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Lehman’s Morbid Legacy

NEWPORT BEACH – As the fifth anniversary of the disorderly collapse of the investment bank Lehman Brothers approaches, some analysts will revisit the causes of an historic global “sudden stop” that resulted in enormous economic and financial disruptions. Others will describe the consequences of an event that continues to produce considerable human suffering. And some will share personal experiences of a terrifying time for the global economy and for them personally (as policymakers, financial-market participants, and in their everyday lives).

As interesting as these contributions will be, I hope that we will also see another genre: analyses of the previously unthinkable outcomes that have become reality – with profound implications for current and future generations – and that our systems of governance have yet to address properly. With this in mind, let me offer four.

The first such outcome, and by far the most consequential, is the continuing difficulty that Western economies face in generating robust economic growth and sufficient job creation. Notwithstanding the initial sharp drop in GDP in the last quarter of 2008 and the first quarter of 2009, too many Western economies have yet to rebound properly, let alone sustain growth rates that would make up fully for lost jobs and income. More generally, only a few have decisively overcome the trifecta of maladies that the crisis exposed: inadequate and unbalanced aggregate demand, insufficient structural resilience and agility, and persistent debt overhangs.

The net result goes beyond the weak growth, worsening income inequality, high long-term unemployment, and alarming youth joblessness of the here and now. Five years after the global financial crisis, too many countries are being held back by exhausted and out-dated growth engines. As a result, prospects for a rapid, durable, and inclusive economic recovery remain a serious concern.

Given this harsh reality, it is not surprising that the second previously unthinkable outcome concerns inadequate policy responses – namely, the large and persistent imbalance between the hyperactivity of central banks and the frustrating passivity of other policymakers.

The big surprise here is not that central banks acted decisively and boldly when financial markets froze and economic activity plummeted. Given their relatively unrestricted access to the printing press and their high degree of operational autonomy, one would expect central banks to be active and effective first responders. And they responded in an impressive and globally coordinated fashion.

What is surprising is that, five years after the crisis, and four years after disrupted financial markets resumed their normal functioning, Western economies still overwhelmingly rely on central banks to avoid even worse economic performance. This has pushed central banks away from their core competencies as they have been forced to use partial and imperfect policy tools for quite a long time.

This outcome reflects domestic political polarization in the United States and the complexity of regional interactions in Europe, which have blocked comprehensive and balanced policy approaches. To appreciate the extent of the problem, consider the repeated failure of the US Congress to pass an annual budget (let alone deliver medium-term reforms) or incomplete eurozone-wide initiatives at a time of alarming unemployment and residual threats of financial disruptions.

Such political dysfunction has undermined the responsiveness of other policymaking entities, including those that possess better tools than central banks. This has compelled central bankers to remain in the policy forefront, building one bridge extension after another as they wait for other policymakers to get their act together. The result has been to expose Western economies to ever-more experimental measures, with considerable uncertainty about the longer-term impact of operating sophisticated market-based systems on the basis of artificial constructs.

The third previously unthinkable outcome relates to how developing countries have fared. Having initially suffered from the financial crisis as much as Western countries did (indeed, more in terms of output and trade), these historically less-robust economies staged a remarkable comeback – so much so that they became the engine of global growth. In the process, however, they slipped into an unbalanced policy mix that now threatens their continued growth and financial stability.

Renewed risks of financial instability point to the fourth and final surprise: the failure to recast major contributors to the crisis in a credible, sustainable, and socially responsible manner.

Consider large Western banks. Given their systemic importance, many were bailed out and, with continued official support, returned to profitability quite quickly. Yet they were not subject to windfall profit taxation, nor have policymakers sufficiently altered structural incentives that encourage excessive risk-taking. In the case of Europe, only now are banks being pushed to deal decisively with their capital shortfalls, leverage problems, and residual weak assets.

Call me a worrywart, but I remain concerned by the extent to which our systems of economic governance have lagged in addressing these four outcomes. The longer this unusual environment persists, the greater the risk that the disruptive ramifications of the 2008 crisis will continue to reach far and wide, including to future generations.

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