Looking at the financial crisis only from the angle of market returns fails to capture the consequences from an economic, social and political perspective.
The social and political consequences of the GFC are wide ranging. The banks were bailed out and the financial system recovered, with stock markets soaring. However, the bailout of Wall Street failed to help the people on Main Street, with many workers in the US and across the western world enduring a decade of falling living standards, as their wages failed to keep up with inflation. Insolvent households were abandoned – nine million Americans lost their homes; eight million lost their jobs in the US alone while there were significant spikes in unemployment across Europe.
In solving the GFC, policymakers have added yet more debt to an already indebted financial system with unprecedented policy tools used by the central banks, many of which remain in place to this day. Whilst the financial system may have been ‘saved’, central banks have found it very difficult to normalise monetary policy and indeed a decade of ultra-low interest rates appears to have created new problems in terms of consumer and corporate behaviour. According to data from Deutsche Bank, after a very brief dip in the aftermath of the Lehman collapse, global debt is up 43% since September 2008 with total debt now $247 trillion. As a percentage of global GDP, this is 316%, around 30 percentage points higher than in 2008. Whilst the pace of household debt growth has slowed, the fastest pace of growth in debt has been in government and non-financial corporates. Whilst governments have increased debt through the costs of fiscal stimulus and bailouts, companies have binged on record low interest rates, and in many cases, have chosen to increase pay-outs to shareholders or buy back their shares rather than invest in future growth.
Central banks have always played a significant role in the global economy, though the last decade has seen unprecedented intervention. Central bank balance sheets have nearly tripled in size in the past ten years, to more than $15 trillion. The Bank of England balance sheet, for example, climbed from 7% of UK GDP in 2007 to 27% today. The previous high was in the aftermath of World War II at 17% of GDP. It would appear that the central banks will continue to play an increased role, not least given that many policy measures, such as quantitative easing, have yet to come to an end in some places. Equally, interest rates have been held at artificially low levels to encourage cash to flow back into the economy. This financial repression has of course been excellent news for borrowers, less so for savers. Yields remain extremely low across financial markets, and the low returns on offer from traditional investments have forced investors up the risk spectrum into higher yielding, but more risky assets. The flow of liquidity that trickled down from the banks into the financial system through money printing has indeed caused inflation, not as measured by CPI but in financial and real assets, from stock markets to property to classic cars and fine wines.
Whilst the US government pursued stimulus and Europe pursued austerity, the consequences in terms of populism have been the same. Arguably one of the main causes of populism – rising inequality – has been an issue for some time, but it is clear the GFC accelerated this trend. This theme is yet to fully play out around the world – but recent elections and referendums confirm that the momentum for populist figures and themes continues to build. Governments focused in the short term on stabilising the financial system and putting measures in place to restore economic growth through allowing fiscal deficits to balloon. This may have prevented economic collapse but of course had consequences of its own, as witnessed in the European sovereign debt crisis from 2010 onwards. Fiscal largesse swiftly turned to austerity in many countries, serving to dampen economic growth and increase inequality. The sense of bitterness towards the bankers and politicians in the aftermath of the financial crisis and subsequent years of slow growth has impacted the political environment with significant consequences. A study by Amir Sifu of Princeton University analysed the response to financial crises in 60 countries, finding that they tend to radicalise electorates, and the share of moderates in a country declines in favour of left or right-wing radicals. In recent years, real world examples of this are clearly evident, from the Brexit vote in the UK to Donald Trump’s election win, and more recently the populist parties winning the election in Italy. Populism still has a way to go – the great depression of the 1930s showed how international relationships tend to deteriorate over time, and policies such as protectionism are examples of the reversal of globalisation seen in the aftermath of the GFC.
The financial crisis failed to see significant repercussions for the financial services industry despite the public and political backlash against the ‘bankers’. Few individuals saw criminal convictions and while the public lost their homes or jobs, or were impacted by ‘austerity’ the perception has been that the bankers returned to their pre-crisis existence very swiftly. Financial regulations have been tightened significantly, and banks are fundamentally safer now in the sense that they have to hold significantly more capital on their balance sheets and are subject to regular ‘stress tests’. But there is still a sense that the surviving banks escaped relatively lightly despite paying out $243 billion in fines. Financial rating agencies also escaped the crisis unscathed. Despite failing to foresee the issues across the banks and the instruments they were issuing tied to subprime loans, they are still used today as a guide for trillions of dollars of investments. The US securities and exchange commission’s data from 2017 shows that S&P, Moody’s and Fitch are still responsible for just over 96% of all ratings.
