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“Thank you. Now, shall we decide who blames who afterwards?”

We should know better who to blame, even Sporting Lisbon does.


Last week, at a barbershop, I witnessed a very curious debate which I will here summarize. Talking about some news related to the households’ debt loan defaults, and its impact on businesses’ ability to borrow money from the banking system, the barber argued that banks were greedy and deceived borrowers during many years. The other costumer sit alongside me said that households had been the stupid ones, whom failed to understand one shouldn’t spend what he doesn’t have.

On May 18th, almost five months ago, Portugal exited its three-year bailout without needing a second program – not long ago many described as inevitable. The program negotiated with the troika (European Central Bank, the European Commission, and the International Monetary Fund) imposed many austerity measures – such as much higher taxes and strong spending cuts in public expenses with education, health, social care in order  to repair the public finances – and steps towards a more flexible economy in its mechanisms. This came right after the financial crisis of 2007/2008 and during the so called sovereign debt crisis and influenced a lot the way banks and households behaved. To have a better overview about these topics let’s recall a couple facts:

▪ In December 2009 households’ were €178.5 billion in debt (higher value ever registered in Portugal) – more than 105.87% of the GDP;

▪ Households’ savings in % of disposable income decreased 14.16 pp. between 1990 and 2008;

▪ According to Banco de Portugal total household’s bad debt almost doubled between 2008 and 2013 (€2681.58M to €5171.7M);

▪ From 2007 to 2013 the total amount of money lent to businesses decreased approximately €15.157 billion.

It may look like describing and understanding this lending-borrowing market where households, businesses and banks act it’s all about macroeconomics. Sorry, you didn’t get the big picture. That picture is like a puzzle where every single piece counts. The present situation is the result of multiple individual actions that must not be forgotten. But how did we come to this then? Let’s use microeconomic lenses to look at three different sides – Households, Banks and Regulator/Supervisor.

Households’ behavior in what concerns to savings can be explained by the Life Cycle Theory of Consumption (Modigliani e Brumberg (1954)). This theory suggests that that people make intelligent choices about how much they want to spend at each age, limited only by the resources available over their lives. But how to measure our future resources (e.g. Income)? It involves uncertainty and is given by expectations. It’s obvious that the way households formulate expectations depend on their recent past, on the stability of economic conditions and perceived predictability of the future. Almost constant GDP (and GDP per capita) growth between 1990 and 2006 boosted the evolution of repeated positive expectations. Predicting positive growth of income and assets, and feeling the wealth effect of decreasing interest rates – low interest rates make investment and consumption cheaper giving more confidence to spend –  households adjusted their consumption. This explains the decrease in savings, the increase in household’s debt. But these behavior turned out to be biased and consequences came as a huge shock in lifestyle, expectations, confidence and general behavior.

Banks also had their fair share of responsibility. Banks have always had more and more accurate information than households even about the latter’s financial stability. This exploited two problems:  principal-agent and asymmetric information. In a desirable transaction banks should explain the risks to the clients and, with them, try to understand if that is a suitable financial option. But focused only on more and more business they didn’t, and followed their own agendas not bothering with the client’s side.

Banks misjudged the risks _including the default risks) – Exposure to loss due to non-payment by a borrower of a financial obligation –  and therefore prices (interest rates)/restrictions offered to consumers were too low/soft making the demand for money bigger than it would be in an efficient situation – this is, in a situation where the price mechanism translates the true value of a good or service. Banks were either greedy or stupid, maybe both.

The Regulator and Supervisor failed to understand that supervision is more than looking at numbers, it is also enforcing strict rules about the way information is given to clients. More than asking banks if they are acting within the rules it would have been incredibly useful to go on the field and try to understand if the reality was the one banks where describing. However, only after 2007/2008 did Banco de Portugal started to include in its reports relevant information about inspections and “mistery shopper” actions. Financial literacy was also an objective of the supervisor and other public entities, but mere intentions gain real form only after the crisis with the design of the National Plan for Financial Literacy.

Bottom line micro tells us that behavior is all about incentives, that is what really drives agent’s choices. Choices where not efficient because incentives were misplaced and biased and because expectations didn’t took into account the real level of uncertainty. The different agents have at least some fault of what happened and the consequences that followed.

But let me finish the story please…the one that took place in the barbershop. Both turned to me with an expectant look, and asked “But who should we blame after all?.I thought about the topic considering many of the aspects above, but then I remembered one of the most valuable lessons I ever learnt. Exactly the same way one day Dias da Cunha (a Sporting Clube de Portugal ex-president) told reporters, when excusing himself about his team’s bad performances: “Who to blame? Blame the system!” – that’s what I said, and it was the most complete and honest answer I was able to give in one sentence.

(Sources: BP Stat e PORDATA databases)

692 | Rodrigo Pina Cipriano

Author: studentnovasbe

Master student in Nova Sbe

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