Where’s the next Lehman?
Five years after the maelstrom of September 2008, global finance is safer. But still not safe enough
Sep 7th 2013 |From the print edition
THE bankruptcy of Lehman Brothers, an American investment bank, in 2008 turned a nasty credit crunch into the worst financial crisis in 80 years. Massive bail-outs from governments and central banks staved off a second Depression, but failed to prevent a deep recession from which many rich economies have yet fully to recover. Five years after that calamity, two big questions need to be answered. Is global finance safer? And are more crises on the horizon?
The quick answers are yes, and yes. Global finance looks less vulnerable because reforms to the financial industry have made it more resilient, and because America, the country at the heart of the Lehman mess, has got rid of much of the excess debt and righted many of the imbalances in its economy. Today’s danger zones are elsewhere. They are unlikely to spawn a collapse on the scale of 2008. But they could produce enough turmoil to hit growth hard.
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The three harbingers of the apocalypse
The disaster of September 2008 had many causes, as the first of our series of “schools briefs” (see article). But, put crudely, Lehman’s demise spawned catastrophe because it combined three separate vulnerabilities. The underlying one was a surge in debt, particularly in the financial sector, brought on by a housing bubble. The ensuing bust was made more dangerous because of the second weakness: the complex interconnections of securitised finance meant that no one understood what assets were worth or who owed what. Lehman’s failure added a third devastating dimension: confusion about whether governments could, or would, step in as finance failed. A rule of thumb for spotting future disaster is how far those weaknesses—a debt surge, ill-understood interconnections and uncertainty about a safety net—are repeated.
The overhaul of financial regulation since 2008 has made most progress on the first two. Under the new Basel capital standards banks are being compelled to hold more, and better, capital relative to their assets; the biggest “systemic” banks even more than others. Another strand of reforms, such as pushing derivatives trading onto clearing-houses, has tried to improve transparency. Least progress has been made on what to do when big banks fail—though new efforts to write global rules that would force banks to issue bonds that can be “bailed in” in the event of failure is a promising step.
American finance has become safer. The country’s big banks have raised more capital and written off more dud assets than most others. At around 13%, their risk-weighted capital ratio is far above the new global norms and some 60% higher than before the crisis. American property prices have adjusted and households have cut their debts. Government debt has risen, but most of that rise is the sensible mirror-image of efforts by households to reduce theirs. Now that the economy is recovering, the budget deficit is tumbling. You can find bubbliness in bits of American finance, including the corporate-bond market, and some nasty off-balance-sheet liabilities like student loans and public-sector pensions, but America does not look like a source of imminent trouble.
