monthly payments even with interest rates at a record low, the Bank has estimated. The writedowns on that may not be huge, but when taken with overvalued commercial property and other hidden losses, it’s easy to get to a figure of £60bn of writedowns, using Bank calculations.
If there is a country that needs to address its private and banking sector debts, as well as the public ones, it is the UK. Mr Rogoff told me at Davos that “by and large Britain is having a typical post financial crisis period, exacerbated by the dependence on the financial sector and the eurozone”.
In other words, we’ll grow anaemically for a decade at least. “Patience” is the authorities’ euphemism for what they used to call “a lost decade”.
If that’s the choice they have taken, fair enough. But Britons – in particular the younger generation who can not get on the housing ladder and are struggling to find a proper job - deserve at the very least to be told there was another option.
Patience, we’re constantly told, is what’s needed to get through this painfully slow recovery. Sir Mervyn King and George Osborne make the point so often you need the patience of a saint just to keep listening.
Writing down £60bn of unrecognised private sector losses in the UK may lead to a lot of short-term pain but it could prevent other people who didn't make bad decisions in the run-up to the financial crisis from suffering as well. Photo: Rex By Philip Aldrick
11:47AM GMT 26 Jan 2013
23 Comments Everyone’s fed up with waiting, though. Unemployment may be coming down but it hardly feels like a recovery. It’s been almost five years since the end of the boom. The economy has flat-lined since mid-2011. GDP per head - according to Citi’s Michael Saunders - is now 6.7pc below the pre-crisis peak, worse even than Japan’s “lost decade”. And the pound in your wage packet really won’t be worth as much tomorrow.
Vincent Reinhart, Morgan Stanley’s chief economist who was a senior US Federal Reserve official and is the author of seminal papers on post-financial crisis responses, thinks there is an alternative, though. That there is a quicker way back to prosperity.
“A financial crisis is really about an enormous loss of wealth,” he told me at the Word Economic Forum in Davos. “And it’s only when you recognise that loss of wealth that you can set about rebuilding.”
What he was talking about was writing down private sector debt – that of over-borrowed households, companies and banks. According to the Bank of England, there may be as much as £60bn of unrecognised losses in the UK.
Writing down that amount of debt would normally lead to an awful lot of pain – with some families losing their homes and jobs lost as companies go bust. But if the debts aren’t written down, the rest suffer too.
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A little bit of honesty here from the political classes would go a long way, Mr Reinhart reckons.
In the wake of a major financial crisis, he said, the authorities have two options: denial - letting banks, companies and households pretend they can service their debts and sparing them short-term pain.
Or forcing writedowns upfront. Individuals would suffer and unemployment would almost inevitably rise, but the country would get over the hump quicker.
“How long would those laid off be out of a job, though,” Mr Reinhart said optimistically. Effectively, his second option prescription is classic economic “creative destruction”.
Mr Reinhart is not some misguided hairshirt ideologue, though. He has studied in detail the 15 biggest financial crises since the Second World War, and worked on the issue with the world’s foremost authorities – his wife Carmen and Harvard economist Ken Rogoff.
According to his research, the “more successful economies were the ones where you recognise losses, take writedowns and get over it early”.
“The incomplete recognition of losses means a prolonged period of below par growth. You never really grow your way out of a debt problem, you limp out.
If that’s the case, you have to do QE1, QE2, QE infinity,” he said.
QE brings its own problems by distorting market behaviour and perpetuating the problem of “zombie banks, zombie companies, and zombie households”. “The attrition can last a really, really long time,” Mr Reinhart said, citing Japan’s two “lost decades”.
So where does that leave the UK? First, his argument suggests policymakers are not being entirely honest with the public. Patience is not the only option.
Aggressive debt restructuring is another.
The problem is, as Mr Reinhart pointed out, that the taxpayer would almost certainly have to step in – to recapitalise the banks as they wrote off billions of pounds of bad lending, or to protect households by capping their maximum loss. The US stepped into help householders in the 1930s under President Roosevelt, and the idea has been recently endorsed by the International Monetary Fund no less..
According to Mr Reinhart, the instruction for banks to write down their assets would have to come from the financial regulator – in the UK in future, the Bank of England. But the decision would need to be made politically. Taxpayers, after all, would probably be coughing up.
Ideally, this would be when to use quantitative easing. The economy would suffer a brief shock as a result of the hurt households were feeling and as unviable businesses went bust. Low rates and cheap money would be the cushion to ease the blow.
Instead, Mr Reinhart reckons, QE is being used because politicians are failing to take the big decisions: “Of the – say - 15 things that need to be done, QE is number 15. It’s just that the other 14 aren’t happening.”
“I think of it like one of the old service comedies. The commander asks his troops to volunteer for a dangerous but vital mission and they all take a step back except one guy – the hapless hero. That’s the central bank. Because of the failure of politicians to address the real issues, you’re left with the hapless hero trying to do the right thing.”
There is some evidence the UK is trying to grasp the debt restructuring nettle. The Bank of England is currently forcing banks to declare their hidden losses. But, the Treasury has made it crystal clear that the taxpayer will not be forking out a penny more, which will limit the policy’s effectiveness.
As much as £100bn of mortgage debt in the UK is in forbearance, where borrowers are struggling to keep up with their monthly payments even with interest rates at a record low, the Bank has estimated. The writedowns on that may not be huge, but when taken with overvalued commercial property and other hidden losses, it’s easy to get to a figure of £60bn of writedowns, using Bank calculations.
If there is a country that needs to address its private and banking sector debts, as well as the public ones, it is the UK. Mr Rogoff told me at Davos that “by and large Britain is having a typical post financial crisis period, exacerbated by the dependence on the financial sector and the eurozone”.
In other words, we’ll grow anaemically for a decade at least. “Patience” is the authorities’ euphemism for what they used to call “a lost decade”.
If that’s the choice they have taken, fair enough. But Britons – in particular the younger generation who can not get on the housing ladder and are struggling to find a proper job - deserve at the very least to be told there was another option.