Debt and (not much) deleveraging

Debt and (not much) deleveraging Peterson Institute for International Economics Susan Lund, McKinsey Global Institute

Global debt has increased by $57 trillion since the crisis began with $25 trillion increase in the private sector Global debt outstanding by type 1 $ trillion, constant 2013 exchange rates 199 40 Household 87 19 26 142 33 38 33 56 Corporate 58 Government 22 20 37 45 Financial Total debt as % of GDP 4Q00 4Q07 2Q14 1 246 269 286 1 2Q14 data for advanced economies and China; 4Q13 data for other developing economies. SOURCE: McKinsey Global Institute analysis

Household debt Hidden time bomb?

Household leverage outside the core crisis countries continues to grow Household debt-to-income ratio, 2000 2Q14 % XX Change in debt-to-income ratio, 2007 2Q14 Percentage points 325 325 300 300 275 275 Denmark 2 250 250 Norway -5 225 225 Netherlands 200 200 Australia 175 150 125 0 75 Ireland United -17 Kingdom Spain -13 United States -33-26 175 150 125 0 75 Sweden Canada Malaysia South Korea Thailand Finland 19 22 7 18 28 11 50 50 France 15 25 25 0 0 2000 07 2Q14 2000 07 2Q14 SOURCE: McKinsey Global Institute analysis

Changes in house prices are correlated with changes in household debt-to-income across countries Change in household debt to income 2007 13, Percentage points 35 30 25 20 15 5 0-5 - -15-20 -25-30 Ireland Thailand Korea Poland Canada Sweden Czech Republic Belgium France Russia Indonesia Netherlands Denmark Finland Australia Italy South Africa Norway Spain Japan United States United Kingdom Germany Singapore Advanced economies Developing economies Correlation coefficient = 60% Malaysia China -45-40 -35-30 -25-20 -15 - -5 0 5 15 20 25 30 35 40 45 50 55 60 65 70 75 Change in house price 2007 13, % SOURCE: McKinsey Global Institute analysis

US states with the greatest increase in house prices before 2007 also saw the biggest rise in debt-to-income ratios Household debt-to-income ratio 1, % 2000 2007 House price increase 2000-07, % Debt-to-income ratio End-2013, % California 126 214 7 149 Nevada 2 189 112 120 Arizona 1 185 91 131 Maryland 5 157 116 133 Florida 76 139 6 99 Illinois 83 125 56 1 New York 74 9 87 95 Ohio 78 8 8 89 Texas 74 98 30 82 Kansas 68 93 20 82 1 Household debt balances by state are estimated by the Federal Reserve Bank of New York based on the population with a credit report. We estimate household debt to disposable income by state using additional data from the US Census Bureau. SOURCE: McKinsey Global Institute analysis

In Denmark, the wealthiest households had the largest increase in leverage - in contrast to the United States Median debt-to-income ratio for indebted households by income percentile, % Denmark United States 280 263 2000 2007 79 74 55 52 117 80 205 160 216 231 178 138 140 115 192 194 196 157 135 125 116 4 Income percentile Change in debt-toincome ratio, 2001 07 Percentage points Median debtto-income ratio, 2013, % <20 20 40 40 60 60 80 80 90 90 0 <20 20 40 40 60 60 80 80 90 90 0 24 22 37 45 47 49 41 26 57 70 79 54 81 82 127 216 277 292 197 156 155 171 172 151 SOURCE: Statistics Denmark microdata; US Survey of Consumer Finances microdata; McKinsey Global Institute analysis

In Denmark, the wealthiest households had the largest increase in leverage - in contrast to the United States Median debt-to-income ratio for indebted households by income percentile, % Denmark United States 280 263 2000 2007 79 74 55 52 117 80 205 160 216 231 178 138 140 115 192 194 196 157 135 125 116 4 Income percentile Change in debt-toincome ratio, 2001 07 Percentage points Median debtto-income ratio, 2013, % <20 20 40 40 60 60 80 80 90 90 0 <20 20 40 40 60 60 80 80 90 90 0 24 22 37 45 47 49 41 26 57 70 79 54 81 82 127 216 277 292 197 156 155 171 172 151 SOURCE: Statistics Denmark microdata; US Survey of Consumer Finances microdata; McKinsey Global Institute analysis 7

