Ten Years on from the Lehman Brothers Collapse – have we learned anything?
14 September 2018
Tomorrow we mark a decade since the collapse of Lehman Brothers – one of the largest US investment banks that had a substantial operation in London. For most people, that collapse was what made them realise that the French, US, and UK financial difficulties that had become apparent over the previous months, had transmogrified into a global financial crisis. Had it not been for this crisis, the world would be very different today – possibly there would have been a different outcome for the US election and for the UK Brexit referendum. It is also likely that we would not have seen nationalist movements in Europe gaining strength to the degree that they have. For those living in the UK, incomes would almost certainly have been at least 20% higher than they are today.
Financial crises occur with monotonous regularity in all financial systems as they are not so much a capitalist phenomenon as a human behavioural phenomenon. The odd thing about the 2008 crisis is not that it happened but that it took so long to happen. We were led to believe that we had reached nirvana in the global financial system where stability had been assured. But clearly, despite a widespread belief that this was so, we had not in fact achieved that stability.
Crises happen because of human optimism, over-confidence, and a belief that in stable times we can take risks that will enable us to become wealthier. Without this human trait, we would not have entrepreneurs and intrapreneurs creating and expanding industry and we would be the poorer for it. In the domestic arena, we might buy a larger house than we can really afford, borrow too much money to pay for it but believe that things will work out OK, that the future will be at least as good or better than the present and that “all is for the best in this best of all possible worlds”. This is the Panglossian philosophy in Voltaire’s novel, Candide.
It is also the basis for one of the most insightful concepts relating to financial markets – the “Minsky moment”. Hyman Minsky was possibly the only US economist who observed well before the crisis that what often leads to a sudden collapse in asset values (share and debt prices) and thereby brings on a financial crisis is a long period of prosperity. Believing the future will be like the past (as financial models also predict) and observing property prices and share prices rising year after year, more and more people, companies and banks speculate (on houses and shares) using borrowed money. But when prices suddenly fall, those over-borrowed people, companies and banks, cannot make their debt payments leading to a snowballing debt crisis.
Today most people don’t yet have the confidence that we are in the ‘best of all possible worlds’ – perhaps quite the opposite. But the global economy is much more highly leveraged than ever – total debt is a higher percentage of GDP then before the 2008 crisis, commercial banks are larger than ever and while they remain too large to fail (and are safer than they were in 2008), they are also now too large to save.
But the next financial crisis will, almost certainly, come out of the blue yet again and have a different starting point. It could be financial problems in China, tariff wars leading to falling trade and GDP, problems in the EU initiated by the UK Brexit chaos and by nationalist movements in Europe, illiquidity and falling values in mutual funds, pension funds and insurance funds resulting from the US and other markets (such as the UK which is well above its peak in 2008) falling from record high levels. We also have a US president who is determined to cut back on the new regulations introduced to make banks safer and regulation in general. That is often a forewarning of trouble ahead. He also tweets that thanks to him the US market is at a record high. His next tweet to that effect could be the start of the Minsky moment.
A key problem we have in financial markets is that they have little to collective memory. It’s a young industry and new graduates who have not experienced a financial crisis will soon be in charge. Collective memory withers and this leads to repeat behaviour of the type that set of the last crisis. The definition of insanity is doing the same thing over and over again and expecting a different result. But without a strong collective memory, this is what in fact happens.