Sweden Faces Recession as Housing Market Troubles Take Toll on Economy

Economic

Summary:

For years, Sweden has been warned that its dysfunctional housing market, plagued by under-supply and kept aloft by low rates and generous tax benefits, was a risk to the wider economy.

Now those risks are becoming reality. Households with big mortgages are reining in spending as interest rates rise, and house-builders are pulling the plug on investment, tipping Sweden into recession.

The country is set to be the only EU economy experiencing outright recession this year. The crown is trading at around its weakest level against the euro since the global financial crisis, partly due to housing market worries, making the central bank's job of curbing inflation more difficult.

"It's not that no one saw this coming," Riksbank Governor Erik Thedeen said at the end of February. "The Riksbank has warned about this ... for a long time. And now it is clear that it is a problem."

After years of ultra-low borrowing costs, the pandemic and the Ukraine war have served up a toxic cocktail of high inflation and rapidly rising interest rates to many countries.

But in Sweden, the structural problems rooted in its housing market are magnifying the effects.

House prices in Sweden have almost quadrupled in the last 20 years, easily outstripping wage growth, boosted by generous mortgage tax relief, almost non-existent real estate taxes and a rental market with limited supply because of tight regulations.

Debt levels are among the highest in the European Union at around 200% of disposable incomes, much of which is mortgage debt. And around 60% of Swedes have floating-rate mortgages, meaning rate increases have an immediate impact on the majority of households.

Banking group Nordea expects household consumption to fall around 2% in 2023, while the National Board of Housing expects housing starts to fall around 50% in the coming year compared with 2021. Sweden Faces Recession as Housing Market Troubles Take Toll on Economy_1

Sweden Faces Recession as Housing Market Troubles Take Toll on Economy_1

Sweden Faces Recession as Housing Market Troubles Take Toll on Economy_2

Many home-owners are already struggling with higher mortgage repayments alongside surging food and energy prices - even though the full effects of interest rate rises over the last year have yet to be felt.

Philippa Logan, a single mother of two, bought her 89 square meter (958 square feet) apartment in Ostberga in the south of Stockholm in 2017 and paid off some of the mortgage after getting divorced in 2020.

"However, in the last few months, the interest rate has almost tripled making it almost unaffordable to survive," Logan said.

"The stress has been indescribable," she said, adding she had been forced to take on extra work to make ends meet.

The central bank expects further rate increases in the coming months. Markets expect borrowing costs to peak at 4%, up from 3% currently.

"Our forecast is for the Riksbank to raise rates to 3.75 as a peak," Gustav Helgesson, economist at Nordea said. "I think at that level we are very near some kind of pain threshold for households."

Home Truths

The European Commission expects Sweden's gross domestic product to contract by around 1% this year - the only country in the 27-member bloc likely to see negative annual growth.

Nordea expects GDP to contract by around 2%.

House prices are down around 15% since their peak in spring last year, a bigger drop than during the global financial crisis. Some regions have experienced a fall of as much as 40%, the real estate division of insurer Lansforsakringar said.

Sweden Faces Recession as Housing Market Troubles Take Toll on Economy_3

While Sweden is not alone in seeing big house price falls, its households are almost uniquely sensitive to interest rate hikes because more than half have floating rate mortgages.

In Germany, for example, most borrowers have fixed mortgages and rising rates have largely been shrugged off.

"No, we don't have any fear with the mortgages," said Hannah, a teacher in the city of Bochum, in the west of the country, whose joint mortgage with her partner is fixed at 0.9%.

"We have 15 years to pay back and it was all planned in a way that we could pay back even if interest rates rose," she said.

In Canada, while debt levels are high, variable rate mortgages only account for about one-third of total outstanding mortgage debt, according to the Bank of Canada.

While some economists predict a mild recession in Canada, the OECD think tank expects the Canadian economy will grow around 1.3% in 2023.

A fixer-upper?

Sweden's housing problems date back decades, but have proven hard to fix.

Plans to ease rent controls have been fiercely opposed by the political left which believes introducing market forces would increase social division by pricing many people out of desirable areas of Sweden's cities.

All the main political parties agree an overhaul of mortgage tax relief is needed, but none are prepared to give their rivals a stick to beat them with when elections come around.

