A ringside view of the economic crisis

David Fenton, Senior Economist

March 2012

Slide 2

Was the Greenspan “put” a shot in the foot?Policy rates, UK and US

Source: Datastream

0

1

2

3

4

5

6

7

2000 2001 2002 2003 2004 2005 2006 2007

BoE Fed Reserve ECB

Slide 3

Goodbye dot-com bubble, hello housing bubble

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

5,500

Ma

r-97

Ma

r-98

Ma

r-99

Ma

r-00

Ma

r-01

Ma

r-02

Ma

r-03

Ma

r-04

Ma

r-05

Ma

r-06

Ma

r-07

Ma

r-08

Ma

r-09

Ma

r-10

Ma

r-11

Ma

r-12

100

120

140

160

180

200

220Case-Shiller 20-city Comp Index

RHSNasdaq Comp LHS

Equity prices, house prices

Source: Datastream

Slide 4

(Taylor) rules are made to be broken?

Federal funds rate (%)

Source: “Housing and monetary policy”, Jackson Hole conference 2007

Housing starts (millions of units)

Slide 5

Signs of a property bubble – difficult to miss

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Comm prop yield

10y gilt yield

Normal(c200 bps)

Nuts(inverted!)

Nasty!(c400bps)

Commercial property and gilt yields, %

Source: Datastream, IPD

Slide 6

The Great Moderation made us complacent

0%

1%

2%

3%

4%

1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

US UK

GDP % growth, standard deviation

Source: Datastream, RBS calcs

Slide 7

The price of risk fell sharply

RBS net interest margin (%)

Source: Bloomberg

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Slide 8

The loan to deposit ratio shot upRBS loan to deposit ratio (%)

Source: Bloomberg

97

104

124

147152

134

60

70

80

90

100

110

120

130

140

150

160

2000 2002 2004 2006 2008 2010

Slide 9

We saw it coming...sort of

“Unlike previous scenarios, the main source of the economic downturn is in the banking system...it is the resultant ‘credit crunch’ that propagates this initial shock, and turns recession into depression.”

RBS stress scenario, July 2006

Slide 10

Strange things afoot in the inter-bank marketSpread between 3m LIBOR and bank rate (bps)

Source: Datastream

-50

0

50

100

150

200

250

300

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Slide 11

Did we really think Greece was like Germany?10y bond yields (%)

Source: Datastream

0

5

10

15

20

25

1995 1997 1999 2001 2003 2005 2007 2009 2011

Germany Italy Spain Ireland Portugal Greece

36%LehmanBrothers

fails

Greece joins euro

Birth of

euro

Slide 12

Where do we from here?

Goldilocks Returns

“V”

Deflation“L”

Not much spare

capacity

Strong demand

Weak demand

Lots of spare

capacity

Return of macro instability

“W”

Slow Grind Higher

“U”

Slide 13

The long road to recovery

90

95

100

105

110

115

120

1 2 3 4 5 6 7

Years from start of recession

1990s recession/recovery

Current recession/recovery

Slide 14

Fiscal rebalancing: a good start, but still far to go

0.0

2.0

4.0

6.0

8.0

10.0

12.0

2001-02 2003-04 2005-06 2007-08 2009-10 2011-12* 2013-14 2015-16

Net borrowing, % GDP

Source: HM Treasury

Slide 15

“Plan A” requires a private sector response

Government

Financial companies

Rest of the world

Non-financial companies

Households

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

Deficit Surplus

Net financial surplus/deficit, % GDP (flow of funds)

Source: Datastream, RBS calcs

Slide 16

Rates expectations fade into the distance

0

1

2

3

4

5

6

7

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Feb-10

Feb-11

Aug-11

Nov-11

Feb-12

UK policy rate

Source: Datastream, Bank of England

Slide 17

Are we turning Japanese?

Market expectations of policy rate (%)

Source: Fathom

1996

Actual

1998

Slide 18

Drastic times?

Increase demand (symptom)

Massive fiscal stimulus

QE max

Liquidity unbounded

“Use it or lose it” deposit tax

PFI v2.0

Beg to China

Reduce debt (cause)

(Big) “bad bank”

Debt forgiveness

Financial repression

Monetise debt

Raise interest rates

Outright default

Slide 19

The darkest hour is just before the dawn?

“Initial projections for a V-shaped recovery are subsequently revised to a U-shaped recovery and eventually to an L-shape just as the recovery arrives.”

Blanchflower, Feb 2009

Slide 20

Keep in touch!

Internetwww.rbs.com/economics

E-mailwww.rbs.com/economics/registration

Social media@rbs_economics

Slide 21

Legal disclaimer

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