Financial Crisis 10 years on - How the response to the last crisis laid the foundations for the next

The causes of the crises
The crisis that culminated in the Lehman collapse was caused by three interrelated factors:

The first one was rising inequality. In many countries including the USA, real wages stagnated or fell during the 1990s and early 2000s. Poor people could no longer fund their consumption through wage income. At the same time access to credit was made much easier, so they took out loans to fund their needs and became ever more indebted. In addition, there was an increasing concentration of wealth in the hands of the few rich, later branded by the Occupy Movement as “the 1%”, and the rich needed investment opportunities, which included lending to the cash-strapped poor. The banks facilitated this “subprime-lending” system, also due to the high commissions that could be made. This system was never sustainable, and it collapsed in 2008.

The second one was the privatization of public services and the financialization of ever more sectors of life and society. Since the start of the neoliberal age in the 1980s, the supply of public housing, education, healthcare and other services that by nature should be public has been reduced. People had to start to pay for essential services, and getting into debts made it possible. The financial sector innovated and introduced new “asset classes” such as student loans or healthcare loans which boosted the overall debt even more.

Finally, deregulation of the financial sector played an important role. The governments of Bill Clinton and George W. Bush had lifted many restrictions that had been put in place after the Great Depression of the 1930s. Instead of doing the boring old business of connecting savers with borrowers, investment banks changed their business model and invented new financial products such as credit default swaps or collateralized debt obligations. This encouraged and allowed overly risky lending. Even the official regulators such as the US’ Securities and Exchange Commission and rating agencies such as Moody’s did not fully understand the risks that these products entailed, or simply ignored them. When the crisis started, it turned out that many of these derivatives contained nothing more than ‘hot air’. Essentially, the financial sector had produced a house of cards of fictive capital that collapsed in a ripple effect.

The crisis unfolds
The crisis unfolded from 2007 with a massive drop in real estate prices and related financial products, in particular the mortgage-backed securities. Banks on both sides of the Atlantic got into trouble: Bear Stearns, Merrill Lynch, Lehman Brothers in the USA, Northern Rock and Royal Bank of Scotland in the UK, IKB and Hypo Real Estate in Germany were just some of the more prominent cases of banks that folded or were de facto nationalized.

The collapse of Lehman Brothers in 2008 was a turning point. From there on, there was a real or perceived risk that the meltdown of the bloated and highly overleveraged financial industry could result in the world economy’s complete Armageddon. The financial industry’s lobby fuelled these fears, unfortunately highly successfully. As a result, governments changed their policies. Instead of letting bankrupt banks go bankrupt, large public monies were injected to stabilize private banks’ balance sheets. In what can be described as the largest redistribution from the poor to the rich ever, governments all over the world channelled an estimated 4 to 5 trillion dollars in public money or guarantees to the private banks.

From bank crises to sovereign debt crises
These bailout programs stopped the overdue and in the long-term unavoidable deleveraging process. Private debts were transferred to public balance sheets. Between 2007 and 2014, sovereign debt in the EU increased from 57.5 to 86.5% of GDP, with particularly steep increases in countries that had the highest bank bailout burdens to carry. In Ireland sovereign debt levels increased fivefold, from 23.9% in 2007 to 119.6% of GDP in 2012, in Spain they tripled from 35.6% to a peak of 100.4%. For Greece, a vulnerable country with relatively high sovereign debt levels before the crisis started, the bailouts were the final blow.

Greece was the first country where the financial sector disaster caused a sovereign’s bankruptcy. Also in this case, the financial sector lobby successfully convinced policy-makers that a bailout was necessary to avoid the economic Armageddon. Instead of writing off the unsustainable debts mainly owed to French, German and British banks in a comprehensive debt restructuring, Greece was ‘convinced’ to pay off the banks, using official loans from other EU Member States through the Greek Loan Facility, the IMF, and later the new EU bail-out funds EFSF and ESM. 95% of the bailout loans officially taken out by the Greek state went to private banks. The practice was repeated in four other EU countries - Ireland, Portugal, Spain and Cyprus. Ireland originally planned to follow the Icelandic example – which was to refuse to bailout the private banks – but was forced by the European Central Bank to go the bailout way.