Reintroducing a property tax, abolished in 2008, is seen as another sure-fire vote-loser.

Financial regulators have introduced tougher lending practices and tightened mortgage repayment rules. Sweden's banks are among the most strongly capitalised in Europe - partly as a result of worries about the housing market.

These should prevent falling real estate prices from triggering a financial meltdown as happened in Sweden in the early 1990s.

But Sweden's economy is likely to remain a hostage to imbalances in the housing market while its structural problems go unresolved.

"It's up to the politicians to decide whether they want to deal with these problems and, more than anything, when," Nordea's Helgesson said. "In the current situation, it is very hard to tackle them."

($1 = 10.6895 Swedish crowns)

Source: Yahoo

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Justin

Economic

Western visitors returning to China for face-to-face meetings, as OMFIF did last week, will find a country as keen to attract outside investment as it is to develop a self-sufficient financial and technological ecosystem. Hong Kong’s role in this complex process seems more important than before.

Hong Kong has noticed a marked outflowing of wealth management operations to Singapore and is now putting together a well-funded campaign to try to reverse the trend. To hear this from the Hong Kong Monetary Authority, InvestHK and others based in the special administrative region isn’t surprising. To hear it from the People’s Bank of China and the major Chinese banks perhaps is. The clarity and uniformity of the message sounded like Chinese government policy. Why?

The wealth management migration is attributed to political risk, as some high-level financiers have disappeared in Hong Kong and found themselves helping Chinese authorities with their enquiries. Departing expats grumble about the national security law, although a Hong Kong official contended that it is less stringent than the US Patriot Act.

Before Covid-19, when civil unrest in Hong Kong was more of a visible nuisance for Beijing than it is now, financiers suggested that Hong Kong would eventually become merely a suburb of neighbouring Shenzhen on the mainland, now a 15-minute train ride away. The political unrest has subsided, while China’s interest in attracting external investment has risen.

A senior regional government official, who had managed to attract a foreign whisky producer to his city despite the challenges of doing business during Covid-19, enquired how serious a problem OMFIF thought China’s indebtedness is (with a 273% economy-wide debt to gross domestic product ratio). Another mentioned state belt-tightening after Covid-19, alongside a keenness to re-engage foreign direct investment in China’s expected resumption of growth (5% in 2023 versus a little more or less than 1% in the US and euro area respectively). A central banking official also raised the idea of converting troubled Belt and Road Initiative debts into bonds to move them off Chinese bank balance sheets and into the capital markets at large.

China’s capital account remains materially closed. Investment in onshore securities requires qualified foreign institutional investor status. The Shanghai Stock Exchange enables international investors to access some Chinese securities via its Stock Connect programmes, including with Hong Kong, and the SAR remains a key venue for major Chinese companies. Alibaba has moved there from the US as geopolitical rivalry increases. The US Inflation Reduction Act includes a provision to prevent subsidies drifting towards Chinese battery makers, for example.

Though some suggested that the resumption of face-to-face business meetings would improve East-West estrangement by osmosis, most Chinese bankers are under no illusions about American political antipathy. The idea that this lives in a separate universe to the $700bn mutual trade relationship is beginning to erode. We heard anecdotal evidence of US asset management investment decisions being withdrawn.

Our interlocutors are still trying to work out whether Europe is in the same camp. While Germany, for example, has said it is in no rush to decouple, European receptiveness probably depends on the materiality of Chinese support for Russia’s military operations in Ukraine.

Those officials hosting OMFIF did not need prompting to raise this prickly theme, though they greeted with mild acquiescence rather than enthusiastic endorsement the idea that China might hold the answer to ending the war.

Trade and investment with the UK are even more ambiguous for Chinese business people. There is pragmatic acceptance in private that mutual investment in strategic technology is moving off limits. But there is also frustration at the unpredictable nature of the rules as the ruling Conservative party under an assortment of prime ministers zigzags between crass mercantilism and American-sponsored Sinophobia.

The UK remains an interesting case for the Chinese. It is home to a global bank with Chinese roots, has long-standing business links via Hong Kong and a well-developed global financial centre. China sends the largest cohort of foreign students to British universities. OMFIF met officials who expected this to continue despite geopolitical divergence and the UK’s perceived tutelage to US priorities, which include the ring-fencing of key technologies, protection of the leading global reserve and trading currency and defence of interests in the Pacific region.

