Lehman Lesson: Crisis Prevention, Resolution Need Political Power
Sep 22--The failure to prevent and then deal fairly with financial crises is mainly due to the lack of political power and will to do so, so say Bloomberg and the Economist, see first seven article links below, with my emphasis added.
And by far the best time to try to deal with another possible financial crisis is before it occurs. Once the crisis hits, the options to deal with it become far more difficult, per Ben Franklin’s “an ounce of prevention is worth a pound of cure.”
Those are two key lessons of the 2007-09 Great Financial Crisis (GFC). At this moment, it seems unrealistic to expect a change in the lack of political power for meaningful reform of the financial/economic system between now and if/when another financial crisis might occur.
But unlike some writers I respect, I still hope that such a deep crisis is not necessary to gather the political power to bring about much needed positive change in the global financial/economic system.
Because if there is another such deep crisis, it may be be made worse by the current breakdown in global and domestic political cooperation, possibly so much so that liberal democracy might be threatened, at minimum tens of millions of innocent lives will be ruined again globally, as in the GFC.
So if you think Trump and other nationalist populists are bad now, then you don’t want to wait until there is another crisis to see what they or more extreme successors might be like. Especially because there has been and remains no effective opposition to them, as of yet.
In a September 7 op-ed in the New York Times, Bernanke, Geithner and Paulson wrote:
“The paradox of any financial crisis is that the policies necessary to stop it are always politically unpopular. But if that unpopularity delays or prevents a strong response, the costs to the economy become greater. We need to make sure that future generations of financial firefighters have the emergency powers they need to prevent the next fire from becoming a conflagration. We must also resist calls to eliminate safeguards as the memory of the crisis fades. For those working to keep our financial system resilient, the enemy is forgetting.”
That is a paradox only IF a crisis is allowed to develop in the first place, and then only IF those in power to deal with it are more intent are saving the financial system that created the crisis in the first place, as these three were, however well intended they may have been in trying to do so.
Their firefighter analogy is the wrong one. At the time, and evidently to this day, that may have seemed the best of the poor alternatives, to them, they probably allowed Lehman to fail because of the politics of bailing out Wall Street. But that’s my key point, it should have never come to that, and much more importantly, it shouldn’t come to that again.
I have no idea if/when another such deep crisis will occur, but the economic-political-social “tail risk” of one is high enough over the next few years that it must be seriously considered and prepared for NOW. The tail risk is that American leadership will be so weak and divided due to the current extremely divisive partisan politics that a new crisis will not be prevented and dealt with even worse than the GFC.
What that means is putting together plans on how to deal with the crisis before it occurs, and most importantly organizing the political power to implement those plans, especially in the frenzied midst of a crisis.
Rather than running around if/when another crisis hits like self-described firefighters, as Paulsen/Bernanke/Geithner did during the GFC, then patting themselves on the back for a job well done.
So what is needed right now is to create a Financial Crisis Prevention/Resolution Committee (FCPRC) of those qualified to make plans to try to prevent and resolve the next crisis.
I would suggest Sheila Bair as co-chair, since she was the only high-ranking Federal official in the 2007-09 GFC willing to stand up to Wall Street, and was of course frozen out by the boys' club, along with Nobel winner Joseph Stiglitz. Other names that quickly come to mind are Gillian Tett of the FT, who played a very positive role before and during the GFC, Ray Dalio of Bridewater, who is now warning of debt issues, Aaron Brown (see link below), there are many others.
Since August 5 I have been calling in my weekly articles for the tech elite to organize national debates of bipartisan experts in October before the November elections on the serious issues facing America, such as the high cost and poor performance of the health care and education systems, housing, immigration, trade, good jobs, national security, etc., with perhaps Bill Gates chairing the organizing committee.
I have called these debates MAWA, Make America/World Awesome, and tweeted about this well over a thousand times since then, to every serious influencer I could find, without a single reply from anyone in the tech elite, which is not surprising, especially with the stock market and tech stocks at all-time highs.
The two major political parties are currently unable to deal with serious economic issues facing the American people. For decades, the GOP’s main concern has been tax cuts for the 1%, the Democrats' politically correct identity politics for victimized constituencies.
