Five years ago this week, the investment firm Lehman Brothers imploded, setting off the largest bankruptcy in U.S. history and the fall of financial dominoes that produced the worst economic collapse since the Great Depression of the 1930s. Only concerted and concentrated work by financial authorities around the world staved off a second Great Depression. Instead, the world economy “only” suffered the Great Recession.
Five years later, stability has returned to the global financial system but it remains fragile. There have been efforts to ensure that the meltdown of 2007-2008 will not be repeated, but they remain a work in progress, with many projects stymied by finance industry resistance to measures that might reduce their ability to turn a profit.
More troubling still are the millions of people whose status was badly damaged by the downturn and who have not recovered. While national income has returned to pre-crisis levels, most of those gains have been captured by the highest earners: the poor and middle class remain stunted and battered by the events of a half decade ago.
The crisis was the product of an over-extended finance industry that was more focused on returns than prudent lending. That mind-set was prompted by an industry incentive structure that maximized short-term gains and expected the government to step in when financial institutions took a beating. Believing that they were too big to fail — that the cost of insolvency was more than any government could bear — financial institutions around the world privatized profit and socialized loss.
This process was facilitated by ratings agencies that worried more about their own profits than accurate assessments of the financial products they were evaluating. The increasing complexity of those offerings compounded the difficulty of regulation; carelessness contributed to systemic instability, but so too did mendaciousness and greed.
Bankers were designing financial products that were intended to fail or pit one set of clients against another. Their readiness to put their own money at risk implies at least that even they did not understand the forces they were unleashing.
To their credit, policymakers learned the lessons of the Great Depression and injected massive amounts of funds to stabilize battered financial systems. Hundreds of billions of dollars flowed to tottering banks, shoring them up and staving off collapse. The Group of 20 emerged as an international coordinator to avert a slide into protectionism. That sense of unity and sense of purpose faded over time but it served its purpose.
Today, many, if not most, of the losses have been recouped. By 2011, total global wealth exceeded that of 2007. Unfortunately, the gains have not been well distributed. Since 2009, the total wealth of high net worth individuals globally grew almost 10 percent per year, and now the top 1 percent now controls 44 percent of global wealth. By contrast, 50 percent of the world’s population — about 3.5 billion people — share only 1 percent of global wealth.
The situation is especially acute in the United States, where recently released census figures show that income gains have accrued almost entirely to top earners. The top 5 percent— households making more than about $191,000 a year —recovered most of their losses and took in about as much in 2012 as they did before the downturn. For the bottom 80 percent, incomes have fallen. Persistently high unemployment rates are the proof of the unequal recovery. The vogue for austerity in the face of plunging domestic demand is proof of misplaced priorities and an indifference to the human cost of the prolonged economic downturn.
Misplaced priorities are also evident in the attempts to protect the financial system against future calamities. Many financial institutions remain too big to fail, capable of inflicting extraordinary damage on their economic ecosystem if they become insolvent. Their insistence that they have learned lessons is belied by the steady drip of scandal that is uncovered on a regular basis, from the rigging of the London Interbank Offered Rate (LIBOR) to the accumulation of oversized positions in derivative markets (and not knowing about it, as in the case of JPMorgan’s “London Whale”) to fraudulent mortgage processing.
International financial regulators forced banks to retain more capital to protect them against losses, a process that was fought tooth and nail. The Bank of International Settlements agrees that banks are better capitalized and while lending has been reduced, that makes sense if one of the causes of the crisis was excess lending.
In the U.S., the Dodd-Frank bill provided a critical framework for regulation but the opposition of banks has meant that many of the most important rules remain to be written. There remain significant doubts about how tough they will eventually be and if regulators will have the tools and the gumption to do their jobs.
Meanwhile, the global economy has expanded again, but every time the U.S. Federal Reserve intimates that it will end a stimulus program that pumps $85 billion into the economy each month, stock markets convulse. Japan, too, has embraced a bottomless stimulus effort and China’s response to most crises is to pour money into the economy. Disaster has been averted, but this situation cannot be mistaken for stability. Much work remains to be done to ensure another crisis doesn’t shake the foundations of the global financial system