Lehman Brothers and the next GFC

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It has been a decade since the banking aristocracy of Lehman Brothers filed for bankruptcy in what would be the chant of doom that became the Global Financial Crisis. It was a Wall Street firm that had lasted some 158 years.

Lehman Brothers Times Square by David ShankboneThe previous year, the global investment bank Bear Stearns began its decline into financial ruin. The demise of both enterprises revealed, in all too discomforting ways, the manner in which privately made losses can become socialised (or not, as the case might be). The economic calamity also unmasked the unruly nature and dangers posed by an unregulated financial market while revealing the threats posed to the global economy by the banker turned speculator.

Banks on both sides of the Atlantic found a shortage of capital. Too much had been lent in the form of subprime funding to US households, European financial bodies and member states. This resulted in a transatlantic binge of overleveraging, covering debtors from US home buyers to the Greek government.

Suddenly, treasurers and central bankers were begging for acts of socialisation. The neoliberals were in shark retreat. The heralded invisible hand attributed to Adam Smith had miraculously withdrawn itself. Not saving Lehman Brothers was deemed by such figures as Daniel Gros, director of the Centre for European Policy Studies, a mistake of global proportions.

The banks had slumped, requiring propping up by the public purse. Wall Street became a ghost of itself, with such august institutions as AIG, Washington Mutual and Merill Lynch gathered up. Capitalism could no longer be regarded as 'self-cleansing'; bankers, now colloquially known as banksters, could not be permitted to be entirely autonomous and free dealing.

Today, the legacy of Lehman Brothers and the crisis it helped precipitate supply warnings of the next shock. Global debt stands at a boggling amount: some US$215 trillion. Banking, rather than being simplified, is achieving greater levels of complexity. Such institutions, claim Heidi Moore, 'are bigger, more complicated, harder to manage, on the wrong side of history and, evident to everyone, more than ever at risk of hurting everyone if they fail'.

Regulatory efforts are now being wound back. The Basel III international regulatory framework for banks, developed by the Basel Committee on Banking Supervision to 'reduce excessive variability of risk-weighted assets', has not stayed free market nostalgia. In May this year, US President Donald Trump signed into law provisions winding back the oversight mechanisms imposed by the Dodd-Frank Act of 2010.

 

"Australia's own contribution to this, characteristically late, is now becoming clear."

 

All this was done in the name of providing 'consumer relief' while also lessening the costs of regulatory oversight by banks. It entailed the removal of protections guaranteeing the health of various credit unions and community banks no longer deemed 'too big to fail'.

As Lord Adair Turner, chair of the UK Financial Services Authority between 2008 and 2013 has outlined, 'irrational exuberance' remains prevalent, marked by 'debt overhang', a phenomenon marked by the way certain countries prove unable to escape the depredations of the debt cycle. Developed economies, he argues in Between Debt and the Devil, have become addicted to borrowing money to boost economic growth, a situation that feeds the next damaging bust.

Australia's own contribution to this, characteristically late, is now becoming clear. While the country's banking system weathered the battering storms of the GFC, with the healthy injection of financial stimulus initiated by the Rudd government, Australia's bankers got cocky. A three-and-a-half week period at the height of the shock saw the federal government guarantee all bank liabilities for no fee.

In 2008, large deposits and funding measures were buttressed by a supporting fee structure. The four giants were permitted to straddle the system with confidence and impunity. In May 2017, Anna Bligh, Chief Executive of the Australian Bankers' Association would confidently say that Australia's banks were simply 'too big to fail'. That cockiness has become all too evident with the revelations of the Royal Banking Commission, an object lesson to those who think that regulating finance is an evil worth avoiding.

The nailbiting worry now is that the global public purse has now been obesely leveraged. Debt begets debt and to reduce and write it off would be, as Lord Turner argues, the catalyst for recession. And this is not the constructive debt of Keynesian expenditure, the stuff spent on infrastructure and projects for the tangible public good. It is fictional money with genuine consequences, paper debt that risks returning to inflict another terror on economic tranquillity.

As that student of macroeconomics Rudi Dornbusch noted when asked about Mexico's economic crisis in 1990s, 'The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought.' A sensibly gloom proposition.

 

 

Binoy KampmarkDr Binoy Kampmark is a former Commonwealth Scholar who lectures at RMIT University, Melbourne.

Topic tags: Binoy Kampmark, Lehman Brothers, GFC

 

 

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Indeed, global debt of US$215 trillion is a mind boggling amount. But who wants to do anything about it? Between the crony capitalists, the rent-seekers, and the more-government/welfare mob, not very many. And those who advocate balanced budgets are quickly howled down including politicians who’d be voted out of office. In addition, economy-destroying climate change policies are accelerating this madness. We have reached the situation predicted by Alexander Fraser Tytler, the 19th century Scottish professor of History to whom the following quotation has been attributed: “A democracy will continue to exist up until the time that voters discover that they can vote themselves generous gifts from the public treasury. From that moment on, the majority always votes for the candidates who promise the most benefits from the public treasury, with the result that every democracy will finally collapse due to loose fiscal policy, which is always followed by a dictatorship.” And then the irresponsible, the selfish, and those who deliberately pushed these policies, will claim that it was the system that was responsible for the collapse.
Ross Howard | 14 September 2018


Pre crisis, an employee on Wall Street could sell a “product” and the product “profit” would be calculated at the time of sale. The bank would account for the profit at the time the product was sold and the employee would receive a bonus on the same profit calculation. This is despite, of course, products enduring for 6, 10 or 20 years. The crisis showed that the accounting for products at time of sale could be wrong and by large margin. Time and markets provided ample opportunity for products to underperform their theoretical outcome. Indeed the crisis showed structured housing products were generating substantial losses once capital growth assumptions failed. Instead of providing a profit they made a loss but the bank had already encouraged the employee with bonus payments and the employee has spent the money. Indeed they had been paid on products that lost money. The mismatch occurs between duration of product and timing of employee remuneration. If the product lasts six years then the bank should realize the profit during that six year period and incentivize the employee with the same duration of payments. The ONLY bank to have meaningfully changed this structure in Australia is Macquarie. The four major banks lack badly and indeed the RC has showed the way these banks have incintivized employees to sell products to the Australian public falls into the same pre crisis erroneous method. Of all the people that should have enderstood this risk, it was Malcolm Turnbull. He did not want a RC for the same reason that Shorten did not want one ... corruption of ideals, process, incentives, controls and governance.
Patrick | 15 September 2018


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