The PBoC, which emphasised to OMFIF the importance of Hong Kong to the Chinese capital markets ecosystem, dismissed the idea that China seeks to supplant the dollar. But it raised the not unreasonable suggestion that China’s $18tn economy might conduct trade with partners in its own currency.

Meanwhile the ‘mBridge’ cross-border central bank digital currency project, which includes the UAE as well as PBoC, looks to some like the potential evolution of a financial ecosystem outside the control of the West – as Swift is perceived to be and was obliged to sanction Russia. mBridge includes Hong Kong, whose currency remains pegged to the dollar and whose financial markets are still underpinned by ‘Common Law’, praised by President Xi Jinping last year despite its colonial origins.

Hong Kong’s twin life between Chinese and Anglo-Saxon financial systems is only going to become more important as those ecosystems diverge, while needing still to do business.

Source:John Orchard

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Thomas

East Asia is set to remain the top wind power production region thanks to a project development pipeline that will expand current wind power capacity by 65% by the end of 2030, according to data from Global Energy Monitor (GEM).

Wind is the largest and fastest-growing source of renewable power globally, and is expanding by a record pace in every major economy as part of global efforts to transition energy systems away from fossil fuels and reduce harmful emissions.

Wind power generated roughly 7.8% of the world's electricity in 2022, but must expand by enough to produce 21% of global electricity by 2030 if net-zero emissions goals are to be achieved, according to think tank Ember.

Such aggressive expansion targets mean that the recent breakneck development pace must be maintained or surpassed annually for the rest of the decade, and be distributed throughout the world's largest power consuming regions.

East Asian Dominance

China will remain the largest wind producer and top wind capacity developer, but South Korea, Japan and Taiwan will all post faster growth rates than China through 2030, according to GEM.

East Asia Set to Win Scramble for Wind Power Dominance by 2030_1

China's current wind generation capacity of 278,876 megawatts (MW) will balloon by 41% to nearly 400,000 MW once projects that are currently under construction or planned by 2030 come online, GEM data shows.

While no other country will match the sheer scale of China's wind power additions, many will dwarf its growth rate as they play catch up with the world's green power leader.

South Korea, which currently ranks 38th on the global list of wind power by capacity, will vault to 6th place by the end of 2030 once all 40,869 MW of planned and under-construction projects come on stream - a 3,275% swell from current capacity.

Taiwan is set to grow its current wind capacity by 823% to 16,460 MW, while Japan's is set to grow by 440% or by roughly 15,000 MW to nearly 19,000 MW in total by 2030.

Combined, these East Asian countries are set to account for 36.2% of world wind capacity by 2030, GEM data shows, with the region remaining the largest hub for wind power.

Europe Rising

Europe will be the second largest wind power developer over the remainder of this decade, boosting capacity by 68% from current levels.

East Asia Set to Win Scramble for Wind Power Dominance by 2030_2

Germany, Spain, France and Sweden plan to boost their collective capacity by nearly 40,000 MW by 2030, and will all rank among the top 10 global wind producers.

Other large capacity increases are planned in Poland, Finland and the United Kingdom, ensuring that the region's largest economies will all benefit from double-digit growth in green energy supply capacity within the coming decade.

American Expansion

Steep wind power growth will also be seen across the Americas, with the United States set to cement its position as the second largest wind producer via a 53% swell in current capacity to 212,133 MW by 2030.

Brazil looks set to more than treble its current wind capacity and jump to third in global rankings from 7th place currently, while Canada and Mexico also look primed for notable growth.

South Asia, Africa & Middle East

India's wind power capacity will climb by 25% by 2030, but the country will slip in world rankings from 4th to 7th as other nations bring greater wattage online.

South Africa, currently Africa's top ranked wind producer (25th), will drop to 28th by 2030, and be replaced by Egypt as the continent's top wind generator, followed by Morocco and Algeria.

Saudi Arabia looks set to be the largest wind power producer in the Middle East once it raises current capacity by 125% to 900MW.

