Economic view: Dennis Turner, former chief economist, HSBC
The 21st century is less than 14 years old but already there have been two seismic events that have re-defined the global military/political and economic/financial landscape, the long-term consequences of which are still being played out.
The attack on the Twin Towers on 9/11 has cost many lives well beyond New York and raised tensions globally, while changing the nature of military conflicts. Seven years later, on 15 September 2008, the largest ever corporate failure, Lehman Brothers, sparked a chain reaction that rocked the global economy to its foundations and will change for ever the perception of banks as masters of the universe.
The long-term implications of the Lehman failure will encourage the proliferation of academic theses for generations to come.
But it is difficult to disentangle the direct results of then US treasury secretary Henry Paulson’s actions in pulling the plug on ‘The Brothers’ from the more obvious effects of the general credit crunch that followed. The Lehman effect has in many ways become a generic label applied to the fragile and (in some areas at least) corrupt financial services sector. The effects are both short-term – jobs lost, huge hits for investors and creditors, sharp rises in public sector debt, slowing economies pushed deeper in recession – and long-term as there needs to be a re-ordering the role of banks and regulators. While the credit crunch was an international phenomenon, the effect was different in various countries, as was the response of the authorities.
What actually happened?
At the heart of the Lehman crisis was a clash of two concepts. The idea of “moral hazard” was that if banks got into trouble, they would not be bailed out. It was supposed to ensure they were aware of the risks of their actions. After emergency actions had rescued several heavyweight Wall Street institutions, the Bush administration decided to let Lehman go. It was, after all, a wholesale bank rather than retail and the impact, though large, would not be widespread and felt largely by players in the financial market. But they underestimated “systemic risk”. The inter-linkages of the financial system, globally as well domestically, meant that if one body was cut everyone else bled, even those that were apparently healthy. And consequent loss of public confidence might have sparked a run on the banks and a collapse of the financial system.
In the UK, it was only weeks after the Lehman crash that RBS and Lloyds TSB went into intensive care to be drip-fed billions in taxpayers’ money. This coincided with the economy’s nose-diving into deep recession. But it would be wrong to say that either bank or the UK economy was a direct consequence of the Lehman debacle. Although there were similarities in terms of a reckless disregard of risk, the two British banks were undone primarily by their own corporate misjudgments, a ludicrously overpriced acquisition of ABN-Amro and a merger with HBOS. By Q3 2008 the economy was officially in recession, hit by a 1.8% fall after a contraction in Q2.
Although credit fuelled the boom, the credit crunch did not cause the recession. But it made recovery more difficult in all sorts of ways, and this is probably where the Lehman effect kicks in. Firstly, the Brown government, seeing the reaction to Lehman in the US, bought into the idea that some institutions were “too big to fail”. Rather than let Lloyds and RBS go, and put the whole financial system at risk, taxpayers have continued to fund the restructuring at a time when the public sector can least afford it. And the timing and price of a return to the private sector (and hence the ultimate cost to the taxpayer) is still a matter of speculation.
Looking to Labour
Viewed from Canary Wharf, this was a surreal time. In some ways there was a sense of schadenfreude when the big US banks, such as Bear Stearns, Merrill Lynch and Citigroup, hit the skids, a feeling that the alleged best and the brightest had been rumbled.
The US housing market was known to be an unsustainable bubble but nobody fully appreciated the extent of the alphabet soup of products (MBS, CDO, CDS and so on) that would spread virus-like internationally. It was only when the waters started lapping closer to home with RBS and Lloyds that the temperature in London started to rise. The images of staff and sometimes former colleagues in the street with a cardboard box of personal possessions looking bewildered is still vivid. Concerns about who was next dominated the lunchtime conversations in the watering holes of West India Quay as the share prices plummeted.
Then there was the unnatural experience of the UK banks looking to a Labour government for leadership and answers. And only the very churlish would deny that Gordon Brown and Alistair Darling did not rise to the occasion. The humbled captains of capitalism had to go cap in hand to the traditionally hostile territory of Whitehall. Although Prime Minister Brown might not have “saved the world”, as he inadvertently claimed at the time, his government’s prompt action did avoid a far worse crisis in the financial sector.
But the Lehman effect goes beyond the two British ailing banks. Once the stone was lifted, the public saw what was underneath – and this has led to a shift in attitudes to banks, even those that were apparently well managed. Bonuses, Libor rigging, product mis-selling and money laundering are just a few of the charges levelled against once-untouchable organisations. The EU also sees banks as a soft touch for much-needed tax revenues while regulators are demanding that banks put more capital aside to avoid a re-run of 2008-09. In the UK, there is a demand to separate the riskier and more profitable investment bank activities from the old-fashioned retail functions.
The long-term impact
All of this has, of course, cast a huge cloud over the banking sector. Some of it is self-inflicted but some has been created by populist politicians fighting yesterday’s battles.
In terms of public opinion, of course, they are pushing at an open door but they also risk damaging the structure of one of the few industries in which the UK has a clear international comparative advantage.
While the Brown notion of a light regulatory touch has clearly failed, better rather than more regulation is needed. This means real penalties for miscreants, effective controls over excesses including bonuses and some appreciation that more and smaller banks will not necessarily be more competitive, safer or offer a better service. Why do shoppers prefer Tesco, Sainsbury’s and Morrisons, among others, to the average corner shop?
The Lehman effects may be indirectly felt in the UK but they are profound and many of the issues remain unresolved. The golden days of banking, in terms of share prices, dividends, salaries and bonuses, are almost certainly over, and lending is likely to become more expensive over time. What other effects Lehman and the credit crunch have depend largely on the regulators.
See also:
• The Lehman’s Collapse: Five years on
• Peter Bill: Where were you when Lehman’s collapsed?
• The day Wall Street collapsed: Views from New York and London
