Andrew G Haldane: The debt hangover
Speech by Mr Andrew G Haldane, Executive Director, Financial Stability, Bank of England, at
a Professional Dinner, Liverpool, 27 January 2010.
* * *
I am grateful to Marnoch Aston, Simon Brennan, John Carmichael, Geoff Coppins, Sebastiano Daros, Richard
Davies, John Elliott, Simon Hall, Salina Ladha, Jack McKeown, Laura Piscitelli and Nick Vause for comments and
contributions.
Economists have not covered themselves in glory recently when it comes to forecasting.
Tonight I want to put that right by making a prediction that is big, bold and frighteningly
precise. Liverpool Football Club will finish this season third in the league. Manchester United
will top the table followed by Arsenal. Having been top for most of last year, Chelsea will
finish the season near the foot of the table. Newcastle United, meanwhile, will finish fourth.
I know what you are thinking. Even by economists' standards, some of those predictions
sound implausible. Liverpool third? So let me explain. The season I have in mind is not the
English football season; it is the financial reporting season. And the table to which I refer is
not the Premiership points table; it is the league table of English football club
debt1. Rarely
has securing a slot in the top four held less allure. Debt is the subject of my talk tonight.
We are living through an extraordinary period for the economic and financial system. Events
of recent years will be seen by financial historians as among the most significant in the past
millennium. At the worst point of the crisis, savers and borrowers around the world came
close to losing confidence in financial institutions. The resulting panic has had deep and
long-lasting consequences for global activity. The statistics are striking.
Between July 2007 and March 2009, the equity prices of global banks fell by 75%. That is a
loss of market capitalisation of around $5 trillion. In the UK, banks' equity prices fell by over
80%. Taken alongside falls in other asset prices, the loss of global wealth peaked at over
$25 trillion, or almost 45% of global GDP. At that point, asset price falls in the UK and US
were as large as during the Great Depression (Chart 1).
Knock-on effects to the real economy were no less dramatic. Peak to trough, output in OECD
economies has fallen by around 4%. In the UK, output is likely to have fallen by around 6%,
peak to trough. The present value of those losses, carried forward across generations, would
be a significant multiple of those falls. Today's Great Recession is the most significant
economic event since the Great Depression.
That this Great Recession did not become a second Great Depression is in large part the
result of policy actions. These have been unprecedented in speed and scale. Monetary
policy around the world has been loosened dramatically. And direct support for the financial
system has been equally swift and large, at around a quarter of global GDP. In the US and
UK, it is nearer three-quarters of GDP (Chart 2).
The road to recovery
The good news is that these measures appear to be working. The recovery in global financial
markets and the world economy over the past year has been almost as remarkable as the
preceding fall. Certainly, it has been far earlier and far sharper than during the Great
Depression (Charts 1 and 3). Having fallen off a cliff, the bounce in financial markets has
been more startled bunny than dead cat.
From their trough almost a year ago, global banks' equity prices have risen by over 130%,
recovering more than half of their losses. For UK banks, the recovery has been even more
dramatic, rising 140%. Since 1900, there has been only one 9-month period when the rally in
UK financial sector equity prices has been greater (Chart 4).
This rebound in asset prices has been broad as well as steep, spanning the maturity and risk
spectrum. Yields on safe securities have fallen across all maturities. Policy rates in the UK
fell to their lowest levels since the founding of the Bank of England. And long-term real
interest rates in the US and UK, at around 1%, are around half their average level over the
past decade.
Moving up the risk spectrum, the price of both investment and sub-investment grade
corporate bonds has risen since March last year, by 20% and 60% respectively. Global
equity prices have risen by over 70% over the same period. The rise in UK equity prices is
one of the largest in the 316-year history of the Bank of England (Chart 4). Residential and
commercial property prices in the UK have turned. And global wealth losses on private sector
securities, at around $6 trillion, have fallen by a factor of four over the past year alone.