Australasia And Beyond

Australia and New Zealand are also set for rapid wind power expansion over the coming years, with current capacity primed to jump by 422% or roughly 52,000MW to 64,109MW if all planned projects tracked by GEM come to fruition.

Such a steep increase in renewable power capacity has the potential to drastically reshape Australia's power system, and potentially turn the country into a net power exporter if proposed interconnection lines feeding Southeast Asia are built.

Vietnam is also primed for major wind power growth, with over 11,000 MW of capacity planned by 2030 to cement the country's status as a top-20 global wind producer.

In all, given the rapid pace of wind expansion in every region, the global goal of having wind power generate over 20% of global electricity by 2030 is potentially achievable, especially if outdated fossil fuel generation capacity is shuttered over the same period.

Source: Reuters

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Justin

Central Bank

Cryptocurrency

Take a moment to empathise with cryptocurrency regulators. We’ve tasked them with managing a constantly morphing ecosystem that is both plagued by lawlessness and built atop blockchain technology that thwarts outside control. The effort required to identify and apprehend pseudonymous criminals makes enforcement impracticable for most blockchain crimes, and no amount of effort can stop an automated decentralised autonomous organisation like Tornado Cash.

As a result, regulators are relegated primarily to know-your-customer processes via fiat on-/off-ramps to accomplish enforcement. In a decentralised, permissionless environment, relying on KYC alone is like attempting to tame the ocean by damming a few rivers. Effective regulation requires the full capabilities of law enforcement to protect property rights, remedy breaches of contract and intervene to stop crimes in progress.

Such capabilities are available through layer 1 protocols that enforce the law on-chain. These protocols obviate the need to seize private keys from pseudonymous criminals by enabling direct action on wallets and smart contracts. Officials invoke these protocols by obtaining a court order, just as they would for off-chain enforcement. For example, the US Treasury could shut down Tornado Cash by demonstrating cause to enjoin its smart contracts, or could seize assets by obtaining a warrant.

On-chain enforcement was unthinkable to most even a year ago but, having endured weekly hacks for hundreds of millions of dollars and frauds for tens of billions more, the blockchain community is ready to embrace it. Most market participants not only acknowledge the need for effective law enforcement but are demanding it. Many see on-chain enforcement as the best hope to thaw the crypto winter and establish blockchain as the backbone of mainstream commerce and the decentralised internet.

Adoption is already underway. Bitcoin SV (a top-50 blockchain proclaiming dedication to ‘Satoshi’s vision’) recently implemented a protocol for blockchain authorities to enforce court-ordered transfers of BSV coins. The community hopes this development ingratiates it with regulators and diverts users from legacy bitcoin. Similarly, Jurat’s layer 1 protocol enables consensus about the meaning of court orders so that nodes can execute them autonomously. The premise for on-chain enforcement is strong. More blockchains will follow.

There are several objections to on-chain enforcement, but none should give regulators pause.

First is the fear that tyrannical officials will seize digital assets. It is worth noting that those expressing this concern also own houses, cars and bank accounts, all of which the government leaves alone. Due process is an excellent protector of property rights, so limiting on-chain enforcement to valid court orders will keep digital property as sacrosanct as physical.

Potential for abuse by intermediaries is a second objection, but an exaggerated one. Bitcoin SV chooses trusted ‘notaries’ (assumedly solicitors) to interpret and publish court orders to the network. Jurat, by contrast, eliminates intermediaries by generating machine-readable hashes for judges to include in their docketed orders.

Third is concerns about ledger immutability. These misunderstand the on-chain enforcement process. Courts do not rewrite ledgers. Rather, they enforce the law through a new remedial transaction that changes the effect of a prior (illegal) one. They do not alter the ledger itself.

Regulators have multiple paths forward. Mandating minimum enforcement standards is one, but the multijurisdictional nature of public blockchains makes this impracticable. A second option is to do nothing. Self-interest should drive adoption given that property becomes more valuable as legal protections are strengthened. A third is for influential agencies like the US Treasury and the Securities Exchange Commission to offer a regulatory sandbox when providers use blockchains with on-chain enforcement. The move is justified because oversight is reduced when private actors can enforce legal rights (think of shareholder suits for fraud). This approach will also hasten legal protections on-chain – the ultimate goal for any regulatory scheme.

