September 15 was the 10th anniversary of Lehman Brothers’ bankruptcy filing. There has been wall-to-wall coverage of the 2008 crisis. In truth, Lehman Brothers’ bankruptcy marked neither the beginning nor the end of the crisis. In fact, it might be impossible to date the end of the crisis, until a few years from now. The bankruptcy of Lehman Brothers was an important event in the crisis that began to manifest itself in the summer of 2007. When did the global crisis of 2008 actually begin?
Perhaps it began when China devalued its currency in 1994. Among other things, that devaluation worsened the current account deficit of some Southeast Asian nations. The Asian crisis followed. That was humiliating enough for countries seen as the next Asian tigers following in the footsteps of Japan, Taiwan, South Korea, Singapore and Hong Kong.
More humiliation, in the form of conditions imposed by the International Monetary Fund (IMF), followed. Asian economies swore not to go to the IMF. China joined the World Trade Organization in 2001. An export boom for China ensued. China worked actively to keep its currency either undervalued or at least not overvalued. It accumulated foreign exchange reserves by the billions and, soon, trillions of dollars. Other countries followed suit, partly because of the memories of humiliation, and partly to preserve whatever little export competitiveness was left in the wake of Chinese currency manipulation.
Dollar reserves were invested in US Treasuries. US Treasury yields did not rise as much as they did when the Federal Reserve was hiking interest rates before. Maybe it was because many developing countries were investing their reserves in dollars or maybe because Alan Greenspan (chairperson, Federal Reserve Board, from 1987 to 2006) telegraphed his rate increases like never before.
The relatively low long-term interest rates and regulatory forbearance towards banks’ leverage and towards real estate loans to subprime borrowers inflated home prices. When home prices collapsed, mortgage loans went unpaid and panic ensued. Financial products that were based on packages of mortgage loans and built on the assumption of “never a nation-wide collapse of home prices" unravelled and financial panic followed. The panic was big and it was global. This needs explanation.
Former Federal Reserve chairperson Ben Bernanke was right that it was not the collapse in the prices of homes in America but the financial panic that followed it that triggered the economic recession (six quarters from January 2008 to June 2009) in the US. But the analysis is incomplete. Financial panic, in turn, was a consequence of the financialization of the global economy. Central to financialization is the pervasive recourse to debt that simply raids the future for the present. The second feature of financialization is that activity in financial markets and among financial market participants drives economic activity.
Thanks to America’s intellectual and other forms of coercion (including the role of the dollar), both these features of financialization had gone global in the decades since the 1980s. That is why it was a global crisis. Real estate and stock markets collapsed everywhere and not just in America. In many countries (developing and developed), bank lending for real estate development and mortgages comfortably outpaces lending for commerce. It is collateralized and hence, carries a lower risk weight than commercial loans. Hence, bank loans are mostly made for non-productive ends—an unintended consequence of risk-weighting. The 2008 crisis had many epicentres and the common faultline was the Rise of Finance.
Another important causal factor was central bank hubris. Greenspan and then Bernanke acquired a halo for achieving the great moderation in economic cycles as expansions lengthened and inflation remained tame. Hence, the perception that monetary policymakers had things under control encouraged excessive risk-taking and central bankers did not stop it because doing so would amount to conceding that they were mere mortals.
So, where do we stand now on these two causal factors? We stand where we stood in 2008. The Rise of Finance has not been curbed. A prolonged period of abnormally low interest rates has ensured that global debt has spiked since the crisis, and as long as financial leverage is the driver of economic activity, the financial sector—markets and financial institutions—retains its dominant role. That is not healthy. Leverage facilitates financial engineering, financial market speculation and unviable mergers and acquisitions. As existing assets change hands, their values are bid up to unjustified levels, resulting in concentration of wealth. New assets are seldom created, and where they are, artificially low interest rates flatter their financial viability. Simply, risk has migrated from home mortgages to other areas that we will know about when the next crisis arrives.
As for central bankers, ever since financial markets became the mechanism for transmitting their policies to the economy, they had lost control but are unwilling to admit it. They have been throwing darts in the dark and when they hit their targets by chance, they claim victory, not counting the many accidental victims of their random dart throwing. So, we are where we were in 2008. Unprepared and, worse, unrepentant.
V. Anantha Nageswaran is an independent consultant based in Singapore. He blogs regularly at Thegoldstandardsite.wordpress.com. Read Anantha’s Mint columns at www.livemint.com/baretalk
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