Lehman crisis should have changed the world more than it did

Allister Heath

FIVE years ago, like every Sunday night, I was in the City A.M. newsroom, supervising the production of the newspaper.

Traditionally, Sundays are a quieter day for business news: while there’s always lots to write about, there are few on-diary corporate announcements. Not that Sunday. It was the most manic day any business journalist can remember, an astonishing, terrifying, nail-biting evening.

We kept rewriting pages, changing headlines and updating pictures. It wasn’t just Lehman Brothers that was collapsing. AIG was clearly finished and Bank of America was set to buy Merrill Lynch. It was carnage on Wall Street, a crisis of a kind that we had read about in history books but had never experienced, reported on or analysed in real life.

As we left the office at around 2am, none of us really knew what to expect in the morning. It was obvious that a lot of City workers – our readers – would be losing their jobs. Lessons needed to be learnt and major economic reforms were required. But it was impossible at the time to determine whether the world was about to suffer a very nasty recession – or whether we were set for a total collapse of our economy and our society.

The next day, copies of City A.M. were picked up so quickly that our stocks ran out by 8:30am. City workers and all Londoners were desperate to find out what was happening, and what it all meant. But the hunger for news was inversely proportional to the appetite for business transactions. Sales teams around the capital complained that their phones must have broken down: nobody was calling.

Over the next few days, meetings were cancelled, deals fell through and restaurants suffered a collapse in business – in fact, many usually bustling venues were sickeningly empty that Friday night. Paradoxically, this deep freeze didn’t last; there was a temporary rebound in confidence in some quarters after a few days, a dead cat bounce that lasted until everybody finally realised the gravity of the situation. Credit was crunched, swathes of the financial system were bust and the good years were well and truly over.

Five years on, the economy remains smaller than it was and much has changed in the financial system and in politics. Banks are less leveraged and hold greater amounts of capital, making them safer, among many other good changes. But plenty of other reforms have been either useless or counterproductive, and key problems remain unchecked.

The authorities still haven’t finished ensuring that even very large banks can fail in a controlled manner, without requiring bailouts and without endangering the entire economy. We need fully-functioning resolution mechanisms. Another Lehman needs to be able to go bust without inflicting a lethal shock on the rest of us. The moral hazard that helped drive the bubble has not yet been eradicated.

Hence why risk continues to be mispriced. The bond market bubble – fuelled by quantitative easing – is deflating, but it was a continuation of a trend which helped trigger the original boom by reducing the cost of credit. We are now witnessing a surge in issuance of junk bonds at cheap yields. As the Bank for International Settlements put it yesterday, we are seeing “a continuing squeeze of credit spreads and increased issuance of riskier bonds, a phenomenon reminiscent of the exuberance prior to the global financial crisis.”

Last but not least, central bankers continue to be seen as superheroes, whose job it is to create permanent “growth”. Now that Larry Summers has pulled out of the race to be the next Fed chairman, Janet Yellen is the favourite. While she will differ superficially from Ben Bernanke, she remains a dovish establishment economist; she is no revolutionary. So yes, we have learnt a great deal since 2007 – but sadly not enough to prevent the next crisis.

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