Hubris is a dangerous condition, and in hindsight it was evident in spades ahead of the 2008 crisis. Fed Chair Ben Bernanke declared that problems in the US subprime housing market were “so limited they would not create significant spillovers”. Governments and central banks were convinced that the syndication of loans was reducing overall risks by diversifying them, and there was talk from the Bank of England of the era of NICE (non-inflationary continuous expansion). We have learned that unchecked financial innovation is a dangerous thing as it becomes clear that few individuals fully understand the products they are investing in nor the underlying investments they are tied to. In 2008, no one knew where the risks were, and who held them. Hence a complete collapse in trust. Has anything really changed? Many of the markets that failed in 2008 have resumed, albeit with tighter regulation to ensure the issuers interests are more aligned with the investor. A decade of ultra-low interest rates has also encouraged risk taking with borrowing so cheap and so little yield on offer from conventional investments. The borrowing frenzy may not be in US housing but is evident in other economies, particularly in emerging markets where borrowing in dollars has suddenly become very expensive as emerging market currencies have weakened over the summer. With the US continuing to raise rates and the dollar likely to rise further, there are likely to be consequences. Another country binging on debt is the US, where the budget deficit is pushing higher under the Trump administration. Again, the seeds of future problems are being sown with fiscal stimulus at a time where the economy is already growing strongly.
It seems like we will likely continue to see higher levels of market intervention than before the crisis. It is important though to remember that economic cycles are necessary for the economy to function efficiently in the long term – recessions may be unpleasant but they are needed to clear out inefficient and poorly run enterprises of which there are many thanks to low interest rates, and fuel the innovation to drive the next economic cycle.
Massive policy stimulus failed to produce anything more than a decade of sluggish economic growth; the recent upswing in global growth is only a result of yet another round of huge stimulus from China in 2015/16. This is being further fuelled by stimulus in the US but both countries are piling on the debt to generate growth. The total debt overhang globally continues to climb and leaves the global economy vulnerable to shocks. These huge debt levels are easy to service when interest rates are so low but will they remain so forever? There are reasons to believe central banks will face political pressure to keep interest rates low in order to maintain the status quo.
In a word, yes. As always, history does not repeat itself exactly but there are plenty of reasons to believe that we will see a financial crisis again at some stage. A financial system with record levels of debt, artificially low interest rates and political instability driven by populism is not a stable system. Yet this is where we find ourselves ten years on from the GFC.
Back in 2008, US politicians ultimately allowed the US Federal Reserve to do “whatever it takes” to save the financial system. Next time round, with the world a very different place politically, they are unlikely to be given the same flexibility. The US was happy to bail out and support allies in Europe; would they do the same for China? The dollar remains the dominant currency for global finance, and much of the debt build-up in the aftermath of the GFC has been in the emerging markets, not least in China, with Chinese businesses borrowing over $1.5 trillion in foreign currency, the majority of which is in dollars.
We would hope that the next time it comes, governments and central banks have the willingness and firepower to intervene as we saw in 2008. In hindsight, policy mistakes were made but this is almost inevitable at a time of crisis and financial market paralysis. The next time, with government debt and central bank balance sheets so bloated, this may not be the case. Interest rates are unlikely to return to pre-crisis levels any time soon, and this leaves less scope for central banks to use conventional monetary policy tools to ease financial conditions before they have to resort to policies such as quantitative easing. The global political backdrop, with the US more inward-looking leaves Europe and China more likely to have to face any future crisis on their own.
We believe that we are closer to the end of this economic cycle than the beginning, and while the global economy is likely to enjoy another year of stimulus fuelled growth into 2019, the impact is likely to fade into 2020. At the same time, central banks are set to continue gently removing their accommodative polices, with interest rates rising in the US as the Fed also reduces the size of their balance sheet. Meanwhile, the European Central Bank will soon call time on QE with a rate rise likely in the second half of 2019. Risks to economic growth from politics are also evident, with protectionism and populist policies set to increase uncertainty and weigh on global trade.
Any market correction will test the structure of the financial system – investment banks no longer act as a shock absorber holding large inventories of bonds or equities on their balance sheets. We have had brief moments of market volatility in recent years, and each time we have seen liquidity disappear very swiftly from some markets. Investors should also consider that we go into any downturn with equity and bond markets at elevated levels and without many risks to the outlook priced in. Given the forward-looking nature of markets, any downtown in the economic outlook in 2020 should become a feature of risk asset valuations in the coming months. We may already be seeing this as emerging market bonds, equities and currencies suffer the consequences of a stronger dollar
Looking back on the events of the GFC, it is clear that financial markets have recovered and moved on a lot quicker than many governments, companies and individuals. The consequences of the crisis are yet to fully unfold in the world of politics as populism drives the policy agenda towards a more insular world. The economic backdrop post 2008 was saved from an even worse fate thanks to unprecedented intervention from governments and central banks but it has left an unbalanced system and significant inequalities in income across society giving rise to populism and a backlash against the globalisation trends of the past forty years. The financial crisis may have reached its peak a decade ago, but the consequences are likely to linger and weigh upon the global economy, politics and wider society for many years to come.