tag:theconversation.com,2011:/africa/topics/lehman-brothers-3378/articlesLehman Brothers – The Conversation2024-03-04T01:44:38Ztag:theconversation.com,2011:article/2242712024-03-04T01:44:38Z2024-03-04T01:44:38ZCan you make a compelling play about economics? The Lehman Trilogy tries – but ultimately comes up short<figure><img src="https://images.theconversation.com/files/579454/original/file-20240304-48028-f7rssq.jpg?ixlib=rb-1.1.0&rect=16%2C8%2C5475%2C3630&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Daniel Boud</span></span></figcaption></figure><p>“Can’t move ‘em with a cold thing, like economics.” </p>
<p>So says the modernist, Ezra Pound, in the first section of his epic poem, <a href="https://en.wikipedia.org/wiki/The_Cantos">The Cantos</a>. </p>
<p>This is something I kept coming back to while watching Stefano Massini’s five-time Tony Award-winning play, The Lehman Trilogy.</p>
<p>Opening in 1844 and and closing in 2008, The Lehman Trilogy is self-consciously ambitious and epic in scope, concerning the spectacular rise and fall of one of America’s biggest financial institutions: <a href="https://en.wikipedia.org/wiki/Lehman_Brothers">Lehman Brothers</a>. </p>
<p>It strives to explain the historical development of American capitalism in a single evening. While admirable, this cannot disguise the fact that the play is also wildly uneven, and chooses, problematically, to omit important – and commonly known – information regarding the Lehman family: their support for the Confederacy, their direct involvement in the <a href="https://www.nybooks.com/online/2019/06/11/the-lehman-trilogy-and-wall-streets-debt-to-slavery/">slave</a> <a href="https://www.washingtonpost.com/opinions/the-hole-at-the-heart-of-the-lehman-trilogy/2019/04/08/51f6ed8c-5a3e-11e9-842d-7d3ed7eb3957_story.html">trade</a>, and the reasons behind the Global Financial Crisis, which ultimately led to the collapse of the financial institution they founded in 1850. </p>
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Read more:
<a href="https://theconversation.com/anniversary-of-lehmans-collapse-reminds-us-booms-are-often-followed-by-busts-102758">Anniversary of Lehman's collapse reminds us – booms are often followed by busts</a>
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<h2>An international phenomenon</h2>
<p>A <a href="https://www.ft.com/content/ecab7159-2f37-41c1-a419-3d4969c38dfa">cultural phenomenon</a> in his native Italy, Massini is one of the 21st century’s most celebrated dramatists. </p>
<p>Born in Florence in 1975, Massini started his career as an assistant director to <a href="https://en.wikipedia.org/wiki/Luca_Ronconi">Luca Ronconi</a>, who encouraged him to try his hand at playwrighting. He has since gone on to produce works inspired by writers and artists such as Shelley, Kafka and Van Gogh.</p>
<p>The Lehman Trilogy, Massini’s most famous work, has a curious compositional history. It started out as a nine-hour radio play in 2012, before being reworked as a five-hour, three-act piece of <a href="https://www.theguardian.com/stage/theatreblog/2008/nov/11/postdramatic-theatre-lehmann">post-dramatic theatre</a> written entirely in free verse. </p>
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<a href="https://images.theconversation.com/files/579456/original/file-20240304-22-8ioo4x.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="A man on stage" src="https://images.theconversation.com/files/579456/original/file-20240304-22-8ioo4x.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/579456/original/file-20240304-22-8ioo4x.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/579456/original/file-20240304-22-8ioo4x.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/579456/original/file-20240304-22-8ioo4x.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/579456/original/file-20240304-22-8ioo4x.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/579456/original/file-20240304-22-8ioo4x.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/579456/original/file-20240304-22-8ioo4x.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">The Lehman Trilogy has been through many iterations before this version made it to Australia.</span>
<span class="attribution"><span class="source">Daniel Boud</span></span>
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<p>The Lehman Trilogy debuted in Paris in 2013, was adapted by Massini into a <a href="https://www.goodreads.com/en/book/show/52584856">700-page novel</a> that year, and was staged in <a href="https://www.theguardian.com/stage/2015/feb/28/ronconi-lehman-trilogy-play-theatre">Italy</a> for the first time in 2015. This production featured 20 actors and was directed by Ronconi, <a href="https://www.theguardian.com/stage/2015/feb/28/ronconi-lehman-trilogy-play-theatre">who died</a> while the play was still being performed.</p>
<p>Oscar-winning director Sam Mendes and Ben Power, associate director of the National Theatre, developed a comparably lyrical English-language adaptation in 2018, and now this version of the play is being staged in Australia.</p>
<h2>A tighter retelling</h2>
<p>Directed by Mendes and featuring a live soundtrack performed by pianist Cat Beveridge, this creation departs from Massini’s original in a number of important ways. </p>
<p>Firstly, by comparison the show is significantly shorter, clocking in at relatively trim three-and-half hours. Secondly, it has a cast of only three. </p>
<p>Aaron Krohn, Howard W. Overshown and Adrian Schiller play a remarkable number of male and female characters, including the three German Jewish immigrants who, in 1850, established the family business that subsequently became Lehman Brothers.</p>
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<a href="https://images.theconversation.com/files/579457/original/file-20240304-16-cyqhrj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Production image" src="https://images.theconversation.com/files/579457/original/file-20240304-16-cyqhrj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/579457/original/file-20240304-16-cyqhrj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/579457/original/file-20240304-16-cyqhrj.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/579457/original/file-20240304-16-cyqhrj.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/579457/original/file-20240304-16-cyqhrj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/579457/original/file-20240304-16-cyqhrj.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/579457/original/file-20240304-16-cyqhrj.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">The performances they deliver are uniformly excellent and engaging.</span>
<span class="attribution"><span class="source">Daniel Boud</span></span>
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<p>The performances they deliver are uniformly excellent and engaging. They never change costumes but transition seemlessly from character to character, delivering incredibly complex and detailed lines.</p>
<p>Es Devlin’s <a href="https://www.abc.net.au/listen/programs/the-stage-show/es-devlin-lehman-trilogy-dictionary-of-lost-words-pip-williams/103411032">set design</a> is equally memorable. The centre of the stage is taken up by a spinning glass box, in which the actors pace back and forth, stopping occasionally to scrawl and expunge names and numbers on the walls. The rest of the space is dominated by a panoramic digital display, which modulates as we move between different historical periods and geographical locales in the United States.</p>
<p>The first act opens with Henry Lehman setting foot on North American soil for the first time. After a short stint in New York City, Henry makes his way down south. He establishes himself as a goods trader in Montgomery, Alabama. </p>
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<a href="https://images.theconversation.com/files/579458/original/file-20240304-22-4wvyvd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Production image" src="https://images.theconversation.com/files/579458/original/file-20240304-22-4wvyvd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/579458/original/file-20240304-22-4wvyvd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/579458/original/file-20240304-22-4wvyvd.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/579458/original/file-20240304-22-4wvyvd.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/579458/original/file-20240304-22-4wvyvd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/579458/original/file-20240304-22-4wvyvd.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/579458/original/file-20240304-22-4wvyvd.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Es Devlin’s set design is memorable.</span>
<span class="attribution"><span class="source">Daniel Boud</span></span>
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<p>Here he is joined by his two brothers, Mayer and Emanuel. They start dealing in raw commodities: cotton, tobacco, coffee. The brothers amass a fortune. The American Civil War starts and ends. They brothers talk finance and family at great length. The money keeps on rolling in. A lot of ground gets covered in the play’s first act, yet it never feels rushed. </p>
<p>Unfortunately, the same can’t be said of the second and third acts.</p>
<h2>Too much is left unsaid</h2>
<p>Given its thematic focus and sheer duration, the play is, at times, strangely short on detail when it comes to its coverage of major economic events and financial catastrophes. </p>
<p>This becomes increasingly apparent as the piece progresses. </p>
<p>The second act focuses on the <a href="https://en.wikipedia.org/wiki/Wall_Street_Crash_of_1929">Wall Street Crash of 1929</a>. To be sure, there are moments of genuine dramatic intensity on display in this section of the play, as when the actors describe the human damage caused in the immediate wake of the crash. Yet the pain and hardship endured during the decade-long <a href="https://en.wikipedia.org/wiki/Great_Depression">Great Depression</a> that came next is more or less brushed aside.</p>
<p>Something similar happens at the climax of the play, which wraps up without much of an exploration of the underlying <a href="https://en.wikipedia.org/wiki/Subprime_mortgage_crisis">reasons</a> behind the <a href="https://en.wikipedia.org/wiki/2007%E2%80%932008_financial_crisis">Global Financial Crisis</a> of 2008. This elision struck me as especially jarring and unsatisfactory, given it resulted in Lehman Brothers going bankrupt.</p>
<p>While there is much to praise in The Lehman Trilogy, the impression I was left with one of a missed opportunity. Still, judging by the audience’s effusive reaction, it seems clear to me that – contrary to what Ezra Pound might think – people are willing to engage with and can in fact be moved by discussions of pressing economic matters. </p>
<p>Surely this can only be a good thing, as we continue to lurch from one financial crisis to the next. </p>
<p><em>The Lehman Trilogy is at the Theatre Royal Sydney until March 24.</em></p>
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Read more:
<a href="https://theconversation.com/response-to-past-crises-shames-post-lehman-dithering-18205">Response to past crises shames post-Lehman dithering</a>
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<img src="https://counter.theconversation.com/content/224271/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alexander Howard does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>While there is much to praise in The Lehman Trilogy, now playing in Sydney, the impression I was left with was one of a missed opportunity.Alexander Howard, Senior Lecturer, Discipline of English and Writing, University of SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2023242023-03-29T12:29:05Z2023-03-29T12:29:05ZSVB’s newfangled failure fits a century-old pattern of bank runs, with a social media twist<figure><img src="https://images.theconversation.com/files/517784/original/file-20230327-17-juw7wk.jpg?ixlib=rb-1.1.0&rect=49%2C19%2C3196%2C2318&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Thousands of banks failed in the Great Depression.</span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/depositors-congregate-outside-the-state-ordered-closed-news-photo/514877484">Bettmann via Getty Images</a></span></figcaption></figure><p>The <a href="https://theconversation.com/silicon-valley-bank-biggest-us-lender-to-fail-since-2008-financial-crisis-a-finance-expert-explains-the-impact-201626">failure of Silicon Valley Bank</a> on March 10, 2023, came as a shock to most Americans. Even people like myself, <a href="https://scholar.google.com/citations?user=RYY7tWEAAAAJ&hl=en&oi=ao">a scholar of the U.S. banking system</a> who has worked at the Federal Reserve, didn’t expect SVB’s collapse.</p>
<p>Usually banks, like all companies, fail after a prolonged period of lackluster performance. But SVB, the nation’s 16th-largest bank, <a href="https://ir.svb.com/financials/annual-reports-and-proxies/default.aspx">had been stable and highly profitable</a> just a few months before, having earned about US$1.5 billion in profits in the last quarter of 2022. </p>
<p>However, <a href="https://americandeposits.com/brief-history-us-bank-failures/">financial history is filled with examples</a> of seemingly stable and profitable banks that unexpectedly failed. </p>
<p>The demise of <a href="https://www.investopedia.com/articles/economics/09/lehman-brothers-collapse.asp">Lehman Brothers and Bear Stearns</a>, two prominent investment banks, and <a href="https://publicintegrity.org/inequality-poverty-opportunity/no-1-of-the-subprime-25-countrywide-financial-corp/">Countrywide Financial Corp.</a>, a subprime mortgage lender, during the 2008-2009 financial crisis; the <a href="https://www.investopedia.com/terms/s/sl-crisis.asp">Savings and Loan banking crisis</a> in the 1980s; and the complete collapse of the U.S. <a href="https://www.federalreservehistory.org/essays/great-depression">banking system during the Great Depression</a> didn’t unfold in exactly the same way. But they had something in common: An unexpected change in economic conditions created an initial bank failure or two, followed by general panic and then large-scale economic distress.</p>
<p>The main difference this time, in my view, is that modern innovations may have hastened SVB’s demise.</p>
<h2>Great Depression</h2>
<p>The Great Depression, which <a href="https://www.investopedia.com/terms/g/great_depression.asp">lasted from 1929 to 1941</a>, epitomized the public harm that bank runs and financial panic can cause.</p>
<p>Following a rapid expansion of the “<a href="https://www.history.com/topics/roaring-twenties">Roaring Twenties</a>,” the U.S. economy began to slow in early 1929. The <a href="https://www.investopedia.com/terms/g/great_depression.asp">stock market crashed on Oct. 24, 1929</a> – a date known as “Black Tuesday.”</p>
<p>The massive losses investors suffered weakened the economy and led to distress at some banks. Fearing that they would lose all their money, customers began to withdraw their funds from the weaker banks. Those banks, in turn, began to rapidly sell their loans and other assets to pay their depositors. These rapid sales pushed prices down further.</p>
<p>As this financial crisis spread, depositors with accounts at nearby banks also began queuing up to withdraw all their money, <a href="https://doi.org/10.1016/j.jfineco.2015.01.006">in a quintessential bank run</a>, culminating in the failure of thousands of banks by early 1933. Soon after President Franklin D. Roosevelt’s first inauguration, the federal government resorted to <a href="https://www.newyorkfed.org/research/epr/09v15n1/0907silb.html">shutting all banks in the country</a> for a whole week.</p>
<p>These failures meant that banks could no longer lend money, which led to more and more problems. The <a href="https://theconversation.com/how-high-will-unemployment-go-during-the-great-depression-1-in-4-americans-were-out-of-work-135508">unemployment rate spiked to around 25%</a>, and the <a href="https://www.federalreservehistory.org/essays/great-depression">economy shrank until the outbreak of World War II</a>.</p>
<p>Determined to avoid a repeat of this debacle, the government tightened banking regulations with the <a href="https://www.investopedia.com/articles/03/071603.asp">Glass-Steagall Act</a> of 1933. It prohibited commercial banks, which serve consumers and small and medium-size businesses, from engaging in investment banking and <a href="https://www.fdic.gov/about/history">created the Federal Deposit Insurance Corporation</a>, which insured deposits up to a certain threshold. That limit has risen sharply over the past 90 years, from <a href="https://www.bankrate.com/banking/fdic-limits-history/">$2,500 in 1933 to $250,000 in 2010</a> – the same limit in place today.</p>
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<a href="https://images.theconversation.com/files/517797/original/file-20230327-28-tieoq7.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="The Federal Deposit Insurance Corporation's round logo on a shiny stone wall" src="https://images.theconversation.com/files/517797/original/file-20230327-28-tieoq7.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/517797/original/file-20230327-28-tieoq7.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/517797/original/file-20230327-28-tieoq7.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/517797/original/file-20230327-28-tieoq7.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/517797/original/file-20230327-28-tieoq7.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/517797/original/file-20230327-28-tieoq7.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/517797/original/file-20230327-28-tieoq7.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">The government created the FDIC to protect depositors from bank failures.</span>
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<h2>S&L crisis</h2>
<p>The nation’s new and improved banking regulations ushered in a period of relative stability in the banking system that lasted about 50 years.</p>
<p>But in the 1980s, <a href="https://www.federalreservehistory.org/essays/savings-and-loan-crisis">hundreds of the small banks known as savings and loan</a> associations failed. Savings and loans, also called “thrifts,” were generally small local banks that mainly made mortgage loans to households and collected deposits from their local communities. </p>
<p>Beginning in 1979, the Federal Reserve began to hike interest rates very aggressively to fight the <a href="https://fred.stlouisfed.org/series/DFF">high inflation rates that had become entrenched</a>.</p>
<p>By the early 1980s, <a href="https://www.presidency.ucsb.edu/documents/remarks-signing-into-law-the-depository-institutions-deregulation-and-monetary-control-act#axzz1mquUfO88">Congress began allowing banks to pay market interest rates</a> on depositers’ accounts. As a result, the interest rate S&Ls had to pay their customers was much higher than the interest income they were earning on the loans they had made in prior years. That imbalance caused many of them to lose money.</p>
<p>Even though about 1 in 3 S&Ls failed from around 1986 through 1992 – somewhere around 750 banks – most depositors at small S&Ls were protected by the <a href="https://americandeposits.com/history-and-timeline-of-changes-to-fdic-coverage-limits/">FDIC’s then-$100,000 insurance limit</a>. Ultimately, resolving that crisis cost taxpayers the equivalent of about <a href="https://www.investopedia.com/terms/s/sl-crisis.asp">$250 billion in today’s dollars</a>.</p>
<p>Because the savings and loans industry was not directly connected to the big banks of that era, their collapse did not cause runs at the bigger institutions. Nevertheless, the S&L collapse and the <a href="https://fraser.stlouisfed.org/title/financial-institutions-reform-recovery-enforcement-act-1989-firrea-1046">government’s regulatory response</a> did reduce the supply of credit to the economy.</p>
<p>As a result, the U.S. economy underwent a mild <a href="https://www.thebalancemoney.com/the-history-of-recessions-in-the-united-states-3306011">recession in the latter half of 1990 and first quarter of 1991</a>. But the banking system escaped further distress for nearly two decades.</p>
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<a href="https://images.theconversation.com/files/517790/original/file-20230327-14-hky2rp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Black and white photo of people lined up outside a bank." src="https://images.theconversation.com/files/517790/original/file-20230327-14-hky2rp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/517790/original/file-20230327-14-hky2rp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=459&fit=crop&dpr=1 600w, https://images.theconversation.com/files/517790/original/file-20230327-14-hky2rp.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=459&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/517790/original/file-20230327-14-hky2rp.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=459&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/517790/original/file-20230327-14-hky2rp.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=577&fit=crop&dpr=1 754w, https://images.theconversation.com/files/517790/original/file-20230327-14-hky2rp.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=577&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/517790/original/file-20230327-14-hky2rp.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=577&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">High inflation spurred failures of many small savings-and-loan banks in the 1980s.</span>
<span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/depositors-lined-up-for-the-fourth-day-to-withdraw-money-news-photo/515242014">Bettmann via Getty Images</a></span>
</figcaption>
</figure>
<h2>Great Recession</h2>
<p>Against this backdrop of relative stability, Congress <a href="https://www.investopedia.com/terms/g/glba.asp">repealed most of Glass-Steagall in 1999</a> – eliminating Depression-era regulations that restricted the scope of businesses that banks could engage in.</p>
<p>Those changes contributed to what happened when, at the start of a recession that began in December 2007, the <a href="https://fred.stlouisfed.org/series/USRECD">entire financial sector suffered a panic</a>.</p>
<p>At that time, large banks, freed from the Depression-era restrictions on securities trading, as well as investment banks, hedge funds and other institutions outside the traditional banking system, had <a href="https://www.investopedia.com/terms/m/mbs.asp">heavily invested in mortgage-backed securities</a>, a kind of bond backed by pooled mortgage payments from lots of homeowners. These bonds were highly profitable amid the housing boom of that era, and they helped many <a href="https://fred.stlouisfed.org/series/BOGZ1FA796060035Q">financial institutions reap record profits</a>.</p>
<p>But the Federal Reserve had been <a href="https://fred.stlouisfed.org/series/DFF">increasing interest rates since 2004</a> to slow the economy. By 2007, many households with <a href="https://files.consumerfinance.gov/f/201204_CFPB_ARMs-brochure.pdf">adjustable-rate mortgages</a> could no longer afford to make their larger-than-expected home loan payments. That led investors to fear a rash of mortgage defaults, and the values of securities backed by mortgages plunged.</p>
<p>It wasn’t possible to know which investment banks owned a lot of these vulnerable securities. Rather than wait to find out and risk not getting paid, most of the depositors rushed to get their money out by late 2007. This stampede led to cascading failures in 2008 and 2009, and the federal government <a href="https://www.russellsage.org/publications/rethinking-financial-crisis">responded with a series of big bailouts</a>.</p>
