Saturday, November 29, 2014

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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    1. CommentedBrent Beach

      I would be interested in further links or amplification of this paragraph. What unbalanced policy mix? Which countries are becoming unstable?

      Otherwise thanks for the article.

    2. CommentedMukesh Adenwala

      I wonder if two more problems can be brought to table for deliberation and debate. First, the present policy stance is oriented towards de-risking public institutions. For example, defined benefits for the employees (by the businesses) or the citizens (by the governments) are fast evaporating. Banks pass on various risks to the customers, who do not have any bargaining power against a banking system. Same is the story in insurance, power and other sectors. One of the outcomes of such a shift in focus is that life of individuals have become more risk prone. As Elizabeth Warren found out, a single adverse medical event was significantly responsible for causing bankruptcy in middle class America; families are becoming highly sensitive to slightest volatility in the their incomes and do not have any savings or safety nets to fall back upon. The distress caused by the policies to the individuals remains to be integrated in policy deliberations and debates.

      Second, there have been social outcomes of the present model of growth through economic liberalism, which are damaging to the individuals and the society, and which in their present trajectory may soon become unsustainable. One such outcome is higher divorce rate and single parent homes - 90% of whom are single mothers. There is ample evidence in psychological research that for healthy development of the child, she needs cordially conjoined parents. The present economic policies demand harder work for longer hours from both the parents, which translates into lesser availability of time for the child, which though is known to be vital for healthy development of the child, is becoming less and less available for more and more children across the world. Under the present economic policy regime, the needs of the child has become a casualty. There are several other such social outcomes that needs to be recognized and discussed.
      Sure, all these are unintended effects of the economic policy structure, but the evidence for such effects are overwhelming. We may disregard these and similar outcomes at our peril.

    3. CommentedProcyon Mukherjee

      When I started my career, I do not recall discussing the name of the Governor of Reserve Bank, if at all the recall would be in remembering the name from the signature in a 100 Rupee note; the politicians were running the economy and the Finance Minister remotely came close to representing the Financial world including the regulatory domain. Then the balance of payment crisis struck and the liberalization happened, but even then the role of the Central bank was in the background. In recent times it has become quite different, the Central banker becomes the crucial guardian of the finances of the country.

      What has changed in India happened many years back in the Western World and central banks were the critical engines of growth, who came with their policy instruments to unlock credit flows or to stymie them. These processes have now moved from the conventional to the unconventional, while the role of the government has come down so dramatically.

      Perhaps the times would again change, as in this shared responsibility, there is no binding that monetary policy would be the do-all and end-all for the economic engine to gain traction for all times; may be the time has already arrived.

    4. CommentedZsolt Hermann

      The truth is the Lehman Brothers Bank and all contributing to its collapse in 2008 should have received the Nobel Peace Prize.
      When someone is sick with a serious disease one of the greatest news, and the basis of the healing is finding the right diagnosis.
      When the bank collapsed, pulling the world economy with it we had the right diagnosis, that this way of life, this socio-economic system is unsustainable.
      We had a fantastic chance to start some honest, and thorough self-examination and adjust, start building a new system for a better future.
      Instead we launched a series of cosmetic, superficial "solutions", blowing bubbles on top of bubbles all over the place.
      Thus we are sitting in no man's land now, dejectedly waiting for the next collapse that is going to be much harder and much more devastating as even the previously still growing "BRICS" have slowed and started to fall since, so there is nobody whose remaining momentum could carry the collapsing structure forward.
      Sometimes the "bad guys" are really "good guys" as long as we use their acts properly.
      Unfortunately we have mistaken our life with a Hollywood movie, here we have to write and act out the happy ending, provided we understand the movie we are in.

    5. CommentedPaul A. Myers

      A major driver of private sector productivity, and thus private sector wages, is public sector logistics productivity: the ability to move goods and services around the economy, including information of broadband.

      For the first time in US history, a challenging economic situation was not been responded to with robust investment in transportation infrastructure. The modern Democratic party cares nothing about middle-of-the road private sector workers. Nothing. These people are props used for public hallelujah town hall meetings to kvetch about "the middle class."

      The entire experience of the complete Obama economic team is limited to having worked in big bank buildings in New York. Wealth is not something that comes from work, but is simply blips moving across a video screen to these people. Give me my bonus!

      And why are we worrying about future generations. We're teaching the young ones the lessons of life with our internship programs. Wage and house laws? Down with excess regulation.

    6. Commentedlee kus

      Aggregate demand will pick up in a couple of centuries while we wait for Chinese and Indian laborers to be able to buy our goods.