AUDITING THE FINANCIAL CRISIS:SOME AFTERTHOUGHTS FROM
THE NETHERLANDSBAS JACOBS
PROFESSOR OF ECONOMICS AND PUBLIC FINANCEERASMUS SCHOOL OF ECONOMICS
EUROSAI CONGRESSNETHERLANDS COURT OF AUDIT
JUNE 18, 2014
THE CRISIS
Not a public debt crisis! … except Greece
Introduction of Euro caused a capital flow bonanza that led to massive build up of private debt
Risks exploded when US mortgage crisis ignited a banking crisis in the EZ
Sudden stop capital flows triggered systemic problems in construction of EZ no crisis resolution insolvent sovereigns no lender of last resort illiquid sovereigns no banking union
CRISIS DUE TO PRIVATE DEBTS AND CONSTRUCTION FAILURES EUROZONE
Source: Shambaugh (2012), BPEA
CRISIS FADED
Draghi saved the Euro (so far): lender of last resort for solvent but illiquid sovereigns
Rescue funds (EFSF/EFSM) ESM: restructure debts, reform economies
Bankingunion supervision crisis resolution
But, no real burden sharing and no EDGS ‘doom loop’ between banks and sovereigns not broken
Debt write downs public debts Greece necessary
PUBLIC MISMANAGEMENT CRISIS
Totally misguided focus on synchronized austerity throughout EZ destroyed economic growth deepened banking crisis triggered public debt crisis despite austerity efforts
Private debts hardly came down and still very high Public debts did not come down at all and keep on rising Banks are still very weak: interventions 6 years too late Recovery? Secular stagnation and Japanese scenarios
are most likely for EZ
WHY DID THIS HAPPEN?
Creditor countries played the blame game: crime and punishment!
Governments hijacked by financial sector Lack of knowledge of basic macro-economics:
it’s not a morality tale not all sectors/countries can simultaneously deleverage
Policy device: ‘austerity above all’
CONSEQUENCES MISGUIDED AUSTERITY
Austerity policy does not pass social-cost benefit test for all non-GIIPS EZ countries (DeLong and Summers, 2012)
GDP NL in 2015 still below 2008 Loss = 15% GDP relative to pre-crisis growth Loss = 10% GDP structurally Unemployment rate doubled to 9% (CBS) / 7,5% (ILO) 10% structural GDP loss = fiscal gap increase of 5%
GDP austerity measures largely self-defeating 2011-2015: 7,5% GDP austerity, 2,2% GDP deficit
reduction
PUBLIC BUDGETS ARE GOVERNED BY ECONOMICALLY SILLY RULES
1. Static rules of GSP ignore that GBC is inherently dynamic
2. Exclusive focus on liabilities ignore asset side3. Off balance liabilities are ignored
STATIC RULES OF SGP Government budget constraint is dynamic Example: Netherlands has no long-run sustainability
problem in the public budget sustainability gap (fiscal gap) = approx. +1% of GDP
Public finances sustainable due to raising retirement age reform mortgage rent deduction reforms long-term care
NL embarked on a massive austerity program between 2011-2017: 9% GDP budget cuts: 5,5% GDP tax increases: 3,5% GDP
ASSETS MATTER FOR PUBLIC FINANCESEXAMPLE: NL GOVERNMENT HAS NET ASSETS
Assets Public capital stock: 64%
bbp Financial assets: 27% bbp Gas stock: 22% bbp
Total assets: 112% bbp
PM Tax claim future pensions: approx. 63% bbp
Liabilities Gross debt: 74,5% bbp
Total liabilities: 74,5% bbp
PM Latent liabilities (state pensions, health care)
PM guarantees
Source: CPB (2013) De naakte feiten over de Nederlandse overheidsschuld
GOVERNMENT AS A HEDGE FUND Private risks were socialized
rescues banks and interbank markets country rescues
Rescue operations required huge off-balance sheet transactions Eurozone governments deposit guarantee schemes mortgage insurance bank guarantees guarantees for rescue funds (ESM etc)
Arbitrage off-balance transactions public/private sector
SOMETIMES SOVEREIGN NEEDS TO INTERVENE
Correct market failure = social gain lacking liquidity banks/sovereigns lacking risk-bearing capital
Bailing out insolvent banks or sovereigns = social cost insolvency banks: capital ratios SIFI’s way too low insolvency governments: public debts unsustainable
HOW TO CONTROL EXPOSURE SOVEREIGN TO FINANCIAL RISK? Guarantees financial sector (DGS, mortgage insurance,
etc) are public liabilities need to be transparant need to be valued as liabilities on public balance sheets use market valuations as much as possible
Valuation TBTF subsidies to banks as liability on public balance sheet Reduce TBTF subsidies by increasing capital
requirements banks (Admati and Hellwig, 2013) (Also: remove tax advantages high leverage
interest deductibility mortgage rent mortgage insurance interest deductibility corporate income tax)
LESSONS CRISIS FOR PUBLIC AUDITORS SGP rules should focus on long-term sustainability, not one-
year deficit measures true measure for sustainability: fiscal gap calculations theoretically superior, practically more difficult
SGP rules should be based on all assets and liabilities, explicit and implicit value all liabilities of financial sector for sovereign
Higher deficits possible if larger assets lower implicit debts lower risk-exposure financial sector
LESSONS CRISIS FOR PUBLIC AUDITORS
Control public liabilities financial sector no longer off balance: value liabilities higher bank capital remove tax advantages debt stop mortgage insurance