<p>The government even <a href="https://www.politico.com/story/2018/12/19/bush-bails-out-us-automakers-dec-19-2008-1066932">bailed out General Motors and Chrysler</a>, two of the country’s three largest automakers, in December 2008 to <a href="https://doi.org/10.1093/qje/qjw031">keep the industry from going bankrupt</a>. That happened because the major car companies relied on the financial system to provide potential car buyers with credit to purchase or lease new cars. But when the financial system collapsed, buyers could no longer obtain credit to finance or lease new vehicles.</p>
<p>The <a href="https://www.federalreservehistory.org/essays/great-recession-of-200709">Great Recession lasted until June 2009</a>. Stock prices <a href="https://www.thebalancemoney.com/stock-market-crash-of-2008-3305535">plummeted by more than 50%</a>, and <a href="https://www.bls.gov/opub/mlr/2018/article/great-recession-great-recovery.htm">unemployment peaked at around 10%</a> – the highest rate since the early 1980s.</p>
<p>As with the Great Depression, the government responded to this financial crisis with significant new regulations, including a new law known as the <a href="https://www.cftc.gov/LawRegulation/DoddFrankAct/index.htm">Dodd-Frank Act of 2010</a>. It imposed stringent new requirements on banks with assets above $50 billion.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/517792/original/file-20230327-19-xsl2ub.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="A group of despondent men look aghast." src="https://images.theconversation.com/files/517792/original/file-20230327-19-xsl2ub.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/517792/original/file-20230327-19-xsl2ub.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=407&fit=crop&dpr=1 600w, https://images.theconversation.com/files/517792/original/file-20230327-19-xsl2ub.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=407&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/517792/original/file-20230327-19-xsl2ub.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=407&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/517792/original/file-20230327-19-xsl2ub.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=512&fit=crop&dpr=1 754w, https://images.theconversation.com/files/517792/original/file-20230327-19-xsl2ub.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=512&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/517792/original/file-20230327-19-xsl2ub.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=512&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Traders in Chicago watch stock index futures plunge on March 17, 2008.</span>
<span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/traders-watch-prices-in-the-s-p-500-stock-index-futures-pit-news-photo/80276991">Scott Olson/Getty Image</a></span>
</figcaption>
</figure>
<h2>Close-knit customers</h2>
<p>Congress <a href="https://www.cnn.com/2023/03/14/politics/facts-on-trump-2018-banking-deregulation/index.html">rolled back some of Dodd-Frank’s most significant changes</a> only eight years after lawmakers approved the measure. </p>
<p>Notably, the most stringent requirements were now reserved for banks with more than $250 billion in assets, up from $50 billion. That change, which Congress passed in 2018, paved the way for regional banks like SVB to <a href="https://www.govexec.com/oversight/2023/03/regulatory-failure-101-what-collapse-silicon-valley-bank-reveals/384124/">rapidly expand with much less regulatory oversight</a>.</p>
<p>But still, how could SVB collapse so suddenly and without any warning?</p>
<p>Banks take deposits to make loans. But a loan is a long-term contract. Mortgages, for example, can last for 30 years. And deposits can be withdrawn at any time. To reduce their risks, banks can invest in bonds and other securities that they can quickly sell in case they need funds for their customers.</p>
<p>In the case of SVB, the <a href="https://www.reuters.com/business/finance/svb-collapse-unleashes-treasury-volatility-whiplashing-investors-2023-03-14/">bank invested heavily in U.S. Treasury bonds</a>. Those bonds do not have any default risk, as they are debt issued by the federal government. But <a href="https://www.schwab.com/learn/story/what-happens-to-bonds-when-interest-rates-rise">their value declines when interest rates rise</a>, as newer bonds pay higher rates compared with the older bonds.</p>
<p>SVB bought a lot of Treasury bonds it had on hand when interest rates were close to zero, but the <a href="https://fred.stlouisfed.org/series/DFF">Fed has been steadily raising interest rates</a> since March 2022, and the <a href="https://www.cnbc.com/bonds/">yields available for new Treasurys</a> <a href="https://www.usbank.com/investing/financial-perspectives/market-news/interest-rates-affect-bonds.html">sharply increased over the next 12 months</a>. Some depositors became concerned that <a href="https://www.npr.org/2023/03/19/1164531413/bank-fail-how-government-bonds-turned-toxic-for-silicon-valley-bank">SVB might not be able to sell these bonds</a> at a high enough price to repay all its customers.</p>
<p>Unfortunately for SVB, these depositors were very close-knit, with most in the tech sector or startups. They <a href="https://www.washingtonexaminer.com/news/business/svb-collapse-peter-thiel-silicon-valley-">turned to social media</a>, <a href="https://www.marketplace.org/2023/03/17/behind-svbs-collapse-are-a-whole-lot-of-texts-on-messaging-groups/">group text messages</a> and other modern forms of rapid communication to share their fears – which quickly went viral. </p>
<p>Many large depositors all rushed at the same time to get their funds out. Unlike what happened nearly a century earlier during the Great Depression, they generally tried to withdraw their money online – without forming chaotic lines at bank branches.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/517794/original/file-20230327-15-712uah.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="People line up, social distanced, along a wall with the letters s, v and b." src="https://images.theconversation.com/files/517794/original/file-20230327-15-712uah.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/517794/original/file-20230327-15-712uah.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/517794/original/file-20230327-15-712uah.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/517794/original/file-20230327-15-712uah.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/517794/original/file-20230327-15-712uah.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/517794/original/file-20230327-15-712uah.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/517794/original/file-20230327-15-712uah.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Most of the SVB bank failure drama occurred online rather than in person.</span>
<span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/people-wait-for-service-outside-silicon-valley-bank-in-news-photo/1248284116?adppopup=true">John Brecher for The Washington Post via Getty Images</a></span>
</figcaption>
</figure>
<h2>Will more shoes drop?</h2>
<p>The government allowed SVB, which is being <a href="https://www.fdic.gov/news/press-releases/2023/pr23023.html">sold to First Citizens Bank</a>, and <a href="https://www.fdic.gov/bank/historical/bank/bfb2023.html">Signature Bank</a>, a smaller financial institution, to fail. But it agreed to repay all depositors – including those with deposits above the $250,000 limit.</p>
<p>While the authorities have not explicitly guaranteed all deposits in the banking system, I see the bailout of all SVB depositors as a clear signal that the government is prepared to take extraordinary steps to protect deposits in the banking system and prevent an overall panic. </p>
<p>I believe that it is too soon to say whether these measures will work, especially as the Fed is still fighting inflation and raising interest rates. But at this point, major U.S. banks appear safe, though there are growing risks among the smaller regional banks.</p><img src="https://counter.theconversation.com/content/202324/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Rodney Ramcharan does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Crises fueled by bank runs, starting with the Great Depression, have had something in common: Unexpected changes spur bank failures, followed by general panic and then large-scale economic distress.Rodney Ramcharan, Professor of Finance and Business Economics, University of Southern CaliforniaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/2016262023-03-11T00:09:29Z2023-03-11T00:09:29ZSilicon Valley Bank biggest US lender to fail since 2008 financial crisis – a finance expert explains the impact<figure><img src="https://images.theconversation.com/files/514761/original/file-20230310-2469-mth9ci.jpg?ixlib=rb-1.1.0&rect=4%2C14%2C3275%2C2168&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">SVB encountered a perfect storm of high interest rates and fearful clients. </span> <span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/BanksInflation/a1dcd3d738b4472c8205afbc50aa815c/photo?Query=Silicon%20Valley%20bank&mediaType=photo&sortBy=arrivaldatetime:desc&dateRange=Anytime&totalCount=38&currentItemNo=20">AP Photo/Jeff Chiu</a></span></figcaption></figure><p><em>Silicon Valley Bank, which catered to the tech industry for three decades, <a href="https://www.bloomberg.com/news/articles/2023-03-10/silicon-valley-bank-collapses-enters-fdic-receivership?srnd=premium&sref=Hjm5biAW">collapsed on March 10, 2023</a>, after the Santa Clara, California-based lender suffered from an old-fashioned bank run. State regulators seized the bank and <a href="https://www.fdic.gov/news/press-releases/2023/pr23016.html">made the Federal Deposit Insurance Corporation its receiver</a>.</em></p>
<p><em>SVB, as it’s known, was the <a href="https://www.cnbc.com/2023/03/10/silicon-valley-bank-is-shut-down-by-regulators-fdic-to-protect-insured-deposits.html">biggest U.S. lender</a> to fail since the 2008 global financial crisis – and the <a href="https://www.wsj.com/livecoverage/stock-market-news-today-03-10-2023/card/these-are-the-10-biggest-bank-failures-by-assets-pcLTXpSwlRgWLJM0RZXj">second-biggest ever</a>.</em></p>
<p><em>We asked <a href="https://scholar.google.com/citations?user=eP0xZ1kAAAAJ&hl=en&oi=ao">William Chittenden</a>, associate professor of finance at Texas State University, to explain what happened and whether Americans should be worried about the safety of their financial system.</em></p>
<h2>Why did Silicon Valley Bank collapse so suddenly?</h2>
<p>The short answer is that SVB did not have enough cash to pay depositors so the regulators closed the bank. </p>
<p>The longer answer begins during in the pandemic, when SVB and many other banks were <a href="https://www.wsj.com/articles/silicon-valley-bank-crisis-unsettles-bank-investors-bc4ee834?mod=article_inline">raking in more deposits</a> than they could lend out to borrowers. In 2021, <a href="https://www.wsj.com/livecoverage/stock-market-news-today-03-10-2023/card/what-silicon-valley-bank-and-silvergate-have-in-common-rcvKr06ursDTRXA6mPtv">deposits at SVB doubled</a>.</p>
<p>But they had to do something with all that money. So, what they could not lend out, they invested in ultra-safe U.S. Treasury securities. The problem is the <a href="https://theconversation.com/why-the-fed-raised-interest-rates-by-the-smallest-amount-since-it-began-its-epic-inflation-fight-199057">rapid increase in interest rates</a> in 2022 and 2023 caused the value of these securities to plunge. A characteristic of bonds and similar securities is that when yields or interest rates go up, prices go down, and vice versa.</p>
<p>The <a href="https://s201.q4cdn.com/589201576/files/doc_downloads/2023/03/Q1-2023-Mid-Quarter-Update-vFINAL3-030823.pdf">bank recently said</a> it took a US$1.8 billion hit on the sale of some of those securities and they were unable to raise capital to offset the loss as their stock began dropping. That prompted prominent venture capital firms to advise the companies they invest in to <a href="https://www.bloomberg.com/news/articles/2023-03-09/svb-ceo-becker-asks-silicon-valley-bank-clients-to-stay-calm?sref=Hjm5biAW">pull their business from Silicon Valley Bank</a>. This had a snowball effect that led a growing number of SVB depositors to withdraw their money too.</p>
<p>The investment losses, coupled with the withdrawals, were so large that regulators had no choice but to step in to shut the bank down to protect depositors. </p>
<h2>Are the deposits now safe?</h2>
<p>From a practical perspective, the FDIC is now running the bank. </p>
<p>It is typical for the FDIC to shut a bank down on a Friday and have the bank reopen the following Monday. In this case, the FDIC has already announced that the bank will reopen on March 13 as the <a href="https://www.fdic.gov/news/press-releases/2023/pr23016.html">Deposit Insurance National Bank of Santa Clara</a>. </p>
<p>At the end of 2022, <a href="https://www.cnbc.com/2023/03/10/silicon-valley-bank-is-shut-down-by-regulators-fdic-to-protect-insured-deposits.html">SVB had $175.4 billion in deposits</a>. It’s not clear how much of those deposits remain with the bank and how much of those are insured and 100% safe.</p>
<p>For depositors with $250,000 or less in cash at SVB, the FDIC said that customers will have access to all of their money when the bank reopens. </p>
<p>For those with uninsured deposits at SVB – basically anything above the FDIC limit of $250,000 – they may or may not receive back the rest of their money. These depositors will be given a <a href="https://www.fdic.gov/consumers/banking/facts/payment.html">“Receiver’s Certificate” by the FDIC</a> for the uninsured amount of their deposits. The FDIC has already said it will <a href="https://www.cnbc.com/2023/03/10/silicon-valley-bank-is-shut-down-by-regulators-fdic-to-protect-insured-deposits.html">pay some of the uninsured deposits by next week</a>, with additional payments possible as the regulator liquidates SVB’s assets. But if SVB’s investments have to be sold at a significant loss, uninsured depositors may not get any additional payment.</p>
<figure class="align-center ">
<img alt="men in uniform walk out of a building with glass doors under a sign that reads silicon valley bank" src="https://images.theconversation.com/files/514762/original/file-20230310-2087-c4fw8d.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/514762/original/file-20230310-2087-c4fw8d.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/514762/original/file-20230310-2087-c4fw8d.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/514762/original/file-20230310-2087-c4fw8d.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/514762/original/file-20230310-2087-c4fw8d.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/514762/original/file-20230310-2087-c4fw8d.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/514762/original/file-20230310-2087-c4fw8d.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Santa Clara Police officers exit Silicon Valley Bank.</span>
<span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/BanksInflation/29b034ff1a7f46cd84b931df656768bf/photo?Query=Silicon%20Valley%20bank&mediaType=photo&sortBy=arrivaldatetime:desc&dateRange=Anytime&totalCount=38&currentItemNo=0">AP Photo/Jeff Chiu</a></span>
</figcaption>
</figure>
<h2>What was the last US bank to fail?</h2>
<p>Prior to the failure of SVB, the most recent bank failures occurred in October 2020, when both <a href="https://www.fdic.gov/news/press-releases/2020/pr20119.html">Almena State Bank</a> in Kansas and <a href="https://www.fdic.gov/news/press-releases/2020/pr20112.html">First City Bank of Florida</a> were taken over by the FDIC. </p>
<p>Both of these banks were relatively small – with about $200 million in deposits combined. </p>
<p>SVB was the biggest bank to fail since September 2008, when <a href="https://www.thebalancemoney.com/washington-mutual-how-wamu-went-bankrupt-3305620">Washington Mutual failed with $307 billion in assets</a>. WaMu fell in the wake of investment bank Lehman Brothers’ collapse, which <a href="https://www.project-syndicate.org/topic/the-lehman-legacy">nearly took down the global financial system</a>. </p>
<p>On the whole, U.S. <a href="https://www.fdic.gov/resources/resolutions/bank-failures/failed-bank-list/">bank failures aren’t all that common</a>. For example, there were none in 2021 and 2022.</p>
<h2>Is there any risk that more banks might fail?</h2>
<p>At the end of 2022, <a href="https://www.federalreserve.gov/releases/lbr/current/">SVB was the 16th-largest bank in the United States</a> with $209 billion in assets.</p>
<p>That sounds like a lot – and it is – but that’s just 0.91% of <a href="https://fred.stlouisfed.org/series/TLAACBW027SBOG">all banking assets in the U.S</a>. There is little risk that SVB’s failure will spill over to other banks. </p>
<p>Having said that, SVB’s collapse does highlight the risk that many banks have in their investment portfolios. If interest rates continue to rise, and the <a href="https://www.nytimes.com/2023/03/07/business/economy/fed-powell-interest-rates.html">Federal Reserve has indicated that they will</a>, the value of the investment portfolios of banks across the U.S. will continue to go down. </p>
<p>While these losses are just on paper - meaning they’re not realized until the assets are sold – they <a href="https://www.stlouisfed.org/on-the-economy/2023/feb/rising-rates-complicate-banks-investment-portfolios">still can increase a bank’s overall risk</a>. How much the risk will go up will vary from bank to bank.</p>
<p>The good news is that most banks currently <a href="https://www.bankregdata.com//allLE.asp">have enough capital</a> to absorb these losses – however large – in part because of efforts taken by the Fed after the 2008 financial crisis to ensure financial firms can weather any storm. </p>
<p>So rest easy for now, the banking system is sound.</p><img src="https://counter.theconversation.com/content/201626/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>William Chittenden does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>SVB, as it’s known, collapsed with lightning speed following a run on its deposits.William Chittenden, Associate Professor of Finance, Texas State UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1944052022-12-09T10:44:55Z2022-12-09T10:44:55ZWhy we need more Lehman Sisters: the significant benefits of female leadership<figure><img src="https://images.theconversation.com/files/499076/original/file-20221205-17-f2tyhd.jpg?ixlib=rb-1.1.0&rect=46%2C15%2C5184%2C3406&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/fr/image-photo/silhouette-super-business-woman-look-somewhere-1024943923">Shutterstock</a></span></figcaption></figure><p>Establishing gender equality is one of the <a href="https://european-union.europa.eu/principles-countries-history/principles-and-values/aims-and-values_en">founding values of the European Union</a>, yet women are still underrepresented in decision-making positions in Europe. According to the <a href="https://eige.europa.eu/gender-statistics/dgs">European Institute of Gender Equality (EIGE)</a>, women represent just 32.3% of presidents, board members and employee representatives, and 21.5% of CEOs, executives and non-executives of the largest listed companies in Europe. The situation is much the same in other sectors, including governments, financial institutions and national academies of science.</p>
<p>Beyond the importance of equal representation, our <a href="https://www.axa-research.org/en/project/paola-profeta">research at the AXA Lab on Gender Equality</a> shows gender-balanced leadership has many benefits. Given that women make up half of the earth’s population, ensuring that they’re equally represented among potential candidates for a leadership post results provides larger pool being available; this, in turn, leads to a higher quality of the person selected. Thus, when women are involved in leadership positions which were traditionally male-dominated, there is a higher probability to have more qualified leaders.</p>
<p>This has been empirically proved by research. For example, the introduction of <a href="https://pubsonline.informs.org/doi/abs/10.1287/mnsc.2021.4200">board gender quotas</a> in Italy not only increased the share of women on boards but raised the qualifications of all board members, male and female, because less-qualified men previously on the board were not re-appointed. This outcome depends on the status quo and becomes possible when qualified and competent women ready to be leaders are in abundant supply, as is the case today in many European countries.</p>
<h2>Imagining Lehman Sisters</h2>
<p>A second argument relates to the agenda and outcomes of institutions and organisations. The agendas of gender-balanced leaderships can include items typically neglected by a male-dominated groups, but that may be important for their organisations – for example, sustainability goals. There is evidence that the presence of women in political leadership is associated with <a href="https://www.sciencedirect.com/science/article/pii/S0176268020300446">higher childcare funding</a>, which are positively related to maternal employment. This creates a virtuous circle, with women’s greater representation in leadership leading to policies that reduce gender gaps in the labour market.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/499072/original/file-20221205-24-dchtz0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/499072/original/file-20221205-24-dchtz0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/499072/original/file-20221205-24-dchtz0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/499072/original/file-20221205-24-dchtz0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/499072/original/file-20221205-24-dchtz0.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=502&fit=crop&dpr=1 754w, https://images.theconversation.com/files/499072/original/file-20221205-24-dchtz0.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=502&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/499072/original/file-20221205-24-dchtz0.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=502&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">The president of European Central Bank, Christine Lagarde, arrives for a hearing of the committee on economic and monetary affairs of the European Parliament in Brussels.</span>
<span class="attribution"><a class="source" href="https://www.afpforum.com/AFPForum/Search/Results.aspx?pn=1&smd=8&mui=3&q=4823152774898244456_0&fst=christine+lagarde&fto=3&t=2#pn=1&smd=8&mui=3&q=4823152774898244456_0&fst=christine+lagarde&fto=3&t=2">Kenzo Tribouillard/AFP</a></span>
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<p>Leadership style also matters. <a href="https://www.axa-research.org/en/news/barriers-to-women-in-employment-and-leadership">Research has established</a> that compared to men, women leaders tend to be more risk-averse and less competitive, more democratic and innovative, and that they have a longer-term horizon. These traits are not details: Christine Lagarde, former director of the IMF and current president of the European Central Bank, often noted that <a href="https://www.weforum.org/agenda/2018/09/ten-years-after-lehman-lessons-learned-and-challenges-ahead">if Lehman Brothers had been “Lehman Sisters”</a>, the 2007-2008 financial crisis might never have occurred. The reason is that if decision-making bodies do not have an equal number of women, an overrepresentation of men may lead to <a href="https://www.pnas.org/doi/pdf/10.1073/pnas.0704025105">aggressive and overcompetitive behavior</a>. Given the global damage left behind by the financial crisis, a leadership of “brothers and sisters” has become a benchmark for organisations.</p>
<p>A more recent example is the Covid-19 pandemic. A 2021 study on 194 countries found that in the first quarter of the crisis, <a href="https://www.tandfonline.com/doi/full/10.1080/13545701.2021.1874614">countries led by women experienced better outcomes</a> because they tended to impose lockdowns significantly earlier than male leaders did. This is in line with women’s being more risk-averse than men, even when they are in leadership positions. <a href="https://www.pnas.org/doi/10.1073/pnas.2012520117">Evidence also suggests</a> that women were more likely to perceive Covid-19 as a serious health problem, to agree with restraining public policy measures, and to comply with them.</p>
