The crash 10 years on
A decade later, maybe we’ll finally learn the lessons of the meltdown.
The most telling contemporary observation about the ‘worst financial crisis in global history’ (to quote Ben Bernanke, who was chair of the US Federal Reserve when the crash hit in 2008) is that its causes are unresolved. It is true that the financial crash brought about a recession 10 years ago, but it did not trigger the fundamental weakness of the real economy. Slowing productivity growth across the mature economies can be traced back to the early 1970s. It was from that decay within production that the rot spread, gradually, unevenly, but steadfastly. The financial crash was simply one of this decay’s most serious manifestations.
Despite the shock felt in 2008, it is striking how little has changed in economic terms since then. Today’s coexistence of record prices for financial assets, like shares and bonds, with barely perceptible productivity and wage growth tells us all we need to know about our economic prospects. Financial buoyancy is hiding the same stagnant economy. And we know how that mismatch worked out last time.
This absence of change illustrates that, so far, this has been a status quo crisis. The financial froth that disguised the Long Depression during the 1990s and early 2000s remains. So, too, does the protracted slowdown in capital investment that characterises economic atrophy. And just like before 2008, central banks remain capitalism’s most significant institutional support.
These state banks continue to prop up their economies with huge amounts of extra liquidity. This is what we all got to know after 2008 as ‘quantitative easing’ (QE). Buying up $10 trillion of bonds has been good for a wide range of asset prices but it has done nothing to revive economic dynamism.
Although the US Fed has started gradually to increase official interest rates – mainly so it has something to ease again when the next recession hits – little has been done to reverse QE, even in the US. The reluctance of the big central banks to tighten monetary policy comes from their anxiety that just as they were able to boost prices in financial markets, so unwinding their ‘emergency’ measures is likely to have the opposite effect. And they worry that, like last time, this financial happening could be the trigger for another recession.
How the debt bubble burst last time
The 2008 crisis was in essence a huge debt bubble that burst. Without durable productivity growth Western economies had become increasingly dependent on the expansion of all forms of debt since the 1980s. Most governments were borrowing and many businesses were borrowing. In particular, during the 1990s and early 2000s, households were borrowing in order to keep up their spending when real wages were pretty flat for many people. Topping the debt mountain at that time was the build-up of liabilities between financial institutions, especially evident in Britain with London’s role as the world’s biggest financial trading centre. All this debt created the fragile house of cards that needed only a tremor to knock it down.
The US Fed initiated the tremor by starting to raise official interest rates. Its rationale was to slow down the debt-driven economy before it overheated. By mid-2006, US rates hit 5.25 per cent. Mounting mortgage costs precipitated a decline in US house prices. Houses were operating then not just as places to live, but also as debt-underpinned financial assets.
Smaller mortgage issuers in America went down first. In April 2007, New Century Financial fell. It had specialised in subprime mortgage lending to poorer households and into economically deprived areas where borrowers would have greater difficulty maintaining their regular payments once interest rates began to move up. The subprime debacle also hit financial institutions that had heavily invested in securities based on home mortgages. These were known, unsurprisingly, as ‘mortgage-backed securities’, or MBSs, an acronym you will recall if you watched some of the movies made about the crash.
As financial losses began to mount, concerns grew about who really owned these bits of paper and whether they were strong enough to survive the damage incurred. The repercussions quickly spread beyond the US, since non-American institutions owned about a quarter of US mortgages. On 9 August 2007, the leading French bank BNP Paribas issued a wake-up call that reverberated around the Western world. It froze three of its funds with the explanation that the evaporation of liquidity in parts of the US securitisation market had made it ‘impossible to value certain assets’ regardless of their quality or credit rating.
A liquidity and funding freeze spread rapidly around international financial markets. Indebted institutions that relied a lot on short-term wholesale funding were the next to be hit. A few weeks later, in September 2007, the Northern Rock building society faced Britain’s first bank run since the 19th century, even though it had minimal exposure to US subprime mortgages.