The people are paying the price
The crisis that was caused by the financial sector and that started in the financial sector had a massive impact on the real economy, and on the living conditions of actual people. The recession that followed wiped out 4 trillion USD of global GDP, industrial production in Europe dropped by 20% in the first year of the crisis, and in some countries, it still has not fully recovered. The ILO has calculated that 61 million workers lost their jobs, and the FAO observed a surge of people suffering from hunger by 100 million.

Particularly harsh has been the impact on people living in the worst bailout countries. In order to relieve the financial sector from the need to adjust, the burden has been put on the people through brutal austerity and adjustment policies imposed through loan conditionality. Greece has been forced to cut public spending so substantially that the country lost 25% of its GDP, a quarter of the economy has thus been wiped out. Wages overall have fallen, minimum wages have been reduced substantially, labour rights have been slashed, public services cut, and the welfare system diminished.

For the affected countries, the last decade has been a ‘lost decade’, and a whole generation of young people has been turned into the ‘lost generation’. Young Greeks, Portuguese and Spaniards have had to leave their countries by the millions in search for jobs in more fortunate places of Europe. While job markets now slowly recover, the crisis has been used for a neoliberal transformation. Formal employment got replaced by trabajo basura, as the Spaniards call them – trash jobs without security or rights.

The next crisis and the new debt vulnerabilities
What the policy response to the crisis did not do is to address the underlying causes of the crisis. The world economy is now higher leveraged than ever. According to the IMF’s Fiscal Monitor 2018, worldwide debt now stands at $164 trillion, equal to 225% of global GDP, and up from a previous record of 213% in 2009. All country groups have been affected: Developed economies’ public debt has risen to 106.9% of GDP in 2017, the highest level in times of peace. Things do not look better in the private sector. Especially corporate debt has surged to a record level of USD 66 trillion globally.

The quantitative easing policies that Central Banks in the global North have implemented to relieve private banks from pressure has unleashed a tsunami of speculative capital flows to the global South. It has triggered a lending boom that has pushed poor countries into a new debt trap. The IMF reports that only 1 in 5 low-income countries (LICs) can now be considered to be in low risk of debt distress. The positive impact of the Heavily Indebted Poor Countries initiatives since the 1990s has been undone. The developing countries' debt crisis has already returned to many parts of the global south, and it will be even more difficult to manage than the last crisis. The creditor landscape has become ever more complex, and even low-income countries have started to use innovative financial instruments such as Eurobonds or collateralized loans - mortgaging their future export revenue - which are extremely difficult to restructure.

Innovations in financial regulation have been insufficient. While for example the European Commission is proud to report that it has put forward more than 50 major files for financial regulation in response to the crisis, these have largely been missing the point. No debt resolution mechanism has been introduced to reduce debt when needed, to deleverage the economy and address debt crises in a sustainable manner. Attempts at United Nations level to create such a mechanism have to date not been fruitful either. Instead, irresponsible banks can further rely on being bailed out.

Indeed, the fact that the banks were bailed out has allowed for business as usual and can be seen as one of the main reasons for why a more substantial change or transformation in the financial system has not taken place. While the consequences of a non-bailout certainly would have been severe, it is perhaps what the world had needed to wake up and take action.

Urgent action is in particular required to protect vulnerable developing countries. Just in time for the 10 years anniversary of the crisis, the currencies of Argentina and Turkey crashed, indicating the arrival of a new emerging market crises. Private corporations and banks in these countries have borrowed heavily in foreign currency and now foreign investors are pulling out their money. If no international solution to prevent debt crises is found, developing countries should at least start with unilateral measures, such as effective capital controls against speculative flows, or by introducing caps on foreign currency lending.

10 years after the collapse of Lehman, the financial industry continues to hold citizens and whole nations hostage. This 15^th of September, activists all over the world stand up in protest. It is urgent that we change finance before the financial industry causes the next crisis.