Source:JMichael Kanovitz

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Justin

Central Bank

Economic

Forex

PBoC cuts RRR

China's central bank, the People's Bank of China, cut its required reserve ratio by 25bp to 10.75%. This releases yuan liquidity of 500 billion.

Why does the PBoC need to inject liquidity in the money market during an on-track recovery?

The economic data is not as good as expected. Retail sales grew 3.5% year-on-year, year-to-date, which was slower than market expectations. But this was mainly driven by the discontinued subsidies for electric cars. We believe that the RRR cut will hardly help to boost EV sales.

However, the cut could help to lower market interest rates, which could help to lower bond issuance interest costs. This may benefit real estate property developers and local government financial vehicles for their funding needs.

Another reason for the cut, which should be a supplementary one, could be to provide a cushion against any potential negative impact from global market turmoil. If foreign investors need cash and there are sudden capital outflows from China, there is at least some immediate cushion. Surely in such an event, the PBoC would inject more liquidity into the market.

RRR cut should have negligible impact on USD/CNY

The CNY exchange rate usually follows the dollar index closely. This is especially true right now when market players are watching the market very closely.

As such, this RRR cut should not affect the USD/CNY exchange rates to a large extent. There might be some softening of the yuan briefly. We keep our forecast of USD/CNY at 6.90 by the end of this quarter

We do not expect the PBoC to cut interest rates or the RRR any further in the first half of this year unless global market conditions become extreme, as the economic recovery is on track.

Source:ING

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Devin

Bond

Rising interest rates are beginning to awaken concerns about debt sustainability in several overextended eurozone nations. Steering them away from a fatal path may soon become the European Union's next big challenge.

However, a remake of harsh austerity measures implemented in Greece and some other EU countries during the previous decade's financial and sovereign debt crises will not happen, given the undeniable failure of these policies. What remains possible is a "hybrid" approach that could combine the eurozone's further monetary tightening with even looser fiscal policies by member governments.

From a free lunch to public debt

In early 2015, the European Central Bank (ECB) launched its first large-scale quantitative easing (QE) programs. Ever since, the euro area economy has been drowning in cheap money. Moreover, interest rates stayed near zero for years. Between September 2019 and July 2022, they even went negative – clearly, a debt-friendly context.

Back then, the vertiginous rise of debt was not a concern for the ECB; its priority was to combat critically low inflation. Strangely enough, despite trillions of euros pumped over time into the eurozone, the central bank's 2 percent inflation target remained out of reach.

When the pandemic hit in March 2020, forcing governments to lock down their economies, inflation fell even lower. As the specter of deflation was looming, policymakers and economists urged governments worldwide to "spend as much as they can … and then spend a little bit more." Eurozone governments took the advice quite literally. Many let their debts and deficits balloon to unseen levels – substantially higher than those observed during the 2010s when a systemic sovereign debt crisis had threatened to destroy the euro.

And yet, elite economists, mainly those close to the International Monetary Fund (IMF), insisted that "we must think differently about the sustainability of public debt." As long as growth rates exceed interest rates, governments should not worry about debt too much, the argument went.

Undeniably, a more lenient attitude toward debt helped mitigate the real economy's damage caused by the pandemic. However, to some particularly spendthrift governments, the IMF's famous "spend, spend, spend" motto may have sounded like an invitation to take on ever more irresponsible debt.

Governments had been reassured that they could count on the ECB as a lender of last resort if their debt came under pressure on sovereign bond markets. And indeed, early in the health crisis, the ECB had acquired the habit of buying the debt notably of southern eurozone states. As a result, its total asset curve rose sharply, peaking at nearly 8.9 trillion euros in July 2022. Still, inflation did not pick up – until it did, and 2022 finally became a wake-up year to reality.

Sovereign debt specter returns

By late 2021, a rising inflation trend was perceptible in the eurozone. A few months later, it would hit double-digits. Also, it turned out to be persistent, not transitory (i.e., pandemic-related), as the ECB had pretended for over a year. And then, on February 24, 2022, the Ukraine war took the world by surprise.

