McKinsey Global Institute
McKinsey Global InstituteSeptember 2009Global capital markets:Entering a new era
McKinsey Global InstituteThe McKinsey Global Institute (MGI), established in 1990, is McKinsey &Company’s business and economics research arm.MGI’s mission is to help leaders in the commercial, public, and social sectorsdevelop a deeper understanding of the evolution of the global economyand to provide a fact base that contributes to decision making on criticalmanagement and policy issues.MGI’s research is a unique combination of two disciplines: economics andmanagement. By integrating these two perspectives, MGI is able to gaininsights into the microeconomic underpinnings of the broad trends shapingthe global economy. For nearly two decades, MGI has utilized this “micro-tomacro” approach in research covering more than 15 countries and 28 industrysectors.MGI’s research agenda focuses on topics at the intersection of business andeconomics, including productivity and competitiveness, capital markets,energy, labor, consumption and demographics, and the impact of technology.The partners of McKinsey & Company fund MGI’s research, which is notcommissioned by any business, government, or other institution.Further information about MGI and copies of MGI’s published reports can befound at www.mckinsey.com/mgi.Copyright McKinsey & Company 2009
McKinsey Global InstituteSeptember 2009Global capital markets:Entering a new eraCharles RoxburghSusan LundCharles AtkinsStanislas BelotWayne W. HuMoira S. Pierce
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McKinsey Global InstituteGlobal capital markets: Entering a new era5PrefaceGlobal capital markets: Entering a new era is the latest research by the McKinseyGlobal Institute (MGI) on the evolution of the world’s financial markets. This report isbased in large part on findings from three proprietary databases that document thefinancial assets, capital inflows and outflows, and cross-border investments of morethan 100 countries around the world since 1990. In this report, we assess the effectsand implications of the current financial crisis and economic downturn through thelens of global financial assets and capital flows. Although the crisis will take yearsto play out fully, we detail how the financial landscape has already shifted in severalimportant ways. We also analyze the future growth prospects for financial assets inmature and emerging markets.Susan Lund, MGI Director of Research, and Charles Roxburgh, MGI Director, ledthis project. The project team comprised the following MGI fellows: Charles Atkins,Stanislas Belot, Wayne W. Hu, and Moira S. Pierce. The team benefited from thecontributions of Paul Arnold and Nidhi Sand. Nell Henderson provided editorialsupport.This report would not have been possible without the thoughtful input and expertiseof numerous McKinsey colleagues around the world. The authors particularly wishto thank Martin N. Baily, a senior adviser to McKinsey & Company and to MGI, andLowell Bryan, a director of McKinsey & Company in the New York office.Our aspiration is to provide business leaders and policy makers around the worldwith a fact base to better understand some of the most important trends shapingglobal financial markets today. As with all MGI projects, this research has not beencommissioned or sponsored in any way by any business, government, or otherinstitution.Richard Dobbs, DirectorSeoulJames Manyika, DirectorSan FranciscoCharles Roxburgh, DirectorLondonSusan Lund, Director of ResearchWashington, DCSeptember 2009
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McKinsey Global InstituteGlobal capital markets: Entering a new eraGlobal capital markets:Entering a new eraThe current financial crisis and worldwide recession have abruptly halted a nearlythree-decade-long expansion of global capital markets. From 1980 through 2007,the world’s financial assets—including equities, private and public debt, and bankdeposits—nearly quadrupled in size relative to global GDP. Global capital flows similarlysurged. This growth reflected numerous interrelated trends, including advancesin information and communication technology, financial market liberalization, andinnovations in financial products and services. The result was financial globalization.But the upheaval in financial markets in late 2008 marked a break in this trend. Thetotal value of the world’s financial assets fell by 16 trillion last year to 178 trillion,the largest setback on record. At this writing in September 2009, equity marketshave bounced back from their recent lows but remain well below their peaks. Creditmarkets have healed somewhat but are still impaired.Going forward, our research suggests that global capital markets are entering a newera in which the forces fueling growth