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10 Years Later - Are We Heading Towards Another Financial Crisis?

“Contrary to popular perception, the Lehman Brothers crash in September 2008 did not cause the global financial crisis. It revealed the crisis. Suddenly it was clear to see that just about every bank and the entire banking system was, in that moment, bankrupt.”

Dr. Pippa Malmgren, American policy analyst who served as Special Assistant to President George W Bush and co-author of The Leadership Lab, warns leaders that during times of crisis and tranquillity managing the mood matters as much as addressing the math. In the aftermath of the crash, Citigroup reported a loss of $27.7 billion and the Bank of America fell by 21%. Instead of an illiquidity crisis at one firm, policymakers were suddenly dealing with the insolvency of the entire financial system. “They made a deal with the devil we’ve been paying for ever since” Dr Malmgren commented.

To prevent the entire financial system from crumbling the United States government introduced the Trouble Asset Relief Program (TARP). At $700 billion, TARP was the biggest fiscal stimulus in American history, exceeding even the largest wartime budget.

In addition to flooding the market with cash the US government, like the UK government, dropped interest rates. The inherent purpose of freely available cheap money was to push up asset prices and to create inflation. “Inflation pressures are apparent in the data almost everywhere in the world now.” Malmgren continues, “The most popular subject of discussion from Beijing to Delhi and Birmingham to Dallas is the rising cost of living.”

The reality has been that that since the last banking crisis of 2008, interest rates have been extremely low in the UK. Between March 2009 to August 2016 interest rates were held constant at 0.5% - then, for almost a year the rates were further reduced to 0.25%, before returning to 0.5% in November 2017. Even today, the Bank of England has not had the opportunity to recoup all their reserves since providing substantial bail-outs during the 2008 crisis. Whilst Lloyds Banking Group has returned to full private ownership, the Royal Bank of Scotland has yet to commence its state-ownership share repayment programme. Even with the modest recent increase of interest rates in November 2017, should another financial crisis hit the UK financial banking system, the Bank of England is not in a position to use interest rates as a relief mechanism and with monetary policy already at its limit, the only option available to the Bank of England would be to inject more money in to the system.

Beyond the banks

No sector was immune to the ‘domino effect’ that followed. In the United Kingdom, one of the biggest sectors to be impacted was the property sector, both residential and commercial.

Residential property developers are directly influenced by the mortgage market, which in turn is impacted by the ability of the public to obtain mortgages and as banks became increasingly risk-averse, new borrowers (usually first-time buyers) were finding it much harder to borrow. They were being asked in many cases to find up to 25% deposits (on a property worth say £150,000 this would have meant a deposit of at least £38,000), which in reality meant first-time buyers were shut out of the market.  

Adrian Cudby, author of Commercial Lending who has over 30 years’ experience in banking, describes how the residential market froze as a result. “Existing property owners couldn’t move, because first time buyers are incredibly important to the system. In a very short period of time residential property developers found they couldn’t sell their newly built stock and banks were left with commercial customers who couldn’t repay their residential building loans.” In the meantime property values were dropping in many areas across the UK and in the North-East of England for example, values dropped up to 30%.

The rise of populism

The greatest consequences of the financial crisis were, and continue to be, felt by the public who got higher tax bills, increased inflation rates and a lower standard of living. Privatising the rewards and socializing the losses broke, for some, faith in capitalism.

The slower economy halted confidence in the future while the higher cost of living has eaten into the standard of living. Property prices and stock market values rose but wages did not. Public and private debt exploded. Austerity ensued. It revealed the existential problem we now face – our leaders lost confidence in the system they sought to uphold. They did not believe that the financial system could sort itself out without the injection of massive public funds. Malmgren believes “They lost faith in capitalism and, as a result, the public did too.”

Suddenly, the public cared about the location of power and began to vote for more local control which continues to echo into today’s political landscape. Brexit and the other European populist movements and the election of President Trump all symbolize decentralization and re-localization of decision-making. Though, whether a localized approach can deliver is an entirely different question.

“We cannot blame people now for trying to find a new business model, or a third way, if they feel that the system is rigged” Malmgren argues. Much of modern politics centres on this one question – what is the right economic model going forward? As long as the system is perceived to tilt in favour of the speculators and against the interests of the savers and ordinary citizens, this question will continue to dominate politics and promote populism everywhere. All this gives rise to an entirely new set of challenges for today’s leaders, in politics and business.

Are we heading for another crisis?

John Henderson, Head of Process Operations Solutions at RBS and author of Retail and Digital Banking, thinks so. “If only we could know when for sure. What is certain is there will be another one.”

Many banks are still recovering and are continuing to re-build their way out of the last financial crisis. “As we stabilize and work our way out, we should do so with open eyes as the next crisis is likely to be lurking around the corner. It is during the re-building phase that the dangers lie. As new regulations bed in, creativity starts, during periods of stability, innovation commences, as growth happens, risks are taken – the next financial crisis will already be forming and we haven’t really recovered from the last one yet.”

Trends would indicate that in our current system financial crises happen once every decade, if not more frequently.

Are We Ready for Another Financial Crisis?

The short answer is no.

Crises are not easy to predict - on 5th June 2007 at the International Monetary Conference, Ben Bernanke, Chairman of the Federal Reserve System, rebuffed any suggestions that the collapse of the US sub-prime mortgage business would lead to wider systemic failure. He stated that, “at this point, the troubles in the sub-prime sector seem unlikely to seriously spill over to the broader economy or the financial system”.

How wrong he was. The reality is, the next banking crisis might just happen soon. There are sufficient indicators present today that would point to that being entirely feasible and what is worrying is the lack of defence strategies at central banks disposal to combat any downturn in the sector.

Henderson concludes, “Even with the modest recent increase of interest rates in November 2017, should another financial crisis hit the UK financial banking system, the Bank of England are not in a position to use interest rates as a relief mechanism. With monetary policy already at its limit, the only option available to the Bank of England would be to inject more money into the banking system.”