What lessons have been learnt over the decade since Lehmans collapsed? (Part II)
Four-part Big Question special
In the second part of our Lehmans 10th Anniversary Special, industry leaders and commentators reflect on the last ten years and discuss how the financial system has improved since the Global Financial Crisis (GFC), where more work needs to be done and what could trigger the next crisis.
Didier Saint-Georges, managing director at Carmignac
Abundant liquidity
Investors and regulators have a habit of preparing for the last crisis. The 2008 financial crisis taught everyone that financial leverage from banks creates enormous risk for the financial system when asset quality deteriorates.
This lesson led to a global regulatory effort to force banks to recapitalise and improve the credit quality of their books. Therefore, the risk of another bank collapse triggering another global economic recession is behind us, but this will hardly preclude the next financial crisis from happening. All to the contrary.
The reason is cruelly logical. Central banks pumped gigantic amounts of liquidity into the system over the past ten years in order to try stimulating the economy.
But because banks - as requested - were shunning risks, economic growth remained subdued globally, therefore that liquidity led to asset price inflation.
And this central-bank sponsored bubble created a sense of security that encouraged investors to take ever more market risks.
The next financial crisis will come from the end of abundant liquidity, when central banks try to regain control of the monster they created.
Rachel Reutter, co-manager of the JO Hambro UK Opportunities fund
Passive funds
James Grant, financial journalist and author of Grant's Interest Rate Observer, once said: "Progress is cumulative in science and engineering, but cyclical in finance".
Ten years on and our industry has seemingly learnt nothing, with levels of debt, yield-seeking behaviour and capital-destructive M&A all surpassing 2007's peaks.
While the majority of issues in 2008 were in banks and property, today, thanks to the distortive effects of quantitative easing (QE), the mispricing of risk is evident, in our view, across all asset classes.
But monetary tightening, led by the Federal Reserve, is starting to expose the governments, corporates and individuals who have binged on cheap debt. Bumps in the real economy will occur, yet when excess leverage is involved things become toxic.
Meanwhile, the social impact of QE has been a world of rising inequality. The resultant rash of political populism across the world raises the risk of erratic political intervention, something which cannot be forecast by spreadsheets, nor processed by the biggest area of asset growth since 2008: passive funds.
When the great flow of capital turns, it will be the computers leading the charge for the exit, becoming the price-insensitive sellers.
David Owen, chief European financial economist at Jefferies
Capital flows
The origins of the last financial crisis are well understood. The banking systems of many countries have been strengthened and, in some cases, central banks have introduced macro and micro prudential policies to help further safeguard the system from a build-up of imbalances and speculative bubbles.
Achieving a low inflation target is no longer viewed as an end in itself if it is then followed by a financial crisis and deep recession.
But as things stand, growth has fallen short of expectations and world trade has disappointed. We are now entering a crucial phase when key central banks are trying to normalise policy.
At some point there will be another financial crisis, with the risk that we could be only one more recession away from outright deflation for more economies.
In the year ahead, fault lines in the euro area and across emerging markets need to be monitored, a disorderly Brexit needs to be avoided, along with no further escalation in trade tensions.
But without winding the clock back to a world where capital flows globally were much less, it is difficult to know how periodic financial crises can be completely avoided.