The war exacerbated Europe's emerging inflation problem by creating an unprecedented energy shock. The timid post-pandemic recovery was wiped out within weeks, and a new recession was looming. Globalization was in retreat. Europe found itself in a perfect storm of adverse, deeply entangled geopolitical and macroeconomic factors. In this exceptional context, eurozone governments continued on their path of fiscal activism, this time to help households (and, to a lesser extent, firms) get through the energy crisis.

However, the threat of stagflation forced the ECB to change course and tighten its monetary policy. Between July 2022 and February 2023, it proceeded to six interest rate hikes, pushing borrowing costs to the highest levels since late 2008. Moreover, asset purchase programs were closed, leading to a progressive slimming of the ECB's balance sheet. By January 2023, its total assets had already fallen to 7.894 trillion euros (from the peak of 8.828 trillion euros in July 2022).

The time seems ripe for closer attention to public debt and deficits. In a setting of low (possibly negative) growth perspectives, rising interest rates generate concerns about debt sustainability in several eurozone nations. Steering those countries away from disastrous debt paths might soon become the EU's next big challenge.

'Austerity' as a dirty word

The word "austerity" had been banished from European policymakers' vocabulary long ago. Apparently, too many negative or punitive connotations can be associated with the term for it to still fit in the policy toolkit of a modern welfare state.

The United Kingdom, a former EU member state, recently broke the taboo by announcing significant tax hikes for the upcoming months, combined with no less drastic public spending cuts. Facing the consequences of years of excessive fiscal spending and a monetary policy running out of options, the EU may be tempted to follow Britain's lead.

The pending reform of the bloc's common fiscal rules for limiting public debt and deficits, grouped under the Stability and Growth Pact, suspended at the pandemic's outbreak and not reinstated yet, could become the occasion to revive long-abandoned debates.

Reportedly, some voices in European policy circles already call for a return to the hardline austerity policies adopted in the EU during the financial and sovereign debt crises a decade ago. However, it is unlikely that these appeals will be heeded: the blatant failure of the austerity experiments conducted in the early 2010s is still vivid in policymakers' minds.

The damaging rescue

In those turbulent years, to fend off a devastating euro crisis, European heads of government had agreed to bail out those standing closest to the precipice: Greece, Cyprus, Ireland and Portugal. A credit line was granted to Spain. In return, the beneficiary countries had to comply with highly stringent conditions, notably the structural reforms they were asked to carry out at home. "Cut as much as you can" was the leading motto back then.

The idea was that drastic reductions could be applied virtually to everything in the concerned nations' economies – from the number of public companies to the salaries of public employees and all kinds of government services, including in critical infrastructure sectors such as healthcare and education. Bonuses, overpay, and pensions had to be capped, while the age of retirement needed to go up. Labor markets had to be reformed, and government hiring largely adjourned.

Existing taxes were to be increased substantially, and new ones were invented. The targeted member states also needed to rebuild their administrative capacity to collect and spend funds more efficiently. Some had overly complicated and ineffective tax collection systems that favored tax evasion, corruption and the development of large informal sectors. In some cases, entire institutional and regulatory frameworks had to be revised.

Many of the required reforms made sense. After years of profligate public spending (before and after the 2008 financial crisis), these countries had amassed structural deficits so colossal that many eurozone leaders believed outside coercion was the best way to bring their finances into order.

Oxymoronic policy

At the time, the bet was that the painful efforts and sacrifices would inspire "business-boosting confidence" among foreign investors. Hence, economic growth would be at the end of the tunnel for the eurozone's problem children. That assumption was at the heart of a policy model optimistically named "expansionary austerity."

Alas, the plan backfired badly on the nations under duress. Investors largely stayed away, and companies went bankrupt in droves. Unemployment exploded, and productive capacities declined. Growth was fading. Public debt-to-GDP ratios and, with them, the risk of sovereign default did not necessarily decrease. Social unrest was brewing, giving rise to anti-European sentiments. A profound divide between the eurozone's north and south emerged, and the bloc's already fragile cohesion was at risk of a breakdown.

According to some critics, the bailout programs implemented in the 2010s were not even lawful. The terms had been so severe that their application pushed several countries into a fiscal trap from which some have yet to fully emerge.

The spiral of economic contraction (some referred to it as "austerity on steroids") forced upon societies not only deepened their depression and delayed economic recovery but pushed large parts of populations to the brink of poverty. Notably, Greece was driven into a genuine humanitarian emergency.