What explains this remarkable recovery in risky asset prices? Three factors seem to have
been important, all of which can be traced to policy actions by the authorities:

First, the rate at which the future cashflows on risky assets are discounted has fallen
due to lower short and long-term global real interest rates. Using a standard asset
pricing model, this discount rate effect accounts for perhaps around one fifth of the
rise in UK and euro-area equity prices and one third of the rise in US equity prices
since March last year (Chart 5).

Second, as fears of a repeat of the Great Depression have abated, the premium that
investors require to compensate for this risk - the risk premium - has fallen,
boosting expected future cashflows on risky assets. This more than accounts for the
rise in UK and US equity prices over the past year (Chart 5). It also accounts for a
significant proportion of the rise in risky debt prices: a year ago, corporate debt
prices were signalling larger losses on company securities than seen during the
Great Depression (Chart 6).
 Third, improved liquidity in financial markets has lowered decisively uncertainty
about future market prices. This has lowered the compensation investors require for
such risk - the liquidity premium - boosting asset prices. This accounts for around a
half of the fall in spreads on sterling investment grade corporate bonds since March
last year (Chart 7).
Mirroring the recovery in asset prices, there is now convincing evidence of global output
having turned in the second half of 2009. The IMF projects that the global economy will grow
by 3.9% in 2010, having contracted by 0.8% in 2009. Surveys of manufacturing in the major
economies are at levels last seen prior to the crisis.
This combination of a stronger real economy and buoyant financial markets has generated a
dramatic turnaround in fortunes of the banking system. Global banks' net income in 2009 is
expected to be around $60 billion, compared to a loss of roughly that amount in 2008.
Income from market-making in various financial products has been especially lucrative, given
higher bid-ask spreads and client activity (Chart 8).
This windfall gain has helped repair banks' over-extended balance sheets. Global banks
have boosted their Tier 1 capital ratios by almost 3 percentage points since the start of 2009.
UK banks' Tier 1 ratios have increased by around 3.4 percentage points. Liquidity ratios
among global banks have also risen, with sterling liquid assets relative to total asset holdings
more than trebling among UK banks.
On the back of this positive news, the authorities in some countries have begun withdrawing
extraordinary levels of support. More than half of the capital provided to the US banking
system was repaid in 2009. The US authorities have also announced their intention to wind
down several special liquidity facilities, as has the European Central Bank. This exit is far
sooner than might have been expected six months ago. Stability, if not normality, is
beginning to return.
Debt overhangs and debt hangovers
If that were the end of the story, it would be a happy ending. But there are good reasons for
believing this story has some way to run. For while the flow of news over the past year has
been positive, some of the stock problems which were the root cause of the crisis remain
intact. The lasting legacy of this crisis is too much debt held by too many sectors against too
little capital.
Economists have a special word for this type of problem - a debt overhang. Its economic
effects are fairly well understood. Debt operates rather like a tax. Debt servicing costs, like a
tax, reduce the disposable income of the borrower. Too much debt means a higher debt "tax"
and a greater drag on activity - lower lending by banks and spending by households and
companies. Debt and taxes also affect incentives. Set too high, they may dissuade people
from working and investing.
These effects are often captured in a relationship called the Laffer curve. Higher tax rates
may boost tax revenues, but only up to a point. After that point, the tax take could actually fall
due to the disincentive effects of higher tax.2 In that event, both the taxpayer and the tax
collector are worse off. The same applies to debt. There is a debt Laffer curve. If a debt
overhang is sufficiently severe, the interest burden weakens debtor incentives to repay. In
the event borrowers and lenders find themselves on the wrong side of the debt Laffer curve,
both are worse off.3
Non-economists sometimes have a different word for an overhang. Conveniently, this is
found by simply transposing the syllables. What we face today may be called a debt
overhang, but what it will feel like is a debt hangover. Like a hangover, it will slow activity in
the period ahead. If it is severe enough, it may diminish incentives to work and invest. Too
wild a financial party risks borrowers finding themselves on the wrong side of the Laffer curve
the morning after.