Household debt in seven countries appears most worrisome Highest Country Debt-to-income ratio, 2Q14, % Change in debt-toincome ratio, 2007 2Q14, p.p. Debt servicing ratio, 2013, % Lowest House price increase, 2007 2Q14, % Netherlands South Korea Canada Sweden Denmark Norway Australia Malaysia Thailand Ireland Belgium Finland UK Spain Portugal China France Brazil Russia United States Germany Italy 230 144 155 157 269 266 168 146 121 175 93 6 133 113 115 57 87 41 27 99 83 62 18 22 19 2-5 7 28-33 16 11-17 - 13-9 22 15 14 9-26 - 11 7 23 22 8 15 24 19 26 44 19 20 22 16 25 21 8 18 22 20 13-18 15 28 18-13 30 28 62 27-43 15 14 9-31 - 2 86-2 178 20-9 18-18 SOURCE: National sources; BIS; Eurosystem Household Finance and Consumption Survey; IMF; McKinsey Global Institute analysis

China s soaring debt Three risks to watch

China s debt reached 282 percent of GDP in 2014, higher than debt levels in some advanced economies Debt-to-GDP ratio, % Household Non-Corporate Government Financial China By country, 2Q14 282 38 China 38 125 55 65 282 121 8 83 23 7 2000 158 125 20 72 55 42 65 24 2007 2Q14 Australia 113 69 31 61 274 United States 77 67 89 36 269 Germany 54 54 80 70 258 Canada 92 60 70 25 247 NOTE: Numbers may not sum due to rounding. SOURCE: McKinsey Global Institute analysis

Nearly half of China s debt is related to real estate China s real economy outstanding debt by sector, 2Q14 % 14 Real estate sector Other sectors 56 0% = $21.6 trillion 12 Real estate - related sectors 8 Local govt. financing vehicles (LGFV) Household mortgages SOURCE: People s Bank of China; National Audit Office; McKinsey Global Institute analysis

Local government debt has grown rapidly since 2007, linked to real estate and infrastructure Outstanding balance of China s government debt by source $ trillion, constant exchange rate, 2013 6 5 4 5.5 0.1 1.1 Local government bonds Other local government debt 40% of loans are repaid with land sales 1.7 LGFV bank loans 1 3 2 1 1.9 2.6 Central government debt 20% of new loans are used to repay old loans 0 2001 03 07 2Q14 1 Local government financing vehicles. SOURCE: People s Bank of China; National Audit Office; IMF; McKinsey Global Institute analysis

Shadow bank loans now accounts for 30 percent of outstanding Chinese debt Composition of China s debt, 2Q14 1 $ trillion Total = $21.6 trillion Banks 53% 30% 30.0% Shadow bank loans 2 Shadow banking entities $ trillion Wealth management products Entrusted loans 6.5 1.7 1.6 Credit growth 2007 2Q14 % 86 38 Trust loans 0.8 59 13% Government bonds 4% Corporate bonds Financing companies and other loans 2 2.4 23 1 Excludes financial-sector debt. 2 Includes loans from world co-operatives, microcredit institutions, Internet peer-to-peer lending, and informal loans. SOURCE: People s Bank of China; National Bureau of Statistics of China; National Audit Office; BIS; CICC; Goldman Sachs; expert interviews; McKinsey Global Institute analysis

China s government could raise enough debt to recapitalize the financial system, even if half of property loans defaulted Government debt-to-gdp % 1 Required increase to cover losses Assumptions: Default rate Property loans = 50% Property related = 40% Recovery rate = 20% 79 24 55 Advanced economy average Current Debt 2Q-2014 China SOURCE: People s Bank of China; expert interviews; McKinsey Global Institute analysis