<h2>Shifting cultural stereotypes</h2>
<p>A major obstacle to gender-balanced leadership positions are well-established stereotypes. There is a general consensus that gender gaps are a matter of culture, and because culture changes slowly, policies and measures can accelerate the reduction of gender gaps, but we will need time to see real changes. How to measure gender culture and how to assess the progress is difficult. Scholars use data from the <a href="https://www.worldvaluessurvey.org/">World Value Survey</a> to measure gender stereotypes.</p>
<p>These data show that explicit stereotypes have been declining over time, although differences across countries within Europe are still substantial. For example, the statement “Men are better business leaders than women” was approved by 15,8% of Italian citizens, yet only 4.6% of Swedes. Yet implicit stereotypes are everywhere stronger than explicit ones.</p>
<p>Recent research shows that implicit stereotypes, as measured by the <a href="https://implicit.harvard.edu/implicit/">Implicit Association Test</a> on gender and career, are well established in the workplace: for example, people tend to associate women with family and men with careers. Managers who make hiring and promotion decisions are found to share such stereotypes, similar to rates in the general population. How to counter and diminish them is a more complicated task, but an important one to reduce gender gaps in the workplace.</p>
<p>A clear successful policy which has promoted women’s presence in the workplace in Europe is childcare. Day-care services are not only important for child development, but they also help families with small children – and in particular women – to deal with their professional and personal life. How to see this policy implemented? We could start by having more women in leadership positions as politicians and in top business places, as suggested by results of the research at the AXA Research Lab on Gender Equality.</p>
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<img alt="" src="https://images.theconversation.com/files/310261/original/file-20200115-134768-1tax26b.png?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/310261/original/file-20200115-134768-1tax26b.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=158&fit=crop&dpr=1 600w, https://images.theconversation.com/files/310261/original/file-20200115-134768-1tax26b.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=158&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/310261/original/file-20200115-134768-1tax26b.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=158&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/310261/original/file-20200115-134768-1tax26b.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=198&fit=crop&dpr=1 754w, https://images.theconversation.com/files/310261/original/file-20200115-134768-1tax26b.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=198&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/310261/original/file-20200115-134768-1tax26b.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=198&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<p><em>Created in 2007 to help accelerate and share scientific knowledge on key societal issues, the AXA Research Fund has supported nearly 700 projects around the world conducted by researchers in 38 countries. To learn more, visit the site of the AXA Research Fund or follow on Twitter @AXAResearchFund.</em></p><img src="https://counter.theconversation.com/content/194405/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Paola Profeta ne travaille pas, ne conseille pas, ne possède pas de parts, ne reçoit pas de fonds d'une organisation qui pourrait tirer profit de cet article, et n'a déclaré aucune autre affiliation que son organisme de recherche.</span></em></p>Women are still underrepresented in decision-making positions, yet research shows that gender equality can lead to more qualified leaders and better outcomes.Paola Profeta, Director of Axa Research Lab on Gender Equality, AXA Fonds pour la RechercheLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1688522021-10-03T19:00:22Z2021-10-03T19:00:22Z3 ways the collapse of Evergrande will hurt the Australian economy<figure><img src="https://images.theconversation.com/files/423976/original/file-20210930-20-4cxkwj.jpg?ixlib=rb-1.1.0&rect=0%2C180%2C3647%2C1845&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Miyuki Yoshioka/AP</span></span></figcaption></figure><p>Evergrande, China’s second-largest property developer, is in peril. After a decade of massive growth, including investing in “<a href="https://www.bloomberg.com/news/articles/2021-07-22/china-evergrande-is-said-to-explore-listing-of-tourism-business">Fairyland</a>” theme parks, an <a href="https://www.scmp.com/business/companies/article/3150633/evergrande-autos-ev-production-plans-hit-bump-debt-ridden">electric car company</a> and a professional football team (<a href="https://gzfc.evergrande.com/english/about.aspx">Guangzhou FC</a>), it is now struggling to service debts exceeding US$300 billion. </p>
<p>So far it has avoided the fate of dozens of its unfinished apartment towers — demolished in spectacular fashion in recent weeks — by selling off assets to make its payments. </p>
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<p>But this is not a sustainable strategy. Credit rating agency Fitch has in the past week <a href="https://www.fitchratings.com/research/corporate-finance/fitch-downgrades-evergrande-subsidiaries-hengda-tianji-to-c-28-09-2021">downgraded Evergrande</a> to a “C”, indicating <a href="https://info.creditriskmonitor.com/Help/FitchGlossary.asp">exceptionally high risk</a>, with default “imminent or inevitable, or the issuer is in standstill”.</p>
<p>Without intervention by the Chinese government, the company will collapse. Here are three key ways in which that could affect Australia.</p>
<h2>1. Lower demand for iron ore</h2>
<p>Evergrande’s collapse will reverberate throughout China’s real estate market. Investors and lenders will be more cautious, potentially resulting in a credit crunch. This could severely dampen property development, and thereby demand for construction materials including steel, made using mostly imported iron ore. </p>
<p>China is by far the world’s biggest steel producer, and accounts for <a href="https://oec.world/en/profile/hs92/iron-ore">nearly 70%</a> of global iron ore imports. About 60% of that iron ore has been imported from Australia. </p>
<p>This trade has made iron ore Australia’s most valuable export commodity, worth an <a href="https://publications.industry.gov.au/publications/resourcesandenergyquarterlyjune2021/index.html">estimated AU$149 billion</a> in the 2020-2021 financial year. About <a href="https://publications.industry.gov.au/publications/resourcesandenergyquarterlyjune2021/documents/Resources-and-Energy-Quarterly-June-2021-Iron-Ore.pdf">75% went to China</a>. Any drop in Chinese demand will therefore affect the Australian economy.</p>
<p>China has already been seeking to <a href="https://www.9news.com.au/national/iron-ore-prices-why-is-it-falling-china-cuts-steel-output-carbon-emissions-explainer/b444b066-a740-43c3-9ef8-6ff9468bdcbe">cut back steel production</a>, a high-energy process, to reduce carbon emissions. The iron ore price has halved since July. </p>
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<p><strong>Plummeting demand for iron ore</strong> </p>
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<img alt="Iron ore spot price (US$ per tonne)" src="https://images.theconversation.com/files/424123/original/file-20211001-13-1t3ecdd.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/424123/original/file-20211001-13-1t3ecdd.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=330&fit=crop&dpr=1 600w, https://images.theconversation.com/files/424123/original/file-20211001-13-1t3ecdd.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=330&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/424123/original/file-20211001-13-1t3ecdd.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=330&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/424123/original/file-20211001-13-1t3ecdd.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=414&fit=crop&dpr=1 754w, https://images.theconversation.com/files/424123/original/file-20211001-13-1t3ecdd.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=414&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/424123/original/file-20211001-13-1t3ecdd.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=414&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Iron ore spot price (US$ per tonne)</span>
<span class="attribution"><a class="source" href="https://tradingeconomics.com/commodity/iron-ore">tradingeconomics.com/</a></span>
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<p>Further falls in demand and thus prices will affect the Australian businesses and <a href="https://www.minister.industry.gov.au/ministers/pitt/media-releases/pilbara-iron-ore-powering-australias-economy">45,600 jobs</a> employed directly by the industry, as well as the thousands of jobs sustained though their wages, and government revenues from mining-related royalties and taxes.</p>
<h2>2. Overall weakening of China’s economy</h2>
<p>Beyond the direct effects, problems in China’s real estate and financial sectors could ripple across China’s economy, hurting Chinese demand for other goods and services in which Australia is a major provider. </p>
<p>To put <a href="https://www.abs.gov.au/articles/australias-trade-goods-china-2020">trade with China</a> in context, Australia’s exports to China are about three times those of our second-most valuable market, Japan. Even with iron-ore exports removed from the equation, China is still our biggest export market.</p>
<p>The effect of China buying less from Australia has been a matter of considerable debate. Some have argued Australia can compensate by diversifying into other markets. But such things take time. Economists Rod Tyers and Yixiao Zhou, who have simulated the <a href="https://theconversation.com/an-all-out-trade-war-with-china-would-cost-australia-6-of-gdp-151070">effects</a> of Australia-China trade being shut down, have argued short-term effects could be severe.</p>
<h2>3. Global contagion</h2>
<p>Evergrande’s debt crisis has echoes of the case of Lehman Brothers, the US investment bank whose bankruptcy in 2008 played a big part in precipitating the Global Financial Crisis. </p>
<p>Although most of Evergrande’s debt is localised in China, in financial and real estate sectors there is always a risk of investors and banks in other markets getting spooked, leading to a credit crunch throughout global markets. </p>
<p>Australian share markets have already fallen off their highs over the past few weeks, certainly in part over concerns about China’s economy. The mining sector has experienced the real <a href="https://www.mining.com/mining-stocks-carnage-as-iron-ore-copper-prices-fall/">carnage</a>, but there are indicators of general unease in falls across all sectors. </p>
<h2>Will the Chinese government intervene?</h2>
<p>Without external help Evergrande has a very high likelihood of failure. All the signs are there. It is averting bankruptcy by servicing the interest payments on its massive debt by selling assets at unfavourable prices.</p>
<p>All eyes are now on the Chinese government as a potential saviour through some form of debt restructure or guarantees. </p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/vital-signs-evergrande-may-survive-but-for-its-executives-expect-a-fate-worse-than-debt-168930">Vital Signs: Evergrande may survive, but for its executives expect a fate worse than debt</a>
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<p>So far it <a href="https://www.nytimes.com/2021/09/26/business/china-evergrande-crisis.html">has not committed itself</a>, and it has taken a <a href="https://www.reuters.com/article/us-china-property-policy-idUSKBN2761ES">strong stance against high debt</a> by developers. But it may consider Evergrande “too big to fail” — its collapse having potentially disastrous local and global implications. So some form of intervention to stabilise the situation seems more likely than not.</p>
<p>Australians, and the rest of the world, will need to wait to see exactly what hand the Chinese government will play.</p><img src="https://counter.theconversation.com/content/168852/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Robert Powell does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Evergrande has a very high likelihood of failing without intervention by the Chinese government.Robert Powell, Professor, Edith Cowan UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1689302021-09-30T20:06:33Z2021-09-30T20:06:33ZVital Signs: Evergrande may survive, but for its executives expect a fate worse than debt<figure><img src="https://images.theconversation.com/files/423971/original/file-20210930-16-wo1q4.jpg?ixlib=rb-1.1.0&rect=0%2C1008%2C7091%2C3556&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Alex Plaveski/AP</span></span></figcaption></figure><p>A large, financially interconnected company is on the verge of collapse, weighed down by massive debt. The government ponders a bailout. There’s no easy answer. Doing nothing risks serious financial upheaval. But bailing it out will signal that greed, irresponsibility and moral hazard have no consequences.</p>
<p>It’s a tough call. And if this all sounds eerily familiar, then you’re right. In 2008 the US government faced the dilemma with what to do about Lehman Brothers, the nation’s fourth-biggest investment bank which found itself unable to pay debts totalling more than US$600 billion.</p>
<p>Now the Chinese government is facing a comparable situation with Chinese property and financial behemoth Evergrande.</p>
<p>Lehman Brothers, established in 1847, survived the US Civil War, the Great Depression and two world Wars. Then in the feverish bubble of risky bets on the US mortgage market in the 1980s, it got into deep trouble. </p>
<p>US Treasury Secretary Hank Paulson — a former senior Wall Street executive — was, by all accounts, offended that Lehman had so recklessly gotten into this position. Why not send a message that the US government wasn’t going to bail out big banks who behaved badly?</p>
<p>The answer, it turned out, is that letting Lehman fail ricocheted through the US and global economy. </p>
<p>When Lehman filed for Chapter 11 bankruptcy protection, it was facing the largest bankruptcy in history. Those to whom it owed money were immediately put under pressure. That put those to whom they owed money under pressure. Money markets almost completely froze up. </p>
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<em>
<strong>
Read more:
<a href="https://theconversation.com/vital-signs-the-gfc-and-me-ten-years-on-what-have-we-learned-103514">Vital Signs: the GFC and me. Ten years on, what have we learned?</a>
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<p>Even Goldman Sachs – Wall Street’s most venerable firm and basically on the good side of mortgage-market trades — was hammered. It took legendary investor Warren Buffett plowing US$5 billion into the company to avoid a modern-day bank run.</p>
<h2>China’s Lehman moment?</h2>
<p>Unlike Lehman Brothers, Evergrande isn’t an investment bank. Ostensibly it is a real estate developer, responsible for building apartments across China. But it has morphed into more than that — a highly leveraged and integrated company that does everything from banking to property development to selling electric cars.</p>
<p>Like many things in China, the true state of affairs is all a little unclear, but one reading is that Evergrande is basically a hedge fund with a property and vehicle business attached.</p>
<p>The proximate cause of concern is Evergrande missing an US$83 million interest payment on September 23. The clock is running, in that is has 30 days to “cure the breach” and figure out a way to pay. Otherwise things, as the cool kids say, will “start getting real”.</p>
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<strong>
Read more:
<a href="https://theconversation.com/chinas-problem-with-property-the-domino-effect-of-evergrandes-huge-debts-168601">China's problem with property: the domino effect of Evergrande's huge debts</a>
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<p>For now disaster has been averted by Evergrande agreeing to sell off its stake in a local bank (Shengjing Bank) <a href="https://www.reuters.com/world/china/china-evergrande-transfer-15-bln-stake-shengjing-bank-state-firm-2021-09-29/">for nearly 10 billion yuan</a> (about US$1.5 billion) to the state-owned Shenyang Shengjing Finance Investment Group. </p>
<p>But Evergrande has US$300 billion in debt, so there’s really no running away from the issue for the Chinese authorities. If there are more dodgy dealings on Evergrande’s books then that US$1.5 billion will simply be buying time.</p>
<p>If things are as rotten in the state of Evergrande as many observers seem to think, then the Chinese government is going to have to bail it out, or let it fail. </p>
<p>In a sense, the CCP may be feeling “we’re all Hank Paulsons now”.</p>
<h2>China’s extra tools</h2>
<p>That said, there is an intriguing — if somewhat troubling — option available to Chinese authorities. </p>
<p>They could bail out the company but punish its top brass with serious personal sanctions. To put it bluntly, they don’t have to be concerned with the niceties of due process in the same way the US government does.</p>
<p>The Chinese government can, if it wishes, prevent the reverberations throughout the economy that would flow from an Evergrande collapse, but deter moral hazard in the future. It can send a very clear message of consequence for executives who engage in reckless and potentially corrupt behaviour. Maybe incarceration for life. Maybe worse.</p>
<p>It’s an interesting, if rather grim, example of the Tinbergen Rule — named after Jan Tinbergen, the winner of the <a href="https://www.nobelprize.org/prizes/economic-sciences/1969/tinbergen/facts/">first Nobel prize for economics</a>. This rule says for each policy challenge one requires an independent policy instrument. The US government had one. The Chinese regime has two.</p>
<h2>This all raises bigger issues</h2>
<p>Beyond this lie much bigger issues. How well have Chinese enterprises actually been performing? Up until now it looked like the answer was remarkably well. But is this all a mirage, sustained by the lack of transparency that shrouds all Chinese institutions?</p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/china-is-financing-infrastructure-projects-around-the-world-many-could-harm-nature-and-indigenous-communities-168060">China is financing infrastructure projects around the world – many could harm nature and Indigenous communities</a>
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<p>It looks as if there may be two types of Chinese corporation: the ones that “make” things, which have been successful and still are, and the ones that “bank” things, which look disturbingly similar to their capitalist counterparts in the Western world when moral hazard and corruption are allowed to run rampant.</p>
<p>The shakeout of the coming years will reveal a lot about the economic bedrock of Chinese global power.</p><img src="https://counter.theconversation.com/content/168930/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Richard Holden is President-elect of the Academy of the Social Sciences in Australia.</span></em></p>Chinese authorities have an intriguing, if troubling, option in handling the Evergrande crisis.Richard Holden, Professor of Economics, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1422032020-07-08T11:52:37Z2020-07-08T11:52:37ZLessons from the 2008 financial crisis for our coronavirus recovery today – Recovery podcast series part six<figure><img src="https://images.theconversation.com/files/346336/original/file-20200708-31-o478pd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Markets panicked following the collapse of investment bank, Lehman Brothers, in 2008.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/stock-market-concept-crash-324802937">Shutterstock.com</a></span></figcaption></figure><p>In this sixth and final episode of <a href="https://theconversation.com/uk/topics/recovery-series-87523">Recovery</a>, a series from <a href="https://theconversation.com/uk/topics/the-anthill-podcast-27460">The Anthill Podcast</a> exploring how the world rebuilt after historic crises, we look at the 2008 global financial crisis. The recovery over the last decade has been slow and painful, and offers important lessons for the coronavirus recovery ahead.</p>
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<p><iframe id="tc-infographic-564" class="tc-infographic" height="100" src="https://cdn.theconversation.com/infographics/564/df7570dc1ec7680034215f0ca19d2e0378e13f3b/site/index.html" width="100%" style="border: none" frameborder="0"></iframe></p>
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<p>The 2008 financial crisis resulted in the worst global recession since the second world war. The collapse of US investment bank Lehman Brothers in September 2008 caused a meltdown of the global financial system. Money markets froze and there was a major credit crunch as the ability to borrow money suddenly dried up. </p>
<p>But the crisis had multiple, underlying causes. It followed years of excessive risk taking by bankers and lax government regulation. This had fuelled a US housing market bubble and glut of other dodgy investments. When Lehman went bankrupt, taking US$700 billion in liabilities with it, markets panicked. </p>
<p>To stop the contagion and make sure other major financial institutions didn’t collapse, governments stepped in to shore up the system by bailing out the banks. Anastasia Nesvetailova, professor of international political economy at City, University of London, explains what these bailouts involved and why they were so necessary. </p>
<p>The government response to the crisis had some unintended consequences, she says. Low interest rates and easy access to capital made those who were already wealthy even wealthier, drove up asset prices (like property) and failed to stimulate the economy in a way that benefited everyone. </p>
<p>The recovery was also very uneven geographically. Aidan Regan, associate professor at University College Dublin, tells us how the crisis spread across the eurozone and why some countries rebounded a lot more quickly than others. </p>
<p>The austerity policies that many governments adopted following the 2008 financial crisis also come under the spotlight. Nesvetailova and Regan explain why the decision to cut public spending hampered economic growth in the UK and across Europe. </p>
<p>Plus, we explore how emerging markets were affected by the 2008 financial crisis. Carolina Alves, fellow in economics at the University of Cambridge, outlines how some emerging markets were shielded from elements of the crisis but also left vulnerable to the large reduction in finance that followed. </p>
<hr>
<p><em>This episode was produced by Gemma Ware and Annabel Bligh with sound design by Eloise Stevens.</em></p><img src="https://counter.theconversation.com/content/142203/count.gif" alt="The Conversation" width="1" height="1" />
