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The GFC: When will it end?

While the Lehman Bros collapse in September 2008 marks the acme of the global financial crisis, the train started running off the rails more than a year earlier – around this time a decade ago.

In the space of a few weeks, ratings agency Standard & Poor’s finally put securities backed by American sub-prime mortgage loans on credit watch, mortgage giant Country Wide warned of trading difficulties and Bear Stearns – which ultimately had to be bought out in a rescue deal in March 2008 – liquidated two hedge funds with heavy exposures to junk loans.

There’s been plenty of anniversary commentary on the crisis – and there’ll be a lot more - but the critical misconception is the crisis is an event of the past. The crisis is still going. And it has spread beyond the financial system.

Certainly, the aftershocks of this seismic event continue to jolt the financial system a decade later: Italy has just bailed out two banks. Canada and Spain have also had to euthanise some institutions which had effectively been on life support.

The global regulatory reformation which commenced in response to the crisis may be closer to the end than the beginning but crucial elements remain to be decided. While experts continue to debate how much safer the system actually is.

Take Italy. According to Fabio Panetta, deputy governor of the Bank of Italy, “after going through an unprecedented recession and setting out on a path of capital strengthening under very difficult conditions, the positive performance of the real economy has now created the pre-conditions for Italian banks to move out of the stage where they are just reacting to the crisis”. The “pre-conditions”….

Protracted

Such a protracted recovery from the worst economic catastrophe since the Great Depression is hardly surprising. Even as it struck economists were warning the aftershocks from a financial crisis would be different in kind and degree to a more run-of-the-mill recession. This year also signifies the 20th anniversary of the Asian financial crisis and that is still rippling through economic policy in the region.

Indeed, the bigger question for this 10th anniversary of the global financial crisis is how has the contagion spread?

The always erudite Martin Wolf in the Financial Times wrote (and appeared in) an incisive item last week about the broader political and cultural damage wrought by the crisis. He argued previously unthinkable events like Brexit and the election of Donald Trump were symptoms of the crisis – although it wasn’t the only cause.

“Economic and cultural phenomena are interrelated,” Wolf argued.

In discussing the rise of populism, he noted research which considers immigration a cultural shift. He counters “it can also be reasonably viewed as an economic one”.

“More important, the study does not ask what has changed recently. The answer is the financial crisis and consequent economic shocks. These not only had huge costs. They also damaged confidence in - and so the legitimacy of - financial and policymaking elites. These emperors turned out to be naked.”

This outbreak of Imperial nudity has exposed and exacerbated other cultural and economic factors, notably the shrinking share of economic output going to the middle and lower classes via wages relative to the growing share of wealth going to the owners of capital.

As many have noted, no one went to jail for the financial crisis and corruption of the sub-prime mortgage market yet millions globally had their lives impacted. This perceived inequity was further aggravated by the fact the measures adopted to combat the crisis – which were correct – included fiscal stimulus, monetary easing and quantitative easy which inflated the value of assets predominantly owned by the wealthy such as shares and property.

Profits in the run up to the crisis had indeed been privatised while the massive losses were socialised.

It is in this environment tat the savage reaction to the elites – even when, as in the case of the crisis, they actually averted greater catastrophe – has fomented into rebellion.

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" The aftershocks of this seismic event continue to jolt the financial system a decade later."

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Source: 2017 Edelman Trust Barometer

Consider the latest barometer of the global mood in advanced economies, the Edelman Trust Barometer, which reveals not just a collapse in trust in institutions but a widening of the gap between the “informed public” and the “mass population” in attitudes to institutions and experts.

This mood swing impacts even countries where the direct impact of the financial crisis was contained, like Australia. The animus towards banks which has provided one defence for new taxes against the industry captures not just multiple episodes of misconduct but the idea the “banks got us into this” mess. It may be demonstrably untrue but that isn’t relevant today.

The banks may have actually paid the Australian taxpayer $4.5 billion for a government guarantee during the crisis but the public perception is banks should keep paying.

Interestingly, in Canada, a similar commodity-based economy which came through the financial crisis as robustly as Australia, trust in institutions remains an order of magnitude higher than in Australia and the political climate is dramatically less toxic.

This ongoing cross-fertilisation – or contagion – between the financial system, economic growth, cultural developments and populism is of course complex and evolving and it would be stupid to be reductive.

But it’s worth bearing in mind that even the direct response to the crisis, 10 years on, continues to unfold. The final elements of what is now known as “Basel IV” are yet to be revealed by the Bank for International Settlements and domestic supervisors. Capital levels, leverage ratios and floors on risk weightings of loans remain to be finalised.

The Financial Stability Board, a construct of the BIS, provided an update for the G20 meeting in Germany this week making the case for how much had been achieved in making the financial system more resilient.

FSB chairman and Bank of England governor Mark Carney delivered a letter to G20 Leaders and the FSB also released its third Annual Report on the Implementation and Effects of the G20 Financial Regulatory Reforms.

The letter sets out four main points:

• G20 reforms are building a safer, simpler, fairer financial system – without, the FSB says, impeding the supply of credit to the real economy.

• Some unfinished business to finalise and implement reforms merits attention. Basel III must be completed urgently and then implemented faithfully while the underlying causes of misconduct are being addressed by bolstering individual responsibility accountability and better aligning incentives and reward. The FSB concedes more needs to be done.

• The financial system is evolving, so the FSB will continue to scan the horizon to identify, assess and address new and emerging risks to financial stability.

• G20 countries now have a strategic opportunity to build on this foundation to create an open, global financial system.

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Meanwhile, the FSB’s Third Annual Report on the Implementation and Effects of the G20 Financial Regulatory Reforms reports implementation continues to progress but is uneven across the four core areas of the G20 financial reforms.

Much indeed needs to be completed. We are still working through the crisis a decade on.

Moreover, some of the work is starting to be undermined even before it is complete, notably with the Trump administration in the US working to dismantle many of the safeguards brought in after 2008.

The anti-globalisation nationalism and protectionism emerging has its agency in the financial system too with the re-emergence of more national regulation – creating the conditions for one of the more corrosive forces, regulatory arbitrage.

The danger is institutions – and risk – migrate to domains where they are less closely supervised.

So what have we learned from the greatest financial debacle of the last 80 years a decade on? To paraphrase Zhou Enlai’s misquoted line in the 70s about the impact of the French Revolution 200 years earlier: it’s too early to tell.

Andrew Cornell is bluenotes managing editor

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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