Both the past and future of our financial system remain as poisonous a topic as they were five years ago, when Lehman Brothers failed. That is a lesson to draw from the forced withdrawal of Lawrence Summers, former US Treasury secretary, from the list of candidates for chair of the US Federal Reserve. For many Democrats, Mr Summers is responsible for the financial liberalisation that led, in their view, to the crisis of 2007-09. Indeed, the debate about the origins and aftermath of the crisis is not over. How can it be when the exceptional policies it caused are still with us?
The fifth anniversary of Lehman’s failure is an opportunity to assess where we have come from and where we are going. How important, for example, was Lehman’s failure? It was less significant than many believe, for two reasons. The less important one is that a financial crisis was on its way, anyway. The more important one is that the financial crisis was a manifestation of overstretched balance sheets. These impaired balance sheets are, in turn, the reason a strong recovery has been so long in coming.
This is not to argue that the decision to let Lehman fail in September 2008 was unimportant. The shock began a devastating run on markets. An indicator of these stresses is the spread between three-month Libor (the rate at which banks could supposedly borrow from one another without offering any security) and the overnight indexed swap rate (the implied central bank rate over the same period). This spread, already elevated, started to widen on the day of Lehman’s failure. It kept on widening as the financial dominoes kept on falling in the US and Europe. The stresses revealed in this measure of the perceived solvency of banks peaked on October 10. (See chart.)
So what happened on October 10? The finance ministers and central bank governors of the Group of Seven leading high-income countries, meeting in Washington, declared that they would “take decisive action and use all available tools to support systemically important financial institutions and prevent their failure” (my emphasis). The core global financial system became the ward of the states. The idea that this was a private system was revealed to be an illusion. Taxpayers woke up to discover that bankers were exceptionally highly paid and out-of-control civil servants.
Governments and central banks dealt with the global financial panic relatively quickly and effectively, though a devastating aftershock emerged in the eurozone in 2010. Yet eliminating panic and even restoring the banks to health relatively quickly, as the US did, was not enough to generate a vigorous recovery. Even in the US, which has recovered faster than the other large crisis-hit economies, gross domestic product has fallen consistently relative to the pre-crisis trend (see chart). In the second quarter of 2013, it was 14 per cent below that trend. In the UK, it was 18 per cent below trend. Since much of the income generated in the recovery has accrued to the very top of the income distribution (partly because of the policies employed), it is little wonder discontent is rife.
Lehman was not the only possible cause of a panic. Any one of a host of institutions might have failed, with similarly devastating effects. The big impact of Lehman was to make transparent the losses. That had to happen. The reason for the subsequent economic weakness is also clear: economies had become dependent on the debt-fuelled spending promoted by rising property prices. The panic was itself a result of the cessation of this demand engine. The intermediaries that had bet their prosperity on ever-rising asset prices were in trouble. So, too, were economies that had made exactly the same bet. So, too, were economies that had bet on selling to these debt-fuelled economies. Should we have been surprised by this aftermath? No. Several well-informed economists had warned of just this dire possibility.
Why had important economies become so dependent on debt-fuelled growth? The best answer is the one advanced by Ben Bernanke, the Fed chairman, in 2005: the global savings glut, especially in developing countries after the Asian crisis. There are two simple indicators of that worsening glut: one is the real interest rate on safe securities, which can be measured from the yield on index-linked government bonds (see chart); the other is the global imbalances.
The simplest explanation of the outcome of this glut was that central banks, particularly the Fed, responded to the contractionary forces coming from the world economy with a monetary policy that worked by promoting a domestic bubble economy. Given its mandate, it simply had to do so. The explosive rise in gross debt was a result of the leveraging up of both property assets and the financial sector to generate household spending at levels sufficient to absorb potential supply (including foreign net supply) in the economy.
This, then, was a world of excess potential supply, as Daniel Alpert of Westwood Capital argues in The Age of Oversupply – a fascinating new book. It still is – indeed, even more so. Not just today, but for many years, the central banks of Japan, the US, the UK and the eurozone – essentially the whole high-income world – are not just offering free money but creating vast quantities of it. Even so, economies are weak. Upward twitches are hailed as a new dawn in economies that remain smaller than they were before the financial panic, as in the UK. US economic performance is better than that, but still decidedly poor. Lehman’s failure did not cause all this. Its failure was a symptom of imbalances that did.
Worse, the one way we seem to know to restore health to our economies is to restart the credit machine, as is now at last beginning to happen in the US and UK. On the principle that a bad recovery is better than none, I accept over-reliance on monetary policy as the least bad available option. In countries suffering from foreigners’ mercantilism and domestic aversion to investment and fiscal deficits, little alternative seems to exist. But managing that policy is really tricky. For this reason, though not only for this reason, it is high time that the White House nominated the next chair of the Fed. It needs to be someone who understands and believes in the only policy available.
It should, of course, be Janet Yellen, the current vice-chair.
Martin Wolf
Fonte: FT
