It has been ten years since the crash that shook the foundations of modern capitalism. Like the Great Depression of 1929 before it, the Global Financial Crisis revealed the failings of entire economic and political system and the weaknesses in public finances and monetary policy. The crisis led to an essential review of financial regulation and ultimately became a watershed moment.
The G20 leaders held their first summit in Washington, DC on 14-15th November 2008 in the midst of the financial meltdown The goal was to address the crisis and ultimately prevent the contagion in a number of developed countries from causing global collapse. The programme of reform that was devised was directed at strengthening the solvency, liquidity and risk management of all key elements of the banking system, non-bank financial institutions, markets (including cash and derivatives) and transaction channels.
A decade on, there seems to be widespread faith that the structural catalysts for the 2008 crash have been addressed. New regulation to reduce banks’ leverage and rules on the levels of liquid funding means that an operating model akin to that of Northern Rock could simply not exist today.
Though the global economy is in one of its longest expansions and stock indexes have hit new highs, recovery remains uneven. The global debt of governments, nonfinancial corporations and households has grown by $72 trillion since the end of 2007. Developed countries have borrowed heavily with China alone, accounting for more than one-third of global debt growth since 2007. Indeed, its debt to GDP ratio has soared from 145 percent of GDP in 2007 to over 300 percent this year. A strained property sector, untenable local government finances and a “shadow banking” system could eventually lead to combustion in China but the chances of global contagion remain low due to its under liberalised capital account.
A decade ago, banks were deemed too safe to fail and yet today, due to mergers and continuing growth, many are even bigger. JPMorgan is two-thirds bigger, BNP has expanded by fifteen percent and Bank of America’s balance sheet is fifty percent larger. Regulation and scaled back returns have made banks safer but unavoidably less profitable. The Tier 1 capital ratio has risen from less than four percent on average for European and US banks in 2007 to more than fifteen percent in 2017.
With better-capitalised banks and curtailed international activity reducing exposure to another global financial crisis, many of the regulatory changes have been positive. Thanks to lengthy central bank intervention, the results are apparent as equity market volatility this year has hit its lowest in a generation and interbank lending channels have regenerated. Furthermore, MSCI’s main world equity index has recovered to hit new record highs this year, though it is still only twenty-two percent above the levels ten years ago. Lastly, yields on ten-year government debt benchmarks have more than halved due to active bond stockpiling by central banks.
Many risks remain unclear and unknown. The attractiveness of passive exchange-traded products may create volatility and make capital markets less efficient. the implications of cryptocurrencies for monetary policy and financial stability remain undetermined. Another source of risk to watch is the growing non-financial corporate debt, which has grown globally by $39 trillion while credit quality in corporate bond markets continues to decline. Investors are constantly seeking ‘yield’ where they can find it, creating asset bubbles as the value of a range of investments increase.
Asset prices will deflate one way or another. Nevertheless, whilst bursting bubbles of debt may cause localised pain for investors and lenders, it seems improbable that any will produce the systemic collapse that occurred in 2008. What we know for certain is that the next crisis will not look like the last. Our biggest lesson? To avoid complacency while everything remains good.
Author: Michael Moss, Business Development Director, LGT Vestra LLP. To find out more contact your financial adviser
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