PODCAST: Part six of The Anthill Podcast’s Recovery series looks at the 2008 financial crisis and Great Recession that followed.Annabel Bligh, Business & Economy Editor and Podcast Producer, The Conversation UKGemma Ware, Head of AudioLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1321472020-03-31T13:28:29Z2020-03-31T13:28:29ZCoronavirus: comparing today’s crisis to 2008 reveals some interesting things about China<figure><img src="https://images.theconversation.com/files/324300/original/file-20200331-65503-115cg99.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Interesting times. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/coronavirus-wuhan-sars-illness-concept-quarantine-1623243526">EPA</a></span></figcaption></figure><p>With the new coronavirus still <a href="https://gisanddata.maps.arcgis.com/apps/opsdashboard/index.html#/bda7594740fd40299423467b48e9ecf6">spreading rapidly</a>, the shock to the global economy is becoming ever more apparent. I’ve been comparing the different major economies, and how this relates to the great financial crisis (GFC) of 2007-09. </p>
<p>World stock markets are currently down by about 25% from their January highs, having recovered a little since the US government unveiled its <a href="https://www.cnbc.com/2020/03/25/coronavirus-stimulus-bill-updates-whats-in-the-2-trillion-relief-plan.html">US$2 trillion (£1.6 trillion) economic relief package</a>. This <a href="https://www.thebalance.com/stock-market-crash-of-1929-causes-effects-and-facts-3305891">remains the</a> markets’ fastest decline in history – but how does it compare in scale to 2007-09? </p>
<p>In the four weeks from mid-February to mid-March, the stock markets of the G7 countries fell by about 33%, compared with 55% during the worst 18-month period of 2007-09. The leading markets still have to fall some way to outdo the previous crisis, though this varies considerably between countries. China’s main market, the SSE Composite Index, fell by about 97% in the year ended October 2008, but only about 15% this time – despite the pandemic starting there. </p>
<p><strong>Fall in stock markets GFC vs 2020</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/324294/original/file-20200331-65495-ms7iyd.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/324294/original/file-20200331-65495-ms7iyd.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/324294/original/file-20200331-65495-ms7iyd.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=382&fit=crop&dpr=1 600w, https://images.theconversation.com/files/324294/original/file-20200331-65495-ms7iyd.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=382&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/324294/original/file-20200331-65495-ms7iyd.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=382&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/324294/original/file-20200331-65495-ms7iyd.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=480&fit=crop&dpr=1 754w, https://images.theconversation.com/files/324294/original/file-20200331-65495-ms7iyd.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=480&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/324294/original/file-20200331-65495-ms7iyd.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=480&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="source">Sajid Chaudhry</span></span>
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</figure>
<p>But this compares a short 2020 period with a much longer period during the previous crisis. A more reasonable comparison of the COVID-19 crash might be with the four weeks after the <a href="https://theconversation.com/response-to-past-crises-shames-post-lehman-dithering-18205">Lehman Brothers collapse</a> of September 15 2008. On that basis, it’s a COVID-19 fall of 33% against 19% after Lehman. (On this comparison, China’s performance was actually worse in 2020, since its market flatlined for two months after Lehman.)</p>
<p><strong>Fall in stock markets post-Lehman vs 2020</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/324296/original/file-20200331-65503-otsbcw.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/324296/original/file-20200331-65503-otsbcw.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/324296/original/file-20200331-65503-otsbcw.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=416&fit=crop&dpr=1 600w, https://images.theconversation.com/files/324296/original/file-20200331-65503-otsbcw.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=416&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/324296/original/file-20200331-65503-otsbcw.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=416&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/324296/original/file-20200331-65503-otsbcw.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=523&fit=crop&dpr=1 754w, https://images.theconversation.com/files/324296/original/file-20200331-65503-otsbcw.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=523&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/324296/original/file-20200331-65503-otsbcw.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=523&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="source">Sajid Chaudhry</span></span>
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</figure>
<h2>Recession comparisons</h2>
<p>The shock to the world economy in 2020 is quite different, since the lockdowns have severely hampered everything from manufacturing to services. In 2007-09, the problem was a banking crisis as a result of too much bad debt, and there was no equivalent crisis on what economists call the supply side of the economy. </p>
<p>Nonetheless, the COVID-19 pandemic is having knock-on effects that are showing some similarities with the previous crisis. The credit markets <a href="https://www.theguardian.com/world/2020/mar/20/coronavirus-crisis-could-lead-to-new-credit-crunch-as-companies-struggle-with-debt">have frozen</a> and corporate bonds have plunged in value: <a href="https://fred.stlouisfed.org/series/AAA10Y">the gap or spread</a> between corporate bond yields and those of the benchmark ten-year US government bond has now widened more than during 2007-09. </p>
<p>The best realistic economic outcome is probably a recession no deeper than last time, where GDP <a href="https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG?end=2015&start=2008">fell 1.7%</a> in 2009. It could yet be a lot worse, however. According to <a href="https://www.brookings.edu/wp-content/uploads/2020/03/20200302_COVID19.pdf">this paper</a>, led by distinguished Australian economist Warwick McKibbin, the G7 plus China could be <a href="https://www.theguardian.com/australia-news/2020/mar/03/the-first-economic-modelling-of-coronavirus-scenarios-is-grim-for-the-world">heading for</a> an average decline of 8% of GDP this year, including 6% in the UK, 8% in the US and 9% in Germany. </p>
<p>The good news is that they assumed that 30% of the Chinese population got infected. In the month since the paper was published, the pandemic seems not to be turning out as badly in China. On the other hand, the US and Europe could be heading towards the gloomier end of expectations. </p>
<p>Another leading economist, Pierre-Olivier Gourinchas, <a href="https://twitter.com/pogourinchas/status/1238596558368706561">predicts a</a> 10% decline in world GDP if economic activity halves for a month and then spends a further two months at three-quarters the norm. </p>
<h2>Fiscal stimulus</h2>
<p>However the figures turn out, the economic outcome of COVID-19 seems arguably worse than 2007-09 because of such severe collapse in such a short time. If a significant amount of income is held up for even six months, it will drive a number of firms into effective insolvency, with consequences for everything from employment to bad debts on bank balance sheets. </p>
<p>No wonder the world’s leading economies have been unveiling economic relief packages. When I compare these with the last crisis, it reveals the scale of the economic problem: the average package by the G7 countries is 4.4 times bigger than last time. </p>
<p>Again, there are considerable variations. The UK package is ten times bigger, amounting to 15.4% of GDP compared to only 1.6% of GDP in 2008-09. Since the UK has just left the EU, this big response might be with an eye to the Brexit shock as well. Next biggest is Germany, whose stimulus is five times that of 2008: 17.6% of GDP compared to only 3.4% last time. </p>
<p>At the other end of the spectrum are Canada and Japan. These two countries look to be at <a href="https://www.ft.com/coronavirus-latest?segmentId=9211f020-1a27-0dc7-acef-0979034ad907">different stages</a> in the pandemic: Canada is only 16 days after its 100th case, whereas Japan is 35 days from that point. They could also be on <a href="https://www.worldometers.info/coronavirus/">different trajectories</a>, with Canada reporting 24 new deaths on March 30 compared to Japan’s two, taking their totals to 89 and 56 respectively.</p>
<p>The most noteworthy relief package is that of the US, which is only 1.9 times bigger than in 2008 – that’s 10% of GDP compared to 5.3% of GDP last time. In such a huge relief package, there might be economies of scale. Nonetheless, the US response is arguably too small compared to other countries at similar stages of the pandemic, such as the UK, Germany and also France. </p>
<p><strong>Relief packages as a % of GDP</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/324314/original/file-20200331-65537-zqlqbd.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/324314/original/file-20200331-65537-zqlqbd.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/324314/original/file-20200331-65537-zqlqbd.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=395&fit=crop&dpr=1 600w, https://images.theconversation.com/files/324314/original/file-20200331-65537-zqlqbd.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=395&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/324314/original/file-20200331-65537-zqlqbd.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=395&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/324314/original/file-20200331-65537-zqlqbd.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=497&fit=crop&dpr=1 754w, https://images.theconversation.com/files/324314/original/file-20200331-65537-zqlqbd.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=497&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/324314/original/file-20200331-65537-zqlqbd.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=497&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="source">Sajid Chaudhry</span></span>
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</figure>
<p>Also notice China. Just like the Chinese stock market has reacted more coolly than its western rivals, Beijing’s economic relief package is ten times smaller than in 2008. Considering China has been at the epicentre of the pandemic, and industrial output <a href="https://www.ft.com/content/318ae26c-6733-11ea-800d-da70cff6e4d3">declined by</a> an estimated 13% in the first two months of lockdown, you might have expected the government to fire a comparable bazooka to Germany or the UK. </p>
<p>Time will tell if this is the right move. Perhaps China’s strict lockdown measures have made such spending unnecessary, especially in a country probably big enough to make up for an economic problem centred on one province. With Chinese manufacturing having <a href="https://www.ft.com/content/c0eddc35-9bab-44ff-9974-ebfdd8edee6f">rebounded strongly</a> in March, it will be interesting to compare the overall effect of the coronavirus on the world’s leading economies a year or two in the future.</p><img src="https://counter.theconversation.com/content/132147/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Sajid Mukhtar Chaudhry does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Beijing might have been ultra-tough on the pandemic, but it has been horizontal in response to the economic shock.Sajid Mukhtar Chaudhry, Senior Lecturer in Finance, Aston UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1077802018-12-03T11:16:09Z2018-12-03T11:16:09ZCOP24: ten years on from Lehman Brothers, we can’t trust finance with the planet<p>Lehman Brothers filed for bankruptcy on September 15, 2008. The investment bank’s collapse was the drop that made the bucket of global finance overflow, starting a decade of foreclosures, bailouts and austerity.</p>
<p>The resulting tsunami hit the global <a href="https://www.independent.co.uk/news/business/analysis-and-features/financial-crisis-2008-why-lehman-brothers-what-happened-10-years-anniversary-a8531581.html">economy and public sector</a>, <a href="https://www.newstatesman.com/politics/economy/2018/09/decade-after-lehman-brothers-collapse-finance-remains-major-risk">discrediting finance</a> and its attempts to extract large rents from every aspect of the economy, including housing and food. An alternative was urgently needed.</p>
<p>Ten years later, private finance and large investors will play a central role at the COP24 in Katowice, Poland, and in the full implementation of the <a href="https://theconversation.com/uk/topics/paris-agreement-23382">2015 Paris Agreement</a>.</p>
<p>Representatives from pension funds, insurance funds, asset managers and large banks will attend the meeting and lobby governments, cities and other banks to favour investments in infrastructure, energy production, agriculture and the transition towards a low-carbon economy. </p>
<h2>Has finance cleaned up its act?</h2>
<p>There is a <a href="https://unctad.org/en/pages/PressRelease.aspx?OriginalVersionID=194">US$2.5 trillion gap in development aid</a> which needs to be filled if poor countries can adequately mitigate the effects of climate change. With <a href="https://www.nytimes.com/2018/09/09/world/asia/green-climate-fund-global-warming.html">little enthusiasm among rich countries</a> to stump up, the role of private finance is inevitable. Policy makers trust financial capital as our best hope of securing investment to avoid the <a href="https://www.ipcc.ch/report/sr15/">catastrophic warming beyond 1.5°C</a>.</p>
<p>This has been the case for a while – the first announcement came at the <a href="https://unfccc.int/news/un-climate-summit-financing">UN Climate Summit</a> in 2014, when a press release on the UN website said the investment community and financial institutions would “mobilise hundreds of billions of dollars for financing low-carbon and climate resilient pathways”.</p>
<p>Since then, networks that stress the role of private finance in rescuing the planet have multiplied, including the <a href="https://www.cop-24.org/speakers/climate-finance">Climate Finance session</a> at the Sustainable Innovation Forum, which will also take place in Katowice, on December 9-10 2018.</p>
<p>It is difficult to ignore that a strong reliance on private finance means putting the future of Earth in the hands of individuals and institutions that brought the global economy to the verge of collapse. It may be partially true that some are divesting from fossil fuels and funnelling their money into <a href="https://www.theguardian.com/business/2017/nov/19/norway-fund-sells-out-of-oil-fossil-fuels-starting-to-look-risky-norges-bank">better projects</a>. But before we pin our hopes on finance to solve climate change, there are some things we need to ask ourselves.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/248168/original/file-20181130-194950-1vo6lgl.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/248168/original/file-20181130-194950-1vo6lgl.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/248168/original/file-20181130-194950-1vo6lgl.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/248168/original/file-20181130-194950-1vo6lgl.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/248168/original/file-20181130-194950-1vo6lgl.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/248168/original/file-20181130-194950-1vo6lgl.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/248168/original/file-20181130-194950-1vo6lgl.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Poor countries like Bangladesh have little responsibility for climate change and need significant investment to adapt to it.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/bangladeshi-people-stand-on-street-full-756368578?src=bpkrolop7rEsMGxFq4E4DQ-1-14">Suvra Kanti Das/Shutterstock</a></span>
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<h2>Difficult questions for COP24 negotiators</h2>
<p>How did we get to a point in history where it is taken for granted that public money alone can never be sufficient to finance our transition from fossil fuels? Is it an objective condition with no clear causation and responsibility, or something else? </p>
<p>What about the fact that <a href="https://www.cnbc.com/2018/05/02/global-military-spend-rose-to-1-point-7-trillion-in-2017-arms-watchdog-says.html">global military spending in 2017 reached US$1.7 trillion</a> while poor countries promised funding for climate change adaptation and mitigation in 2015 <a href="https://www.ft.com/content/cbce4e2e-ee5b-11e8-89c8-d36339d835c0">are still waiting</a>?</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/cop24-climate-protesters-must-get-radical-and-challenge-economic-growth-107768">COP24: climate protesters must get radical and challenge economic growth</a>
</strong>
</em>
</p>
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<p>What about the cost of bailouts to the financial sector, which in the UK alone has been estimated at <a href="https://www.independent.co.uk/news/uk/politics/163850bn-official-cost-of-the-bank-bailout-1833830.html">US$850 billion</a>? As Michael Lewis noted in his <a href="https://www.nytimes.com/2011/09/27/books/boomerang-by-michael-lewis-review.html">boomerang theory</a>, states that have propped up financiers with public money are now asking those same financiers to step in and do the job that states should do. And this leads to the second consideration.</p>
<p>Climate change is historically, politically and socially complex. Although sustainable finance is not presented as the sole solution, analysing its role produces a series of strategic short circuits. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/climate-change-and-migration-in-bangladesh-one-womans-perspective-107131">Climate change and migration in Bangladesh – one woman's perspective</a>
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<hr>
<p>It oversimplifies and depoliticises the response to climate change. It legitimises the idea that sustainability can be achieved within <a href="https://www.theguardian.com/environment/2015/dec/14/climate-change-and-the-continual-demand-for-economic-growth">continuous growth and expansion</a>, which are essential to the survival of the financial sector. </p>
<p>It rewrites the way we think about our planet in the vocabulary of finance and its obsession for a return on investment. It marginalises any claim to address climate change based on present and historical injustices, redistribution and bottom-up projects organised by ordinary people.</p>
<p>It accepts that the financial way of defining sustainability and its achievements are inherently aligned with the rights, interests and needs of people and the planet.</p>
<p>Finance may be a partner in the fight against climate change, but it is certainly not a partner motivated by altruism. It’s motivated by generating profit from the transition. It is therefore unsurprising that energy generation, railways, water management and other forms of climate mitigation have been identified as <a href="http://www.worldbank.org/en/topic/climatefinance/projects">priorities for sustainable finance</a>.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/248166/original/file-20181130-194956-1xuuqz4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/248166/original/file-20181130-194956-1xuuqz4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/248166/original/file-20181130-194956-1xuuqz4.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/248166/original/file-20181130-194956-1xuuqz4.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/248166/original/file-20181130-194956-1xuuqz4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/248166/original/file-20181130-194956-1xuuqz4.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/248166/original/file-20181130-194956-1xuuqz4.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Action on climate change has to involve standing up to the Wall Street Bull.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/new-york-usa-june-25-2017-666063667?src=S260w08ESgGAZk8p5hzsRw-1-0">Quietbits/Shutterstock</a></span>
</figcaption>
</figure>
<h2>Fighting climate change on Wall Street’s terms</h2>
<p>Wall Street can find <a href="https://www.weforum.org/agenda/2015/07/is-the-boom-in-megaprojects-sustainable/">large returns</a> by investing in the transition to “greener” infrastructure, including the not-so-green <a href="https://www.cgdev.org/blog/chinas-green-belt-road-initiative-isnt-very-green">Chinese green belt and road</a> and dams like the Belo Monte, a project that originally applied for carbon credits and was labelled as a <a href="https://www.pri.org/stories/2013-07-01/brazils-hydro-dams-could-make-its-greenhouse-gas-emissions-soar">sustainable investment</a>. <a href="https://www.climatebonds.net/get-involved/green-city-bond-campaign">Green bonds</a> can help cities finance projects to reduce their environmental impact or adapt to climate change. </p>
<p>However, if money is the driver, we should not expect private investors to have any interest in projects that won’t generate a sufficient return, but would benefit people or cities that cannot pay for the service or for the debt, or that would protect vulnerable people from climate change. If climate change is fought according to the rules of Wall Street, people and projects will be supported only on the basis of whether they will make money.</p>
<p>Ten years ago, the world saw that finance had permeated every aspect of the global economy. Back then, it was clear that financial interests could not build a better and different world. Ten years later, COP24 should not legitimise large financial investors as the architects of a transition where sustainability rhymes with profitability.</p><img src="https://counter.theconversation.com/content/107780/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Tomaso Ferrando does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Private finance crashed the economy and is too consumed by the profit motive to be a reliable ally against climate change. We should not allow COP24 to be their board meeting.Tomaso Ferrando, Research Professor, University of BristolLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1031892018-09-14T13:11:28Z2018-09-14T13:11:28ZSleepwalking towards the next financial crisis? Here are the five biggest risks<p>Wall Street giant Lehman Brothers <a href="https://theconversation.com/anniversary-of-lehmans-collapse-reminds-us-booms-are-often-followed-by-busts-102758">filed for bankruptcy</a> on September 15, 2008, triggering the most significant global financial crisis since the great depression. Lehman’s collapse was not triggered in a day but over a much longer period, with assets of US$680 billion (£518 billion) supported by only US$22.5 billion of capital by the time it went under. As the subprime mortgage crisis began to eat up financial institutions, this once invincible bank was suddenly no more. </p>
<p>A decade later, with many of the world’s leading economies <a href="https://data.worldbank.org/indicator/ny.gdp.mktp.kd.zg?end=2017&start=1964">struggling</a> to grow consistently, one would have hoped that the banking industry and its regulators would have learned from what happened. Gordon Brown, UK prime minister at the time of the collapse, doesn’t think so. </p>