The Democrats have now doubled down on #MeToo politics in the Kavanaugh nomination, where the stakes are very high since Supreme Court justices serve unlimited terms, hoping to further mobilize the anger of millions of especially women voters in the November election, which also seems payback for the GOP’s unwillingness to even consider Obama’s highly qualified nominee Merrick Garland in 2015.
While the Dems’ #hashtag identity politics does deal with legitimate issues and real concerns, if/when there is another economic/financial crisis, both parties will be completely unprepared to deal with it, as they were in the 2007-09 GFC, in which the Democrats were panicked into being the main support for Paulson's TARP and Bernanke's extraordinary money printing.
Even in the absence of such a crisis, neither party is focused on the key economic issues facing the American people, as a nation as a whole, not just for separate victim groups, that I have proposed be taken up in the MAWA debates, such as good jobs, healthcare, education, and housing.
To be sure, there have been some positive changes since the last crisis, e.g. in the safety of the banking system, see links below. As the chart above shows, the big global growth in debt as a percent of GDP since the 2007-09 GFC has been in the government and non-financial corporate sectors, it has actually declined in the financial sector and slightly increased in the household sector (though this may vary by geography), both of which had grown rapidly before the GFC and were the center of that crisis.
But to prevent another crisis from happening, or dealing with it if it does, what is needed is a fundamental rethink of the role of the global financial system in the global economy, something that I have not seen in the many crisis post-mortems published recently on the tenth anniversary of the Lehman bankruptcy.
The first principle is what is needed is a global financial system that is focused on financing the real productive economy, rather than the current cancerously outsized one that feeds itself and those few in the 1% who mainly benefit from it.
To re-establish that principle probably needs a revolutionary capitalist elite to take over one of the major political parties. Those three words don’t usually go together, they might seem absurd or jarring. But the idea of a revolutionary capitalist elite is really not very far-fetched.
Indeed the Founding Fathers were just that, with Hamilton perhaps the most obviously so. So was Lincoln and his new Republican party. And such elites have modernized developing nations, starting with the Meiji Restoration in Japan in 1868.
What other social forces are powerful enough to accomplish the necessary change? There is no longer a strong enough union-organized working class in the United States to be much of a force for positive change, as there was from the 1930s to the 1960s. And as I said above, politically correct identity politics simply doesn't focus on these key economic/financial issues.
I will again quote from a recent speech by Obama in Illinois, as I did in my last article:
"And we won't win people over by calling them names, or dismissing entire chunks of the country as racist, or sexist, or homophobic. When I say bring people together, I mean all of our people....And we can't do that if we immediately disregard what others have to say from the start because they're not like us, because they're not – because they're white or they're black or they're men or women, or they're gay or they're straight; if we think that somehow there's no way they can understand how I'm feeling, and therefore don't have any standing to speak on certain matters because we're only defined by certain characteristics."
Looking outside the U.S., the China Communist Party (CCP) still sees itself as a Leninist elite. In the current trade war, it is trying to find interlocutors with influence on Trump, without success so far, in Europe and on Wall Street and with American business. Those on Wall Street whom the CCP leadership is familiar with are actually a big part of the problem.
Unfortunately there seems to be no one, so far, in the 1% elite willing to step forward to help try to forge a new globalization 2.0 to replace the dysfunctional financialization neoliberal version 1.0. The tech elite certainly has its revolutionaries, but they are mostly techno-utopianists.
Even under the financialization neoliberal version 1.0 of globalization, global extreme poverty has greatly decreased in the past 25 years, see last link below, but this huge benefit of globalization doesn’t have a voting constituency in the United States, and much of that decrease occurred in China due to its own internal efforts, which is now under attack by Trump.
In his 2011 book, “Boomerang,” the follow-up to his much more popular book on the GFC “The Big Short,” Michael Lewis wrote:
“One of the hidden causes of the current global financial crises is that the people who saw it coming had more to gain from it by taking short positions than they did by trying to publicize the problem. Plus, most of the people who could credibly charge Iceland—or, for that matter, Lehman Brothers—with financial crimes cold be dismissed as crass profiteers, talking their own book.”
That is still the case today. Hopefully some of these knowledgeable people will step forward and consider creating and working with the Financial Crisis Prevention/Resolution Committee (FCPRC) that I am proposing here. If not, then the big risk is that American leadership will be so weak and divided due to the current extremely divisive partisan politics that the crisis will not be prevented and dealt with even worse than the GFC.
