Home Business Big Business Have we ignored the lessons of the GFC?

Have we ignored the lessons of the GFC?

10 years after the collapse of US investment bank Lehman Brothers, how much progress has the finance sector made in putting consumers first and could history repeat itself?

Aleks Vickovich

Digital Editor, Your Money

Lehman Brothers corporate sign being sold off at auction in London
Lehman Brothers corporate sign being sold off at auction in London. (AAP/AP/ John Stillwell)

Around the globe, the events that followed the collapse of Lehman Brothers became known as the Global Financial Crisis. But in the United States the downturn was so monumental and personally felt that most Americans just call it ‘2008’.

The Wall Street giant’s bankruptcy filing – on 15 September 2008 – was the largest in world history and though it began as a problem specific to America’s inflated property market and related ‘securitisation’ industry (i.e. the packaging of mortgage and other kinds of debt into investible financial products), its impact was far-reaching.

The subsequent credit crunch affected almost every advanced economy and resulted in widespread recession and plummeting global trade.

It hit the hip pockets of governments and consumers around the world and significantly damaged the relationship between regular folks and those trusted with safeguarding their assets.

Household-name, century-old institutions were suddenly viewed with deep (if warranted) suspicion and distrust.

Given the populist uprising against the financial sector – culminating most memorably in the pitchfork-wielding Occupy Wall Street movement – politicians were quick to have a crack at changing the system that led to the crisis.

Changing the rules

While it was too late for Lehman Brothers, its ailing rivals received unprecedented financial assistance from President George W Bush’s administration.

Bush’s treasury secretary Hank Paulson – a former exec at blue-chip investment bank Goldman Sachs – masterminded a USD $700 billion bailout of the “too big to fail” banks (including an indirect benefit picked up by Goldman Sachs, much to the chagrin of the Occupy folks).

Here we had what decades before might have seemed unthinkable: A Republican government (which usually favour minimal state intervention in the market) using an alarming amount of taxpayer funds to rescue organisations synonymous with capitalism itself.

The government involvement went a step further in 2010, when President Barack Obama signed the so-called Dodd-Frank Wall Street reforms into federal law, establishing a new watchdog (the Consumer Financial Protection Bureau (CFPB) and a range of new regulatory requirements for banks and institutions, including new rules mandating the amount of capital surplus (rainy day money) banks keep on file. In Europe, similar regulations were enacted under the Basel III framework.

The current US federal administration under Donald Trump has rolled back the regulations a little, but overwhelmingly there is more red tape and oversight than there was previously.

To many voters and consumers, this increasing state oversight of the banking system seems sensible, even welcome, given the largesse and bad behaviour that the global big end of town has been found guilty of.

But politicians have a knack of hurting when they’re trying to help. Have the policy responses to the crisis actually solved the underlying problems?

Guilty governments

Naturally, banks and big financial services providers have been the main culprits at which our fingers have collectively been pointed since the GFC.

They were the ones who offered and approved the dodgy ‘sub-prime’ loans to people that couldn’t afford them, developed complex and risky financial products off the back of these loans and profited enormously in the process.

And then, of course, they gobbled up a huge amount of taxpayer money – i.e. your money – around the globe in order to stop themselves from collapsing and ruining their customers as a result.

But while these organisations and their executives must take a substantial portion of the blame, consensus is growing that government may have played a larger role in causing the crisis in the first place.

American academic and commentator Sheldon Richman, a former staffer at the Foundation of Economic Education, lays fault squarely at Bill Clinton’s administration.

“Clinton sowed the seeds of the Great Recession by helping to inflate the housing bubble,” Richman wrote in Reason magazine in 2012.

“His secretary of housing and urban development Andrew Cuomo…accelerated easy-housing policies and inflated the housing bubble, setting the stage for its collapse.

“The meltdown was the consequence of a combination of the easy money and low interest rates engineered by [US central bank] the Federal Reserve and the easy housing engineered by a variety of government agencies and policies.”

Granted, Mr Richman is writing from a pro-capitalist position that is naturally sceptical of government intervention (as his chosen publication, and perhaps his surname, may suggest).

