The New Financial World
The New Financial World
by Mark Cliffe, ING Group Chief Economist
After multiple shocks and surprises, the worst financial crisis since the Great Depression has profoundly changed the landscape of the financial world. But what will the new world look like? An emerging consensus on the causes of the crisis points to 14 themes:
1. Tomorrow's rules won't be the same as today's
Yesterday's experts are today's humbled spectators, who feel less certain than ever of what the future holds. In such a psychological environment, the rules of the game may change several times before the picture becomes clear.
2. The law of unintended consequences
The severity of the economic downturn will make everyone so determined to avoid a repeat that lenders and borrowers even more cautious, making recovery harder in the short term.
3. Back to Basics
The financial trendsetters will shift from investment banks and hedge funds—whose high returns turned out to have been based on high levels of borrowing—to conservatively run banks with in-house credit skills, diversified sources of funding, low lending multiples, and large pools of retail savings. If the price of all this is a slower recovery, it is widely seen as a price worth paying for more stable and sustainable growth.
4. The market isn't always right
The boom was based on faith in efficient markets, and market prices as the best measure of “value.” This has been shaken by the crisis, as lending has collapsed due to the uncertainty over the scale and location of losses in the financial sector. Transparent securities on open exchanges will be essential to the creation of future liquid markets.
5. The Age of Frugality
The lessons of excessive borrowing will stimulate consumers to rebuild their savings, and banks will be keen to cultivate retail savers by offering attractive interest rates and services.
6. Trust will need to be rebuilt
A collapse in trust in—and between—financial institutions has been both a cause and a consequence of the crisis. Financial institutions will have to show that they are worthy of consumers' trust and respect, through clarity about their financial strength, business models and products. Between financial institutions, transparency will be required for a revival in trust, and trading.
7. Keep it simple
Many investors, both individual and institutional, clearly did not understand the risks that the new financial markets were exposing them to. As a result, customers will demand easily understandable information about what they are buying. The appeal of simplicity will force financial institutions to think from the customer's point of view.
8. Politicians will have their say
Popular anger at the real economic pain caused by the crisis will put pressure on politicians to press financial institutions to take noncommercial considerations into account, such as modifying loans to troubled mortgage borrowers, or favoring small- and medium-size enterprises when lending. Meanwhile, failing financial institutions may force governments to pick the winners and losers with a view to consolidating the industry around the stronger players. “Temporary” government involvement in this context is likely to last several years.
9. The paradox of thrift
When previously debt-fuelled economies like the US start to raise their savings rates, the economic growth, spending, and overall savings in the economy as a whole tends to decline. To counteract that, the public sector may pick up the slack by increasing its borrowing, through extra spending and tax cuts, which will increase the overall role of government in the economy.
10. Tougher discipline will be imposed
The systemic nature of the crisis has revealed glaring gaps in international and domestic regulation, and prompted regulators to pledge “never again!” The first area of focus is toughening the existing capital adequacy rules, which intensified risky lending by allowing rising asset prices to lower the regulated risk of lending institutions. There will also be an effort to shift the massive credit default swap market, the locus of much of the crisis, onto a transparent open exchange. A third category of regulatory change is consumer protection, especially the terms and structure of US mortgage loans.
11. Central banks to pay more attention to asset prices
Central banks' asymmetric approach, where rising asset “bubbles” were tolerated and even encouraged, while falls in prices prompted monetary easing, has been widely criticized for encouraging the excessive risk-taking that led to the plunge in asset prices. As a result, central banks my clamp down on strongly rising asset prices and credit growth in the future, another indication that theeconomic upswing may be more subdued than earlier cycles.
12. From globalization to localization
It is said that “economics is global and politics is local.” Although a laudable search for global solutions is under way, the rebuilding of trust and regulation, along with government intervention, will inevitably start at the national rather than the global level. US Government policy is likely to encourage a move away from dependence on foreign capital, while creditor nations, led by China, will find it tougher to pursue export-led growth and will therefore have to boost domestic spending. Now that “cash is king” and creditors royalty, this trend toward self-reliance will accelerate the rebalancing of global economic and financial power towards the East.
13. A more competitive financial eco-system
Deleveraging has already changed the shape of the financial services industry. Those that avoided the toxic complexities of the crisis may continue to thrive, but the 60-year long boom in financial sector profits is probably over. Structural changes in the industry like lower leverage, more standardized products, tougher regulations and possible extended state involvement, will weigh on profitability. On the other hand, the industry will benefit from savers' efforts to rebuild their wealth, while in the emerging markets there is still scope for structural expansion of financial services.
14. The cycle still exists… there will be an upswing
Aggressive policy responses should reassure us that another Great Depression is not in the offing and that a recovery will ultimately emerge. Indeed, the crisis presents some tremendous opportunities as asset prices are driven down to below depression levels. Across industries, survivors with strong, innovative brands will benefit from higher margins as competitors disappear from the scene, and public-sector-led investment initiatives, such as on infrastructure and energy, will present attractive long-term opportunities. The new financial world, while chastened and more conservative, will eventually shake off the current gloom.
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This commentary has been prepared by ING Investment Management for informational purposes. Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Any opinions expressed herein reflect our judgment and are subject to change. Certain of the statements contained herein are statements of future expectations and other forward-looking statements that are based on management's current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels and (4) increasing levels of loan defaults (5) changes in laws and regulations (6) changes in the policies of governments and/or regulatory authorities.
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