The McKinsey Global Institute has recently looked at the debt accumulated by ten developed
economies over the past decade, including the UK and US.4 Since 2000, gross debt in these
ten economies has increased by around $40 trillion, a rise of 60%. The sectoral contributions
to this rise in debt are roughly equally split between households, companies, the financial
sector and governments.
The accumulation of debt has perhaps been greatest within the financial system. Among UK
and US banks, leverage has increased dramatically over the past century. The ratio of assets
to equity rose from single digits at the start of 20th century to over twenty by its end.5 Despite
recent capital raising, banks' leverage remains high absolutely and relative to the past, at
between 20 and 50 times equity (Chart 9).
Among households, debt-to-income ratios have risen materially over the past twenty years.
In the UK, household debt-to-income ratios rose from around 100% in 1988 to a peak of
around 170% in 2008. In the US over the same period, the household debt-to-income ratio
rose from 80% to 135%. From different starting points, similar trends are evident in Spain,
Canada and South Korea. Most households in these countries still have significant net
wealth, however; in the UK, total assets are five times household debt.
Those debt trends are repeated in parts of the corporate sector. Among UK companies, debt
as a fraction of companies' total financial liabilities has risen from around 20% in 1988 to
around 34% today. In certain sectors, the run-up in debt has been more dramatic - for
example, among US and UK commercial property companies whose leverage has more than
doubled in the past decade. It is also true of some companies subject to leveraged buy-outs
including, of course, Liverpool Football Club.
Finally among sovereigns, the picture up until recently has been benign with public debt flat
relative to GDP. But the crisis means that picture is set to change dramatically. Among the
G7 countries, the IMF forecast that public debt ratios will rise from around 80% of GDP in
2007 to around 125% by 2014. In the UK and US, public debt ratios are forecast by the IMF
to double, mirroring the pattern following past financial crises.6
Taking together the debt position of the financial sector, households, companies and
sovereigns paints a sobering picture. Total debt ratios relative to GDP rose significantly in all
ten countries studied by McKinsey's, from an average of around 200% in 1990 to over 330%
by 2008.7 Over the same period, UK debt ratios more than doubled, from just over 200% to
around 450% of GDP.
To date, servicing these debts has been cushioned by policymakers' actions. Government
debt and equity have substituted for private debt and augmented private equity to support
impaired balance sheets, especially among financial firms: a third of capital raised by banks
since the crisis began has come courtesy of government. And through monetary measures,
interest costs have been lowered dramatically: debt servicing has fallen, often dramatically,
across many sectors.
These extraordinary policy measures have acted like a painkiller for debt problems. But
painkillers offer only temporary relief. Loans from government to repair balance sheets need
ultimately to be repaid. And monetary stimulus will need ultimately to be withdrawn. Public
policy can act as a balm for debt problems, not a long-run cure. So how severe might the
hangover be once the painkillers have worn off?
As a thought experiment, consider the impact on debt servicing costs of long-term interest
rates reverting to a more normal level (say, 5%) assuming debt levels remained as they are.
At current mortgage spreads, UK households' long-term debt servicing costs would almost
double relative to income, rising to over 13%.8 In other words, income gearing would be
close to levels reached in the early 1990s recession.
Aggregate numbers may under-estimate the burden on deeply indebted households. Around
a third of UK households have debt servicing costs which exceed 20% of income. For those
households, debt servicing appears not to have fallen in the past two years, with higher
mortgage spreads offsetting the effects of lower interest rates (Chart 10).
For companies the picture is similar. A normalisation of long-term interest rates would
increase UK companies' debt servicing costs from 17% of profits currently to around 33%.
That is significantly below the levels reached in the early 1990s, when debt servicing peaked
at 58% of profits. But the distribution of debt across companies again paints a less promising
picture. In 2007, around 25% of UK firms made insufficient profits to cover their interest
payments (Chart 11). This is a long tail.
