Ending Over-Lending


Kudos & Criticisms


The following kudos were received regarding the original published October 2011 Ending Over-Lending paper:

Results/findings are new and contributes to body of knowledge. Originality and timeliness are shown.
- Formal academic peer review

The potential to mitigate the risk of a country from experiencing financial calamity through what seems to be a simplistic concept is very intriguing.
- Junior academic

This appears to be a direct implementation of H.P. Minsky’s Financial Instability Hypothesis, and if so, could be an important contribution.
- Senior academic

I’ve been looking for more sophisticated and new approaches to sovereign analysis, and this would work very well, particularly with a panel of indicators.
- Hedge fund manager

You’re right, comparing debt to revenue (ie. GDP) doesn’t work, but debt-to-cash flow makes total sense. This has been a core measure in our industry for decades and it makes sense to measure it for nations.
- Oil industry executive

I read the paper, and I like the concept. You are quite right in correcting for savings, rather than using GDP. Your measure is simple, which I like. My sense is that you have to get a little more complex to get more precision, although your measure surely is a quick and ready guide.
- Credit industry expert and author

The analysis of a nation’s flow of savings and its impact on financial stability is quite understudied, I would encourage you to continue to pursue your thesis, it looks quite promising.
- Central bank analyst

A wonderful clear simple, to my inexpert eye, irrefutable assertion.
- Successful entrepreneur

The work / idea seems rather obvious once its been set forth and it is one of those things that astonishes in that it has not been a focus until now.
- Friend



The following criticisms were received regarding the original published October 2011 Ending Over-Lending paper, along with comments from the author:



Author’s Responses & Comments:

Literature review is inadequate.
- Formal academic peer review


Acknowledged. Going to work on this.

Very useful approach, but you need to properly assess the statistical predictive capability, not just look backwards. Looks a bit like being a chartist.
- Senior academic


Acknowledged. A project is underway to provide ex-post / ex-ante analysis. This work will be important towards testing the predictive capability of the metric. The initial results are very encouraging.

I have a hard time reading the charts.
- Financial analyst


Acknowledged. Progress towards clearer and improved charts has been made in more recent work presented at conferences in 2012.

Its only one metric. Using one indicator grouping all a country’s sectors may hide where the real problems are.
- Hedge Fund manager


Acknowledged. Yes, Debt/Cash Flow should always be used with a panel of indicators. Over time, the author believes Debt/Cash Flow will come to be recognized as the core interface between the balance sheet and the income statement (GDP) of a nation, and hence the most direct indicator of leverage and financial stability. Also, further progress has been made in applying the metric to individual economic sectors in order to expose escalating instabilities (in Financial sector and Housing sector for example).

The paper uses annual data, and because of OECD reporting lags, your analysis is largely historical, that is, backwards looking. If quarterly data were used, the charts would be more up to date. Also, the paper should take the next step and forecast the components of the ratio, in order to get a forecast for the likely direction of the Debt/CF itself.
- Investment industry analyst


Only annual data has been available so far for the specific calculation, in its current form. Quarterly data has not been available for this core calculation. However, other formats of the ratio can be produced on quarterly data, as was shown and published in the BIL Deleveraging report. In this report, Total Liabilities is utilized for the debt component, which is a broader measure than that originally used. The emphasis to date has been on introducing the concept. Data availability will improve over time.

Gross Savings data is volatile and therefore its use as a denominator in the proposed ratio tends to exacerbate the trends observed.
- Economist


Agree that Gross Saving is more volatile than GDP but disagree in the sense that Gross Savings is not particularly inherently volatile, and it is certainly less volatile than Net Saving. Moreover, the data is long-term, any short term volatility is played out into the long term trend. Gross Saving volatility does increase when bank write downs are large for example, or in the case of ‘sudden stops’ such as in the case of Iceland (see below).  Hence, these exacerbated ‘spikes’ in Debt/CF are clearly associated with financial instability and therefore useful in understanding the causes of crises.

Is it a good leading indicator? According to the indicator Iceland moved from the optimal zone in 2006 to a financial crisis in 2008, two short years.
- Economist


Iceland is the only nation with such a steep and short escalation of instability. The explanation for this rapid deterioration for Iceland was identified in Figure 11 of the published October 2011 paper, which presented the Net Lending / Borrowing accounts for several nations.  The author acknowledges that the connection was not explained in detail in the original paper. The point is that nations which are large Net Borrowers (Iceland was an extreme Net Borrower, by far the largest) have artificially inflated GDP and savings figures that in turn make several economic indicators including the Debt/CF ratio appear stronger than the reality.  Recent work has adjusted the gross saving statistic for the net lending account, which exposes the developing financial instability for Iceland much earlier. These dynamics will be better explained in a future release.

The critical zones the author has set are arbitrary, as has been admitted.
-  Junior academic


Arbitrary is too strong a word, but there certainly is an “art” element at this early stage. The “science part” of setting the zones was by way of a study of the utility industry, including a study of the Debt/CF data for the 10 years prior, and the 10 years after Chapter 11 insolvency events. The details of this approach are set out in Figure 8 of the original October 2011 paper. Simplistically, the utility industry was deemed to be an acceptable peer to a nation given the industry’s stable cash flows (this peer grouping is the ”art” part).  Similarly, nations have diversity in their cash flows (different industries, sectors) which provide stability to their cash flow (gross saving). Granted, the assignment of zones is preliminary and subject to further research.  As cited in the original paper, the delimits between the zones are intended as indicative grey areas of overlap – not definitive divisions. The Zones have already been refined in more recent presentations at conferences; see the discussion on Hungary below as an example.

Hungary is in the Optimum Zone, but it was in recent financial difficulty.
- Central bank analyst


Correct that Hungary has had recent financial difficulties, but at the time the chart was produced the most recent OECD data for Hungary was 2007. More current data for Hungary is now available through Eurostat. Hungary’s Debt/CF peaked at 18x in 2009, and the country entered into conversations with the IMF for possible assistance. The point is that the original paper laid out the methodology in conceptual format, and is now getting more refined.  These refinements are aided with the improved availability of data, a process which will continue over time.

Australia looks wrong.  Something is wrong with the data. Australia is far worse off than indicated in the paper.  Australia could not be in the Optimum Zone.
- Hedge Fund executive


Indeed, there was a bust in way the Australian data was drawn down. In the original October 2011 paper, Australia is likely incorrectly depicted in the Optimum Zone (it is depicted in a more positive position than is the reality). Comparable data (consistent with the other countries presented) to complete the calculations for Australia cannot be obtained at this time. Australia has been withdrawn from more recent charts and will only be re-presented when the necessary data is available.