Groping for creative solutions

Overall, these "austericidal" policies had disastrous economic and political consequences that continue to haunt Europe up to the present day. In hindsight, many asked: How could seasoned policymakers fall prey to what American economist Paul Krugman called the "austerity delusion"? How could they reasonably believe that growth would come back after desperate and indebted governments were compelled to impose on their already depressed economies the strictest fiscal austerity measures ever seen in the economic and monetary union?

Today, EU policymakers face a nasty dilemma. Hardline austerity was a failure, a remake is not an option. But the opposite stance, aggressive fiscal stimulus, has reached its limits too.

An option to consider: selective austerity

Some economists predict a "regime shift" that marks a rupture between monetary and fiscal policies. The ECB's monetary policy may shift toward ever more tightening to fight inflation, while member states' fiscal policies might become ever looser. Budgetary spending is already exploding in sectors such as healthcare, defense, and the green and digital transitions. Big government is here to stay.

Beyond an emerging conflict between monetary and fiscal policies, there are hints supporting even more hybrid scenarios.

For example, in July 2022, the ECB adopted an emergency QE program dubbed the Transmission Protection Instrument (TPI). Even in the current context of quantitative tightening, this new monetary policy tool will allow the ECB to implement selective QE by purchasing all the new debt issued by eurozone countries in distress.

In a way, TPI is a bailout mechanism in all but name, except that (unlike what was going on during the 2010s austerity era) very few conditions are attached for countries to benefit from it. Even though it has not been put into practice yet, the newly created rescue program has been criticized for incentivizing fiscally fragile governments to continue assuming more and more excessive debt without engaging in serious structural reforms.

EU policymakers seem aware of the problem. The European Commission is currently exerting pressure on precisely those governments whose debt-to-GDP ratios are excessively high, urging them to implement cost-containment measures, notably in pensions.

Spain is a case in point. By now, the national social security fund is well shy of being able to cover the payment of pensions. In 2022, over 224 billion euros was needed, but only 152 billion euros was available. Year after year, the difference is financed by public debt. Currently, Spain's public debt-to-GDP ratio stands at an explosive 115 percent. According to forecasts, if nothing changes, it could balloon to 191 percent by 2050.

Three reform options are currently being discussed: decreasing pension amounts, raising the retirement age and increasing mandatory contributions to the system. So far, no consensus is in sight for any of them, much to the discontent of Brussels. France, too, is committed to conducting an ambitious pension reform needed to restore the state's fiscal balance. And that is supposed to be accomplished in a climate of social unrest.

If a government forces people to work longer and then pays them lower pensions, this can be seen as a selective austerity measure, as a particular group in society is affected. In contrast, other (discretionarily designed) groups are granted tax credits or specific welfare cheques – austerity for some, stimulus for others.

As part of an ideological road map, selective austerity might become a way to fine-tune redistribution within European welfare states. But it can also backfire. The current pension reforms do not consider the demand contraction to which they can lead after an increasingly large part of the population sees their purchasing power melt away.

Especially in European consumption-driven economies, this could adversely impact growth and, once again, affect the sustainability of public finances. The fact is that policies that consist of pressing the brake and accelerator at the same time are likely to create many new challenges for the eurozone's future.

Source: GIS

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Thomas

Sam Bankman-Fried's cryptocurrency exchange FTX collapsed over 10 days in November 2022. Last week, Silicon Valley Bank (SVB), a medium-sized bank little-known outside tech start-ups, crashed within 48 hours after spooked depositors rushed to withdraw their money.

And there is currently a sense of unease around Credit Suisse as the Swiss bank's shares plummeted after acknowledging "material weaknesses" in its internal controls on Tuesday (Mar 14).

Some have pointed to SVB not having a chief risk officer for most of 2022 as a key reason why the bank took wrong risks that led to its downfall. Others argue that loosened regulations on smaller banks to reduce compliance burden during the Donald Trump administration meant US regulators did not have their eye on the ball.

John Ray III, who took over as FTX CEO after Bankman-Fried's fall from grace, said in court documents: "Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here." Strong words, considering Ray oversaw Enron's liquidation in 2001.

