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.
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.
Emergency action
In the nearer term, monetary policymakers may have other problems to deal with. The crisis prompted central banks to take emergency action, slashing interest rates and purchasing government bonds and other assets as part of quantitative easing (QE) programmes.
Having moved off their record lows, global interest rates are broadly anticipated to keep rising, albeit gradually, which could eventually pressure economies now used to cheap money. Such moves, as well as the unwinding of QE programmes, are necessary if central banks are to develop tools with which to fight the next crisis.
But tighter monetary policy could pose a major risk. Edward Bonham Carter, vice chairman at fund house Jupiter, says: “Critics of the programme argue, perhaps with some justification, that it has led to overinflated asset prices. They also worry that central banks will further destabilise markets as they seek to shrink their balance sheets. The ending of central bank support, both feared and wanted, hangs like a sword of Damocles over the market.”
Markets also face new challenges that can ultimately be attributed to the response of governments and central bankers to the crisis. The use of public money to rescue banking institutions – seen by most as the perpetrators of the crunch – has caused widespread anger, particularly given the lack of prosecutions in relation to the crisis.
Sociologists believe this sentiment helped feed into the emergence of surprise political developments, such as the success of the Brexit campaign in the UK and Donald Trump in the US.
Those events have left investors struggling to assess the impact on their holdings, whether it be sterling-based investments in the aftermath of the EU referendum, or those affected by the burgeoning US-China trade war.
New threats?
For intermediaries advising on assets, a question now is whether to follow a cautious investment strategy, or continue to participate in the bull market of recent years. They also have to contend with investors who have turned unduly cautious in the wake of the crash. Many, particularly younger investors, have been left wary by the events of 2008, according to research by Legg Mason.
In its 2017 Global Investment Survey, the firm noted: “As befits their age, millennial investors as a group are ambitious, optimistic and outward looking. Yet over 70 per cent call themselves ‘conservative’ investors, and they have the same inclination to save rather than invest, and to keep cash levels high.
“The cause could be the lingering influence of the global financial crisis and great recession. But these conservative practices could prevent them from using their most important investment tool – time, which they have in relative abundance.”
It is, perhaps, more evidence of how the repercussions from the crisis have affected millennials more severely than older investors.
Advisers face the challenge of guiding clients away from limiting the growth of their savings by being overly defensive.
Regardless of its cause, they will be tasked with steering clients through the next crash, if and when it comes.
