It’s exactly a decade since Lehman Brothers went bust.
If you were watching the financial news at the time, you’ll remember seeing (ex)-employees of the US investment bank carrying office possessions out of building in cardboard boxes.
In fact, you won’t just have seen this on the money channels. Lehman’s demise was worldwide news. It was the poster child of the great financial crisis.
10 years on, things have changed in the markets. But maybe not all for the better.
So could the Lehman saga repeat itself?
Let’s take a look…
Lehman Brothers’ bankruptcy was dramatic. At $639bn, it was the biggest-ever in corporate history, almost twice the size of the second-largest on record.
In effect, Lehman had become a highly-leveraged giant hedge fund due to its exposure to subprime mortgages in the US housing market. When America’s residential property prices tumbled and borrowers defaulted in droves, Lehman was the highest-profile casualty.
Though the investment bank’s ultimate failure was no great surprise, it still served up a massive jolt to the system. Within a few days there was a major stock market sell-off, and by March 2009 the S&P 500 index was more than a third lower.
Some people reckoned that Lehman should have been bailed out by taxpayers along with other insolvent financial institutions (in the UK, RBS springs to mind). Others commented that it was better to let Lehman go “pour encourage les autres” to lend more responsibly in future, as Voltaire might have said.
Indeed, arguments about this mega-bankruptcy, and about the overall concept of whether any institution is ‘too big to fail’, rumble on to this day.
The vast majority of us can’t influence such decisions. Like it or not, they’re made by the financial elites. Unless we somehow manage to join that hallowed group, the best we can do is to assess their pronouncements and to anticipate the potential results.
In other words, let’s look at banks today…
Since 2008, banks have been forced to change their business models. They’ve shrunk their balance sheets, which is banker-speak for saying that they don’t lend as much money as they used to.
“Global banks have faced an unprecedented level of regulatory scrutiny in the aftermath of the crisis and have never been better positioned from a solvency and liquidity perspective”, says JP Morgan. “While the ability to foresee the exact sequence of events that could trigger another recession is limited, banks are unlikely to be the Achilles’ heel the next time around”, says Kian Abouhossein, the bank’s Head of European Banks Research.
Or maybe not.
“It’s shocking to see how… fragile the financial system remains”,says a just-published Bloomberg editorial. “After the crisis, legislators and regulators worked to ensure the system would be better prepared, adopting thousands of pages of laws and rules. In general, they have fallen short. Regular stress tests have improved banks’ risk management, but aren’t nearly as stressful as a real crisis.”
“New derivatives rules and risk reporting… don’t yet provide the real-time, cross-border picture needed to see dangers and respond accordingly. Some of the world’s largest banks still can’t provide timely, complete and accurate data on their own exposures. Regulators have developed a mechanism that allows them to take over a large, distressed financial institution, but it’s untested and unlikely to work in a system-wide crisis.”
Err… just getting a little scared again.
This still sounds like 2007 once more, with a small number of players exposed to huge levels of risk.
“Worse, the world is backsliding”, says Bloomberg. “In Europe, banks have successfully fought back against rules that would have toughened regulatory capital ratios. In the US, Congress and the Trump administration have rolled back bits of the 2010 Dodd-Frank financial reform, weakening some safeguards and undermining institutions designed to protect consumers and create a financial early-warning system.”
Put another way, there are still big question marks on whether the banking system has enough capital to withstand another major financial crisis. Last year the Federal Reserve Bank of Minneapolis concluded that under current capital requirements, the chance of a bank bailout being needed in the next 100 years is about 67%.
Are repeat Lehman worries missing the point?
But even if we’re worrying here about something that won’t happen, “looking for the next Lehman’s misses the point – three post-crisis developments mean that there are new risks for investors to worry about”, says Neil Shearing, Group Chief Economist at Capital Economics.
The world economy still relies on rising debt to sustain demand. But unlike in 2008, China is now the big issue as it accounts for two-thirds of the global debt lift over the past five years. “History suggests debt increases on the scale experienced in China end badly and it’s likely that a significant amount of recently accumulated debt will ultimately be written off”, says Shearing. In Europe, Italy’s debt problems are growing too.
Then there’s the post-crisis weakness of productivity growth as the economic recovery in advanced economies has been the feeblest in recent history. The resultant slower wage and profits growth will make it harder to service debt burdens.
Finally back to those financial elites. We don’t know how well policymakers will respond to the next global downturn, especially if there’s another mammoth stock market slide.
How low will interest rates go?
Will there be more QE?
Or what else will the financial wizards magic up? In particular if another major institution does actually go under.
None of this is good news for anyone looking for decent level of income, of course.