For sovereigns, debt servicing costs among the G7 economies are currently low, at around
3% of GDP. But were medium-term interest rates to normalise, against a backdrop of rising
debt ratios, the combined effect would be significant. Over the medium term, debt servicing
relative to GDP in the G7 economies would double.
Finally, banks' refinancing burden in the next few years has grown as a result of a shortening
of debt maturities during the crisis. The average maturity of US banks' rated debt is
estimated by Moody's to have fallen from 6.7 years to 3.2 years since 2005. Among UK
banks, it has fallen from 6.8 years to 4.3 years. The resulting near-term refinancing schedule
is estimated by Moody's at $7 trillion over the next three years. Among UK banks, it is in
excess of £1 trillion between now and 2014. As hangovers go, this one is large and will
linger.
Dealing with today's debt hangover
The road to balance sheet repair is likely to be long and winding for both the real economy
and financial system. Adjustment needs to be neither too fast nor too slow. Too fast and
lending and spending fall, jeopardising today's recovery. Too slow and balance sheet
fragilities persist, jeopardising tomorrow's stability. So what principles should guide the
transition? Let me highlight two drawn from the past.
The first comes from monetary policy. Over the past 30 years, many economies have sought
to bring down inflation - so-called disinflation. The optimal rate of disinflation is usually felt to
be gradual to limit damage to short-run growth. But there is an important exception to this
gradualist rule. If a downward inflation surprise comes along, it is optimal to pocket this
windfall as this accelerates the path to low inflation without harming growth. Disinflation is
"opportunistic".9
The same general principles apply to the repair of indebted balance sheets. Take banks.
Over the medium-term, their capital ratios are likely to need to rise. If this is achieved too
fast, by constraining lending, it poses a risk to growth. As with disinflation, there is a strong
case for gradualism. But if a positive profit surprise comes along, this windfall should be
pocketed, front-loading the path to higher capital without harming lending and growth - an
opportunistic approach to stabilisation.
Global banks have recently received just such a profit windfall, as full-year results for the
main banks are beginning to attest. There is a strong case for banks, in the UK and
internationally, pocketing this windfall rather than distributing it to either staff or shareholders.
This would allow banks' balance sheets to be repaired while supporting lending to the real
economy. It is prudential opportunism.
So far during this crisis, there has been little evidence of such prudential opportunism.
Among global banks, net income fell by over 20% between 2006 and 2007. Over the same
period, dividends grew by 20%. In 2008, global banks made losses totalling $60 billion, but
on average still made dividend payouts of over $60 billion.
Although it sounds peculiar, this behaviour appears to be deeply rooted. Table 1 summarises
payouts to shareholders by companies in the UK and US since 1965, both banks and
nonbanks. Five features are notable:

First, payout ratios to shareholders from banks' profits have consistently been high.
Since the mid-1960s, the payout ratio has generally exceeded 50%. At times in the
distant past it has been higher still: the average payout ratio to Bank of Scotland
shareholders over the period 1800 to 1995 was around 70%.10
 Second, there is little evidence of payout ratios being higher for financial than for
non-financial companies. Such high payouts are themselves something of a puzzle
because, at least in theory, the payout ratio ought not to affect the value of a firm.11
This may be a collective action problem, with firms fearful of sending an adverse
market signal through lower payouts.
 Third, for both financials and non-financial firms, the flow of dividend income is much
less volatile than firms' stream of profits. In other words, there is evidence of firms
systematically smoothing dividend payouts to shareholders.12 This may also reflect
a problem of collective action.

Fourth, the profits stream of the financial sector is significantly more volatile than for
non-financial companies. That appears largely to be the result of large-scale, one-off
losses by banks. This is as we would expect, given their greater leverage.
 Fifth, as a result, the dividend payout ratio for banks is more volatile than for
nonbanks.