have changed. For the past 30 years, most ofthe overall increase in financial depth—the ratio of assets to GDP—was driven by therapid growth of equities and private debt in mature markets. Looking ahead, theseasset classes in mature markets are likely to grow more slowly, more in line with GDP,while government debt will rise sharply. An increasing share of global asset growthwill occur in emerging markets, where GDP is rising faster and all asset classes haveabundant room to expand.In this report, we assess the effects and implications of the crisis through the lens ofglobal financial assets and capital flows.1 Although the full ramifications of the crisiswill take years to play out, it is already clear that the financial landscape has shifted inseveral ways. Most notably, we find that: Declines in equity and real estate values wiped out 28.8 trillion of global wealth in2008 and the first half of 2009. Replacing this wealth will require more saving andless consumption, which may dampen global economic growth and necessitatesignificant adjustments by the banking business. Financial globalization has reversed, with capital flows falling by more than 80percent. This has created turmoil for multinational financial institutions, causedcurrency volatility to soar, and sharply raised the cost of capital in some countries.It is unclear how quickly capital flows will revive, or whether financial markets willbecome less globally integrated. Some global imbalances may be receding. The US current account deficit has narrowed,as have the surpluses in China, Germany, and Japan that helped fund it. However, thismay be a temporary effect of the crisis rather than a long-term structural shift.1For previous research, see Mapping global capital markets: Fifth annual report, McKinseyGlobal Institute, October 2008 (available at www.mckinsey.com/mgi/) or “Long-term trendsin the global capital markets,” The McKinsey Quarterly, February 2008 (available at www.mckinseyquarterly.com/home.aspx).7
8 Mature financial markets may be headed for slower growth in the years tocome. Private debt and equity are likely to grow more slowly as households andbusinesses reduce their debt burdens and as corporate earnings fall back to longterm trends. In contrast, large fiscal deficits in many mature markets will causegovernment debt to soar. For emerging markets, the current crisis is likely to be no more than a temporaryinterruption in their financial market development, since the underlying sources ofgrowth remain strong. For investors and financial intermediaries alike, emergingmarkets will become more important as their share of global capital marketscontinues to expand.GLOBAL FINANCIAL ASSETS DECLINED BY 16 TRILLION IN2008, THE LARGEST SETBACK ON RECORDFor most of the first eight decades of the 20th century, financial assets grew at about thesame pace as GDP. The exceptions were times of war, when government debt rose muchmore rapidly. But after 1980, financial asset growth raced ahead. In the United States,for example, the total value of financial assets as a percentage of GDP has grown morethan twice as much since 1980 as it had in the previous 80 years (Exhibit 1). Worldwide,equities and private debt accounted for most of the increase in financial assets since1980, as companies and financial institutions turned increasingly to capital markets forfinancing. By 2007, the total value of global financial assets reached a peak of 194 trillion,equal to 343 percent of GDP. 2Exhibit te debt Privatesecuritiesdebt securitiesGovernment debt securitiesGovernment debt securitiesDepositsDepositsUS financial assets as a % of GDPUS financial assets as a % of GDP417400442442392 417400392350350300198 p.p.130020725020020015010015050100198 p.p.124025016793 p.p.113910193 p.p.12401942071941671391010501885 1890 19001910192019301940195019601970198019902000 2008Percentage points of GDP.SOURCE:Federal Reserve; National Bureau of Economic Research; Robert Shiller; McKinsey Global Institute analysis011885 1890 19001910192019301940195019601970198019902000 2008Percentage points of GDP.SOURCE: Federal Reserve; National Bureau of Economic Research; Robert Shiller; McKinsey Global Institute analysis1But the financial crisis interrupted this process. The value of the world’s financial assetsfell to 178 trillion by the end of 2008 (Exhibit 2). This 8 percent decline was the largestsince our data series began in 1990, and in some countries, the drop was far worse.2Unless noted otherwise, all financial figures in this report are stated at 2008 exchange rates.This allows us to compare growth over time, excluding the effects of currency movements.Figures are not adjusted for inflation. Based on the latest available data, this report alsoupdates figures published in our earlier reports.