<p>Brown <a href="https://www.bbc.com/news/business-45504521">believes</a> we are “sleepwalking” into the next global financial crisis. He sees insufficient headroom to resuscitate economies by cutting interest rates or raising public spending. He describes a “leaderless world” in which it looks harder to achieve the global <a href="https://www.theguardian.com/business/2008/oct/13/creditcrunch-marketturmoil1">coordinated action</a> that was critical for avoiding even greater disaster ten years ago.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/236439/original/file-20180914-177953-k6vlpd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/236439/original/file-20180914-177953-k6vlpd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/236439/original/file-20180914-177953-k6vlpd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=469&fit=crop&dpr=1 600w, https://images.theconversation.com/files/236439/original/file-20180914-177953-k6vlpd.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=469&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/236439/original/file-20180914-177953-k6vlpd.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=469&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/236439/original/file-20180914-177953-k6vlpd.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=589&fit=crop&dpr=1 754w, https://images.theconversation.com/files/236439/original/file-20180914-177953-k6vlpd.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=589&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/236439/original/file-20180914-177953-k6vlpd.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=589&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">SOS.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/on-edge-concept-man-standing-cliff-191337065?src=ueU-nvhYfCDXpPHr1h6wUQ-6-21">designelements</a></span>
</figcaption>
</figure>
<p>Is there any room for cheer? Here’s my brief assessment of the indicators that will be crucial in any future crisis.</p>
<h2>1. Debt</h2>
<p>Global debt <a href="https://goo.gl/q5vssd">recently hit</a> a new record high of 225% of world GDP, amounting to US$164 trillion. The world is now 12 points deeper in debt than the previous peak in 2009, with advanced economies’ ratios at levels not seen since World War II. </p>
<p>This is forcing countries with large fiscal deficits to pay ever more interest to cover their bills. And if they can’t reduce their deficits, they will find it tough to deal with even the lightest economic downturn. Hence the <a href="https://www.imf.org/en/News/Articles/2018/04/09/spring-meetings-curtain-raiser-speech">recent call</a> from IMF director Christine Lagarde for countries to fix “the roof while the sun is still shining”, by cutting deficits, improving banking capital buffers and maximising exchange rate flexibility. </p>
<p><strong>G20 fiscal deficits, 2017</strong> </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/236422/original/file-20180914-177947-1y68fsy.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/236422/original/file-20180914-177947-1y68fsy.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/236422/original/file-20180914-177947-1y68fsy.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=247&fit=crop&dpr=1 600w, https://images.theconversation.com/files/236422/original/file-20180914-177947-1y68fsy.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=247&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/236422/original/file-20180914-177947-1y68fsy.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=247&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/236422/original/file-20180914-177947-1y68fsy.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=310&fit=crop&dpr=1 754w, https://images.theconversation.com/files/236422/original/file-20180914-177947-1y68fsy.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=310&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/236422/original/file-20180914-177947-1y68fsy.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=310&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.cia.gov/library/publications/the-world-factbook/fields/2222.html">CIA</a></span>
</figcaption>
</figure>
<h2>2. Emerging markets</h2>
<p>Nervous investors have been heavily selling assets in emerging markets, such that inflows into these countries <a href="http://www.theedgemarkets.com/article/currency-storms-rage-stocks-wipeout-nears-us1-trillion">plummeted</a> to US$2.2 billion in August compared to a high of US$13.7 billion only a month before. The <a href="https://www.businessinsider.com/investing-in-emerging-markets-reasons-benefits-and-mistakes-2018-9/?IR=T">outflow of money</a> has emaciated the currencies of Turkey, Indonesia and Argentina. Meanwhile, the US greenback <a href="https://goo.gl/2c34Ci">gets</a> stronger and stronger as investors seek to benefit from the <a href="https://goo.gl/CFe1r7">strength of</a> US treasury bonds and other dollar-denominated assets. These changes are bound to affect international trade, heightening the prospect of contagion to other countries. </p>
<h2>3. Trade</h2>
<p>The trade tensions between the <a href="https://theconversation.com/donald-trumps-economic-gamble-with-trade-wars-and-tax-cuts-he-could-win-big-or-lose-everything-101945">US and China</a> represent a massive geopolitical risk. These countries <a href="https://goo.gl/EdjfV1">have the</a> highest debt piles in the world, US$48.1 trillion and US$25.5 trillion respectively. Any economic fallout from their trade posturing could put global financial markets in a fix. </p>
<p>We are already seeing the impact on the Chinese stock market, which <a href="https://goo.gl/ELbuK6">has lost</a> about 20% of its value already this year. There are knock-on effects in Hong Kong, <a href="https://goo.gl/Rv6a85">dragging down</a> the Hang Seng trading index to a 14-month low lately. The contagion could soon spread around the globe, including to emerging economies already reeling from the aforementioned currency crises discussed above. </p>
<h2>4. Banking</h2>
<p>In the aftermath of Lehman, the world’s major banks <a href="https://www.nytimes.com/interactive/2018/09/12/business/big-investment-banks-dodd-frank.html">have moved</a> from depending on short-term borrowings to building larger capital buffers to help them steer through another credit crunch. Be that as it may, many other banks have still looked vulnerable – especially after the <a href="http://www.cadtm.org/Banks-are-responsible-for-the">Greek</a>, <a href="https://goo.gl/hs3thW">Spanish</a> and <a href="https://goo.gl/sgph95">Italian</a> banking crises of recent years. It is a strong signal that regulations are still insufficient to protect the system overall. </p>
<p>Then there is <a href="https://theconversation.com/explainer-shadow-banking-and-where-it-came-from-75692">shadow banking</a> – essentially financial institutions which aren’t banks, such as insurance companies or hedge funds, providing banking services such as lending. This <a href="https://themarketmogul.com/uk-shadow-banking/">grew</a> rapidly after the previous crisis, since the institutions in question are subject to fewer regulatory restrictions as the banks. </p>
<p>A mind-boggling <a href="https://goo.gl/XEsz5W">study</a> from the US last year, for example, found that the market share of shadow banking in residential mortgages had rocketed from 15% in 2007 to 38% in 2015. This also represents a staggering 75% of all loans to low-income borrowers and risky borrowers. China’s shadow banking is another major concern, <a href="https://www.bloomberg.com/news/articles/2018-01-23/china-s-15-trillion-shadow-banking-edifice-showing-more-cracks">amounting to</a> US$15 trillion, or about 130% of GDP. Meanwhile, <a href="https://newint.org/features/2018/07/01/the-next-financial-crisis">fears are mounting</a> that many shadow banks around the world are relaxing their underwriting standards. </p>
<h2>5. Cyber hazards</h2>
<p>Some analysts also <a href="https://goo.gl/D32Knt">worry that</a> the next financial crisis could be triggered by cyber attacks on today’s fully digital and interconnected financial system. This has <a href="https://goo.gl/Lu4PLd">consistently been ranked</a> as the number one concern by respondents to the Depository Trust’s Systemic Risk Barometer since its surveys began in 2013. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/236438/original/file-20180914-177941-spfpco.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/236438/original/file-20180914-177941-spfpco.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/236438/original/file-20180914-177941-spfpco.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/236438/original/file-20180914-177941-spfpco.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/236438/original/file-20180914-177941-spfpco.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/236438/original/file-20180914-177941-spfpco.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/236438/original/file-20180914-177941-spfpco.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/236438/original/file-20180914-177941-spfpco.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Game over?</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/computer-code-on-screen-skull-representing-1050436496?src=szgt-1mnKt9HT0UxnzAWbA-1-3">solarseven</a></span>
</figcaption>
</figure>
<p>In sum, despite the efforts to strengthen the financial system, it looks far from failsafe. Gordon Brown is unfortunately right that the world has not managed to do enough to prepare itself for the next shock, and the growing divisions within the international community make the situation look particularly dangerous. We have not been able to curb the tendency of financial institutions to take on excessive risk, and as Brown also said, there is still not enough of a corrective mechanism for those who act irresponsibly. </p>
<p>JP Morgan <a href="https://www.smh.com.au/business/markets/the-next-financial-crisis-will-strike-in-2020-says-jpmorgan-20180914-p503o7.html">is predicting</a> the next crisis will strike in 2020, if not earlier, and this does seem quite foreseeable. So brace yourself and stay prepared, and let’s hope that things don’t turn out as badly as they potentially could.</p><img src="https://counter.theconversation.com/content/103189/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Nafis Alam does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Gordon Brown is worried. So should we all be.Nafis Alam, Associate Professor, University of ReadingLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1027582018-09-12T10:38:48Z2018-09-12T10:38:48ZAnniversary of Lehman’s collapse reminds us – booms are often followed by busts<p>Only a decade has passed since the collapse of <a href="https://www.investopedia.com/articles/economics/09/lehman-brothers-collapse.asp">Lehman Brothers</a>, and it seems the mortgage crisis and subsequent <a href="https://theconversation.com/us/topics/great-recession-13707">Great Recession</a> are already ancient history in the minds of many investors, bankers and regulators.</p>
<p>All it took was a few short years of <a href="https://www.housingwire.com/articles/41000-spexperian-mortgage-default-rate-at-lowest-level-in-a-decade">low default rates</a> and <a href="https://www.clearbridge.com/perspectives/institutional/2018/bank-balance-sheets-loan-growth-interest-rates.html">good loan growth</a> to re-create the kind of heady atmosphere of <a href="https://www.marketwatch.com/story/this-irrational-exuberance-indicator-could-spell-trouble-for-the-stock-market-2017-06-21">irrational</a> <a href="https://www.cnbc.com/2017/10/31/spooky-market-valuations-at-greenspan-irrational-exuberance-level.html">exuberance</a> that <a href="http://blog.runnymede.com/alan-greenspan-warns-of-irrational-exuberance-in-bonds">transforms</a> staid bankers into high-wire risk takers. </p>
<p>For those who have forgotten, such risk takers are the the ones who <a href="https://www.thebalance.com/what-caused-2008-global-financial-crisis-3306176">caused</a> the 2008 crisis, which resulted in the collapse of investment bank Lehman Brothers on Sept. 15 and the worst recession since the 1930s. </p>
<p>With their hubris restored, bankers once again have convinced themselves and others that they are the “<a href="https://www.harpercollins.com/9780887309328/masters-of-the-universe/">masters of the universe</a>,” with superhero risk management skills. </p>
<p>At the same time, regulators are beginning to <a href="http://dealbook.nytimes.com/2014/10/22/u-s-loosens-reins-but-mortgage-lenders-want-more-slack/?_r=0">loosen</a> their reins, in part on the belief that the booming economy, flush with the <a href="https://www.usnews.com/news/business/articles/2018-01-03/fed-officials-hopeful-for-economic-boost-from-tax-cuts">gains</a> from tax breaks and deregulation, no longer needs such restraints.</p>
<p>But, as <a href="https://scholar.google.com/citations?user=mm2zaS8AAAAJ&hl=en&oi=ao">my research</a> into <a href="http://dx.doi.org/10.2139/ssrn.2587168">past financial crises</a> has shown, the seeds of the next bust tend to be sown during the boom times.</p>
<h2>Boom foreshadows doom</h2>
<p>A psychological bias known as the <a href="https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/availability-heuristic/">availability heuristic</a> helps explain why this happens. </p>
<p>This is sort of a mental shortcut in which people rely on only the most readily available information, such as from the very recent past, to arrive at inferences about the current and future state of affairs. In other words, if things are going well, it’s easy to convince yourself that they’ll continue that way indefinitely.</p>
<p>And this bias becomes very prevalent on Wall Street when times are good, leading to the kind of reckless behavior that sparks crises. </p>
<p>Research into the conditions that existed prior to the major financial crises of the past eight centuries shows that virtually every one <a href="http://www.nber.org/papers/w13761.pdf">was preceded</a> by an asset price bubble in the economy – which makes it appear like it’s booming – and an excessive amount of debt held by banks, conditions that suggest an environment tolerant of high risk. </p>
<p><a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2587168">My own research</a> into the conditions and causes of the last two major financial crises – in the 1980s and 2008 – reveals that the longer a lending boom lasts, the more trouble it foreshadows. More generally, during booms, any aspects of risk management in financial institutions <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2565499">get corrupted</a> by a kind of overconfidence in the skills of bankers. </p>
<p>And that’s exactly the environment we have now. A <a href="https://www.forbes.com/sites/bradmcmillan/2016/07/07/should-we-be-worried-about-record-low-interest-rates/">decade of ultra-low interest rates</a> across the world have led to <a href="https://www.cnbc.com/2018/07/11/global-debt-hits-a-new-record-at-247-trillion.html">ever-rising debt loads</a> for every type of borrower in most countries and have created incentives for <a href="https://voxeu.org/article/new-take-low-interest-rates-and-risk-taking">increased risk-taking</a> among investors and traders in the pursuit of high yields. </p>
<p>I believe this is putting the global financial system at risk of another collapse if regulators don’t act soon.</p>
<figure>
<iframe width="440" height="260" src="https://www.youtube.com/embed/u0PUIljjL_k?wmode=transparent&start=0" frameborder="0" allowfullscreen=""></iframe>
<figcaption><span class="caption">The author explains how booms can turn into crises.</span></figcaption>
</figure>
<h2>Stemming the cycle</h2>
<p>So is there something we can do to break this cycle and avert another crisis? </p>
<p>In my view, it primarily comes down to capital requirements, which are rules meant to ensure banks have enough equity – and not too much debt as percentage of total assets – to absorb the risk they’re taking with their investments. </p>
<p>In short, the <a href="http://www.bis.org/bcbs/basel3.htm">current requirements</a> are just not high enough to protect banks and the financial system. Furthermore, regulators tend to loosen them and <a href="https://www.npr.org/sections/thetwo-way/2018/05/22/613390275/congress-to-undo-part-of-dodd-frank-easing-rules-for-mid-sized-smaller-banks">other lending requirements</a> when the economic picture is improving – the precise time when they should be raising them. </p>
<p>Asking banks to hold more capital in good times, like now, will put in place the right incentives to prevent the kind of behavior that puts entire economies at risk. That’s because the more capital banks have, the more circumspect they’ll be in terms of how much risk they take, thus making a bust caused by the kinds of investments they made in the run-up to the last financial crisis much less likely. </p>
<h2>Beefing up Basel III</h2>
<p>One way regulators could do this is by beefing up <a href="http://www.bis.org/bcbs/basel3.htm">Basel III</a>, a voluntary, global regulatory framework on bank capital adequacy, stress-testing and market liquidity risk. </p>
<p>Basel III set banks’ so-called leverage ratio – a measure of how much capital a lender has relative to debt – at 3 percent. U.S. regulators have gone a bit further, requiring 5 percent. But that’s <a href="http://apps.olin.wustl.edu/faculty/Thakor/Website%20Papers/PostCrisis_JFS_37(2018).pdf">far too low</a> for a healthy banking system. </p>
<p>Regulators <a href="http://dx.doi.org/10.2139/ssrn.2341835">should be aiming</a> for 15 percent because research has shown that such a ratio will reduce the systemic risk of the banking sector significantly. With that much equity capital on their balance sheets, banks will resist the temptation to take undue risks that jeopardize the safety net taxpayers provide them through deposit insurance and occasional bailouts. </p>
<p>The greater cushion will also give them more time to adjust when the next crisis comes, as it inevitably will. And the more capital a bank has, the more time it has to take protective actions before going belly-up as losses start wiping out its equity. </p>
<p>Just imagine, would a bank ever give you a reasonably priced home mortgage if you only put 5 percent down and wanted to borrow the other 95 percent? </p>
<p>Some <a href="https://www.americanbanker.com/opinion/theres-more-to-bank-regulation-than-higher-capital">bankers complain</a> this will hurt shareholders because being required to hold more equity as a share of total assets will lead to lower returns.</p>
<p>A paper <a href="https://doi.org/10.1093/rfs/hhq022">I co-authored in 2009</a>, however, found that higher bank capital levels are actually associated with greater bank values, not to mention a safer and sounder banking system. </p>
<h2>Preventing the next big one</h2>
<p>I’m not suggesting that regulators and banks do this overnight, but I think when the economy is doing well, <a href="https://money.cnn.com/2018/05/22/investing/banks-record-profits-fdic-deregulation-bill/index.html">lenders are doing well and profits are high</a>, it’s relatively easy to build up capital over a period of three to five years. </p>
<p>And it’s the most effective means of preventing a financial crisis.</p>
<p>What regulators often do instead is focus on restricting banking activities and driving up the costs of complying with regulations. Rather than creating systemic protection, this simply leads banks to move their riskier activities to areas of the industry where regulators aren’t looking. </p>
<p>Regulators can only do so much to keep these firms from taking excessive risks. What they can do is ensure banks have enough capital to absorb future shocks so that the global financial system isn’t once again brought to the brink of collapse. </p>
<p><em>This is an updated version of an <a href="https://theconversation.com/beware-of-bullish-bankers-their-bubbles-and-the-inevitable-burst-42084">article</a> published on May 27, 2015.</em></p><img src="https://counter.theconversation.com/content/102758/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Anjan V. Thakor does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>It’s when times are good that the seeds of the next financial crisis are sown.Anjan V. Thakor, Professor of Finance, Washington University in St. LouisLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/742652017-03-16T17:46:10Z2017-03-16T17:46:10ZExplainer: how a special tax could protect South Africa from systemic risk<figure><img src="https://images.theconversation.com/files/160700/original/image-20170314-10755-c4bhlj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p><em>Is South Africa safe from systemic risk in its financial system? Systemic risk can lead to the collapse of financial markets as happened in the <a href="http://blogs.lse.ac.uk/politicsandpolicy/systemic-risk-was-the-real-culprit-in-the-2008-financial-crisis-and-with-banks-continuing-to-borrow-huge-amounts-the-dangers-are-still-there/">2008/09 global financial crisis</a>. In a new <a href="http://www.systemicrisk.org.za/">study</a> Qobolwakhe Dube and Co-Pierre Georg provide new insights into the extent of risk the country’s financial system faces. The Conversation Africa’s Business and Economy Editor Sibonelo Radebe quizzed them about their findings.</em></p>
<p><strong>What is systemic risk?</strong></p>
<p>It’s the risk of a collapse of the entire financial system – rather than the failure of individual parts. The word systemic refers to the fact that all the various players in the financial markets are interconnected and have common exposures. </p>
<p>Systemic risk is when the failure of one financial institution leads to severe instability or even collapse of the entire financial system. An example is the collapse of the US investment bank <a href="https://theconversation.com/bankings-lehman-lesson-is-that-change-must-be-cultural-18173">Lehman Brothers</a>. Lehman was declared insolvent in 2008 following the US government’s refusal to bail it out and after it stumbled over investments in dodgy mortgages. Its collapse had a domino effect–first on banks in the US and then across the world. This led to the crash of 2008 which was followed by a global recession.</p>
<p>The Lehman Brothers case also highlighted the quandary that governments often face about whether or not to bail out a troubled bank to avoid the collapse of the financial system. In many instances financial institutions that are the most systemically important are likely to receive a government bailout should they default. This happened in the UK when the <a href="https://theconversation.com/why-the-uk-government-is-willing-to-take-a-loss-on-rbs-42954">Royal Bank of Scotland</a> ran into trouble just after Lehman. But this has it’s own problems as it can invoke <a href="http://www.economist.com/economics-a-to-z/m#node-21529763">moral hazard</a> – when firms are incentivised to take on additional and sometimes reckless risks.</p>
<p><strong>How prone is South Africa to systemic risk?</strong></p>
<p>The South African financial system is exposed to significant levels of systemic risk. This is because of the way it’s structured. The factors that contribute to South Africa’s high exposure to systemic risk are: <a href="http://dx.doi.org/10.1016/S2212-5671(15)01332-5">high levels of market concentration</a> , the fact that financial institutions are all <a href="http://www.essa2011.org.za/fullpaper/essa2011_2218.pdf">highly interconnected</a> through complex structures and <a href="https://www.imf.org/external/pubs/ft/scr/2015/cr1554.pdf">little competition</a>. All play a significant role in maintaining the constant exposure to significant systemic risk. </p>
<p>A case in point was the collapse of <a href="https://www.ft.com/content/e77f49aa-292c-11e4-8b81-00144feabdc0">African Bank</a> in 2014. Although a relatively small institution, its collapse had a devastating effect on money market funds and cost South Africans roughly <a href="http://www.fin24.com/Companies/Financial-Services/Rescue-plan-for-African-Bank-20140811-2">R10 billion</a>. </p>
<p>In our research we found that three financial institutions contribute almost 50% of total systemic risk, with <a href="http://www.businessdaytv.co.za/shows/businessnews/2016/08/18/standard-bank-raises-dividend">Standard Bank</a> being the biggest contributor, followed by <a href="https://www.businesslive.co.za/bd/companies/financial-services/2017-02-24-barclays-africa-gets-r128bn-divorce-settlement/">Barclays Africa</a> and <a href="http://www.fin24.com/Companies/Financial-Services/firstrand-bucks-low-economic-growth-trend-20170309">FirstRand</a>. They are three of South Africa’s four largest banks.</p>