This behaviour is unlikely to support banking stability. It risks profits being distributed as
dividends when they are most needed to augment capital ratios and boost confidence. In
1996, the Chief Executive of a famous company observed: "We are an old-fashioned
business, not a quoted plc, and we don't pay dividends to shareholders". The chief
executive? Peter Robinson. The company? Liverpool FC. Perhaps banks should have
heeded the message.
If they had, this crisis might have felt rather different. If UK banks had reduced dividend
payouts ratios by a third between 2000 to 2007, £20 billion of extra capital would have been
generated.13 Had payouts to staff been trimmed by 10%, a further £50 billion in capital would
have been saved. And if banks had been restricted from paying dividends in the event of an
annual loss, £15 billion would have been added to the pot. In other words, three modest
changes in payout behaviour would have generated more capital than was supplied by the
UK government during the crisis.
Opportunistic behaviour is also needed to repair banks' liquidity positions. Reversing the fall
in the maturity of banks' balance sheets will require a front-loaded terming out of their debt
liabilities. There is some evidence of banks doing so. But given the scale of the refinancing
mountain, this will be an uphill struggle.
There is also some evidence of companies tapping capital markets opportunistically to help
repair their balance sheets. Corporate bond issuance by non-financial companies during
2009 was around $1.2 trillion globally, the highest on record. Manchester United have
recently become one of the first firms to do so in 2010. Surveys of households suggest some
of the windfall of lower interest costs is being used to repay debt. Opportunistic repayment or
refinancing is the financial stability equivalent of repairing the roof while the sun is shining
and it is important it continues.
The second lesson comes from past debt crises, in particular among developing countries. If
a borrower has a large debt overhang, there is a case for restructuring the claim from debt
into equity - a debt-for-equity swap.14 In some cases, such swaps are no more than
recognition that an impaired debt is, in substance, an equity claim. But more than that,
debtfor-equity swaps can potentially benefit both lender and borrowers by airlifting a debtor to the
safer side of the debt Laffer curve.15
A number of global banks have begun putting such a strategy into practice. Around a
hundred debt exchanges were carried out by global banks during 2009, typically converting
debt instruments into equity or retiring debt below face value, so reducing leverage in the
financial sector. That these swaps were voluntary and market-based is evidence of their
benefit to both lender and borrower.
Debt-for-equity swaps could be used to tackle the debt overhang in other sectors. There are
already some examples of voluntary debt-for-equity exchanges among companies. For
example, Chelsea Football Club recently announced a large-scale swap, which accounts for
their plummit down the debt league table. In principle, mortgage contracts could also be
adapted to lessen the burden on over-indebted households by allowing lenders to convert
their loan into an equity stake, as suggested, for example, by the charity Shelter.16
Preventing tomorrow's debt hangover
Once today's debt hangover is solved, how is tomorrow's to be prevented? As debt crises
have been with us for a millennium, it is fanciful to think they could be eliminated. But could
the party be moderated in frequency and scale? In seeking new ways to tackle this old
regulatory policy
problem, two possible avenues would be the re-orientation of on the one
hand and better designed debt contracts on the other.
First, regulatory policy. Since at least the 1970s, public policy has not sought actively to
moderate fluctuations in the credit cycle in most G7 economies. Moderating the business
cycle was believed sufficient to hold credit in check. The experience of the past decade, in
the UK and elsewhere, has called that into question. In the UK, credit grew at three times the
rate of money spending over that period, sowing the seeds of the credit crisis, while inflation
and growth remained remarkably stable.
In tackling this problem, one option is a re-orientation of regulatory policy towards curbing the
cycle in credit supply. For example, regulatory requirements on banks could be raised to lean
against a credit boom and lowered in the teeth of a credit downturn. In the public houses for
credit, intake would be monitored, opening hours restricted and the Happy Hour abolished.
This approach has become known in policy circles as macro-prudential policy.17 Although the
name is new, it is in the time-honoured policy tradition of "removing the punchbowl" from the
party as it is getting started - a fitting analogy if the aim is to prevent a debt hangover. Had
such a party-pooper been in place over the past decade, today's debt headache would
plausibly have been less acute.
