The recent bursting of the great global credit bubble not only led to the
first worldwide recession since the 1930s but also left an enormous burden of
debt that now weighs on the prospects for recovery. Today, government and
business leaders are facing the twin questions of how to prevent similar crises
in the future and how to guide their economies through the looming and lengthy
process of debt reduction, or deleveraging.
To help address these questions, the McKinsey Global Institute launched a
research effort to understand the growth of debt and leverage before the crisis
in different countries, the economic consequences of deleveraging, and the
practical implications for policy makers, financial regulators, and business
executives. In the course of the research, MGI created an extensive fact base on
debt and leverage in each sector of ten mature economies and four emerging
economies. In addition, MGI analyzed 45 historic episodes of deleveraging, in
which an economy significantly reduced its total debt-to-GDP ratio, that have
occurred since 1930.
This analysis adds new details to the picture of how leverage grew around the
world before the crisis and how the process of reducing it could unfold. MGI
finds that:
Leverage levels are still very high in some sectors of several
countries—and this is a global problem, not just a U.S. one.
To assess the sustainability of leverage, one must take a granular view
using multiple sector-specific metrics. The analysis has identified ten
sectors within five economies that have a high likelihood of deleveraging.
Empirically, a long period of deleveraging nearly always follows a major
financial crisis.
Deleveraging episodes are painful, lasting six to seven years on average
and reducing the ratio of debt to GDP by 25 percent. GDP typically contracts
during the first several years and then recovers.
If history is a guide, many years of debt reduction are expected in
specific sectors of some of the world’s largest economies, and this process
will exert a significant drag on GDP growth.
The right tools could have identified the unsustainable build-up of
leverage in pockets of several economies in the years leading up to the
crisis. Policy makers should work to develop a more robust system for tracking
leverage at a granular level across countries and over time. One needs to look
at specific metrics such as the growth of leverage, and the borrowers' ability
to service debt if there is a disruption to income or rise in interest rates.
MGI found that sufficiently granular data do not exist today.
MGI's analysis provides support for several of the current regulatory
proposals, including improving the quality of bank capital through higher Core
Tier I ratios, monitoring leverage as a proxy for asset bubbles, and creating
better macro-prudential regulation to reduce systemic risk. However, the
analysis raises questions about some aspects of the current regulatory agenda,
such as limiting gross leverage ratios (which did not change appreciably in
most banks).
Coping with pockets of deleveraging is also a challenge for business
executives. The process portends a prolonged period in which credit is less
available and more costly, altering the viability of some of business models
and changing the attractiveness of different types of investments. In historic
episodes, private investment was often quite low for the duration of
deleveraging. Today, the household sectors of several countries have a high
likelihood of deleveraging. If this happens, consumption growth will likely be
slower than the precrisis trend, and spending patterns will shift.
Consumer-facing businesses have already seen a shift in spending toward
value-oriented goods and away from luxury goods, and this new pattern may
persist while households repair their balance sheets. Business leaders will
need flexibility to respond to such shifts.
Global capital markets: Entering a new era World financial assets fell by $16 trillion to $178 trillion in 2008, marking the largest setback on record and a break in the three-decade-long expansion of global capital markets. Looking ahead, mature financial markets may be headed for slower growth, while emerging markets will likely account for an increasing share of global asset growth. Read more
McKinsey conversation Authors Susan Lund and Charles Roxburgh examine how the crisis rolled through the global financial system—and discuss the implications for the future of the global economy. Listen to the podcast
An exorbitant privilege? Implications of reserve currencies for competitiveness Observers assume that the United States enjoys an "exorbitant privilege" because the dollar is the global reserve currency. But MGI finds that in 2007/8, the United States gained a net benefit of just $40 billion to $70 billion—0.3 to 0.5 percent of US GDP. In the "crisis year" to June 2009, the benefit fell to between -$5 billion and $25 billion. Given this, could the United States prioritize domestic growth and jobs over its global responsibilities, sparking greater currency volatility that threatens competitiveness? Read the discussion paper Read a series of essays and join the debate on the future of the dollar on What Matters
The new power brokers: How oil, Asia, hedge funds, and private equity are faring in the financial crisis The power brokers collective performance in the financial crisis, though better than the sharp declines in wealth of most institutional investors, masks an important shift: Asian sovereign and petrodollar investors emerged as more influential than ever, while hedge funds and private equity saw their previously rapid growth interrupted. Read more
Will U.S. consumer debt reduction cripple the recovery? U.S. consumers are spending less and saving more. Unless incomes grow faster, each percentage point increase in the saving rate would reduce spending by more than $100 billion—a serious drag on any recovery. Read more
Leading through uncertainty As consumers batten down the hatches and the global economy slows, senior executives confront a more profoundly uncertain business environment than most of them have ever faced. Companies that nurture flexibility, awareness, and resiliency are more likely to survive the crisis, and even prosper. Read more