<p>What this means is that the failure of just one of these institutions would be sufficient to expose the system to the risk of contagion. This in turn would have a significant impact on the economy.</p>
<p><strong>How would you measure systemic risk?</strong></p>
<p>A frequently used metric is the <a href="https://doi.org/10.1093/rfs/hhw060">SRISK</a>, a measure of systemic risk used by Nobel laureate <a href="http://www.stern.nyu.edu/rengle/">Robert Engle</a> and his associates from the New York University’s Stern School of Business. </p>
<p>At the firm level, SRISK is the expected capital shortfall – the amount that it would cost to bailout the institution to maintain stability in the markets – that is associated with the collapse of the institution under stressed market conditions.</p>
<p>This measure is a function of the size of the firm, the extent to which debt is used to finance activity and equity losses would be expected to be incurred in the long term when the system is under distress.</p>
<p>Systemic risk contribution would therefore be estimated by first aggregating SRISK across all the institutions in the market to give a system wide estimation of the expected capital shortage, and then determining how much institution contributes to this.</p>
<p>We conclude that the concentrated distribution of systemic risk among South Africa’s financial institutions will result in huge cost to society should one of these institutions fail. It may therefore be beneficial for regulatory authorities and policy makers to consider imposing a systemic risk tax – or some other form of regulation – to prevent market activity that may lead to financial contagion and mitigate the effects in the event that a systemic institution collapses.</p>
<p><strong>What is a systemic risk tax and how would it work?</strong></p>
<p>A systemic risk tax would involve a special tax which would be raised to support a rescue fund to be used in the event of a crisis. The special tax we propose would be based on the so-called <a href="https://stats.oecd.org/glossary/detail.asp?ID=2065">Pigouvian</a> taxation scheme. This is a tax levied on firms active in the market with the intention of encouraging them to curtail undue risk taking and mitigate their contribution to negative externalities generated by market activity</p>
<p>Financial institutions would be taxed in proportion to how much they contribute towards the aggregated risk to the economy. This in turn would incentivise them to act in ways that would minimise their contribution to creating risk. This whole process would need to be done in a transparent way. And would need to be easily updated.</p>
<p><strong>Where has it been done and to what effect?</strong></p>
<p>To date no regulators or policymakers have implemented a systemic risk tax. But there has been a significant amount of <a href="http://voxeu.org/article/serious-reform-starts-systemic-risk-tax">discussion</a> about it. This has led to a number of possible ideas on how the tax could be implemented. </p>
<p>But how relevant would a tax be if stricter regulations were put in place? Both are policy tools that can be used to curb systemic risk.</p>
<p>A <a href="https://www.imf.org/external/np/res/seminars/2011/arc/pdf/epjs.pdf">report</a> presented at a conference hosted by the International Monetary Fund recommends combining such a tax with stricter regulations in the form of liquidity requirements – the level of liquid assets that must be held to meet short-term obligations. </p>
<p>Given the structures in the South African market a similar approach may be the best way to go. A tax regime alone would be insufficient as it wouldn’t address the concerns about market concentration. Combining it with the appropriate regulatory policy would propel South Africa’s financial system in the right direction. </p>
<p><em>Tresor Kaya, a Masters graduate from the University of Cape Town, also contributed to this article.</em></p><img src="https://counter.theconversation.com/content/74265/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>A new study brings fresh insights into understanding the nature and extent of South Africa’s systemic risks within the country’s financial sector.Co-Pierre Georg, Senior Lecturer, African Institute for Financial Markets and Risk Management, University of Cape TownQobolwakhe Dube, PhD candidate, University of Cape TownLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/451402015-07-24T04:36:21Z2015-07-24T04:36:21ZGE’s return to its industrial roots offers hope US economy may do the same<figure><img src="https://images.theconversation.com/files/89567/original/image-20150723-22818-mvuunk.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">GE's shift away from finance may mean more focus on other products, such as jet engines. </span> <span class="attribution"><span class="source">Jet engine via www.shutterstock.com</span></span></figcaption></figure><p>General Electric <a href="http://www.ft.com/cms/s/0/09a19db2-e0bb-11e4-9f72-00144feab7de.html">is retreating</a> from the financial sector and returning to its industrial roots seven years after its finance unit nearly <a href="http://www.thestreet.com/story/11400179/1/thing-that-killed-lehman-and-almost-ge-popular-again.html">brought down</a> the company. </p>
<p>After Lehman Brothers’ collapse in September 2008, GE was saved only by the <a href="http://www.propublica.org/article/general-electric-tapped-fed-to-borrow-16-billion">largesse</a> of the federal government, borrowing billions through several different programs set up to fight the financial crisis. </p>
<p>The company’s shift, <a href="http://www.businessinsider.com/r-ge-close-to-selling-part-or-all-of-its-real-estate-holdings-wsj-2015-4">announced</a> in April, is a crucial development and is in part the result of the passage of the Dodd-Frank Act, which turned five years old this week.</p>
<p>GE, which <a href="https://www.ge.com/sites/default/files/ge_webcast_pressrelease_01232015_1.pdf">reported</a> revenues of almost US$150 billion from dishwashers, jet engines and other products last year, is an iconic American company and a bellwether of the economy. Its <a href="http://www.businessinsider.com/the-man-who-destroyed-ge-2009-3">embrace</a> of finance to boost stagnating profitability in the 1980s mirrored changes in the broader US economy. That shift triggered a host of socioeconomic problems such as increased inequality and almost caused the global economy to collapse in 2008.</p>
<p>GE’s retreat from finance might signal that the role of industrial companies in the US economy may once again be on the rise. Such a “de-financialization” could boost American innovation in more productive sectors – <a href="http://ser.oxfordjournals.org/content/early/2015/05/13/ser.mwv009.full.pdf?keytype=ref&ijkey=fIz9gDjv4ZzTEu7">especially</a> those in research and development (R&D) and capital-intensive industries – help reduce inequality, and make it less likely that the next financial crisis will snowball into an existential one. </p>
<h2>Seeking profits in finance</h2>
<p>Since the early 1980s, economic activity in the US has steadily moved away <a href="http://www.hup.harvard.edu/catalog.php?isbn=9780674050846">from manufacturing to more financially</a> oriented activities. </p>
<p>For example, the financial services sector <a href="https://www.aeaweb.org/articles.php?doi=10.1257/jep.27.2.3">contributed</a> 7.9% to US GDP in 2007, up from 4.9% in 1980. A major part of this development was the increasing dependency of nonfinancial corporations on financial activities and institutions. </p>
<p>For industrial companies whose profitability had begun to decline in the face of growing foreign competition, the turn to finance meant continued growth and profits, thanks in particular to high interest rates.</p>
<p>Nowhere was the turn to finance more visible than at GE under then-CEO Jack Welch. As a 1997 BusinessWeek article <a href="http://www.businessweek.com/1996/44/b34991.htm">noted</a>, “Welch barnstormed through GE shutting factories, paring payrolls and hacking mercilessly at its lackluster old-line units.” </p>
<p>By the time Welch’s tenure ended in 2001, finance accounted for more than half of GE’s revenue and more than a third of its profits.</p>
<p>Financialization rewarded GE. Stock prices grew immensely through the 1980s and 1990s, a good indicator that stock investors and analysts favored this transformation. A 1997 Fortune magazine article <a href="http://archive.fortune.com/magazines/fortune/fortune_archive/1997/11/10/233789/index.htm">noted</a> that GE Capital “powers GE’s earnings, drives its stock and scares the hell out of its competitors.”</p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/89573/original/image-20150723-22849-e38prr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/89573/original/image-20150723-22849-e38prr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/89573/original/image-20150723-22849-e38prr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=441&fit=crop&dpr=1 600w, https://images.theconversation.com/files/89573/original/image-20150723-22849-e38prr.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=441&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/89573/original/image-20150723-22849-e38prr.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=441&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/89573/original/image-20150723-22849-e38prr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=554&fit=crop&dpr=1 754w, https://images.theconversation.com/files/89573/original/image-20150723-22849-e38prr.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=554&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/89573/original/image-20150723-22849-e38prr.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=554&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">This chart shows the sharp rise in GE’s share price from 1980 to 2001.</span>
<span class="attribution"><span class="source">Yahoo Finance</span>, <span class="license">Author provided</span></span>
</figcaption>
</figure>
<h2>Financialization’s dark side</h2>
<p>For GE, the flaws in this transformation didn’t manifest themselves until 2008, when Lehman Brothers’ collapse caused a short-term credit crisis that nearly destroyed the company. But for the economy and its workers, the negative impacts began much earlier and were far-reaching. </p>
<p>To begin with, starting from the 1980s, it led to a much-changed conception of the firm in the business world. Firms began to be viewed as a bundle of tradeable assets that exist to return <a href="https://www.russellsage.org/sites/all/files/u4/Fligstein%20%26%20Shin_Shareholder%20Value%20and%20the%20Transformation%20%20of%20the%20American%20Economy.pdf">value to their shareholders</a>. Major corporations led by finance-oriented managers made the stock price their primary concern. </p>
<p>The linking of executive pay to stock options promoted this trend. The focus of CEOs and boards shifted away from long-term productive investments toward quick financial gains. The profitability of the companies that turned to finance increased, but employment and economic growth <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2284507">stagnated </a>in the largest nonfinancial firms, in part due to this development. </p>
<p>The bargaining power of labor also diminished. The focus on short-term profits gave firms incentive to cut labor costs, while rewarding top executives who made <a href="http://www.levyinstitute.org/pubs/wp_525.pdf">such decisions</a>. All in all, financialization led to shrinking net wages for many workers operating in the productive industries, and contributed to the widening income inequality <a href="http://www.jstor.org/stable/10.1086/669499">in the US</a> and <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2290720">across the advanced nations</a>. </p>
<h2>The prevailing paradigm shifts</h2>
<p>The 2008 economic crisis was essentially a crisis of a financialized economy run amok. The prevailing paradigm up until the crash was to let markets, including financial markets, self-regulate. </p>
<p>As Barney Frank would <a href="http://www.gpo.gov/fdsys/pkg/CHRG-110hhrg44900/html/CHRG-110hhrg44900.htm">recollect</a> later regarding his work on the House Financial Services Committee in the US Congress: </p>
<blockquote>
<p>When I was about to become the chairman of this committee in 2006, I was told by a range of people that our agenda should be that of further deregulating financial markets. I was told that excessive regulation was putting American investment companies and financial institutions at a disadvantage.</p>
</blockquote>
<p>The crisis disrupted this paradigm. Even Alan Greenspan, who had shepherded financial deregulation and promoted financialization during his 19-year term as chairman of the Federal Reserve, <a href="http://www.nytimes.com/2008/10/24/business/economy/24panel.html">admitted</a> that he had put too much faith in the self-correcting power of free markets.</p>
<p>The result of this change of heart was the <a href="https://www.sec.gov/about/laws/wallstreetreform-cpa.pdf">Dodd-Frank Wall Street Reform and Consumer Protection Act</a>, which President Barack Obama signed into law in July 2010. The act led to the establishment of the Financial Stability Oversight Council (FSOC) to detect and preclude excessive risks to the US economy arising from the distress of large, interconnected bank holding companies, or nonbank financial companies. </p>
<p>The council is authorized to designate companies whose financial failure could pose a threat to US financial stability as systemically important. Such companies will be subject to increased regulatory supervision by the Federal Reserve and other relevant prudential regulators. </p>
<p>So far, the council voted to designate American International Group, General Electric Capital, Prudential Financial and MetLife as systemically important. With their hundreds of billions of dollars invested in finance, these companies were believed to have a significant impact on the health of the financial sector and the overall economy. Or put another way, they were simply too big to fail.</p>
<h2>Dodd-Frank changes the game</h2>
<p>Although Dodd-Frank might not be the most effective piece of legislation one would hope for after a crisis of this size, it has clearly changed the playing field – certainly for GE. </p>
<p>GE Capital, which was once deemed the overall company’s most dynamic component, suddenly became its riskiest. GE’s stock price began to fall, reflecting the concern that investors and analysts had over the risk GE capital imposed. </p>
<p>In retreating from finance, GE’s leadership not only aims to relieve itself of the burden of being considered too big to fail and the extra regulatory scrutiny, but also hopes that the shareholders will give its stock a more favorable valuation.</p>
<p>Last week the company offered its first report card on the transition when it released second-quarter earnings, which showed better-than-expected revenue thanks to growth in its core industrials business. This <a href="http://www.nytimes.com/2015/07/18/business/ge-q2-earnings.html?_r=0">suggests</a> its plan to move away from finance is working. </p>
<p>GE <a href="http://www.wsj.com/articles/general-electric-results-top-expectations-1437129893">said</a> that it had already signed $68 billion worth of sales for its lending business, putting it on track to meet its $100 billion goal by the end of the year. GE Capital had about $500 billion in <a href="http://www.gecapital.com/en/our-company/company-overview.html">assets</a> at the end of 2014. </p>
<h2>There and back again</h2>
<p>GE’s journey from an industrial firm to a highly financialized one and back encapsulates some of the most critical elements of the transformation of American capitalism over the past few decades. </p>
<p>It is rather soon to tell whether GE’s retreat from finance is harbinger of a more structural and long-term transformation in the American economy. After all, the logic that seems to be driving the company’s retreat is the same logic that once drove it into finance: increasing its stock price. </p>
<p>Still, this development suggests that times are changing, however slowly, and Dodd-Frank deserves some credit for altering the incentives and calculations of the investment community. Let’s hope more companies join this trend.</p><img src="https://counter.theconversation.com/content/45140/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Basak Kus does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>GE’s push into finance nearly crippled the company, just as the broader US shift in that direction almost collapsed the global economy.Basak Kus, Assistant Professor of Sociology, Wesleyan UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/346372014-12-01T10:47:45Z2014-12-01T10:47:45ZWhat will the next financial crisis look like – and are we ready?<p>The subprime crisis and the subsequent failure of Lehman Brothers came as such a shock – and the <a href="http://business.cch.com/images/banner/subprime.pdf">repercussions</a> were so severe that when the time came to mount a response, policy makers were as surprised as the rest of us and woefully unprepared.</p>
<p>In the six years since Lehman’s collapse, much effort has gone into thinking about the next crisis and about how to strengthen financial rules and practices so that the fallout is contained. Has this effort been productive? Will the repercussions of the next crisis be less damaging?</p>
<h2>Another banking crisis?</h2>
<p>The answer, as with many things economic, is: it depends. It depends in particular on the form the next crisis takes. Most obviously, that crisis could be sparked by the collapse of a large bank, similar to <a href="http://www.theguardian.com/business/2008/dec/28/markets-credit-crunch-banking-2008">bank failures</a> in the US and other countries in 2007 and 2008. Banks are highly leveraged, and information about their underlying condition can be difficult to obtain. This means that they are always at risk of going bust. </p>
<p>Governments have therefore focused on making the banking system <a href="http://www.bbc.co.uk/news/business-20811289">more robust</a> and better able to withstand the failure of a large financial institution. Banks are now required to hold more capital so that they have a larger cushion to absorb losses from the collapse of one of their number. They are now subject to liquidity requirements to ensure that they have adequate resources if the interbank market, on which they borrow overnight, dries up. </p>
<p>Regulators have taken steps to remove the expectation of a taxpayer bailout and reformed compensation practices in the hope that this will deter excessive risk taking. Bank failures will still happen, but these are among the reasons to hope that their repercussions will be less severe. </p>
<h2>Another euro crisis?</h2>
<p>Alternatively, the next crisis could be sparked by doubts, like those of 2012, about the <a href="http://www.theguardian.com/business/debt-crisis">survival of the euro</a>. An election in one or another European country could bring to power an opposition party committed to abandoning the euro. </p>
<p>Greece’s opposition left wing party, Syriza, is <a href="http://www.policy-network.net/pno_detail.aspx?ID=4763&title=Syrizas-run-for-government-and-the-next-Greek-crisis">likely to form</a> the next government in Athens if parliamentary elections are held next spring. Marine Le Pen is currently a leader in the French opinion polls and has vowed to take the country out of the euro in her first day in office. </p>
<p>If one country was seen as about to leave the euro, the expectation would quickly develop that others would follow. The result could be panicked runs on banks and financial markets Europe wide.</p>
<p>Here, leaders are clearly better prepared than in 2012, before European Central Bank President Mario Draghi <a href="http://www.thisismoney.co.uk/money/news/article-2844695/ECB-president-Mario-Draghi-vows-takes-prevent-euro-decline.html">vowed</a> to “do whatever it takes” to maintain the integrity of the euro area. In a panic, we now expect the ECB to immediately flood financial markets with cash. It would buy every security in sight if doing so was necessary to hold the eurozone together. An isolated exit from the euro would still be disruptive. But there is reason to think that the fallout could be contained.</p>
<h2>A crisis of geopolitics?</h2>
<p>The next crisis could also be sparked by a geopolitical event: worsening conflict in Ukraine or the Middle East, or a naval clash between China and another country bordering the South China Sea. These kinds of events inevitably disrupt financial markets. </p>
<p>But they are more likely to create problems for other countries than for the United States, which remains the world’s only <a href="http://seekingalpha.com/instablog/12713201-rossaldridgelasvegas/3491705-world-liquidity-makes-us-stocks-only-safe-haven-confirmed-by-ross-aldridge-in-las-vegas-nevada">true haven</a>. Geopolitical turmoil is likely therefore to create flight toward US markets, not away.</p>
<p>But there is also the danger of a crisis originating in the United States itself. The US is seen as a haven because its financial markets are so liquid – because it is possible, in other words, to buy and sell government and corporate securities at low cost in virtually unlimited quantities. </p>
<h2>Making things worse</h2>
<p>But recent financial reforms like the Volcker Rule and changes in capital requirements for banks have made it more expensive for US financial institutions to hold inventories of bills and bonds. Consequently, if there is a sudden movement out of those instruments by the same money managers that have the movement in, their prices could implode. </p>
<p>Liquidity premiums – the extra yield investors demand to own a security when it can’t be converted easily into cash – would explode, and exchange-traded funds with positions in such assets could find themselves unable to redeem their shares. Officials like Mark Carney, governor of the Bank of England, have been warning of this danger in the hope that warnings will lead investors to be better prepared. Perhaps those warnings will have some effect. Time will tell.</p>
<p>But these, to <a href="http://www.brainyquote.com/quotes/quotes/d/donaldrums148142.html">invoke</a> Donald Rumsfeld, are the “known unknowns.” These are the crisis risks we perceive and for which we are attempting to prepare because they resemble crises past. </p>
<p>There have been bank failures before. The eurozone had a near-death experience in 2012, as I describe <a href="https://global.oup.com/academic/product/hall-of-mirrors-9780199392001?cc=us&lang=en&">here</a>. The sudden surge in yields of which Carney warns would resemble the liquidity crisis that resulted from the failure of the mega-hedge fund Long-Term Capital Management in 1998. These types of crises are likely to be manageable precisely because they have a history.</p>
<p>More dangerous are Rumsfeld’s “unknown unknowns,” the financial crises that come from unanticipated sources. History provides no guidance about their form; all we know is that there will be some. And the other thing financial history tells us for sure is that their impact will be severe.</p><img src="https://counter.theconversation.com/content/34637/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Barry Eichengreen does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The subprime crisis and the subsequent failure of Lehman Brothers came as such a shock – and the repercussions were so severe that when the time came to mount a response, policy makers were as surprised…Barry Eichengreen, Professor of Economics and Political Science, University of California, BerkeleyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/182112013-09-18T13:28:04Z2013-09-18T13:28:04ZBanking’s future depends on learning lessons from the past<figure><img src="https://images.theconversation.com/files/31572/original/6kd9rkyt-1379504850.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">A banking crash killed the Wall St bull market.</span> <span class="attribution"><span class="source">Robin Stevens</span></span></figcaption></figure><p>A bank in trouble negotiates with its regulatory authorities and other banks for support, but is refused a bail out and closes abruptly, sparking a global contraction as its obligations are left unhonoured. Investors stop trusting international capital markets, which freeze and need a quick injection of liquidity. The date: September 2008? No, June 1974. </p>
