At ExCel London, the very venue where then-UK prime minister Gordon Brown and the G20 met in April 2009 to “save the world economy” during the global financial crisis (GFC), Adam Tooze addressed the 72nd CFA Institute Annual Conference, hosted by CFA Society of the UK, about where the GFC has left us, how the crisis has affected politics and geopolitics, and what the prospects are for the world to manage a future crisis.
Health of the Global Banking Sector: Differences by Region
Tooze, a prize-winning historian, Columbia University professor, and author of Crashed: How a Decade of Financial Crises Changed the World, focused on the extraordinary growth of credit globally resulting from a perpetually low interest rate environment over the last 10-plus years as a major cause for concern, though not for the US banking sector that precipitated the GFC.
“What we learned from 2008 was that it’s not the size of the losses per se, but rather where the losses sit in the financial system,” Tooze said. “Today US banks are bigger and more concentrated than ever, yet they’re much less risky, with significantly lower leverage and less connectedness.”
Even with concerns about the extensive expansion of corporate debt in the United States, big US banks hold only US$90 billion of high-quality tranches of CLOs (securitized corporate debt products) — a fraction of the total corporate debt outstanding as noted in the US Federal Reserve’s May 2019 Financial Stability Report.
“Europe is a more ambiguous scene,” Tooze said. European banks are still weak, but the so called “good news” is that due to financial deglobalization, European bank balance sheets are now much smaller, systemically less risky, and decoupled from US banks. Though the EU has come up short on its promise in 2012 for a banking union.
Tooze observed that many analysts scratch their heads about the cohesion of the European Union. The common reaction is: “This thing cannot possibly work. It’s broken in so many different ways and been stitched back together and under the [weight of] next shock, surely it will break it apart.” Yet the eurozone has not only survived as a political anchor, but also the euro is now more popular with European citizens than ever before.
“People often underestimate the deep political commitment to the institution,” Tooze said. “The trilemma for Europe is that the EU is fundamentally politically indispensable, clearly in need of structural reforms, yet completely absent of political leadership in pushing toward the changes necessary.”
Tooze quipped that today the three biggest risks to the EU are “Italy, Italy, and Italy — which is ‘too big to fail and too big to bail.’” Even years after the GFC, there is still a deep connection between Italy’s sovereign finance and its banking sector and investors continue to worry about the “sovereign-bank doom loop” in CDS markets.
Where do we go from here?
Looking forward, Tooze predicts “all things hinge on China.” Despite crises in some emerging markets over the last few years, Brazil, Russia, Turkey, Egypt, and Argentina, among them, China’s growth machine continued to roll. So there was no aggregating event to cause a global calamity. The main concern is the level of excess private debt in China, currently at historically unprecedented levels, Tooze said. He compared China’s credit boom (in the chart below) to other credit bubbles that ended badly. He highlighted that the UK banking sector has by far the heaviest exposure to Hong Kong and China in general — much more than the United States, Japan, or Europe.
Although the Chinese have not slowed their credit bubble, Tooze noted, they have shown an ability to massively restructure their banking sector in the past, in 1998–2005, for example, and more recently to shrink their shadow banking segment. As for the outlook for the global economy, a lot rides on how China manages its current credit situation.
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Image courtesy of Neil Walker