Last month we were startled by an alarming investigation by the Japanese bank Nomura. According to that research, the Netherlands – along with the US, Germany, Japan, Taiwan and Sweden – would be heading for a financial crisis sometime in the next twelve quarters.
That is remarkable. Because how can a rich country like the Netherlands balance on the edge of the abyss? With our relatively low government debt, a strong competitive position, well-capitalized banks, the highest creditworthiness at rating agencies, a relatively low unemployment rate and a highly educated labor force?
And that while vulnerable emerging markets, such as Hungary, Brazil, Chile, Turkey and Colombia, would not be at any risk. What does Nomura see that the rest of the world doesn’t?
Nomura has developed an early warning system for financial crises. Think of it as a group of smoke detectors that go off before a major fire. Nomura’s signaling system uses five indicators as ‘smoke detectors’, including private sector lending (households and non-financial corporations) and real stock and house prices.
Nomura’s ‘smoke detectors’ go off when the deviation from a long-term trend exceeds a certain threshold value. For the Netherlands, for example, the alarm will go off when real house prices are 12 percent above the historical trend. The detectors can also go off simultaneously if a combination of lower threshold values are exceeded.
According to Nomura, their signaling system would have correctly predicted three quarters of the financial crises since the 1990s. That sounds nice, but closer analysis shows that we wouldn’t think twice about installing Nomura’s signaling system in our own home.
Admittedly, detectors would have been beeping to warn us of the 2008/2009 financial crisis. But those same ‘smoke detectors’ had been beeping for eight years (!) prior to the crisis.
So there is a good chance that in that period we would have pulled them off the wall screaming in misery and thrown them out the window. In addition, the financial crisis started in the US in 2008 and resulted in a global recession that unfortunately did not pass us by.
More generally, Nomura’s signaling system with five indicators simply does not do enough justice to the specific situation in economies, which can eventually lead to a financial crisis. To give an example: the idea behind the real house price as a ‘smoke detector’ is that an excessive rise in it leads to excessively high mortgage debts, which makes households financially vulnerable to, for example, a rise in interest rates.
But for the Netherlands specifically, the fixed-rate period of mortgages is generally fixed for a very long time nowadays. The interest rate sensitivity of our mortgage debt is therefore not that bad and the question is whether this has been taken into account in Nomura’s system.
Nomura also only looks at the debt side of the private sector (households and non-financial businesses), but again they do not take into account that the private sector in the Netherlands has a lot of capital to absorb setbacks, of which roughly 750 billion euros directly. is available.
Nomura’s work is especially useful as a reminder to stay alert for vulnerabilities in the economy. We must continue to pay attention to this, precisely to prevent that we end up on the eve of a financial crisis again at some point.
For example, the housing shortage and the resulting overheated housing market are a problem and lead to an undesirable dichotomy in our country. And although our pension system has many positive aspects, compulsory savings for old age means that young people can take little savings with them when buying their own home and therefore have to take on a high (but fortunately fixed-interest) mortgage debt.
This problem is exacerbated by the fact that our country has a major shortage of affordable rental housing and that taking on debt is strongly encouraged in our country, for example via mortgage interest deduction. So there is definitely work to be done to tackle these kinds of vulnerabilities in the Dutch economy. But is our country in a worse economic position than Brazil or Turkey? That seems very strong to us. Please don’t let us be guided by overly simplistic ‘smoke detectors’.
Hugo Erken and Wim Boonstra