Economy  

After the crash: what have we learned from 2008?

After the crash: what have we learned from 2008?

Late on September 14 2008, an investment bank once regarded as a stable, durable concern filed for bankruptcy protection. 

The demise of Lehman Brothers, stemming from asset writedowns and liquidity problems prompted by the collapse of the US subprime mortgage market, triggered a panic that spread through the global financial system. 

Credit dried up because lenders did not know who could afford to pay back their loans. Investment markets suffered a severe downturn (see Chart 1) and the viability of the world’s banking sector as a whole was brought into question.

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Several institutions ultimately had to be bailed out, at great expense to the taxpayer. The financial system survived, and efforts to strengthen its foundations have followed – albeit not to the extent that some hoped and argued for. 

Nonetheless, post-crisis regulation means banks are much better capitalised. Authorities have taken a more stringent approach when it comes to regulating lending. The global economy has gradually recovered, albeit not in every sphere, but it remains unclear just how resilient the financial system is in the event of a future crisis.

Glass half full

The response to the drying up of liquidity seen across the financial system in 2008 was profound. The UK led a group of governments in putting together a major bank rescue package (see Box 1).  

The response had to be profound, given UK banks were among the shakiest in the world in the aftermath of Lehman’s collapse. Subsequent after-effects included a series of regulatory actions designed to ensure a repeat of those bailouts would never be necessary. Some argue it has worked.

“Another financial meltdown like the one triggered by Lehman’s collapse does not seem probable,” says Fidelity equities chief investment officer Paras Anand. “The root causes of the crisis appear to have been addressed. Banks carry much greater capital levels against their loan books, lending standards have tightened, asset prices have recovered and the financial system has become far less interconnected.”

Dave Lafferty, chief investment strategist at Natixis Investment Managers, says if the spectre of troubled banks has not disappeared, the system as a whole has become more robust.

“While concentration risk among the major global banks has grown since the crisis, broadly speaking, leverage and trading risk are down while equity and capital ratios are up. The gradual de-risking of banks should make the system less vulnerable to contagion in the next Lehman-like crisis,” he says.

Regardless, plenty of market participants are still fearful of a new calamity, and not just because the scars of 2008 have yet to fully heal. In particular, they point to the fact that each new economic emergency tends to differ from the last. 

Additionally, many suspect the post-crisis response has stored up future problems. The most notable argument here is that the bailouts simply shifted the risk from bank ledgers to national balance sheets, particularly as national debt has continued to rise sharply in countries such as the US and the UK since the crisis. But in an era where the structural demand for Western world government bonds is higher than ever, the sight of these ballooning obligations has also given rise to new debates over whether such burdens are truly a problem for countries able to issue debt denominated in their own currency.