McKinsey Global InstituteGlobal capital markets: Entering a new era9Exhibit 2Global financial assets fell by 16 trillion in 2008 Trillion, using 2008 exchange rates for all yearsXXEquity securitiesPrivate debt securitiesCompoundannual growthrate 2000-07,%Government debt securitiesBank depositsLargest declines infinancial assets 2007-08Global financial assets 9GDP TrillionFinancialdepth% of ia-0.832Hong 0.4Canada-0.3611990 1995 2000 2001 2002 2003 2004 2005 2006 2007 7246303297282298305320334343293Excludes debt write-downs of 0.28 trillion in 2007 and 0.98 trillion in 2008.In current exchange rate terms the drop in global financial assets would have been 22 trillion in 2008, or 11 percent of globalfinancial assets.Note: Figures may not sum due to rounding.SOURCE: McKinsey Global Institute Global Financial Assets database; Bloomberg12The damage has been widespread, with financial assets declining in nearly everycountry (Exhibit 3). Only a handful of economies, of which the United Kingdom is mostnotable, had a commensurate increase in 2008. The UK gain, however, was itself aby-product of the crisis: a UK government program to recapitalize troubled bankstriggered a rise in private debt issuance that more than offset the decline in equities.3Exhibit 3Financial assets decreased in all regions except the United Kingdom2008 Trillion, using 2008 exchange rates for all yearsTotal financial assets per major regionPercent ChinaUK1Latin AmericaEmerging AsiaRussia8.08.64.13.94.23.81.91.12007Amount( -40-0.8India2.62.0-23-0.6Eastern Europe4.31.5-64-2.8Assets increase primarily due to an increase in international financial institution debt, reflecting a surge of securitization activityin response to the Bank of England’s accepting securitized assets as collateral for repurchase agreements.Note: Figures may not sum due to rounding.SOURCE: McKinsey Global Institute Global Financial Assets database13The European Central Bank and the Bank of England announced in April 2008 they wouldaccept securitized assets as collateral for repurchase agreements, or repos. This triggered asurge in securitization. Such repo market transactions with these two central banks accountedfor more than 95 percent of all UK securitized asset issuance in 2008.
10Equities declined sharplyFalling equities accounted for virtually all of the drop in global financial assets. The world’sequities lost almost half their value in 2008, declining by 28 trillion. The damage waswidespread, with equity markets declining in every one of the 112 countries in our sample(Exhibit 4)—producing the most severe crash since the Great Depression (Exhibit 5).Markets have regained some ground in recent months, replacing 4.6 trillion in valuebetween December 2008 and the end of July 2009. But as of August 31, 2009, the S&P500 index, for instance, remained 34 percent below its peak.Exhibit 4Every equity market in the world lost value in 2008% of GDPEquity growth in developed andemerging economies2007-08 growth, %Best and worst equity performances2007-08 growth, %Bestperformers-4ColombiaSouth economies-29Czech d average-45Emergingmarkets-43-51-73IcelandSOURCE: McKinsey Global Institute Global Financial Assets databaseExhibit 5The 2008 stock market crash was the most severe since theGreat DepressionS&P 500 crashes% decline from peak, nominal0Black MondaySept 1987 June 1988-5-10-15World War IINov 1938 Apr 1942-20-25-30-352000 dot-com bubbleOct 2000 Feb 2003-40-45-501973 oil crisisJan 1973 Dec 1974-55-60Subprime mortgagecrisisOct 9, 2007 Mar 9, 2009-65-70-75-80Mar 9, 2009 –Jul 31, 2009-85-90012Years from S&P 500 peakSOURCE: Datastream; Robert Shiller; McKinsey Global Institute analysis3Great DepressionSep 1929 Jun 1932
McKinsey Global InstituteGlobal capital markets: Entering a new era11In addition, we estimate that global residential real estate values fell by 3.4 trillion in2008 and nearly 2 trillion more in the first quarter of 2009.4 (See sidebar, A look atglobal housing wealth) Together with equity losses, this has erased 28.8 trillion ofhousehold and investor wealth as of the middle of 2009. Replacing this wealth willrequire a long period of higher saving. To put this in perspective, the world’s householdssaved about 5 percent of their disposable income in 2008, or 1.6 trillion: they wouldhave to save that amount for 18 consecutive years to amass 28.8 trillion. Of course theactual time it will take is unknowable at this point, since it will depend on many factors,including household saving behavior, income growth, and asset appreciation.A look at global housing wealthAlthough the current financial crisis started with the bursting of the US housingbubble, other economies around the world are feeling the effects of their own realestate booms and busts. From 2000 through 2007, a remarkable run-up in globalhome prices occurred (Exhibit A). US housing prices appreciated significantly—and still were surpassed by values of those in at least half a dozen Europeancountries. Residential real estate prices soared in emerging markets, too: forinstance, the value of South Africa’s homes rose by two and a half times overthat period. No publicly available data source on global home prices exists, butwe estimate that the total value of all the world’s residential real estate more thandoubled during this period, to exceed 90 trillion (Exhibit B).Since 2007, however, home prices have fallen sharply in some countries, erasingmore than 3.4 trillion of household wealth in 2008. And the effects have beenuneven, with the worst-hit countries—such as Estonia—suffering real housing pricedeclines of 20 percent or more, and many countries—such as Russia—recordingincreases in 2008. This suggests potential declines ahead for some countries. Andbecause home prices are slow to correct, the current slide may persist for sometime. This could depress global consumption and contribute to mortgage defaults,which continue to plague the financial sector.Exhibit AHousing price indices in many countries soared from the mid-1990sthrough 2007Real house prices1970 020002008SOURCE: Bank of International Settlements, per national sources; Haver Analytics; McKinsey Global Institute analysis4There is no comprehensive database of global real estate values. Our sample includesAustralia, Europe, Japan, the United Kingdom, the United States, and some emergingmarkets. See sidebar, A look at global housing wealth, for more detail.
12Exhibit BGlobal residential real estate values exceeded 90 trillion at theirpeak, but lost 3.4 trillion in value in 2008Compound annualgrowth rate, %Global residential real estate Trillion, using 2008 exchange rates for all .612.69.69.531.830.21996200787.4 7.7200708-3.714.0 18200US1995As a share189of GDP, %ESTIMATE36.9 9.4-4.21 Includes Belgium, Denmark, France, Germany, Italy, Netherlands, Norway, Spain, and the United Kingdom. Data were notavailable for Ireland and Switzerland.2 This data is presented in nominal terms. In real terms (as in exhibit A), the price declines in 2008 would be greaterNote: Figures may not sum due to rounding.SOURCE: Organization for Economic Co-operation and Development; Haver Analytics; McKinsey Global InstitutePrivate debt remained f lat while government debt grewIn contrast to the sharp decline in equities and real estate, the total value of all privatedebt—including corporate bonds, financial institution bonds, and asset-backedsecurities—rose to 51 trillion by the end of 2008. However, this apparent growth occursbecause our database reports the face value of debt securities, not the market value.We estimate that applying current market valuations would reduce current private debtoutstanding by 2.4 trillion to 3.2 trillion, leaving its value roughly the same as a yearearlier.5 Although corporate bond issuance reached a record 1.1 trillion in the first eightmonths of 2009, the issuance of asset-backed securities and financial institution debt—far larger components of total private debt assets—has fallen sharply.6Government debt also grew in 2008, rising 9 percent to 31.7 trillion. This growth wasfaster than its previous trend, and it will accelerate further in 2009 and 2010 as manycountries boost borrowing to pay for planned fiscal stimulus spending.Given the decline in asset values and growth in debt, we see that leverage in the globaleconomy has increased during the financial crisis rather than declined. This is true formany households, governments, banks, and some segments of the corporate sector.In aggregate, the global debt-to-equity ratio nearly doubled, jumping from 124 percentin 2007 to 244 percent by the end of 2008. This raises the vulnerability of the globaleconomy to further shocks. It also indicates that the long process of deleveraging in theprivate sector has at best only just begun, and in the public sector has yet to begin.Bank deposits reached 61 trillion in 2008Global bank deposits7 grew by 5 trillion, or about 9 percent, in 2008 (Exhibit 6).Deposit growth accelerated in developed economies, reflecting both a flight to safety5This calculation is in line with other estimates. The Bank of England’s Financial Stability Report inJune 2009, for instance, reported marked-to-market losses of 2.7 trillion on debt securities.6Even the rise in corporate bond issuance was a by-product of the crisis, occurring becauseother means of debt finan
Global capital markets: Entering a new era McKinsey Global Institute 5 Preface Global capital markets: Entering a new era is the latest research by the McKinsey Global Institute (MGI) on the evolution of the world’s financial markets. This report is based in large part on fi
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