Shadow banking Out of the shadows

The financial sector in advanced economies has deleveraged since the crisis Financial-sector debt (% of GDP) Index: 0 = 2000 200 Financial sector debt-to-gdp, % Peak 2Q14 180 France 2 93 160 United Kingdom 218 183 140 Netherlands 374 362 120 Japan 128 117 0 United States 62 36 80 Germany 97 70 4Q00 4Q07 4Q09 2Q14 NOTE: Debt as percent of GDP is indexed to 0 in 2000; numbers here are not actual figures. SOURCE: McKinsey Global Institute analysis

Shadow banking entities and instruments that were important before the crisis have declined $ trillion 2007 2014 1 58.2 19.5 8.7 7.9 6.4 4.3 5.1 4.6 2.7 1.9 0.3 1.0 0.4 CDS Repos (Europe) Repos United States Money market funds CDO/CMO ABCP SIV -67-9 -33-9 -29-70 -0 Decrease since 2007, % 1 As of June 30, 2014. SOURCE: McKinsey Global Institute analysis

Non-bank sources are ~50% of private sector credit in advanced economies Outstanding debt in advanced economies 1 $ trillion, constant exchange rates Compound annual growth rate (%) 55 12 55 11 59 13 Non - bank loans 2007 20 14 2-1.2 3.4 37 9 5 5 11 6 11 7 9 Securitization Corporate bonds -0.4 5.8-2.5 5.8 19 26 26 28 Bank loans 0.2 2.2 Share of nonbank credit, % 2000 2007 20 2014 2 50 53 53 53 1 United States, United Kingdom, Germany, France, Spain, Netherlands, Japan, South Korea, Canada, and Australia. 2 As of June 30, 2014. SOURCE: McKinsey Global Institute analysis

Since 2009, net new bank lending to corporates has been replaced by other sources Change in corporate debt in advanced economies 1 $ trillion, constant exchange rates Cumulative change $ trillion 1.8 2.1 1.9 2004 08 2009 14 1 1.2 Non-bank loans 2.1 0.6 0.5 0.4 0.7 0.8 1.2 0.9 0.7 0.2 0.8 0.1 0.5 0.4 0.2 0.1 Corporate bonds Bank loans Securitization 0.7 2.3 4.0-0.8 0.7-0.5-0.4-1.0-0.2-0.8 04 05 06 07 08 09 11 12 13 2014 2 1 Australia, Canada, France, Germany, Japan, Netherlands, South Korea, Spain, United Kingdom, United States. 2 As of June 30, 2014. SOURCE: McKinsey Global Institute analysis

Assets of credit funds have more than doubled since 2009 AUM of credit funds of 8 alternative asset managers, $ billion 406 12 26 32 61 CVC KKR Carlyle Group Ares Compound annual growth rate, 2009 14 1, % Types of credit, 2014 1 17 15 28 13 Distressed debt Direct lending 46 64 178 6 13 34 17 16 64 19 2009 48 37 82 8 1 2014 Blackstone Sakaty Oaktree Apollo Structured credit Mezzanine Other 2 1 As of September 30, 2014; Sakaty as of July 1, 2014. 2 Includes $48 billion of assets of Apollo s insurance subsidiary Athene. NOTE: Numbers may not sum due to rounding. 25 20 5 44 14 73 209 SOURCE: McKinsey Global Institute analysis

Finding stability in an indebted world

Eight tools for boosting financial stability in an indebted world 1 Encourage innovation in mortgage contracts 2 Improve process for private sector debt restructuring 3 4 5 6 Use macroprudential tools to dampen credit cycles Reduce tax incentives for debt Consider a broader range of tools for resolving sovereign debt Improve data collection and monitoring of debt 7 Create a healthy mix of bank and non-bank credit sources 8 Promote healthy financial deepening in developing economies

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