Regulation might also be used to lean against the collective tendency of banks to payout
high even when profits are low. Among regulators internationally, there are proposals to
introduce capital conservation rules, requiring banks to distribute less of their profits in
adverse states of the world. By ensuring prudent profit retention on a collective basis, these
rules ought to be in the long-term interests of banks and their shareholders, as well as the
authorities.
A second, complementary, approach for containing or cushioning fluctuations in the credit
cycle would be to rethink the design of contracts - if you like, lowering the alcohol content of
debt instruments. Some debt contracts are ill-suited to the needs of their customers, with the
debt servicing burden rising at just the point borrowers are least able to pay. For example,
the "teaser rate" mortgages offered to households in the US generated an automatic and
correlated spike in income gearing as rates were reset. This amplified repayment and default
risk.
A better-designed debt contract would automatically adjust repayment terms when the
borrower found the going getting tough. Debt would become, in the language of economics,
state-contingent - contingent on the borrower's state of financial health. By cushioning
fluctuations, these instruments have the potential to stabilise automatically debt dynamics.
And by averting costly default, they potentially benefit both creditors and debtors.
There has been recent interest among banks in issuing state-contingent instruments -
socalled contingent capital. These instruments convert into equity in the event of a pre-defined
stress trigger being breached. So these instruments offer repayment insurance to banks at
the point it is most valued. They are, in effect, a contractually pre-committed form of
debtequity swap.
The design of contingent capital needs further consideration - for example, the definition and
calibration of the trigger thresholds. Nonetheless, experience to date offers encouragement.
The contingent capital instruments issued at the end of last year by Lloyds Banking Group
have risen in price since being issued. If contingent capital became more widespread, banks'
capital ratios would be automatically stabilised over the cycle, lowering the chances of future
banking crises.
As several academics have argued, the same basic principles could be applied to the debt
contracts issued by households, companies and even sovereigns. Take a typical mortgage
contract. A rise in the value of a property relative to the loan gives the borrower equity
against which they can borrow. This provides an incentive to trade-up, raising house prices
and generating further equity. This amplifier operates symmetrically, as falling collateral
values reduce refinancing options and drive down prices. Economists call this effect the
financial accelerator.18 It adds to cyclicality in credit provision and asset prices.
US economist Robert Shiller has suggested it might be possible to devise mortgage
contracts that slow, or even reverse, this financial accelerator19. Instead of being fixed in
money terms, imagine a mortgage whose value rose with house prices. So the repayment
burden would rise automatically with asset prices to slow a credit boom and fall in a
recession to reduce the chances of mortgage default. Mortgages would operate like a
contractually pre-committed debt-equity swap between households and banks. They would
automatically stabilise household loan-to-value ratios. By reducing the amplitude of the credit
cycle, they ought to benefit both borrower and lender.
Governments cannot issue equity. But this does not prevent them issuing debt with
equitylike characteristics. For example, Robert Shiller has also suggested governments should
issue GDP bonds, with coupons which vary with GDP. These would lower the public debt
servicing burden at the point in the cycle when public deficits are likely to be largest. In this
way, they would help smooth public expenditure and taxation over time. To date, GDP bonds
have only been issued by some emerging markets. But in principle, they could serve as a
quasi-automatic stabiliser for any country whose public debt experiences cyclical or
crisisrelated fluctuations.20 Given recent events, perhaps their day is nearing.
Conclusion
It is said that the longest journey begins with a single step. Events of the past twelve months
have been a first step - and a big one. But they are just the start of the journey for the
financial system and economy as balance sheets are repaired. This adjustment needs to be
fast enough to repair balance sheets, but not so fast as to risk a setback for the financial
system or real economy. What a hangover requires is neither a day in bed nor a night on the
tiles. Having taken one big step forward, we should guard against taking two steps back.
