Lehman Brothers 10 years on
It’s hard to believe that it’s almost ten years since financial markets globally underwent a cardiac arrest that brought the world economy to its knees.
Financial markets had already been on a slow downward slope in the lead up to events in September 2008, over concerns about the stability of the global financial system that began back in 2007, with the collapse of Northern Rock as concerns started to grow about the prospect of much larger victims.
The events of 15th September 2008 when Lehman hit the wall were a direct consequence of a train of events that claimed the scalps of Bear Stearns, AIG, Fannie Mae, Freddie Mac and HBOS, and culminated in the bailing out of Lloyds, when it was forced to swallow the poison pill of HBOS.
This was followed by the biggest failure of them all, Royal Bank of Scotland which rolled over a month later on October 13th with a £37bn rescue only months after the bank tapped shareholders for £12bn in a vain effort to shore up its tattered finances.
Looking back at the events of ten years ago it’s worth looking back and asking ourselves whether we would be better able to react to a similar situation if one were to occur in the weeks and months ahead.
In hindsight it is easy to look back and argue whether certain things should have been done differently, and while it is easier to make the case for RBS being bailed out given its systemic importance, it is harder to argue the case for HBOS which should have been allowed to fail rather than bringing another bank to its knees in the form of Lloyds.
Politicians and regulators find it easy to apportion blame elsewhere when things go wrong however it was the actions of both that sowed the seeds of the crisis ten years ago, and which have left us with the legacy we have now. The low interest rate environment, the abolition of Glass Steagall, as well regulatory oversight that fell well short of the required standards, all contributed to the crash of 2008.
Glass Steagall came about in 1933 and forced investment banks to separate their retail and investment banking operations in order that retail deposits could not be used to fund speculative activity.
The abolition of this in 1999, by the Clinton administration, along with insufficient oversight from regulators on the behaviour of banks and financial institutions who indulged in reckless lending over that period, helped sow the seeds of a crisis which in the wake of 9/11 saw global interest rates cut even further in an attempt to prevent a global recession.
These low interest rates helped fuel a credit and asset bubble which politicians all over the world were only too happy to ride, fuelling a complacency that ultimately ended in tears.
Who can forget Gordon Brown’s famous quotes that he wanted to avoid the boom and busts of the past, and that he wouldn’t allow house prices to get out of control and put at risk the health of the UK economy. As is always the case with politicians, the actions never matched the words with the UK regulator, the FSA, ignoring a number of warning signs about dubious lending practices in the UK’s banks, in the lead up to events in 2007 and 2008.
When the Royal Bank of Scotland was bailed out in October 2008, the Bank of England base rate was at 5%, having already been reduced from a 5.75% peak in July 2007, having been as low as 3.5% in 2003, and these low rates helped to fuel a property bubble that ultimately came crashing down, as lending markets started to freeze up.
As banks suddenly stopped lending to each other the Bank of England started to cut rates further, reducing them by 0.5% to 4.5%. The central bank then cut them another five times by the time they hit 0.5% in March 2009, where they stayed until August 2016, when the central bank cut them again to an all-time low of 0.25%.
In hindsight the decision by US regulators to not bail out Lehman’s may have been a mistake, fuelling as it did a contagion in the global banking system, but it was the decisions in the years before that sowed the seeds of a crisis that is still with us today.
It is true that some of the actions since then have helped to improve the resilience of the financial system, but there are no guarantees that we won’t see a repeat given that some of the measures taken by politicians to address “too big to fail” institutions bear little relation as to why the crisis occurred.
The crisis wasn’t caused by so called the “casino banking” of trading equities, fixed income and foreign exchange, but primarily by synthetic financial products and off the shelf CDO’s and CDS’s which were sliced and diced debt packages of different levels of loans and debt, which were given triple “A” ratings by credit agencies who should have known better.
