BY EDWARD HADAS

The bankruptcy of Lehman Brothers 10 years ago justified one standard recommendation for economic policy: If a big financial institution collapses in a heap, be sure to keep money flowing through the economy.

It might have been more sensible simply to avoid letting a very big financial institution fail over that September weekend. Lehman could have been fully or partly nationalised, as so many other financial firms were over the preceding and following few months.

At least the response to the Wall Street bank’s demise was good. Following the near-unanimous advice of economists, governments injected equity into banks and free cash into the financial system. The drastic action almost certainly kept the Great Recession from turning into another Great Depression.

So that is one thing economists understand. But there are still many areas of ignorance. Indeed, all the big disputed questions about macroeconomics from 2008 remain unanswered.

Start with the cause of the recession. It is clear that Lehman was wrecked by a popped bubble in the U.S. real-estate market. What is unclear are the causes of this bubble, and why its popping had such global consequences.

One theory, vigorously propounded by Breakingviews contributor Edward Chancellor, is that the original sin was central banks’ low interest rates. Other experts, though, have different views, lots of them.

The list of possible problem areas starts with undercapitalised or underregulated banks, reckless or greedy bankers and the unrestrained, opaque use of derivatives. It goes on to excessive national leverage levels and uninhibited cross-border and inter-institutional flows of capital. Fans of markets blame uneconomic demands from governments while fans of governments cite unrealistic expectations for financial market stability.

There is nothing like a consensus. As a result, there is no agreement on how crisis-prone the global economy is right now. Only one thing is certain. Whatever happens, there will be tribes of economists saying, “I told you so”.

In the early post-crisis days, one idea did seem to be generally accepted, that new-fangled finance had been a big contributor to the problem. It was true that hedge funds had not lived down to the dire expectations of their many critics. However, almost everything to do with probability distributions, risk tranches and derivative instruments was highly suspect.

If there ever was such a consensus, it did not last. While the wild days of CDOs squared and triple-A tranches of toxic subprime paper have not returned, derivative markets in general are still thriving. Total daily turnover in the latest triennial survey from the Bank for International Settlements, in 2016, was 52 percent higher than in 2007. Regulators seem relaxed about the growth. They are confident that the new central clearing facilities, mandated after the crash, has removed much of the risk.

Speaking of relaxed, in early 2008 few economists were actually worrying much about bubbles and leverage. Many more were concerned with the risk of rising inflation after the price of oil had increased almost tenfold in a decade. The gloomiest prognosticators argued that the cuts in policy interest rates which had started in 2007 to counter initial financial market stresses would lead to a reprise of the stagflation of the 1970s.

As it turned out, the 2008 peak annual inflation rate in the United States was 5 percent. That was in September, the same month that Lehman collapsed. It is impossible to know whether prices would have continued to accelerate if a recession had been avoided, because economists have no better understanding of how prices and wages work now than they did a decade ago.

Indeed, the lack of inflationary pressure in most Western countries is an embarrassment to the economics profession. The leading theories hold that labour shortages and money availability push up prices and wages; so it follows that there should now be much more inflationary pressure than can be found in any developed economy.

Another big deal for many economists back in 2008 was the size of the U.S. current-account deficit. It was declining from the 2006 peak level of 5.8 percent of GDP, but was still expected to be close to 5 percent that year. There was much talk of global imbalances and the dangers of a Chinese savings glut.

As it turned out, the U.S. deficit sank almost unnoticed during the recession and the early years of recovery, falling to 2.1 percent of GDP in 2013. The gap has risen since, but not by much. The International Monetary Fund expects the deficit to hit 3 percent of GDP this year. As to what, if anything, trade deficits mean for the economy or the financial system – well, President Donald Trump is confident that he knows, but most economists are baffled.

In contrast, many economists think they do know why the recovery after the crisis has been unusually slow. Unfortunately, they disagree. Too little fiscal stimulus, too cautious monetary policy, not enough bank restructuring, underlying institutional or demographic weaknesses, consumer fears, sociological factors – the list of proposed explanations is too long to inspire much confidence in any one of them.

In sum, few of the economic fogs of 2008 have lifted. From an academic perspective, such ignorance may provide a welcome opportunity to learn more. For the rest of the world, however, it is a cause for concern.

First published Sept. 19, 2018

(Image: REUTERS/Shannon Stapleton)

BY ANTONY CURRIE, GEORGE HAY

Last decade’s financial crisis mostly put the “D” in dealmaking. Cratering markets created plenty of opportunities for less-afflicted banks to try to snap up, or take a stake in, rivals on the cheap. Many of those investments and takeovers, though, brought as much pain as progress to the instigators. Breakingviews looks back at those few that turned out to be the best – as well as some of the worst.

What so often turned deals into duds was the hope that a relatively stable lender could buy a troubled peer and turn it around. Buyers essentially bet they were facing a more or less conventional recession, rather than an epochal U.S. housing collapse that spawned a global financial crisis. In Europe, Lloyds TSB’s acquisition of HBOS in September 2008 and Commerzbank’s digestion of Dresdner Bank a few weeks earlier fall into this camp.

