Greed on Wall Street, malfeasance among mortgage lenders, ineffective regulators, profligate American home buyers, overregulation, underregulation — the list of potential causes of the 2008 financial crisis is both exhaustive and contradictory.
Rather than home in on one aspect of the crisis, taking a longer view of events suggests that the Great Recession, although severe in magnitude, exhibits many of the same characteristics of financial crises since the 1970s: An initial frenzy of lending across borders followed by a sudden stop.
Since the crash of Lehman Brothers a decade ago, the churn of debt across the globe continues to expand, driven in part by the Tokyo-based megabanks which have extended credit to businesses and governments overseas.
And if history is any guide, this debt binge is likely to end the way it has in the past — with borrowers cut off, lenders damaged and real losses likely to stack up for both Japanese banks as well as the savers who entrusted their cash with them.
While the timing of capital backlash is difficult to predict, the result is easy to witness.
It can be seen in the hapless businesses in the immediate aftermath of Lehman Brothers’ collapse on Sept. 15, 2008, or the indebted governments of Europe in 2011, both of which could no longer borrow from international markets. When the panic set in and contagion spread, investors wanted to pull their cash back from abroad without relation to the health of the government or business they lent to.
Now, with Turkish businesses and the Argentine government grasping for a lifeline — and other emerging markets teetering on the edge of financial panic — the capital that rushed to those countries is finally reversing direction, and Japanese banks who lent to many of them are set to face losses on those loans.
Notable economists also see recent events in emerging markets as confirmation that history appears to be repeating itself.
“The large flows that went into (emerging markets) is starting to reverse. … If history is any guide, this will cause some crises,” author and economist Tamim Bayoumi wrote in an email to The Japan Times.
Bayoumi, who is the author of 2017’s “Unfinished Business: The Unexplored Causes of the Financial Crisis and the Lessons Yet to be Learned,” explains in the book that sudden capital stops are a feature of the global financial system.
“The (history of the) international financial system since 1970 can be told through the lens of footloose international debt flows that have ebbed and flowed across regions,” Bayoumi wrote in the book.
Emerging markets not alone
The Great Recession quickly did away with the notion that harsh backlash from capital flows is exclusive to developing countries.
This was painfully demonstrated in 2011 when Portugal, Ireland, Italy, Greece and Spain (collectively referred to as PIIGS) were suddenly unable to finance their government spending after investors severely cut back lending.
While the scenes of panic in Greece left a lasting impression in the collective conscious, these governments, often accused of profligate spending, were not the only ones to feel the burn of capital stops.
The economic giants of the United States, France and Germany also were affected, but rather than the government being unable to lend more cash, both financial and nonfinancial institutions were the ones who saw their funding evaporate.
In the second half of 2008, capital flows between developed nations plunged to barely more than $1.5 trillion from $17 trillion, according to an influential Bank of International Settlements working paper published in May 2011.
In order to fill these trillion-dollar shortfalls in funding, which left U.S. and European corporations scrambling for financing, central bankers stepped in to serve as the lender of last resort to prop up troubled commercial and investment banks, as well as insurance companies.
Whether it was Western corporations in 2008, indebted European nations in 2010 or emerging markets in 2013, rapidly moving debt flows repeatedly showed that a small tremor in financial markets can set off a massive quake.
Bankers unable to avoid fears
Even as calm was restored to financial markets, central bankers around the world worried that their efforts would be unable to avoid their worst fear: falling prices.
In the world of central banking there is broad consensus that falling prices, or deflation, is a recipe for economic malaise.
As a result the U.S. Federal Reserve and many other central banks around the globe moved to spur inflation by almost any means necessary, introducing a grab bag of unprecedented programs in what came to be known as “unconventional monetary policies.”
As these efforts often came up short of restoring inflation, the irony of the situation was not lost on Japan’s policymakers who were, for years, criticized for not doing enough to reflate the economy during the 2000s.
While the efficacy of these unconventional policies is still hotly debated, one lasting effect is clear: debt again began to flood into emerging markets.
U.S. dollar credit surged to emerging market borrowers over this time period, to $3.4 trillion at the end of March 2017 from around $1.5 trillion in 2008, according to a September 2017 report from the Bank of International Settlements.
The nature of dollar denominated credit is riskier than other types of borrowing because large currency devaluations can leave companies conducting business in local currencies unable to pay back their dollar debts.
And Japanese banks served as a key conduit to deliver the large amount of capital that made its way to many of these far-flung markets.
With over $2.5 trillion in dollar assets, Japanese banks’ dollar holdings dwarf all other countries, excluding the U.S. This is an 88 percent increase from 2007 to 2017, while over the same time period European banks’ dollar assets decreased by 42 percent, according to a March 2018 report from the Bank of International Settlements.
This dynamic developed in large part because, compared to their Western peers, Japanese banks escaped the Lehman debacle relatively undamaged, allowing them to step up lending to emerging markets after the crisis.
The consequence was that mountains of Japanese cash was primed and ready to be invested across the globe.
While the banks claim that they have learned from the bubble period experience, there is good reason to remain skeptical that the risks can be completely hedged.
Adam Tooze, a professor at Columbia University, told The Japan Times that some of the Japanese banks may have been unable to compensate for the subsequent risks.
“It looks like Japanese banks have a lot of currency mismatches on the balance sheets and quite a lot of it looks unhedged,” said Tooze, the author of “Crashed: How a Decade of Financial Crises Changed the World.”
The whip begins to crack
In the summer of 2018 warning signs began flashing that capital may once again be on the verge of reversing in some emerging markets.
Turkey is still in the throes of a full-fledged currency crisis, Argentina is unable to fund its government, and financial frictions appear to be creeping into Indonesia, Brazil and South Africa.
Not surprisingly, these same countries experiencing difficulties were the same players that saw international debt flood into their markets in the aftermath of 2008.
Now, in light of recent events, the question appears to be not if — but exactly how far — these debt flows will reverse.
With over $2.5 trillion in dollar assets held by Japanese banks there is likely to be heavy collateral damage to their balance sheets if foreign governments default on debt, or corporate entities declare bankruptcy.
The scale of the problem is likely to hinge on how far the financial panic spreads.
Guillermo Calvo, a prominent economist who has done extensive research into the sudden stops of capital flows, for the time being is inclined to believe that a full bore economic catastrophe can be avoided, although he is less than sanguine about emerging market growth.
“In the big sweep of things, emerging markets are unlikely to re-establish the vigor of a few years back. My gut feeling is that they will converge to a sort of stagnation, resembling Japan’s after 1990,” Calvo wrote in an email to The Japan Times.
Calvo, who has done extensive research into “sudden stops,” added: “In the short run, we are likely to see currency devaluation and inflation spikes all around.”
But with emerging markets now representing over 60 percent of the global economy, even a small crisis is expected to reverberate across the globe. According to the 2018 annual report from the Bank of International Settlements, “In various adverse scenarios that hit growth in (emerging markets) … growth in major economies could be reduced by up to 1 percentage point, possibly a conservative estimate.”
While Columbia professor Adam Tooze is unsure if recent events are enough to set up a global shock, he believes that with capital velocity at an all-time high Lehman will pale in comparison to larger crises in the future.
“What we do know is that the risks of future crises will be enormous. The other thing we know is that no one will be safe,” said Tooze.
“Everyone is interconnected. And given the entanglement of European and American capital to other countries there is going to be reverberations in the West from what goes on in emerging markets,” added Tooze.