Throughout late 2007 and into 2008, other financial institutions began to collapse and/or had to be rescued by their respective governments. Other well-known names went down, including, in March 2008, one of the smaller US investment banks, Bear Stearns. This was followed a few months later by the US mortgage bodies Fannie Mae and Freddie Mac, leading to the emblematic collapse of Lehman Brothers on 15 September 2008.
The financial crisis was then in full flow. Governments, led by the US, stepped in to bail out banks and other businesses caught up in the recession. Central banks pumped liquidity into the markets to prevent a complete financial collapse. Historian Adam Tooze, in his book Crashed, appropriately summarised that the financial crisis was met with a ‘mobilisation of state action without precedent in the history of capitalism’.
The mythical rise and fall of market fundamentalism
However, the ensuing narrative of a ‘return of the state’ after decades of neoliberalism is a fiction. When Tooze went on to write that, ‘Gone were the days when economic policy was about shrinking the state to set free the spontaneous order of market liberty’, he succumbed to the story, promoted ever since the Reagan and Thatcher years, of a triumph of the ‘free market’.
That never happened. The state never withdrew from economic intervention. Public spending hardly ever fell. The regulation of markets just continued to roll forward. Even the famed ‘deregulation’ of financial services represented an active state policy to promote financialisation in the place of previous productive activities.
The strength and durability of that ‘neoliberal’ free-market narrative derives from politics, not from economics. It is a story adhered to by a strange alliance of the old left and the old right. The old left propagated it as an explanation for the political defeats it suffered in the 1980s and for its ongoing diminishing influence in society. The old right pushed the free-market story because it was more than happy to receive the accolades of having ‘won’ the economic war. Yes, a few genuine neoliberal enthusiasts, of the Hayekian variety, did want to keep markets ‘free’, but not so much from the state as from politics – and especially from the pressures of mass democratic politics.
The dog that failed to bark
The anti-political circumstances that spawned this odd conservative alliance accounts for the dog that didn’t bark after the crash. Despite the great fears and turmoil generated at the time, what has been notable since the crash has been the absence of change – this remains a status quo crisis. Even on the geopolitical level, a mostly pragmatic and conservative coalition of national governments has, as yet, avoided a turn towards serious international disorder.
Historically, severe economic crises can be occasions for eroding support for existing economic thinking. This happened in the 1930s and again in the 1970s. The former brought the discrediting of the ‘neoclassical’ idea of a self-balancing economy. The latter undermined faith in the pseudo-Keynesian notion that governments could spend themselves out of economic recessions.
More positively, crises can sometimes create an intellectual climate for new and different approaches. Early predictions that 2008 marked the end of an era and would precipitate such an occurrence were seriously overdone. Over the past decade, we’ve seen little in the way of new economic thinking, or of new ideas in general.
This is because financial or economic crises never change anything on their own. It is only when the economy is politicised, when it is a subject for public debate and contestation, that transformation is possible – though even then change is certainly not inevitable. The contemporary lack of change highlights that a significant achievement of the Western governing groups since the 1980s has been to take politics out of economic life.
This is epitomised by the mantra of ‘there is no alternative’, or TINA. This has been widely adopted across the old political spectrum. It expresses itself through the fearful culture of risk, and it means that initiatives to make changes are discouraged. Change is dangerous. Better to stick with the present and known ways. So far since the early 1990s, the resulting muddle-through policy mix has been relatively successful and resilient – bar the interruption of the 2008 crash.
Not only have we been told to put up with the market system, TINA also seeps into many other areas of our lives. In Britain, for instance, we hear it today about the Chequers plan for UK-EU relations. Honest supporters of these proposals know they represent a denial of the popular vote for Brexit, but, they shrug, there is no alternative. ‘Yes, you’ve had your vote, but we know that the status quo is best.’
A decade on from the crash, the brightest hope comes from the emergence of the populist moment, in one Western country after another. Regardless of the merits or demerits of the particular beneficiaries in different places, this is a positive sign that people are not willing to put up with the status quo. They want change. Potentially, at long last, we can start to debate the real lessons from the circumstances surrounding the collapse of Lehman Brothers.
Phil Mullan’s latest book, Creative Destruction: How to Start an Economic Renaissance, is published by Policy Press.
Picture by: Getty.