The Lloyds deal initially looked like a winner. The UK bank paid below book value to bump its domestic mortgage market share way above 20 percent, while the merger seemed to allow HBOS to put a recent failed rights issue and rapidly disappearing wholesale funding behind it. But a month later the combined group still wound up requiring a bailout from the government, which took a 43 percent stake. And in early 2009 HBOS announced a 10 billion pound pre-tax loss, miles above expectations. Lloyds only escaped Whitehall’s embrace in 2017.

Commerz, meanwhile, paid Allianz roughly the face value of Dresdner’s assets to become Germany’s leading retail bank. Within months Berlin had injected over 18 billion euros to prop it up. The German government still owns some 15 percent – and the bank trades at just 40 percent of book value.

Bank of America can lay claim to the worst example across the pond. In January 2008 it paid $4 billion for Countrywide, one of the largest U.S. mortgage lenders. It paid only a third of book value, so had what seemed like a decent buffer against losses. These and legal fines, though, ultimately cost BofA some $40 billion.

The wrath of regulators upended other deals, too. JPMorgan picked up Bear Stearns and Washington Mutual for around $2 billion apiece, each with assistance from the government. Bear boosted JPMorgan’s trading and prime brokerage units – and came with a new building at the time worth perhaps $1.4 billion. WaMu got the retail bank into lucrative markets in California and Florida. But the two acquired firms accounted for the majority of the $44 billion in crisis-related fines later levied on JPMorgan.

A couple of institutions stand out from the pack. Santander, then under wily Chairman Emilio Botin, struck two deals in the UK that were the essence of canny opportunism. It picked up Alliance & Leicester in July 2008 for 1.3 billion pounds. And two months later it spent 600 million pounds for Bradford & Bingley’s better assets, offloading problem loans onto UK taxpayers. At a stroke, Botin took the bank’s UK market share from 6 percent to 10 percent. The profit from its UK outpost proved more than handy when the euro zone crisis came knocking a couple of years later.

The Breakingviews pick for deal of the crisis, though, involves Morgan Stanley. It’s not the obvious one – its gradual acquisition of Smith Barney from Citi, for a total of $9.3 billion, starting in 2009. That has worked out well enough: Wealth management’s pre-tax profit over the past 12 months was almost two-thirds higher than what the two companies’ divisions managed in 2008.

But it’s Mitsubishi UFJ’s investment in the Wall Street bank that gets the accolade. It got off to an inauspicious start: The Japanese lender announced it had agreed to buy $9 billion of preferred and convertible stock on Sept. 29, 2008 – the day the U.S. Congress voted against a bank bailout, condemning the Dow Jones Industrial Average to a record one-day drop of 777 points.

The investment, though, has paid off handsomely in three ways for MUFG, which converted most of its holdings into a roughly 20 percent ownership stake. First, by ensuring Morgan Stanley’s survival in a drastically consolidated investment banking sector, the Japanese firm was able to roughly triple its money, including dividends, over the past decade, Breakingviews calculates. Second, MUFG now reaps almost a fifth of its earnings from the business arrangements the two struck – a joint-venture investment bank in Japan, access to MUFG’s balance sheet for Morgan Stanley, and access to Morgan Stanley’s global network for MUFG.

Third, the successful business partnership allowed MUFG to avoid having to spend billions of dollars trying to compete with bulge-bracket investment banks from scratch. Corporate Japan’s history of bad overseas deals – Nomura’s crisis-era acquisition of some Lehman assets, for example, makes MUFG’s success all the more notable.

First published Sept. 18, 2018

(Image: REUTERS/Gary Hershorn)

BY RICHARD BEALES

Anyone who has held shares in American International Group since the end of 2007 is still nursing a 95 percent stock-price loss. That’s even worse than fellow crisis basket case Citigroup. The insurer is, arguably, finally emerging from a lost decade after receiving a controversial $182 billion U.S. government bailout in 2008. But investors remain wary.

The disaster 10 years ago centered on AIG’s financial-products unit, which had sold huge amounts of supposedly not-very-risky credit protection on subprime-mortgage products. The consequences included a $62 billion loss in a single quarter, the final period of 2008.

Employees were vilified, and some critics labeled the bailout a conspiracy to help banks, because it enabled AIG to pay billions to trading counterparties including Goldman Sachs and European institutions like Société Générale and Deutsche Bank.

AIG offloaded assets including its historic Asian life-insurance arm AIA, which has more than tripled in value since it was floated in Hong Kong in 2010. Repaying the government in full in December 2012 was a signal achievement of the then chief executive, the late Bob Benmosche.

Revenue shrank steadily under Benmosche, Peter Hancock and, since May last year, Brian Duperreault, as successive CEOs fought to bring both continuing businesses and problematic legacy lines under control.

Duperreault is an industry guru and veteran of AIG, insurer ACE, Marsh & McLennan and Bermuda-based Hamilton Insurance. Ask around his head office in New York, and people say he is a leader who can make the company hum again and who’s assembling a stellar team.