Best,
John Furlan
https://www.bloomberg.com/view/articles/2018-09-13/lehman-brothers-collapse-lessons-of-great-recession-go-unlearned Bloomberg editorial, emphasis added--jf
Given the scale of the damage, the experience should be seared into the memories of politicians everywhere. It’s shocking to see how quickly they’ve forgotten, and how fragile the financial system remains….All told, the global financial system looks troublingly like it did in 2007. Vast risks are still concentrated in a handful of vulnerable institutions. There’s no shortage of proposals for a more fundamental fix, but political will is lacking. Worse, the world is backsliding.
https://www.bloomberg.com/view/articles/2018-09-14/lehman-brothers-collapse-crisis-autopsies-ask-wrong-questions by Aaron Brown emphasis added—jf
As someone who lived through the crisis as a Wall Street risk manager...The crisis constituents were evident early in 2006….It was well known which sectors of the economy were troubled, but not how big the crisis would get….Still, you might expect that precautions were taken in the known problem areas…. Perhaps not in early 2006, but certainly sometime over the next two years as things worsened dramatically ....Preventing bubbles is hard, especially without stifling innovation. It’s particularly hard for governments, who don’t see much to be gained politically by tempering the boom times and embarking on prudence. Once a crisis gets out of hand, all options are bad. What should be relatively easy is once things start going wrong to hold off on massive risk increases in the problem areas. If you don’t want to experience another 2008, figure out how to change 2006 – 2007 behavior.
https://www.bloomberg.com/view/articles/2018-09-13/financial-crisis-10-years-later-the-system-still-needs-change by Mohamed El-Erian emphasis added--jf
Accomplishments: 1. A safer banking system. 2. A more robust payments and settlement system. 3. Smarter international cooperation. Slippages: 1. Still-elusive inclusive growth. 2. Misaligned internal incentives. 3. A scarcity of “patient” balance sheets. Unintended consequences: 1. The big got bigger and the small got more complex. 2. Risk has morphed and migrated to underregulated areas. 3. Reduced policy flexibility….The biggest challenge is to get the political process to address their importance when there is no actual or looming crisis in the advanced world to focus minds.
https://www.economist.com/leaders/2018/09/06/the-world-has-not-learned-the-lessons-of-the-financial-crisis emphasis added
Stagnation has, inevitably, fed populism. And, by looking for scapegoats and simplistic solutions that punish them, populism has made it harder to confront the real long-term problems that the crisis exposed. Three stand out: housing, offshore dollar finance and the euro….Finding ways to make offshore dollar finance safe, such as pooling dollar reserves among emerging-market countries, relies on international co-operation of the type that is fast falling out of fashion….Policymakers have made the economy safer, but they still have plenty of lessons to learn. And fracturing geopolitics make globalised finance even harder to deal with. A decade after Lehman failed, finance has a worrying amount to fix.
https://www.economist.com/briefing/2018/09/06/lehman-ten-years-on-more-has-changed-than-meets-the-eye emphasis added--jf
If the landscape looks similar, and the prospects brighter, the changes to the financial system have been wrenching, nonetheless. Two areas stand out: the balance-sheets, funding and business models of the banks themselves; and the increased clout of the regulators….What the crisis showed is that, in a pinch, authority can expand. More difficult is taking the heat out of problems before they boil over. If it is time to believe the crisis that began in 2008 has really ended, it is past time to wonder how the new conditions which have come about in its wake could contribute to the one that comes next.
https://www.bloomberg.com/view/articles/2018-09-14/maybe-this-financial-system-can-t-be-fixed emphasis added--jf
Ten years after a crisis that brought the world to the brink of Armageddon, the people overseeing the world’s largest economy insist they’ve reduced the risk of another financial disaster. Just one problem: We need a different financial system, not just better risk management. I had a front-row seat for the watershed event of the 2008 crisis...Better risk models are no solution. As I realized after a few years working on credit-derivative models, it’s a matter of politics, not math. Experience has taught bankers not to worry about the downside. The government bailed them out with no personal repercussions and without fundamentally changing the system.
https://www.bloomberg.com/view/articles/2018-09-14/ten-misconceptions-about-financial-crisis-on-10-year-anniversary emphasis added--jf
No. 4. Bailouts were the only option: There were many other options, but they would have been very painful and required considerable foresight. I believed then (and still believe) that the best course of action would have been prepackaged bankruptcies for all the insolvent institutions instead of bailouts. I would have had the federal government provide debtor-in-possession financing, allowed qualified private institutional investors to bid on the assets thereby letting markets set the valuations, with the government picking up the rest. It would have been more difficult in the short term, but the economy would have rebounded much sooner.
