asset

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J A N UA RY 2 0 10
An early warning system
for asset bubbles
New research from the McKinsey Global Institute shows
that the right tools could have identified the recent global credit
bubble years before the crisis broke.
Susan Lund and Charles Roxburgh
▪
M C K I N S E Y G L O B A L I N S T I T U T E
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As policy makers and business leaders gather in Davos, Switzerland, this week,
much of their conversation will no doubt focus on how to drive a global economic recovery.
Yet they should spend just as much time and energy discussing how to prevent the next
devastating fnancial crisis—specifcally, how to spot and prick asset bubbles as they are
infating. For many years, some of the world’s most prominent central bankers said doing
so was impossible. However, new research from the McKinsey Global Institute (MGI)
shows that rising leverage is a good proxy for an asset bubble—and that the right tools
could have identifed the recent global credit bubble years before the crisis broke. We urge
policy makers to develop these tools and use them to ensure a more stable fnancial system,
thereby avoiding more of the widespread pain and suffering caused by the current crisis.
Our new MGI report, Debt and deleveraging: The global credit bubble and its economic
consequences, details how debt rose rapidly after 2000 to very high levels in mature
economies around the world. But to spot a bubble, we need to know how much debt is too
much. Some households, businesses, and governments can carry high levels very easily,
while others struggle with lesser amounts.
The answer lies not in the level of debt alone but in the sustainability of debt. If borrowers
cannot service their debt, they will go through a process of debt reduction, or deleveraging.
We see today, for example, that many debt-burdened households are deleveraging—
voluntarily and involuntarily—by saving more and paying down debt, or by defaulting.
To understand the sustainability of current debt levels, we looked at borrowing within
individual sectors and subsectors of individual economies and at more granular factors
such as the recent growth rate of leverage, borrowers’ ability to service the debt under
normal conditions, and borrowers’ vulnerability to a disruption in income or a spike in
interest rates.
Our analysis is far from perfect. The data we would ideally want are not wholly available.
Still, the results show that borrowers in ten sectors within fve mature economies
have potentially unsustainable levels of debt, and therefore have a high likelihood of
deleveraging. Half of the ten are the household sectors of Spain, the United Kingdom, and
the United States, and to a lesser extent Canada and South Korea—refecting the boom in
mortgage lending during recent housing bubbles. Three are the commercial-real-estate
sectors of Spain, the United Kingdom, and the United States—refecting loans made during
commercial property bubbles. The remaining two are portions of Spain’s corporate and
fnancial sectors, both of which thrived during that country’s real-estate bubble, which is
now defating.
These fndings confrm that the credit bubble was global in nature and fueled primarily by
borrowing related to real estate. More important, we see that this type of analysis could
have identifed the emerging bubble years ago, when its existence was still being debated.
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We performed the same exercise with data from 2006 and found that the household
sectors of several countries (South Korea, Spain, the United Kingdom, and the United
States) were already fashing red, as were the fnancial sectors in Switzerland, the United
Kingdom, and the United States, along with a portion of Spain’s corporate sector.
If these tools had existed and had been made use of in 2006, they would have signaled the
growth of credit bubbles in the red sectors almost two years before Lehman Brothers went
bankrupt, credit markets seized up, and the global economy started contracting for the
frst time since the Great Depression. And by pinpointing the sectors and countries, the
data would have helped regulators identify the specifc sources of the growing problem
and address them in a targeted way. For example, they could have required tighter lending
standards or bigger margin requirements in specifc credit markets that appeared to be
overheating.
Starting now, policy makers should develop a more robust international system to track
the growth and sustainability of leverage in different sectors of the economy, beyond
borders and over time. A key frst step will be collecting better, more granular data. Today,
the available fgures are limited and not always comparable across countries. If the data
existed, we could distinguish between secured and unsecured household debt and between
the debt of banks and nonbank fnancial institutions. Just as the Great Depression
prompted the US government to revamp its outdated methods of measuring consumer
prices, so should the current crisis motivate governments to develop more sophisticated
ways to monitor leverage.
An international body—such as the Financial Stability Board or the International
Monetary Fund—should work with national governments to collect and maintain the
data. Central bankers and other policy makers entrusted with ensuring the overall safety
and soundness of the fnancial system should use the data to identify systemic risks. They
should then consider whether to use monetary policy or regulatory tools (either nationally
or multinationally) to curb the buildup of dangerous pockets of leverage.
Such data would be valuable as well to business leaders. Bank executives, for example,
could use them to guide lending strategies and refne risk models. And corporate
executives could consider leverage trends when reevaluating marketing strategies
and revenue projections. The bursting of the great credit bubble is not yet over. But
governments around the world need to work together to prevent the next one, putting an
end to the recent boom-and-bust cycle. With the right tools, policy makers can create a
healthier fnancial system and lay the foundation for a stronger global economic recovery.
Susan Lund is director of research at the McKinsey Global Institute; Charles Roxburgh is a director in McKinsey’s
London office. This article originally appeared in the Financial Times, on January 27, 2010.
Copyright © 2010 McKinsey & Company. All rights reserved.
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