The world has seen the collapse of Barings Bank and Enron, experienced the Asian Financial Crisis and saw the fall of Lehman Brothers which ultimately led to the Global Financial Crisis. 2022 saw the cryptocurrency crash. United States regulators stepped in to shut SVB, followed by Signature Bank, and had to introduce emergency measures, out of concern it might trigger a broader systemic banking crisis.

Major financial events in the last 25 years should drive home the message that risk and compliance culture is critical and needs to be deeply entrenched for sustainable business. Having no or insufficient checks and governance in place is a recipe for failure.

Compliance Typically Seen as A Chore

But risk and compliance are often seen as a box to be ticked to keep regulators satisfied. Businesses tend to view compliance as a roadblock to business growth, with onerous policies, controls and processes. Often colleagues in business units can see compliance as a chore – something to get over and be done with, rather than a crucial step.

In the early 1990s, compliance primarily focused on the Know-Your-Customer journey to combat money laundering. In the 2000s, the urgency to implement financial crime programmes to combat money laundering, counter financing of terrorism, and administer sanctions were introduced in the wake of the September 11, 2001 attack.

Today, risk and compliance functions have become even more critical, with digital offerings proliferating and a growing need to protect customers against online fraud.

Attitudes towards compliance have improved over the years and more companies are now taking more concerted efforts to get their compliance functions right.

Could SVB have survived if there had been more regulatory supervision? Perhaps. But a tighter regulatory environment still requires companies' compliance to work.

FTX and SVB made me, like it must have others in the risk and compliance profession, reflect on how much more is needed, particularly when it comes to the importance of embedding a compliance culture in our organisations.

Lessons From Prominent Failures

What are some lessons to learn from the fall of global financial players?

First, companies have a responsibility to their customers, especially those who seek wealth and investment services who tend to have FOMO, or a fear of missing out, and may not fully understand service providers' business models and systems.

There is still a long journey to go on consumer protection and to ensure the financial ecosystem remains safe and fair for all. How can we protect and educate those who are vulnerable, including our grandparents, our uncles and aunties, even our crypto-curious kids?

American business guru Warren Buffett once said that every employee must be his own compliance officer. More broadly, every employee, senior leader or even investor needs to be confident of what they stand for and make sure they have done due diligence before making any decisions.

At the bare minimum, companies need to ask if they feel comfortable recommending their products and services to their loved ones. Are we confident that our companies' systems and controls are robust, that personal data is well-protected? It starts with each employee taking personal responsibility and being accountable for the quality of choices, products and services.

Second, compliance culture must be an integral part of every business and not an afterthought. In fact, doing it right is better than doing more.

Especially in fintech start-ups, change is a constant. If the compliance team is involved in the activities of business units, it allows them to raise and resolve issues and gaps early.

Of course, every financial institution has its unique set of risks and vulnerabilities. Standard regulatory requirements provide a good guide and framework, but in truth, there is no one-size-fits-all solution, especially when it comes to policies to deal with financial crime. A good way to start is to understand the regulatory landscape and industry practices before designing a tailored programme that specifically caters to the organisation's needs.

Would it have caught red flags?

Employees with a compliance mindset may not have much impact if the problems start at the top.

Enron had the values it extolled - integrity, communication, respect and excellence - painted on the company's walls and highlighted in annual reports, but the leadership team still fooled regulators with fake holdings and unethical accounting practices.

With FTX, it was a case of lack of governance. There was no board to question the controls as Bankman-Fried treated the company as his "personal fiefdom" and gave free reign to his inner circle.

But these are ultimately extreme examples. They should tell us that for most companies, the approach to compliance needs to move away from the idea that it is simply a matter of preventing fraud.

Instead, it must be aimed at integrity management - honouring individuals' moral, ethical and spiritual values which are key elements for proper functioning of organisations. The responsibility of managing risk and compliance is not just on a person or a division. It is about doing the right thing. Throughout entire organisations, everyone must be trained and educated on what the right thing to do is, and how to react when something goes awry.

The post-pandemic operating environment will throw organisations novel challenges and require changing mindsets and robust corporate governance.

To deal with this, companies will need to re-evaluate and build a culture of compliance that corresponds with the demands of innovation, employees, regulators and the community. Those who recognise the importance of this will have first-mover advantage.