<p>The collapse of a little known bank in Germany shocked the international banking system, suspended international dollar clearing in New York and exposed a lack of coordination among national supervisors and regulators. </p>
<p>The failure of Herstatt bank happened in the middle of a rash of bank collapses in the summer of 1974 across the US and Europe. Volatile exchange rates combined with fraud and excessive risk-taking to bring down globalising banks such as Hersatt and Franklin National in the US. Many others were rocked by substantial losses, including branches and subsidiaries of Lloyds Bank, UBS and NatWest. </p>
<p>Unlike 2008, the crisis did not go global, since the banks’ losses were relatively small and markets soon recovered. Franklin National was nursed by the US authorities until its remaining assets could be sold off to a European consortium. Lloyds quickly restored the losses from a rogue trader in its Lugano Switzerland branch and recovered its reputation. But the events of that year had lasting effects on the governance of international banking and identified systemic weaknesses that remained unresolved by 2008.</p>
<p>The 1974 crash exposed the vulnerability of national banking systems to imprudent banking habits in an increasingly globalising network. In the early autumn, the central bank governors of the richest economies in the world came together to calm markets, share best practice, and to consider creating an early warning system that would prevent future crises. </p>
<p>But the warning system never happened, instead downgraded to an informal sharing of gossip. Instead, the committee spent its first years exchanging details of their national practices and trying to ensure that all banks were supervised by at least one national authority. </p>
<p>Rules incur costs for banks so supervision needs to be coordinated to avoid banks slipping into unsupervised and risky territories, and to make sure that there are no gaps between national regulators. </p>
<p>Despite the strong rationale for some form of multilateral oversight because of the vulnerability to cross-border contagion in the context of globalised financial markets, national regulators have been stubbornly resistant to giving up their sovereignty in the years since the first warning tremor in the globalised financial system.</p>
<p>1974 represented the beginning of sustained efforts to develop a coordinated framework for international banking supervision. But these efforts to agree minimum international standards failed to prevent the 1982 sovereign debt crisis that nearly brought down the global banking system, or the 1990s emerging market financial crises, or the 2008 global financial crisis. In 1999 the Financial Stability Forum took up the effort to bring G7 national regulators together, but ten years of meetings failed to forestall the global financial crisis. </p>
<p>Some reforms are taking place piecemeal at national level (for example Dodd Frank in the USA and the Financial Services Act in the UK) and through the EU’s banking union proposals. However, earlier plans in the 1980s for a European banking union faltered on the inability of national systems to be standardised or for national interests to be undermined. This does not bode well for similar proposals in Brussels today. </p>
<p>It’s not as though the relevant actors disagree on basic goals. Since 1974 there has been a general consensus on the need for collective effort to ensure solvency and liquidity in international banking by coordinated and comprehensive supervision and regulation of this global industry. But the landscape remains fractured and confusing. </p>
<p>As we reflect on the uneven progress made to shore up the global financial system, it is worth remembering that many of the key weaknesses and obstacles have been recognised and grappled with over several decades. The design of new solutions needs to bear this long and disappointing history of international banking supervision in mind.</p><img src="https://counter.theconversation.com/content/18211/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Catherine Schenk receives funding from ESRC. She is Associate Fellow at Chatham House.</span></em></p>A bank in trouble negotiates with its regulatory authorities and other banks for support, but is refused a bail out and closes abruptly, sparking a global contraction as its obligations are left unhonoured…Catherine Schenk, Professor of International Economic History, University of GlasgowLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/182052013-09-13T15:20:37Z2013-09-13T15:20:37ZResponse to past crises shames post-Lehman dithering<figure><img src="https://images.theconversation.com/files/31314/original/s7mdgtt2-1379076778.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Parliament in the early 1800s: good at resolving banking crises.</span> </figcaption></figure><p>The fifth anniversary of Lehman Brothers’ demise is an opportune moment to take stock and contextualise what has happened since. And one good way to do so is to compare this government’s policy response with a predecessor’s response to an earlier, similar, crisis.</p>
<p>To find a British banking crisis of comparable magnitude we must go back as far as 1825. The UK has actually suffered surprisingly little banking instability in the intervening years. Even events which historians have traditionally classified as banking crises pale into insignificance when compared with the devastation of the 1820s.</p>
<p>So what happened? The Bank of England, initially pursuing a deflationary policy in its attempt to return to the exchange rates prevailing before the Napoleonic Wars, started to expand the money supply in a big way from 1822. With more money came more credit, as the government paid off its long-term debts and gave country banks the right to print small-denomination paper money. All this meant there was a lot of money in the system, fuelling a boom in the stock market and foreign investments.</p>
<p>Then, in the autumn of 1825, bank runs in the west of England spilled over to the City and elsewhere. By December, 30 banks had gone bust, with a further 33 entering bankruptcy in the first quarter of 1826. The Bank of England reluctantly assisted these failed institutions. </p>
<p>A subsequent parliamentary enquiry concluded that the entire credit system and economy in December 1825 was within a few days of collapsing. And the crisis had a significant impact on the real economy: GDP fell by more than 5.9% in 1826, a figure not dissimilar to the collapse in UK GDP in the year following the Lehman debacle.</p>
<p>What was the government’s policy response to this crisis in 1825-6? Parliament acted very quickly to remedy the defects in the English banking system by passing a radical piece of legislation to stabilise the system.</p>
<p>Prior to the crisis, banks in England were restricted to partnerships, and note-issuing banks could have no more than six partners. This kept banks small and poorly capitalised, which made them vulnerable to crises. The new legislation was historic in that banks were permitted to form freely as companies, the first time freedom of incorporation was given to any business sector. Within a decade of its passage, more than 100 large and well-capitalised banks had been established, ushering in a long period of banking stability.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/31327/original/ch33gt2h-1379085308.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/31327/original/ch33gt2h-1379085308.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=279&fit=crop&dpr=1 600w, https://images.theconversation.com/files/31327/original/ch33gt2h-1379085308.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=279&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/31327/original/ch33gt2h-1379085308.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=279&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/31327/original/ch33gt2h-1379085308.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=351&fit=crop&dpr=1 754w, https://images.theconversation.com/files/31327/original/ch33gt2h-1379085308.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=351&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/31327/original/ch33gt2h-1379085308.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=351&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">England’s banking crisis was a source of amusement for this Scottish comic.</span>
<span class="attribution"><span class="source">University of Glasgow Library</span></span>
</figcaption>
</figure>
<p>The history of the recent crisis is well known. In some ways it is still ongoing. What is clear is that the financial landscape has been permanently blighted by the ruins of Lehman and others. The economy has yet to fully recover to its pre-crisis levels. While the crisis was more global in nature than 1825-6 and its causes therefore less tractable by any one country, recent history has demonstrated that it remains the responsibility of national governments to design and implement appropriate policy responses to crises.</p>
<p>What steps, then, has the UK government taken to reform the banking system? The government of Lord Liverpool acted quickly, decisively and radically in 1826. But the governments of Gordon Brown and David Cameron have acted slowly, indecisively and conservatively whenever it has come to the reform of the banking system. Despite parliamentary enquiries, the Independent Commission on Banking and the Turner Review, we have not seen a radical reform of the banking system; rather we have witnessed a tinkering with the pre-crisis regulatory regime.</p>
<p>The 1826 legislation resulted in stable banking as bank shareholders were unlimitedly liable for their bank’s debts. This constrained banks from taking excessive risk. After the global financial crisis of 2008, there has been no radical reform of banking and no attempt to make shareholders have more “skin the game” in the form of substantially higher capital, which would act as a check on excessive risk taking. One lesson of the 1826 reforms is that when the political system responds radically and decisively to a banking crisis, it can introduce reforms that promote stability.</p>
<p>Changes in the global economy since the early nineteenth century go some way towards explaining this absence of regulatory radicalism. The UK is no longer a hegemonic economic and political power, and it is far more difficult for its government to act alone out of fear that others will act against it. The European Union could theoretically facilitate a coordinated policy response, but even there an appetite for serious banking reform has remained absent. Popular demonstrations, hung parliaments and electoral cycles have perhaps acted as appetite suppressants.</p><img src="https://counter.theconversation.com/content/18205/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The fifth anniversary of Lehman Brothers’ demise is an opportune moment to take stock and contextualise what has happened since. And one good way to do so is to compare this government’s policy response…Chris Colvin, Lecturer in Business Economics, Queen's University BelfastJohn Turner, Professor of Finance and Financial History, Queen's University BelfastLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/181732013-09-13T05:16:48Z2013-09-13T05:16:48ZBanking’s Lehman lesson is that change must be cultural<figure><img src="https://images.theconversation.com/files/31270/original/qv83548k-1379013245.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Investment bank for sale, no careful owners.</span> <span class="attribution"><span class="source">John Stillwell/PA</span></span></figcaption></figure><p>This weekend will see the 5th anniversary of the collapse of Lehman Brothers, an event that tipped the world into economic crisis and shoved banking into the spotlight. The critical state of the world’s banks during the crisis has meant nearly everyone seems to have an opinion about how to fix these illusive institutions.</p>
<p>Among all the different opinions seems to be an agreement that banks need to be made safer. This means that they should not undertake risky activities as they had in the past, they should have a better understanding of the risks that they are running, and if they do indeed fail, they should be allowed to fail in a way which does not bring others down with them. </p>
<p>So five years on from the collapse of Lehman, it seems reasonable to ask, how are the banks doing on making themselves safer?</p>
<p>Many of the large UK banks have exited from some of the most risky activities. RBS, for instance, <a href="http://www.ft.com/cms/s/0/8b7d81a8-a0ee-11e1-9fbd-00144feabdc0.html?siteedition=uk&siteedition=uk#axzz2eaSXmrim">wound down or sold off</a> much of its investment banking operations in 2010. This has meant what had previously been very profitable businesses have been closed or significantly scaled back. The decreased appetite for risk has seen most banks become less willing to lend to both individuals as well as small businesses.</p>
<p>In addition to taking fewer risks, banks have changed the way risk is placed in their business. Following the <a href="http://www.theguardian.com/business/2011/sep/12/vickers-report-key-points">Vickers report</a>, banks are planning to “ringfence” more investment banking activities so that they are separated from the retail banking. This measure is supposed to buffer individual savers from the activities of investment banks. However, it does not go as far as some had hoped in separating two types of very different activity.</p>
<h2>Spotting the problems</h2>
<p>The inherent risks carried by the banks was one major issue. But an equally large concern was that most banks did not adequately understand the risks they were carrying. This was because of both how complex their dealings had become and because the way that risks were calculated meant that events that had a small likelihood of happening, but would have major systemic consequences (so-called “<a href="http://www.nytimes.com/2007/04/22/books/chapters/0422-1st-tale.html?_r=0">black swans</a>”), were not accounted for. </p>
<p>But perhaps the most important reason behind the poor understanding of risk in many firms is the fact that entrepreneurial risk taking was highly valued. Those staff tasked with assessing risk were seen as getting in the way of doing business, and their power suffered accordingly.</p>
<p>Following the collapse of Lehman, banks made massive investments in their capacity to understand the risks they are running. “Risk management” has grown from being a painful afterthought to an integral part of a bank’s operations, helped by new technology that tracks and assesses risk.</p>
<p>But there are a number of issues that are more difficult to fix. The real thorny problem is whether the technical expertise that the banks now possess is actually matched with a broader culture of safety and prudence. </p>
<p>Other industries which have sought to become dramatically safer have only done so through a widespread cultural shift. This means routines, procedures and mindsets all geared around reducing unacceptable risks. For instance, the oil and gas industry responded to the Piper Alpha disaster by addressing its <a href="http://www.dailyrecord.co.uk/news/scottish-news/piper-alpha-disaster-prompted-drastically-2028350">gung ho approach to safety</a> through a broader process of cultural change.</p>
<h2>The clean-up job</h2>
<p>Spotting risks is important, but having a plan of what to do when things go wrong is perhaps even more important. One of the stunning insights to come out of the collapse of Lehman is that senior figures did not expect failure and certainly did not know what to do when it happened. Letting Lehman go belly-up was supposed to <a href="http://articles.washingtonpost.com/2009-09-15/opinions/36909411_1_lehman-brothers-moral-hazard-largest-banks">reduce moral hazard</a> by showing banks that they should be cautious because no-one was going to help them out if they ran unacceptable risks. </p>
<p>However, this decision ended up revealing another weakness: that a failure in one part of the system would quickly spread to other parts. To avoid these problems, nation states decided to step in to recapitalize the banks. This resulted in huge holes appearing in national finances and subsequent cuts to public spending. Citizen resentment naturally followed.</p>
<p>The lesson from these episodes appeared to be that letting banks fail is not an option, nor is bailing them out. This has left central bankers looking for solutions, from <a href="http://www.nytimes.com/2013/08/11/magazine/financial-crisis.html?ref=itstheeconomy">increasing the amount of capital</a> that banks hold on their balance sheets to <a href="http://theconversation.com/bail-ins-are-the-new-bail-outs-but-they-wont-save-banking-15826">“bailing-in” failed banks</a>, converting creditors into shareholders.</p>
<p>As the banks look back on the past five years, they can be assured that they have learned some tough lessons. They appear to recognise that they need to change their ways in order to win back public trust. And many of the large banks have made a start. They have appointed more risk averse leaders, they have invested heavily in risk management, and they strengthened their balance sheets.</p>
<p>But there is still plenty to do. Banks need to ensure they do indeed meaningfully separate retail and investment banking. And they need to build a culture that encourages financial safety rather than reckless speculation. This won’t be easy, but it is one risk is worth taking.</p><img src="https://counter.theconversation.com/content/18173/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Andre Spicer does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>This weekend will see the 5th anniversary of the collapse of Lehman Brothers, an event that tipped the world into economic crisis and shoved banking into the spotlight. The critical state of the world’s…Andre Spicer, Professor of Organisational Behaviour, Cass Business School, City, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/120872013-02-11T04:49:13Z2013-02-11T04:49:13ZUK banking reform bill won’t curb reckless risk-taking<figure><img src="https://images.theconversation.com/files/20050/original/jdr86p6k-1360282652.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">More of the same: the UK government's banking reform bill is merely another capitulation to the banking lobby. </span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>Some four and-a-half years after the banking crisis that has resulted in massive public debt and a deep austerity program, the UK government has finally unveiled its <a href="http://www.publications.parliament.uk/pa/bills/cbill/2012-2013/0130/2013130.pdf">Financial Services (Banking Reform) Bill</a> . The Bill is going through parliament and is expected to become law by the end of the year.</p>
<p>The legislation will require UK banks to insulate everyday banking activities associated with savings, deposits and loans from more volatile investment or speculative activities, by introducing a ringfence around the deposits of individuals and businesses. Thus two subsidiaries under the same parent company are envisaged. This separation is advocated because investment banking indulged in excessive risk-taking and accelerated the banking crisis. </p>
<p>Bear Stearns, Lehman Brothers and Northern Rock are often held out as exemplars of this reckless risk-taking. Prior to its <a href="http://news.bbc.co.uk/2/hi/business/7007076.stm">demise</a>, Northern Rock had a leverage ratio (the relationship between total assets and shareholder funds) of 50 while Bear Stearns and Lehman had leverage ratios of 33 and 30 respectively, thus making them highly vulnerable to small declines in the value of their assets. </p>
<p>For five years before its <a href="http://online.wsj.com/article/SB124182740622102431.html">collapse</a>, Bear Stearns generated almost all of its income from speculative activities. About 80% of Lehman’s income came from speculative activities. Other banks also indulged in an orgy of speculation and, by December 2007, the global face value of derivatives stood at <a href="http://www.bis.org/statistics/derstats.htm">$1148 trillion</a>, compared to a global GDP of only $65 trillion. No one can consistently pick winners and, when their financial fortunes turned, it set off a domino effect. </p>
<p>Many counter parties to complex financial instruments were in danger of defaulting on their obligations and thus threatened the collapse of whole system. The UK government bailed out the system with loans and guarantees of nearly £1 trillion.</p>
<p>Critics claim that ringfencing will increase administration costs and capital ratios, leading to reductions in the amount of credit in the economy and thus investment and jobs. The Bill is based on the premise that, in the next banking crisis, the government would rescue the retail side, but would probably let the investment side sink. This threat may discipline banks and spare taxpayers the expense of bailing out the entire system. The ultimate sanction is that if banks do not ringfence satisfactorily by 2019, then the regulator can formally split their operations.</p>
<p>The Bill sounds good, but is unlikely to be effective. It does not impose any personal costs for reckless risk-taking. Ringfencing is not the same thing as a legally enforced separation (two independent entities operating retail and investment banking). The Bill does not say what precisely is to be ringfenced as savings can be placed in many exotic securities. </p>
<p>Derivatives have been described by the US investment guru Warren Buffett as “financial weapons of mass destruction”, but the government has yielded to the banking lobby and will permit banks to locate “simple” derivative products — whatever “simple” means — within their retail banking operations. </p>
<p>What if funds flow from a ringfenced entity to non-ringfenced entity via a foreign subsidiary or affiliate in a place where there is no such separation? Would this be a breach of the ringfence? The Bill does not provide any examples of what a breach of ringfencing looks like, though the Treasury will have powers to prohibit unspecified types of transactions.</p>
<p>The lack of precision will fuel uncertainty and encourage banks to play creative games in deciding which side of the ringfence some assets and liabilities are to be shifted. The regulator is expected to negotiate the details with the banking industry.</p>
<p>Ringfencing will neither hermetically seal investment banking nor prevent its contagious effects from spreading. For its speculative activities, investment banks will continue to raise finance from retail banks, pension funds, insurance companies and others. They will still have the benefit of limited liability. </p>
<p>In the event of losses or a crash, investment banks will be able to dump their losses on to the providers of finance and thus infect the whole financial system, and will inevitably force governments to bail out the system again. The only remedy is to ensure that investment banking is accompanied by unlimited liability: investment banks are free to speculate as long as their owners can personally absorb the losses.</p>
