Ten years since Lehman Brothers: and it’s still playing out…

Ten years since Lehman Brothers: and it’s still playing out…

by Ewen Stewart
article from Monday 24, September, 2018

ON SATURDAY 15th September 2008 the collapse of Lehman Brothers was the eye of the storm of what became the financial crisis. Ten years on, while the sun continues to rise the world is a very different place. 

Superficially western economies markets not only survived the collapse but in some cases have prospered. Outside southern Europe unemployment is falling in major economies – and at a 40-year low in the UK; corporate profitability is back to peak levels and while economic growth has varied markedly by country it has generally been reasonable. 

Despite the image presented daily on the TV news and radio, life for most is pretty good, although ten years ago it perhaps did not look quite as rosy with the genuine possibility of economic collapse and a recession on the scale of the 1930’s.

This apparent recovery masks, however, a number of major challenges. Government fiscal deficits have ballooned and normality has only been achieved through an extraordinary monetary response which, in most of the developed world, has amplified asset prices, arguably distorted investment decisions and may have played a part in depressing productivity.

Politics has also been transformed, in my view largely, but not exclusively, as a result of the financial crisis and subsequent monetary experiment, which although successful in averting a 1930’s style collapse, has created a perception of clear winners and losers. 

The winners, notably older and asset rich – have benefited from asset price reflation through Quantitative Easing and very low interest. House values have typically been climbing, as have equities – creating winners as a result but also excluding large sections of the public who cannot afford property or share ownership when before they could have expected to. Thatcher’s property-owning democracy and popular shareholder capitalism is a fading from memory.

As a result ‘the losers,’ or at least the relative losers, as on most measures economies are more substantial today than a decade ago – have reacted by playing a part in breaking the political consensus. Votes against the establishment parties, the establishment figures – and the rejection of all the dire warnings made by the establishment – have rocked the tranquillity and complacency of the political and social elite.

In the UK there was no word for BREXIT in the English dictionary a decade ago, the closest word to it was Eurosceptic, which the BBC tended to say while holding their collective noses.  Before the crisis Greece seemed warm and affluent – this proved an illusion. In the US Trump was a 200-1 outside bet at the start of the Republican primaries. 

While the politics of Trump and BREXIT are very different, the old certainties are not so certain. A loss of confidence in the centre-left or right In Germany, France, Austria, Hungary and other European countries has partially resulted from the aftermath of the credit crisis and the ensuing asset reflation. Potentially, this is a major legacy of the crisis with considerable short and long term macro-economic implications.

A decade on and emergency measures are still largely in place, particularly in the UK, EU and Japan. These measures might have mitigated disaster with varying degrees of success, but we have still to see how this will play out in terms of monetary, fiscal and political response over the next few years. Have we merely kicked the can down the road, or will normality return?

Prior to June 2008 the UK had posted 64 quarters of growth in a row. That is a record period of consistency of 16 unbroken years. Gordon Brown even claimed that ‘modern economics had abolished stop-go.’ Like Canute, Brown discovered that try as you might a centralised authority cannot ultimately tame nature.

Moreover, while the UK record was impressive the fact is most major Western countries delivered something similar to a greater, or lesser, extent. The reasons for this consistency is much debated but, it is my belief this ‘golden age’ was actually laying the foundations for the crash through significant policy error.

The appearance of sustainable consistent growth was less a function of prudent macro-economic management but more a persistent, if silent, leveraging of the economy as governments, consumers, corporates and financial institutions all increased their risk appetite and debt levels, thus ‘bringing forward’ consumption.

Thus, the subsequent analysis of so called trend growthwhich, for the UK, was considered to be around 2.5 – 3.0 per cent GDP pa, was an illusion based on non-repeatable factors, notably increasing leverage, off balance sheet financing and growing risk appetite – rather than stable productivity driven growth. These factors leading up to the crisis have not yet been fully appreciated, with continuing policy implications. 

This buoyant environment created an inevitable complacency culminating in an ever increasing risk appetite as governments gave a monetary and fiscal lead, often supplementing spending with substantial off balance sheet liabilities (PFI being a prime example). Consumers and corporates followed this signal as they too leveraged. This was compounded by investment banks who gambled with increasingly complex and often poorly secured assets. 

This is not the place to recant the history, save to remind readers that, while a global phenomenon, to use a domestic example, RBS leveraged its asset base by 61 times. Given that no significant UK bank had gone down since 1847, such behaviour was perhaps understandable, if rather cavalier, however the speed and severity of the correction very nearly led to a complete collapse of the entire banking and monetary system. 

While the crisis began with a collapse of US subprime loan books it quickly went global with a wholesale banking collapse only avoided by nationalisations with Governments and central banks acting as lender of the last resort – and ultimately an attempt to reflate the lifeboats through QE and the lowest sustained base rates in over 300 years of central banking history.

The policy has been successful, in terms of averting a major depression, unemployment and potentially wholesale deflation, however the implications of the extreme medicine used are still being felt. 

Drawing direct political conclusions is a matter of conjecture as many factors come to play of which the financial crisis is but one, what can be said is the last decade has seen the start of a break down in consensual politics. 

While too much can be made of this, as in many jurisdictions ‘populism’ has been a challenger rather than a victor, there is little doubt that the financial crisis has acted as a subliminal lightening rod shaking confidence in elites, creating arbitrary winners and losers and resulting in a policy micromanagement that has caused dislocation.

In the Eurozone, with the very significant exceptions of Italy and Hungary and possibly Poland, where the non-establishment parties were the victors, ‘populist’ parties have grown their share of the vote materially – but in all cases still remain a challenger, with typical support of between 15-25 per cent.

In the US Trump’s politics clearly is a break with the consensus, but he is to an extent constrained by the substantial checks and balances of the US constitution. Moreover, his economic populism comes from the right in terms of tax cuts and is thus stimulatory and generally positive for investors.

The UK is perhaps the most interesting case as BREXIT would have seemed so unlikely a decade ago that no business ever discussed the possibility. Like Trump, or Leicester City, it was a bet of several hundred to one against. 

Why has this been possible in the UK? There are many possible reasons from weak leadership, the perceived language if not reality of austerity, and the winner/loser intergenerational impact of QE, and rapid cultural and technological change all being key. 

Britain however, seems to be rowing in a different direction with a current choice between micro regulation and modest tax rises under the Conservatives – or the possibility of a ‘hard left’ experiment which would lead to significant capital flight and be highly damaging for domestic UK assets. 

Ten years on and the reaction to the financial crisis has still to play out.

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