Financial crises regularly lead to political polarization and populism, but the recent populist surge has lasted longer than those that followed earlier crises—and done more damage... The tendency to blame elites after financial crises might suggest that far-left parties would benefit as much as far-right ones. But that doesn’t happen. Our research shows that the far left’s vote share stays about the same in the aftermath of a crisis. It seems that when social groups fear decline and a loss of wealth, they turn to right-wing parties that promise stability and law and order.
https://www.bloomberg.com/graphics/2018-lehman-anniversary/ This is a long review of the changes in the financial system since the GFC, with many good charts
https://www.bloomberg.com/graphics/2018-lehman-debt/
No one knows for sure whether the leverage across the financial system is sustainable — only that it’s different from 2008. Back then, some individuals overextended themselves by taking on mortgages they had little hope of repaying. This time, companies are pushing the envelope as far as they can, accepting weaker credit ratings in an effort to maximize profits. Sovereign governments, meanwhile, are in uncharted territory.
https://www.brookings.edu/blog/ben-bernanke/2018/09/13/financial-panic-and-credit-disruptions-in-the-2007-09-crisis/ by Ben Bernanke
At the height of the financial crisis a decade ago, economists and policymakers underestimated the depth and severity of the recession that would follow. I argue in a paper released today by the Brookings Papers on Economic Activity (BPEA) that remedying this failure demands a more thorough inclusion of credit-market factors in models and forecasts of the economy.
https://www.nytimes.com/2018/09/14/opinion/the-credit-crunch-and-the-great-recession-wonkish.html by Paul Krugman
https://www.nytimes.com/2018/09/16/opinion/what-do-we-actually-know-about-the-economy-wonkish.html by Paul Krugman
https://prospect.org/article/bernanke-geithner-and-paulsons-lessons-crash
After the French Revolution it was famously said that the surviving Bourbon aristocrats had “learned nothing and forgotten nothing.” Judging by their recent op-ed piece in The New York Times, “What We Need to Fight the Next Financial Crisis,” the same could be said of Ben Bernanke, Tim Geithner, and Hank Paulson.
The world’s major economies are skating on dangerously thin ice and lack the fiscal, monetary, and emergency tools to fight the next downturn. A roster of top crisis veterans fear an even more intractable slump than the Lehman recession when the current ageing expansion rolls over. The implications for liberal democracy are sobering.
The world needs a new generation of policymakers who don’t hobnob with billionaire speculators and who understand workers’ concerns. Unfortunately, the change will not come smoothly. Political turmoil in the West is very much about this. A heavy price has to be paid to bring about the change. The Sino-US rivalry is the main driving force to bring about the needed global change. The Beijing-Wall Street axis has been driving the global economy towards speculation and inequality.
https://www.nytimes.com/2018/09/16/business/china-wall-street-trade.html
China is hoping that Wall Street will once again use its political heft to soothe tempers in Washington. But as President Trump ratchets up the trade war with Beijing, Wall Street’s words are falling on deaf ears.
https://www.nytimes.com/2018/09/19/us/politics/trump-china-trade-war.html
President Trump is confident that the United States is winning its trade war with China. But on both sides of the Pacific, a bleaker recognition is taking hold: The world’s two largest economies are in the opening stages of a new economic Cold War, one that could persist well after Mr. Trump is out of office.
Ten years after the onset of the global financial crisis, one of its most under-appreciated legacies is the strong U.S. embrace of multilateralism to address growing financial interlinkages around the world.
https://www.nytimes.com/2018/09/16/opinion/politics/kevin-rudd-authoritarian-capitalism.html by Kevin Rudd
After the end of the Cold War, however, four structural challenges emerged to endanger the future of democratic capitalism: financial instability, technological disruption, widening social and economic inequality and structural weaknesses in democratic politics. If the West cannot overcome these challenges, they will, over time, spread to the rest of the world and undermine open polities, economies and societies.