<p>Investment banks may entice corporate executives to provide funds with promises of huge returns, which might boost their performance-related pay, but can land stakeholders with huge losses. Therefore, the Bill should have required that prior to transacting with investment banks, organisations should seek permission from their own stakeholders. </p>
<p>This would have prevented innocent bystanders from becoming the victims of speculators. Perhaps effective reforms will come after the next banking crash.</p><img src="https://counter.theconversation.com/content/12087/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>I receive financial services from banks but do not own shares in any. I do not act as a consultant to any bank and have neither sought nor received research grants from any bank.</span></em></p>Some four and-a-half years after the banking crisis that has resulted in massive public debt and a deep austerity program, the UK government has finally unveiled its Financial Services (Banking Reform…Prem Sikka, Professor of Accounting, Essex Business School, University of EssexLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/97612012-09-24T20:20:44Z2012-09-24T20:20:44ZToo late for Storm, but bank liability the lesson from Wingecarribee<figure><img src="https://images.theconversation.com/files/15784/original/vffj5yz3-1348452666.jpg?ixlib=rb-1.1.0&rect=20%2C35%2C1958%2C1260&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">A rare win for investors: Litigation funder IMF (Australia) helped fund a class action case against Grange Securities, which was found to have misled unsophisticated investors.</span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>Justice Steven J. Rares was blunt when he handed down <a href="http://www.austlii.edu.au/au/cases/cth/FCA/2012/1028.html">his judgement</a> in the long-running class action, Wingecarribee Shire Council vs. Lehman Brothers Australia, last week.</p>
<p>Grange Securities, a subsidiary of Lehman Brothers, had engaged in “misleading and deceptive behaviour” in promoting sub-prime derivatives known as Synthetic Collateralized Debt Obligations to three local authorities in NSW and WA, Justice Rares said. </p>
<p>Led by Wingecarribee Council, a regional council in Bowral in NSW’s Southern Highlands, 72 plaintiffs including councils, charities and churches were found to be entitled to millions of dollars after having been misled into buying toxic investments.</p>
<p>Much already has been, and will be, <a href="http://www.theaustralian.com.au/business/legal-affairs/lehman-found-to-be-liable-for-losses/story-e6frg97x-1226479146991">written</a> about the Wingecarribee case and the judgement. </p>
<p>But of interest here is the fact that the matter went through the full legal process with a hearing in open court and a final judgement made by a senior judge (although there may still be an appeal to a higher court). After considering the evidence, the judge ruled that Lehman was “liable to compensate the councils for [ALL of] their losses incurred as a result of their investments”.</p>
<p>Compare this with the latest settlement in the Storm Financial case. On 14 September, Commonwealth Bank <a href="http://www.abc.net.au/news/2012-09-14/cba-settles-storm-case-with-asic/4262298">agreed</a> to provide $136 million (on top of an earlier payment of $132 million) in compensation to customers who lost money when Storm Financial collapsed in March 2009. The case, brought by the Australian Securities and Investments Commission (ASIC), continues against other banks and Storm itself. Other class actions related to Storm also continue for Commbank.</p>
<p>The timing of the settlement is interesting. On 20 August, CBA released its 2012 annual report, which contained a section on Storm Financial in which the bank noted that it was “close to finalising its resolution scheme for clients of Storm Financial who borrowed money from the Group”. Less than four weeks later, the case with ASIC was wrapped up “without any admission of liability by the Group”.</p>
<p>This is yet another example of banks successfully burying bad news. Doubtless at some time in the future, an enterprising journalist will publish a book on the Storm Financial fiasco when names will be named. But for now, no one has fallen on their sword or been sacked at Commbank over payments totalling some $270 million (not including legal costs) underwritten by the bank’s shareholders. In fact, the Annual Report shows that all Board members received a nice pay rise.</p>
<p>Overseas, it is very different. Earlier this year, the UK banking regulator, the FSA, undertook a “thematic review” of complaints from numerous small companies concerning mis-selling of interest rate hedging products by banks. </p>
<p>When the review was completed, the UK regulator <a href="http://www.fsa.gov.uk/library/communication/pr/2012/071.shtml">ordered</a> the major UK banks to provide redress to any companies affected by mis-selling. The banks complied immediately and apologised. Now that’s regulation.</p>
<p>Thematic review is the new buzzword in regulatory circles. It means looking across the financial system at abuses that may be occurring in more than one institution and is a tool of so-called macro-prudential regulation. In a long overdue <a href="http://www.apra.gov.au/AboutAPRA/Publications/Documents/2012-09-map-aus-fsf.pdf">report</a> into macro-prudential regulation in Australia, jointly published by RBA and APRA, the banking regulator has jumped on the bandwagon and announced its commitment to such cross-industry reviews. </p>
<p>However, APRA has not yet provided details of any areas in which such a review will be undertaken. But the many complaints aired in the recent <a href="http://www.aph.gov.au/Parliamentary_Business/Committees/Senate_Committees?url=economics_ctte/post_gfc_banking/hearings/index.htm">Senate Inquiry</a> on the banking system after the GFC might provide a useful starting point.</p>
<p>The form of words “without admission of liability” has become a cliché whenever cases of bank wrongdoing around the world are settled, usually with a large payment by the banks concerned. So much so that last November, Judge Jed Rakoff of the US District Court in Manhattan had had enough, <a href="http://www.huffingtonpost.com/2012/08/14/jed-rakoff-sec_n_1776300.html">throwing out</a> a settlement between Citigroup and its regulator, the SEC.</p>
<p>Judge Rakoff said that the regulator’s policy of settling cases by allowing a company to neither admit nor deny allegations “did not satisfy the law”. He added that the settlement was “neither fair, nor reasonable, nor adequate, nor in the public interest” because it does not provide the court with sufficient evidence on which to judge the settlement.</p>
<p>The judge’s point is that the regulator is not only the prosecutor, but also the judge and the jury in these settlements. Nor is there independent oversight or appeal. And, as with the Storm case, it is the shareholders, not the wrongdoers, who pick up the tab.</p>
<p>One can sympathise with regulators, especially the SEC, which is inundated with a huge number of cases of bank wrongdoing resulting from the GFC. Banks (correction: shareholders) have deep pockets and can keep litigation going for a long time. On the other hand, regulators must consider the public purse when pursuing cases.</p>
<p>But a case that is judged in court creates case law and legal precedent. For example, as a result of Justice Rares’ judgement, we now know that some of the practices used by Grange were illegal and any banks involved in the same practices, now and in future, can be held to account without a long and expensive trial. Hopefully, regulators will make this point to any banks that may be tempted to follow Grange’s example.</p>
<p>One of the embarrassing facts that emerged from the Lehman trial was that Grange Securities sold these complex and, as it turned out, very risky products to councils and charities with misleading marketing material that praised local banking regulators whose “regulatory requirements make the Australian banking system amongst the safest in the world”. This implied that government would somehow protect the investments sold by Grange. The “safest banking system in the world” is a very powerful meme.</p>
<p>Following the GFC and other scandals, such as the <a href="http://www.guardian.co.uk/money/2012/sep/11/ppi-complaints-1500-a-day-fos">mis-selling of Payment Protection Insurance (PPI)</a> in the UK, governments around the world have beefed up their regulatory environments. One of the key areas that governments have focused on is “financial conduct” especially as regards ordinary consumers.</p>
<p>In the UK, the Financial Conduct Authority (FCA) has been carved out of the banking regulator, the FSA, to focus specifically on the “conduct” of financial services firms not only as regards retail customers but also commercial firms. </p>
<p>In the USA, the Consumer Financial Protection Bureau (CFPB) has been created with a similar mandate, to protect <a href="http://www.consumerfinance.gov/the-bureau/">consumers</a> from “unfair, deceptive, or abusive acts or practices”.</p>
<p>The lesson from these regulatory innovations is that a large single regulator may be too stretched to handle the myriad of issues that can arise in a modern financial system and that smaller and more focussed regulators would do a better job. [This, of course, is a hypothesis that remains to be proven or otherwise]</p>
<p>The new financial conduct regulators in the US and UK have also been given a mandate to improve financial literacy to help protect against financial fraud. In Australia, financial literacy is just one of the regulatory roles assigned to ASIC, along with regulation of financial markets and company registrations.</p>
<p>The ASIC <a href="https://www.moneysmart.gov.au/">Moneysmart</a> web site is primarily aimed at ordinary consumers, giving advice on investing, superannuation and retail credit, such as credit cards. However, as the Lehman case shows, with complex modern investments even finance professionals can have the wool pulled over their eyes.</p>
<p>If one believes that mis-selling of complex financial products could not happen in Australia, there is little need to consider changes to regulatory structures here. However, evidence to the Senate Inquiry would suggest that financial mis-selling was not limited to local councils but was widespread during the property boom of the early 2000s. If so, government should consider whether and how regulatory structures should be changed to meet such challenges.</p>
<p>There is also a need for case law to be clarified surrounding the practices of selling complex financial products. If necessary, the government should, where the law is unclear, be prepared to underwrite legal action by regulators against financial institutions, all the way through the courts until the matter is adjudicated. With the legal certainty of case law, both financial institutions and regulators will be able to move forward on firmer ground. And taxpayers will sleep happier at night.</p>
<p>In those cases where a settlement is agreed, it should be standard practice as part of, and paid for by, the settlement for an independent inquiry to be automatically set up. Since the actions of both regulated and regulator would be considered, such inquiries would be best administered by a truly independent body such as the Australian National Audit Office. To address any open legal concerns, the terms of reference of a particular inquiry would include recommendations from the judge in the settlement.</p>
<p>Wingecarribee shone a light onto dubious financial practices in the Australian marketplace. Such shoddy practices can only be tackled by strong and intrusive regulation, funded and supported by government. There is a need for government to learn all of the lessons from this case.</p><img src="https://counter.theconversation.com/content/9761/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Pat McConnell does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Justice Steven J. Rares was blunt when he handed down his judgement in the long-running class action, Wingecarribee Shire Council vs. Lehman Brothers Australia, last week. Grange Securities, a subsidiary…Pat McConnell, Honorary Fellow, Macquarie University Applied Finance Centre, Macquarie UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/97592012-09-24T00:16:33Z2012-09-24T00:16:33ZUnderstanding the Federal Court’s landmark ruling against Lehman Brothers<figure><img src="https://images.theconversation.com/files/15767/original/hzkfgwr3-1348445553.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The Federal Court has ordered Lehman Brothers to pay hundreds of millions of dollars in compensation to three local Australian councils.</span> <span class="attribution"><span class="source">Ozdos</span></span></figcaption></figure><p>“How was it that relatively unsophisticated Council officers came to invest many millions of ratepayers’ funds in these specialised financial instruments? That is the fundamental question at the heart of these proceedings,” mused Justice Steven Rares, before pronouncing judgement in a case that has far-reaching implications for the regulation of financial services both here and internationally (Wingecarribee Shire Council v Lehman Brothers Australia (in liq) [2012] FCA 1028 at 14).</p>
<p><em>Wingecarribee Shire Council v Lehman Brothers Australia</em> cuts to the heart of both the form and purpose of financial regulation: do investment banks owe fiduciary duties and can these be voided either by contractual terms or legislative exceptions? </p>
<p>The Rares judgement provides the first definitive answer. It finds that Grange Securities, a wholly owned subsidiary of Lehman Brothers, breached its fiduciary duty and engaged in misleading and deceptive conduct in placing highly complex collateralised debt obligations in the portfolios of councils.</p>
<p>The judgement is the first time that the Australian Federal Court has entered these waters since finding in ASIC v Citigroup Global Markets Pty [2007] FCA 963 in 2007 that contractual terms can obviate obligation (at 278).
Curiously, the previous judgement is not referred to in what is a damning indictment of financial engineering and the methods used by its leading practitioners to lure the unwary.</p>
<p>The United States investment bank Lehman Brothers had entered the Australian market through its acquisition of Grange Securities and Grange Asset Management in March 2007. In so doing, it took responsibility for the management of ongoing and prior relationships. These included the provision of transactional services and asset management for a number of local councils. The latter were governed through specific individual management protocols (IMPs). In December 2007, four months after the problems in the US securitisation market became apparent, the business was rebranded as Lehman Brothers Australia and Lehman Brothers Asset Management respectively.</p>
<p>The incoming chief executive was Jim Ballentine. He was acutely aware of the risks associated with complex derivatives. He was interviewed for a <a href="http://www.businessweek.com/magazine/content/05_21/b3934099_mz020.htm"><em>BusinessWeek</em> </a> article as early as 2005 on the risk associated with credit defaults and defective modelling in credit derivatives.</p>
<p>In 2005, Ballentine, as head of structured credit, was partly responsible for Lehman receiving the <em>Euromoney Award for Excellence</em> as “best derivatives house” — an award that the <a href="http://www.euromoney.com/Article/1000868/Awards-for-excellence-Best-credit-derivatives-house.html">magazine claimed</a> was based on the fact that “Lehman Brothers has been one of the more conservative credit derivatives houses … It has protected the bank from the reputational risk that the likes of Barclays Capital and Bank of America have run selling structured credit products”. It was a reputation that was not to last in either the United States or in Australia. Not only was Lehman to spectacularly blow up, the wave of litigation has now brought into question how government itself can protect itself from financial engineers.</p>
<p>The current case involves three local Australian councils representing a class action that includes non-profit and charity claimants. That in itself is interesting. Given the societal implications, it is curious that litigation of this nature was left to commercial funders, listed on the Australian Stock Exchange for profit, rather than the regulator funded by the taxpayer to uphold the public interest.</p>
<p>The Federal Court found that “the improvidence, and commercial naivety, of Grange’s council clients in entering into these transactions, that were highly advantageous to Grange,” (at 266) could only have occurred because the investment bank was dealing with officials variously described as “financially quite unsophisticated and completely out of his depth” (at 483), “uninformed” (at 491), and “careless” (at 462).</p>
<p>Up to this point, “sophistication” had represented a get out of jail card for defendants, who could claim caveat emptor to sway judicial reasoning. The ability to contract out of investor protection mechanisms is central to the rationale behind the bifurcation between sophisticated ( wholesale or professional) and unsophisticated (retail) investors. </p>
<p>In most developed markets, much greater disclosure is required when products or financial advice are offered to retail clients. These restraints are designed to protect the naïve and the unwary from unscrupulous action by those with asymmetrical advantage. Sophisticated investors, by contrast, have traditionally been assumed to have the resources to make informed decisions. The judgement calls into question this critical bifurcation in the <em>Corporations Act</em> and indeed the timidity of its public enforcers to determining how to navigate competing imperatives.</p>
<p>The legislative bifurcation seeks to support financial innovation by offering complex products only to those in a position to evaluate them. Adjudication of sophistication is based on extremely limited criteria, such as wealth or size of specific transactions. There can be no doubting the level of judicial disgust at this crude calculation, a state of affairs worsened “given the subject matter involved, the prudent investment of public money” (at 790).</p>
<p>This also calls into question whether the range of options currently <a href="http://futureofadvice.treasury.gov.au/content/consultation/wholesale_retail_OP/downloads/Wholesale_and_Retail_Options_Paper.pdf">canvassed</a> by the Department of Treasury, which are to (a) retain and update the current system; (b) remove the distinction between wholesale and retail clients; (c) introduce a new sophisticated investor test; or (d) no nothing are sufficient.</p>
<p>“The contrast between the actual, and patent, lack of financial acumen of the various Council officers at each of Swan, Parkes and Wingecarribee and the intelligent, shrewd and financially astute persons at Grange was striking,” said Justice Rares (at 752). “Generally, risk-averse people do not take bets with substantial assets held for public purposes” (at 895). That they did so, could, the court found, be rendered explainable only through an elaborate deception.</p>
<p>What also becomes clear in the reasoning is the extent of the risk that the financial industry has become parasitic on the public interest. Clients were mere patsies, with no “real appreciation of the true risks of SCDOS {synthetic collateralized debt obligations} or the financial wisdom [or otherwise] of its recommendation” (at 265).</p>
<p>Justice Rares is disarmingly forthright: “The nature and risks of a SCDO are concepts that are beyond the grasp of most people … Nonetheless, Grange portrayed itself as an expert in these investments. Most certainly, none of the seven council officers who gave evidence had any expertise in these financial products. Grange knew and preyed on that lack of expertise and the trust the councils placed in its expert advice” (at 410).</p>
<p>In a remarkably detailed judgement, the Federal Court holds that Grange could only do so by actively circumventing the stated objection of its clients. The point is highlighted in dealings with Wingecarribee Council. “Grange tested the water” and when the official “bit” he was “reeled in” by “words of comfort” (at 662). The councils believed that “they had the best of both worlds: principal protection and increased interest. For Grange, this manner of allaying risk averse, financially unsophisticated council officers’ fears of CDOs, was as easy as shooting fish in a barrel” (at 662).</p>
<p>By preying on an arm of government, the deception to society itself was rendered complete.</p>
<p>“Grange was a person who, unlike each of the council officers, had the necessary financial acumen and expertise to be categorised as a ‘sophisticated investor’ … That is the capacity in which each Council engaged Grange to act on its behalf,” rules Justice Rares (at 913).</p>
<p>In so doing, they were failed as much by changes to the law as by the individual executives handling the accounts.</p>
<p>“For many years, all one had to know was that the elegantly simple s 52(1) of the *Trade Practices Act 1974 *(Cth) prohibited a corporation from engaging in conduct, in trade or commerce, that was misleading or deceptive or likely to mislead or deceive … Now the community and the Courts must grapple with a labyrinth of statutes” (at 947).</p>
<p>The Federal Court makes clear its belief that the results have been debilitating for corporate morality, corporate purpose and public order.</p>
<p>“The last thing Grange wanted the Councils to think was that the investment in SCDOs had higher risk than the classes of investments with which the Councils were familiar and comfortable” (at 975). As a direct consequence it is only fair and reasonable that “Grange is liable to the Councils for their claims in contract, in negligence, for misleading and deceptive conduct, as well as for breach of fiduciary duty” (at 984).</p>
<p>As noted above, the Court decision is likely to complicate the Australian Treasury <a href="http://futureofadvice.treasury.gov.au/content/consultation/wholesale_retail_OP/downloads/Wholesale_and_Retail_Options_Paper.pdf">review</a>into how complex financial products were systematically sold to mid-market participants — those that were deemed sophisticated or professional in legal terms but were, arguably, nothing of the sort.</p>
<p>The review heavily references the LBA litigation as the primary rationale for the consultation to redraw the boundary between private rights and public duties. We have yet to hear the outcome of that review. Given the Federal Court decision, we may well have to wait some more. It will be a wait worth having for society, if not for the financial services industry — or indeed the politicians reliant on its support.</p>
<p><em>Justin O'Brien writes a column for The Conversation, The ethical deal, and is director of the <a href="http://www.clmr.unsw.edu.au/">UNSW Centre for Law, Markets and Regulation portal</a>, where this story also appears.</em></p><img src="https://counter.theconversation.com/content/9759/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Justin O'Brien receives funding from the Australian Research Council for four grants related to corporate governance, financial regulation and accountable governance, including an ARC Future Fellowship. This opinion is simultaneously published on an online portal that maps and tracks regulatory reform in the aftermath of the GFC - <a href="http://www.clmr.unsw.edu.au">www.clmr.unsw.edu.au</a>.</span></em></p>“How was it that relatively unsophisticated Council officers came to invest many millions of ratepayers’ funds in these specialised financial instruments? That is the fundamental question at the heart…Justin O'Brien, Professor of Law, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.