The removal of AIG’s “systemically important” designation by regulators last year was a landmark, too. It even looks like a different company: without AIA, with a focus on stronger underwriting practices, and with ambitions to grow again. The company in July closed its biggest acquisition since the crisis – the $5.5 billion purchase of Validus, a Bermuda reinsurer with a Lloyd’s syndicate and catastrophe-bond asset manager.

Yet AIG still isn’t back to profitable growth, and the roughly $50 billion group’s shares are priced at a nearly 25 percent discount to book value, far lower than most peers. Investors don’t yet accept that the company’s dismal recent past is behind it. Maybe that’s something AIG can achieve in 2019, its centennial year.

First published Sept. 13, 2018

(Image: REUTERS/Robert Galbraith )

BY ANTONY CURRIE

Lehman Brothers should not have failed. No, that’s not a criticism of the U.S. government’s refusal to bail out the firm, thus condemning it to file for bankruptcy on Sept. 15 a decade ago. Instead, it’s a recognition of how Chief Executive Dick Fuld and his lieutenants had built a well-run investment bank – until they succumbed to hubris.

Under Fuld, Lehman navigated several crises. The Mexican peso collapse, the Asian and Russian meltdowns and the dot-com bust all hit within six years of the Wall Street firm getting spun out of American Express. Minutes after the first plane hit the World Trade Center in September 2001, executives had a team crossing the Hudson river to Lehman’s backup office. Fuld liked to tell how watching a gambler in a casino lose everything after doubling down taught him the value of caution.

He forgot it during the real-estate bubble – an asset where Lehman was a leader. That, though, bred overconfidence that seeped into other assets from commercial property to leveraged buyouts. In late 2006, Fuld and the gang approved raising the company’s risk limit by almost half – just as Goldman Sachs started cutting exposures. Within months Lehman had shot through that as Fuld, President Joe Gregory and investment-banking boss Skip McGee routinely waived limits on individual deals, as Anton Valukas detailed in his report on Lehman’s collapse for the bankruptcy court.

Those who spoke out against such moves, like risk chief Madelyn Antoncic and trading head Mike Gelband, were sidelined or removed. The top dogs’ response to the worsening crisis was so slow that plans to offload debt and bridge-equity stakes in problem deals like Archstone Property were in the “18th inning” in late 2007, in the words of former finance chief Erin Callan.

Rather than address the concerns she raised, Fuld and Gregory would caution her about her “provocative” clothing and “interrogatory style.” They were similarly tin-eared when confronted by the arguments of short-sellers. All the while, executives were using an accounting trick, Repo 105, to make Lehman’s balance sheet look healthier than it was in its final few quarters. Regulators acquiesced as Lehman raised risk limits.

So was it the government’s fault too? Fuld, for one, argues that it was, also blaming regulators and even homeowners. That question now has little relevance – the rules governing banks have changed dramatically since 2008. But Lehman wouldn’t have failed without hubris – and for that there’s still no cure.

First published Sept. 12, 2018

(Image: REUTERS/Joshua Lott)

BY GINA CHON

The firefighters of the last financial crisis are pointing out smoldering dangers that could exacerbate the next one. Ten years after Lehman Brothers failed, former U.S. officials Ben Bernanke, Tim Geithner and Hank Paulson agree that it is near impossible to predict the triggers for the next economic calamity. That makes defenses, such as a robust economy and strong institutions, all the more important.

At a Brookings Institution event on Wednesday, the trio recalled things they could have done better. Future policymakers will make mistakes of their own but can at least ensure the economy is resilient when the shock hits.

That is why Paulson, a former Treasury secretary, worries about the rising U.S. budget deficit, which he called a debt bomb. The shortfall is estimated to hit $1.1 trillion in 2019, which equates to about 5 percent of GDP. And as Bernanke, who used to be the chairman of the Federal Reserve, pointed out, the share of GDP that is spent on debt interest-rate payments will end up rising. That spells difficult budget choices in the future.

Republican tax cuts passed last year also aggravate income inequality. After-tax incomes will increase most for the top 0.1 percent, according to a March study by the University of Pennsylvania’s Wharton School. Yet the share of total household income for the top 5 percent of earners in 2017 is only slightly smaller than the lowest three quintile income brackets combined, according to a survey released on Wednesday by the U.S. Census Bureau.

Geithner and Bernanke also noted the importance of civil servants who execute policy. The success of the unique credit facilities and backstops created by the Fed and Treasury during the crisis was a function of the creativity and expertise of the government employees implementing the programs.

Under the administration of President Donald Trump, thousands of bureaucrats have left government because of budget cuts and low morale. About 15,000 are estimated to have been culled from federal payrolls between fiscal years 2016 and 2018, according to the Congressional Research Service. Last month, Trump also canceled a 2.1 percent pay raise for federal workers.

The former officials have helped put together a handbook of lessons learned from 2008. But it’s up to current and future policymakers to ensure that inequality and a hollowed-out civil service don’t hamper the next generation of crisis firefighters.

First published Sept. 12, 2018

(Image: REUTERS/Joshua Roberts)