Annex
Chart 1
Equity indices during crises
S&P 500 equity index FTSE All-share equity index
Cumulative decline from peak (per cent)
Cumulative decline from peak (per cent)
0
0
-
-
10
10
20
20
30
30
40
40
50
50
60
60
1929 crash
1929 crash
70
70
1973 oil crisis
1973 oil crisis
80
80
Current crisis
Current crisis
90
90
0 6 12 18 24 30 36
0 6 12 18 24 30 36
Months from peak
Months from peak
Sources: Global Financial Data Inc. and Bank calculations.
Sources: Global Financial Data Inc. and Bank calculations.
(a) Previous peaks taken as: 1929 crash = 30 September 1929;
(a) Previous peaks taken as: 1929 crash = 7 September 1929;
1973 oil crisis = 12 December 1972 and current crisis = 10
1973 oil crisis = 11 January 1973 and current crisis = 9 October
October 2007.
2007.
Chart 2
Public sector interventions during the financial crisis(a)(b)
UK total Per cent of GDP
UK investment
100
US total
90
US investment
Euro area(c) total
80
Euro area(c) investment
70
60
50
40
30
20
10
0
Aug. Nov. Feb. May. Aug. Nov. Feb. May. Aug. Nov.
2007 08 09
Sources: Bank of England, BIS, Board of Governors of the Federal Reserve System,
ECB, FDIC, HM Treasury, IMF World Economic Outlook (October 2009), US Treasury
and Bank calculations.
(a) End-of-month data expressed as percentages of 2007 nominal GDP.
(b) Scale of interventions = potential size of packages when announced
(c) Original euro area 11 countries plus ECB interventions.
Chart 3
GDP developments during recent crises
UK US
Chart 4
Recent decline and rally in UK equity prices in an historical context
UK Financial equity prices UK Equity prices
Sources: Bloomberg, Global Financial Data and Bank calculations.
Chart 5 Chart 6
Changes in international equity European corporate bond spreads
indices since trough(a)
Interest rates Implied risk premium Per cent
Basis points (log scale)
Illiquidity premium (a)
Expected earnings Total
100
10,000
Compensation for credit risk (b)
80
Great Depression (c)
60 Current (d)
40
1,000
20
+
0
-
20
100
40
100
S&P500
FTSE
EuroStoxx
10
Sources: Bloomberg, IBES, Thomson Datastream and Bank
March March March March March
Current Current Current Current Current
calculations.
(a) Based on a three-stage dividend discount model. See
Sources: Citigroup, Moody's Investors Service, UBS Delta and
Panigirtzoglou, N. and Scammell, R. (2002), 'Analysts' earnings
Bank calculations.
forecasts and equity valuations', Bank of England Quarterly
Bulletin (Spring), pages 59-66.
(a) Spread of iBoxx € corporate bond index over iTraxx Europe
(b) Taken as 9 March 2009.
credit default swap index.
(b) iTraxx Europe five-year credit default swap index.
(c) Credit risk premium for realised default rates on US corporate
bonds issued in 1931.
(d) Credit risk premium for Moody's current default probability
forecast for European corporates.
Chart 7
Decomposition of sterling-denominated investment-grade
corporate bond spreads
Basis points
750
Residual (including compensation for illiquidity)
700
Compensation for uncertainty about default losses
650
600
Compensation for expected default losses
550
Actual
500
450
400
350
300
250
200
150
100
50
0
97 98 99 00 01 02 03 04 05 06 07 08 09 10
Chart 8 Chart 9
Bid-ask spreads on selected assets Major UK banks' and LCFI's leverage ratios(a)(b)
Chart 10
Mortgage repayment gearing(a)(b)(c)
Chart 11
Distribution of income gearing (2007 and 2008)
Source: Bureau van Dijk and Bank calculations
1
Solid bars show distribution of income gearing in 2007. Shaded bars show distribution of income gearing in
2008. Income gearing is defined as interest paid divided by earnings before interest payments.
Table 1
Dividends and earnings in the UK and US
Source: Thomson Datastream and Bank calculations.