10 years on from the Lehman Brothers collapse... so, what did we learn?
A decade on from the financial crash, Dan O’Brien assesses how the world has changed, and not changed
This Saturday marks the 10th anniversary of the collapse of Lehman Brothers bank and the beginning of what came to be known as the Great Recession. Last week this column looked at the consequences and policy responses in Ireland. Today’s column looks at the wider international ramifications — for politics, economics, Europe, and the regulation of finance.
÷ Economic mismanagement and the politics of discontent
The deepest slump in living memory across most of the western world caused tens of millions of job losses and increased economic insecurity for billions of people. The huge declines in economic activity recorded at the time also caused tax revenues to fall. That, and multiple bank bail-outs, left many governments constrained in their capacity to mitigate the effects of the crash.
The darkening of the political mood in the western world, the fragmenting of voting patterns and this rise of illiberal parties over the past decade are trends that have almost certainly been hastened by the economic effects of the crash.
The post-World War II dominance of western politics by the parties of centre-ground has been shaken not only by the direct economic effects of the crisis, but of a loss of faith in the capacity of the mainstream to manage economies effectively.
The period leading up to the crash had been dubbed the ‘Great Moderation’ by some economists. Central bankers were particularly pleased with themselves, believing they had learnt to tame the boom-bust cycles that have long been a feature of market economies.
But, right under their noses, a super-bubble inflated within the western financial system in the half decade up to 2008 (the Irish credit binge over the same period was just one part of this bigger international bubble). To have got it so badly wrong has almost certainly contributed to more voters being willing to take a chance on non-mainstream parties. “Could they do much worse?” is a frequently reported response of those who have switched from the centrist to extreme parties.
÷ The end of the European dream
The Great Recession that followed the financial crash of September 2008 exposed underlying weaknesses in structure of the euro edifice. In early 2010 the weakest link — Greece — snapped. The euro became the perfect transmission mechanism for financial contagion. Other countries, including Ireland, were dragged over the edge. A second “double-dip” recession hit the single currency zone.
This was unquestionably the greatest crisis in the history of the European integration project and the only one that has come close to causing the entire enterprise to go into reverse. A deep division between northern and southern countries opened up. It shows no sign of narrowing. “We are not slaves of the Germans and the French,” the Italian deputy premier roared earlier this year. A decade ago it would have been unthinkable for a leader in one of the founding members of the EU even to think such a thing, never mind to utter it.
The euro is not the cause of Italy’s economic woes, but it has created disharmony among the currency’s members that would not otherwise have existed — the very opposite of its intended purpose. How it has worked out has increased scepticism about further integration even among those who are traditionally pro-EU. It has also raised the question of whether integration may already have gone too far. The belief in “ever closer union” is all but dead.
÷ Brexit, the UK and the Great Recession
The reasons 52pc of those who turned out to vote in Britain’s 2016 Brexit referendum chose to leave the EU will be debated for decades to come. But given the narrow margin of the vote it could plausibly be argued that the effects on British public opinion of the Great Recession led to an increase in the pure protest vote component of the electorate.
The fiasco around the Eurozone crisis also surely had an impact. Not only did the double-dip recession in the eurozone have serious negative effects for the UK economy, but the intense media focus on the crisis reinforced the views of Eurosceptics and caused centre-ground voters to doubt the benefits of Europe. This factor alone could have swung the vote in favour of Leave.
÷ The enduring economic consequences of crash
Most western economies suffered their biggest declines in GDP on record in the aftermath of September 2008. Six months after the Lehman Brothers collapse, some indicators for the world economy were showing a pattern eerily similar to the post-1929 crash. Thankfully, the similarities did not persist.
Much more aggressive policy action is likely to have been the main reason the Great Recession did not become a global depression.
Central banks cut rates to historic lows and then engaged in almost unprecedented experiments in money printing. Governments almost everywhere borrowed massively to prevent demand from falling even more rapidly than it was falling at the time.
Despite this stimulus without precedent, none of the major economies recovered strongly. Some, including the US, bounced back more quickly, even if rates of growth in the recovery period were sluggish. For many others, particularly in Europe, it was almost half a decade before the slump ended.
Now, a decade on, there is some semblance of normality as the developed world enjoys a period of sustained expansion. But scars remain. The most lasting effect of the crisis will be the impact of the holes blown in the public finances of so many countries.
Never before in peacetime have governments taken on as much additional debt. As has been the case in Ireland, this has constrained governments and it will continue to do so for a long time to come.
This could hardly have come at a worse time. Demographic changes are pushing up the old-age dependency ratio, making debt reduction all the more challenging. There will also be much less scope for stimulus in the event of another crash.
÷ Could it happen again?
Nobody foresaw what would happen when Lehman Brothers collapsed 10 years ago. The reason it was not foreseen is because nobody fully understood how the massively complex financial system worked and how it related to the rest of the economy. That has not changed.
More onerous regulations were imposed on many parts of the financial system in the wake of the crisis. This, and a recognition among regulators of how badly they failed, has gone some way to limiting the risk of another crisis of the magnitude of 2008 occurring again. But it has not gone away.
Modern finance is an enormous interlinked mechanism with millions of parts. These parts not only move, but change and evolve constantly. The combined problems of complexity and lobbying by ever-powerful financiers have resulted in less structural change than might have been proportionate given the damage done.
Take the “too big to fail” problem. Across the western world, Ireland included, the banking system has become more concentrated. Fewer but bigger banks has made the system more vulnerable to the failure of just one bank. Governments have even greater reason to prevent banks going bust now than a decade ago.
And what about bubbles? The root cause of the last crisis was a bubble in asset prices. Today, financials assets have been soaring in value over a sustained period. Many observers of financial markets see that cycle coming to an end. Not all financial market crashes cause mayhem. Some, like the crash of 1987, caused no discernible damage to economies. But nobody can predict how bad they will be and their consequences for the wider economy.
It was often remarked after the crash of a decade ago that it was a once-in-a-century event. With the financialisation of modern economies in recent decades there is every possibility that such crises will become a more common feature of economic life. If that is the case, tinkering with regulation will have to be replaced with wholesale restructuring of a sector that poses such huge risks. The world cannot continue to live with an uncontrolled and uncontrollable financial Frankenstein.