In 2008, the impact of countries working together was greater than the sum of the parts. Only full-scale, concerted global intervention can deal with the next crisis. I doubt whether it can be salvaged.
[China] will continue to invest and seek to become self-sufficient in key advanced technologies. The U.S. ought to meet this challenge by making its own investments in education and basic research, retraining workers displaced by Chinese competition, and strengthening the global rules-based order that Trump disdains.
https://www.foreignaffairs.com/articles/china/2018-09-21/stop-obsessing-about-china
The greatest risk for U.S. strategy, accordingly, lies not in doing too little but in overreacting to fears of Chinese ascent and American decline. Instead of hyping China’s rise and gearing up for a new Cold War, Washington should take more modest steps to reinforce the existing balance of power in East Asia and reinvigorate the U.S. economy. To keep the peace, U.S. leaders should seek to engage rather than alienate Beijing, safe in the knowledge that long-term geopolitical trends will favor the United States.
https://www.bloomberg.com/view/articles/2018-09-21/junk-bond-market-looks-like-a-runaway-train
With ample cash and little new supply to purchase, investors have pushed the average spread on junk debt down to just 3.15 percentage points, close to the narrowest since 2007, according to Bloomberg Barclays index data. As recently as 2016, that gap was more than twice as wide.
https://www.yanisvaroufakis.eu/2018/09/10/ten-years-after-lehmans-collapse-what-caused-the-crash-of-2008-is-now-shaping-our-post-modern-1930s-der-freitag/ by former Finance Minister of Greece
The result was the strengthening of the Technostructure’s dollar-based hegemony in a manner that no macroeconomic approach (limited, by design, to looking at the national accounts of states) can even recognise as, from the 1990s onwards, the ‘real action’ was taking place in the balance sheets of the global financiers….Two powers proceeded to save the financialised Technostructure from itself: The US government, and in particular the trillions of dollars that the Federal Reserve pumped into European private and central banks (through what is known in the trade as ‘swap lines’). And China, whose skilful economic management ….The pressing question facing this generation is a harsh one that, while no young person deserves to face, none of us have the right to evade: When and how will we rise up against the Nationalist International bred across the West by the Technostructure’s inane handling of its inevitable crisis?
Among the more than 1,100 pages that in both versions make up the [FCIC] official account of the Great Financial Crisis of 2008, there are together zero instances of the words “offshore” and “eurodollar.” Pace Bernanke, how then could something like subprime turn into a massive global disruption? Without eurodollar and offshore, you have no idea. This will continue to be our downfall. In the ten years since Lehman failed “we” don’t really know why it failed, nor does anyone really appreciate the ramifications.
The first of those flawed ideas is that “greed is good” — that the unbridled pursuit of wealth and commercial success by every worker, investor, consumer and firm is necessary to the success of a market economy….The second flawed idea that animates American capitalism is that free markets are efficient and self-correcting…. The third flawed idea is that a high level of inequality of wealth and income is necessary for economic growth and prosperity.
https://www.ft.com/content/17c43268-bcab-11e8-8274-55b72926558f by Edward Luce
Democrats have been hoping for a so-called blue wave to engulf Congress in November. It increasingly looks like a pink one. Almost two-thirds of women disapprove of Mr Trump. Many are college-educated Republicans who reluctantly voted for him in 2016 because of greater antipathy towards Hillary Clinton. She is no longer on the ballot. Some of them are millennial women who did not vote because they thought Mr Trump was going to lose.
https://www.bloomberg.com/view/articles/2018-09-20/five-essential-numbers-for-measuring-an-economy by Noah Smith
when measuring the decade-to-decade performance of a rich country like the U.S., GDP growth isn’t the best measure, for the reasons described above. A better alternative is real median personal income. This looks at the median, so it isn’t changed very much by large gains for the rich. Unlike household income, it isn’t distorted by changes in the number of people who live together. And it looks at all sources of income, including government transfers, benefits and investment income.
https://www.wsj.com/articles/world-poverty-falls-below-750-million-report-says-1537366273
The global population living in extreme poverty has fallen below 750 million for the first time since the World Bank began collecting global statistics in 1990, a decline of more than 1 billion people in the past 25 years. In a report released Wednesday, the World Bank said the extreme poverty rate had dropped to 10% as of 2015, the latest comprehensive data, and they estimate that the decline has continued over the past three years.
Photo credit: zerohedge.com