The problem of “too big to fail” financial institutions still remains a huge problem, as does the overall debt level of governments, as governments took on the liabilities of their failing financial institutions, which has resulted in difficult choices in having to cut back on some public services in an attempt to control the continued rise in total debt levels.
It is this failure to address the perceived injustices in the wake of the bailing out of these institutions that has helped fuel the rise of populism across the US, UK as well as Europe. In the US the US government still has big stakes in Fannie Mae and Freddie Mac, while the UK still has a large stake in Royal Bank of Scotland, which has only recently started to put its legacy issues behind it, with the failure to hold anyone to account for the GRG scandal, the latest in a long line of scandals which has once again shown up the limitations of the current regulatory environment, and the FCA’s ability to oversee it.
While the UK and US have gone some way to dealing with the crises of 10 years ago the same cannot be said for Europe where the banking system still remains in crisis, despite claims to the contrary.
The woes of the Italian banks remain a long way from being dealt with, while Greece’s economy has been in the deep freeze for the last ten years, and will likely remain so for the next ten years, unless the EU changes its policy towards it.
The German banking system is also under strain as can be seen from the woes of German’s largest bank, Deutsche Bank, which is struggling to stay relevant at a time when a lot of its global peers have already undertaken a huge amount of structural reform.
The low interest rate environment that has been symptomatic of the last ten years may well have averted a disaster back in 2008 and 2009, but it has also helped create a much bigger problem in that debt levels now are much higher than they were back then. This in turn has removed the incentive to reform, in what is still a very weak and unstable financial system.
Here in the UK the low interest rate environment has seen consumers take on more debt, while eroding incentives to save and reduce these debt levels. At the same time the governments misguided “help to buy” scheme has kept house prices out of reach for ordinary people, particularly in London and the south east of England.
In keeping interest rates too low for too long the Bank of England has removed any buffer it might have had in dealing with another crisis, should it occur, and that for all the talk of an end to austerity governments worldwide are no nearer to drawing a line under the crisis now than they were a decade ago.
As we look ahead to what might happen next a number of risks present themselves, including an escalation in trade disruptions between the US, the EU and China. This may well cause a global slowdown in economic growth, while an emerging market crisis has the potential to create a significant amount of disruption, as can be seen from recent events in Turkey.
This in turn could prompt a slowdown in Europe which still remains vulnerable given that the euro remains a hugely flawed construct, and the banking system is still far from fixed.
Rising populism could also cause political dislocations in Italy, where a coalition of populists could test the EU’s patience when it comes to budget rules, while the ongoing saga that is Brexit has the potential to become hugely disruptive as well.
Over the next few years you will hear a lot of talk that spending more money that we don’t have will somehow resolve all of society’s ills, and people will buy it because it sounds better than the alternative.
The lack of accountability on the part of politicians, regulators, ratings agencies and central bankers has prompted a crisis of capitalism, and a feeling of unfairness as those responsible were able to walk away, largely unscathed, the RBS GRG scandal being the latest example of a lack of accountability.
This needs to be addressed along with the closing of loopholes that allow companies to pay little or no tax on profits made within a single country.
Unless this is addressed the legacy of 2008 will be an increasingly populist landscape where voters tired of the crony capitalism they now see and who will in turn to politicians who promise to soak the rich and repeat the failed policies of the past. Far from creating a more level playing field, the increased centralised state control and high tax rates made economic decision making even more protracted, and saw tax revenues fall as higher rate tax payers simply left the country.
As is usual with politicians who promise ever higher taxes they soon discover the truth that some people have a lower tolerance for higher taxes than others. Nothing is truer than the saying that 50% of something, is better than 60% of nothing.
The reality is that a lot of these government initiatives tend to be “pie in the sky” programs like Hinckley Point or HS2, which tend to be high profile big ticket items that make nice headlines, but deliver little in the way of long term benefit.
A usual rule of thumb when it comes to political promises is if it sounds too good to be true it probably is, and any politician who suggests otherwise is being economical with the truth. What is needed is more accountability and less state intervention, not more.
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