[SCMP Column] Life after Lehman

September 10, 2018

A week ago, columnist Tom Holland warned us to expect a deluge over coming weeks of “ponderous opinion pieces by worthy pontificators” about the Lehman crash 10 years ago this week, and the story of the decade that has followed: “Most of what they write will be rubbish,” he added.

At the risk of ponderous pontification, and an outpouring of rubbish, I have an irresistible urge to revisit what was perhaps the most traumatic economic event of our lifetimes. Still now, I think one of the most pertinent comments at the time came from Queen Elizabeth: “Why did no-one see this coming?”

Without any precise scientific evidence, I believe the roots of the 2008 crash can actually be found around 1984. It was then that my Lloyds bank manager told me that my quarterly discussions on the state of my paltry finances would end. From then on, if I had queries about my accounts, I could call a help desk in Cardiff.

It was around that time that banks began to veer away from their dull but essential roles of housing our modest savings, and providing loans to small people and small businesses, and fell in love with doing (much more profitable) business with other banks, supercharged with portfolios of exotic leveraging instruments like Collateralised Debt Instruments and Specialised Investment Vehicles.

So a decade on, what for me are the main lessons learned?

First, that our experts’ ability to see a crash coming has always been appalling. There were notable exceptions, but most financiers, government regulators, and academic economists strode into 2008 still confident that “the great moderation” would continue. The myopia of those profiting from the collateralization boom can easily be understood: they had every vested interest in keeping the party well primed. Government regulators should have known better, but were under huge political pressure to keep the party going. Economists have the least excuse. They had no vested interest in the boom, but failed to smell the smoke in the air anyway.

Second, that those same experts naively believed that after a brief intermission, the party was set to continue. I remember writing, appalled, at the end of 2009 about the number of financial commentators who were already talking about evidence of “green shoots”.
As Harvard’s Ken Rogoff noted enigmatically in a recent Project Syndicate article: “Ten years hence, it is now widely agreed that recessions associated with financial crises tend to be extremely deep, with very slow recoveries.” For more serious examination, explore his book with Carmen Meinhart: “This Time is Different”.

Third, that much of the growth of the decade up to 2008 was not growth at all, and that one way or another this “chimerical growth” would need to be bled out of the system. In particular the process of cutting and dicing mortgage debt into millions of “collateralized debt instruments” was an obvious Ponzi scheme creating nothing but the illusion of growth, trade or income.

Fourth, that the “Alice in Wonderland” world created by the unprecedented Quantitative Easting (QE) policies confounded most predictions about what would follow the crash. Ken Lewis, then head of the Bank of America, predicted that about half of the US’s 8,500 banks would disappear. Whoops. Others predicted that a “great deleveraging” would mean the disappearance of securitized lending products, and a reversion to “plain vanilla” banking and a colossal contraction in money available for borrowers.

Quantitative easing confounded all of this, but the jury is still out on whether it has simply delayed the final day of reckoning. By flooding the markets with cash, and charging no interest, governments in much of the developed world now carry unprecedented levels of debt, and have grossly inflated our main asset markets – property and equity markets.

Fifth, the collapse of growth – except in the property and equity markets – has had some dreadful consequences, making inequality more extreme, and harming the foundations of democracy as a political process. Democracies need growth. Politicians need to be able to promise the prospect of improvements for which they can take credit. Promising “less awful” than the other party does not work in a democracy. This has led to growing support for extreme parties, extreme politics, and alarming demagogues.

Sixth, that there was an unexplored alternative to bailing out banks: bailing out the families who defaulted on their mortgages. In the US alone, 7.8m people lost their homes following the 2008 crash. Instead of spending uncountable billions bailing out banks, some asked a naïve but simple question: why not use that money to bail out defaulting mortgage-holders? Imagine the different outcomes: fewer banks; lots of poorer bankers; and millions of Americans still owning their own homes.

A fascinating examination in the Financial Times last week of “the story of a house” following the crash illustrates that many of the houses sold in foreclosure auctions across the US were snapped up at firesale prices by private equity firms. Stephen Schwarzman, head of Blackstone, now has a portfolio of 80,000 homes, making his firm “one of America’s biggest private landlords”. Inequality would not have become the inflamed issue it is today if the victims of the crash had been supported as assiduously as our banking institutions.

Seventh, that despite the current market hubris, the next crash is probably closer than we think. High-tech company valuations are at preposterous levels for companies that rarely make a profit, often have no genuine product, and operate with technologically-enhanced opacity. In a world where normal interest rates have to be paid on debt, many companies active today are in clear difficulty.

Perhaps most nerve-racking of all, with government debt levels at present stratospheric levels, who bails out the next crash?

Despite Tom Holland’s worries about ponderous pontification, I think the process has only just begun. As Ken Rogoff noted: “The global economy never ceases to be uncertain and unpredictable... It took economic historians seven decades to unpack the Great Depression. It is safe to assume that historians will have much more to say about the 2008 financial crisis in the years and decades to come.”
David Dodwell researches and writes about global, regional and Hong Kong challenges from a Hong Kong point of view. Opinions expressed are entirely his own.

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