“The meltdown was the consequence of…easy money and…easy housing”

But even more objective sources admit government policy may have played a role, including Australia’s central bank (hardly a fringe-dwelling commentator).

“Regulation of subprime lending and [mortgage-back securities] was too lax,” the Reserve Bank of Australia (RBA) says in its explainer on the GFC.

“Many central banks and governments did not fully recognise the extent to which bad loans had been extended during the boom and the many ways in which mortgage losses were spreading through the financial system.”

Or, in other words, they dropped the ball.

Research is starting to show that the policy response to the GFC may have been just as misguided as the policies that helped lead to it.

‘Unintended evil’

Harvard professors Larry Summers (a former Obama economic adviser) and Natasha Sarin wrote in a Brookings Institution paper in 2016 that the regulation that followed the GFC has resulted in some “gains” and that the system would be more “fragile” were they not enacted.

But they also say that the regulations have reduced the banks’ “franchise value” which has also made them behave in riskier ways.

Jean Dermine, a professor at INSEAD – a fancy French business school – doesn’t mince his words on the topic.

In a paper entitled Bank Regulations after the Global Financial Crisis: Good Intentions and Unintended Evil, Dermine concluded that the policy responses of global authorities (and Basel III in particular) have not necessarily decreased risk or increased consumer protection.

He argues that some of the Basel requirements will “very likely” lead to “large incentives for securitisation and shadow banking”, which were causal or contributing factors in the credit crunch.

He goes further, saying the entire “too-big-to-fail doctrine” has an inbuilt and dangerous bias for “large size, excessive leverage and risk-taking”.

Even though the point of much of the post-crisis political response was to make a fairer system and reduce systemic risks, it makes sense logically that the government guarantee at the heart of big banking – whereby the state will bail you out with taxpayer money if you get into trouble – does not incentivise good behaviour.

In fact, it effectively places financial institutions above the law.

Arguably, in Australia, this has particularly been the case.

Royal repetition

Whether they were spooked by declining “franchise value”, incentivised by Basel or just prioritising profits over customer service, perhaps we will never know, but Australia’s big banks have been engaged in some pretty crummy activities.

The work of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry is far from done, but the inquiry has already uncovered evidence of unethical and in some cases criminal behaviour by our financial institutions.

Bribery, targeting of vulnerable sections of the community, lying to the regulator and wanton disregard for the law have all featured in day after day of testimony.

And much of this has occurred in the decade since the GFC, not the decade before it.

Many consumers watch on appalled, unable to fathom how such profitable and successful organisations can steep to such lows. The ‘too big to fail’ thesis may offer some explanation.

“If you don’t understand something, don’t invest in it. If you’re getting a high return, you’re probably getting high risk.”

The banks are being punished with bad headlines and expensive legal bills, but deep down they know that if they really get into strife, Canberra will throw them a lifeline.

The federal government in Australia guarantees retail deposits up to $250,000 and the RBA has a “liquidity facility” which would bail out Aussie banks at short notice.

Again, these measures seem to be in consumers’ interests on the surface.

But they also provide financial institutions with a complacent and smug confidence in their own business model that seems to be leading to risky and immoral misconduct.

Echoing shades of the Clinton administration, the Australian government also continues to experiment with policies to help people buy property in an inflated market, offering tax incentives, ownership grants and subsidies to help them get on the ladder.

All of this suggests that even though the memory of the GFC looms large, and reflections like this one are not uncommon, those with hands on the levers of power may not have received the memo.

Asked whether we have sufficiently learned the lesson, AMP’s chief economist Shane Oliver told Your Money predecessor Sky News Business that while the level of risk-taking is not quite at pre-2008 levels, that “there will be another crisis out there”.

Wall Street has gotten its mojo back in the decade since the crash, but consumers are still feeling the effects.

In order to avoid becoming victims once more, Dr Oliver says people should stick to some investment fundamentals:

“If you don’t understand something, don’t invest in it. If you’re getting a high return, you’re probably getting high risk. If it’s not what you own that gets you in trouble, it’s what you owe.”

If only all financial system players lived by these rules.