Ten years on, the long shadow of the fi­nan­cial cri­sis en­dures

The Globe and Mail Metro (Ontario Edition) - - REPORT ON BUSINESS - DAVID PARKIN­SON BAR­RIE MCKENNA

David Parkin­son and Bar­rie McKenna re­port on the cost of sav­ing the global econ­omy

It’s ap­par­ent that sav­ing the world came at a price. The global econ­omy, al­though bet­ter and health­ier, has still not re­turned to its nor­mal state as busi­ness in­vest­ment, wage growth and em­ploy­ment con­tinue to lag

In mid-Septem­ber of 2008, as Henry Paul­son stood face-to-face with one of the most dan­ger­ous fi­nan­cial melt­downs in his­tory, his days were so hec­tic that he didn’t have time to fear he might screw it all up. But at night, the U.S. trea­sury sec­re­tary would lie awake, stare into the dark­ness and be­come over­whelmed with doubt.

“In the night, lit­tle prob­lems seem big, and big prob­lems seem in­sur­mount­able,” Mr. Paul­son re­called this week in Wash­ing­ton, dur­ing a panel dis­cus­sion com­mem­o­rat­ing the 10th an­niver­sary of the col­lapse of U.S. in­vest­ment bank Lehman Broth­ers. “I would look into the abyss and see food lines, see an­other Great De­pres­sion.”

The cri­sis had been build­ing since 2007, but Lehman’s bank­ruptcy fil­ing on Sept. 15, 2008, was a piv­otal event – the domino that top­pled so many oth­ers. Within hours, fail­ing in­vest­ment bank Mer­rill Lynch was pur­chased in a fire sale by Bank of Amer­ica, fail­ing in­sur­ance gi­ant Amer­i­can In­ter­na­tional Group was saved by a mas­sive govern­ment res­cue plan, and fears mounted about just how deeply and widely the fi­nan­cial sys­tem was in­fected with toxic as­sets.

Mar­kets went into freefall, and in­vestors barred up their doors. Au­thor­i­ties around the world raced against time to stanch the bleed­ing, halt the spread and get fresh money flow­ing through a fi­nan­cial sys­tem that was in real dan­ger of seiz­ing up en­tirely.

Mr. Paul­son looks pretty re­laxed talk­ing about it now. Sit­ting in an easy chair along­side two other key play­ers in U.S. eco­nomic pol­icy a decade ago – for­mer Fed­eral Re­serve chair­man Ben Ber­nanke and Tim Gei­th­ner, who was head of the pow­er­ful New York Fed­eral Re­serve when the cri­sis be­gan and Pres­i­dent Barack Obama’s trea­sury sec­re­tary when it ended – Mr. Paul­son can live com­fort­ably in the knowl­edge that he and his col­leagues suc­ceeded where and when it mat­tered most.

The cri­sis was cer­tainly painful: In the en­su­ing months, stock mar­kets lost half their value, cen­tral banks cut their in­ter­est rates to near zero, the North Amer­i­can auto in­dus­try re­quired a govern­ment bailout and al­most half a mil­lion Cana­di­ans and six mil­lion Amer­i­cans lost their jobs. But the con­sen­sus is that the fis­cal, mon­e­tary and reg­u­la­tory pol­icy moves made in the United States, Canada, Europe and else­where saved the world from an all-out col­lapse of the fi­nan­cial sys­tem – and a sec­ond Great De­pres­sion.

But a decade af­ter the Lehman tip­ping point, it’s ap­par­ent that sav­ing the world came at a price. The global econ­omy, though health­ier, has still not re­turned to nor­mal.

Growth has been frus­trat­ingly slow. The global econ­omy has never re­cov­ered all that it lost – has never got­ten back on the tra­jec­tory it was on prior to the cri­sis. Growth in wages has been stub­bornly weak.

Busi­ness in­vest­ment and trade growth have failed to re­cover.

In­ter­est rates set by cen­tral banks re­main far lower than his­tor­i­cal norms, which has en­cour­aged ex­ces­sive risk-tak­ing in cap­i­tal mar­kets and has fu­elled record global debts.

Some of these are old prob­lems that proved hard to re­solve, or re­turned as the econ­omy and fi­nan­cial mar­kets clawed their way out of the deep hole dug by the re­ces­sion.

Other is­sues were ex­ac­er­bated by the cri­sis. But some of the world’s cur­rent set of eco­nomic ills can be linked to the un­prece­dented pol­icy ac­tions – fis­cal, mon­e­tary and reg­u­la­tory – taken to stave off to­tal dis­as­ter dur­ing the cri­sis.

“When you’re in a cri­sis, by ne­ces­sity you have to shorten your hori­zon. You don’t have the lux­ury of think­ing about long-term struc­tural con­se­quences. The first pri­or­ity was to sta­bi­lize the fi­nan­cial sys­tem,” says Tiff Mack­lem, dean of the Uni­ver­sity of Toronto’s Rot­man School of Man­age­ment, who, as sec­ond-in-com­mand at the Bank of Canada a decade ago, played a key role in erect­ing Canada’s own cri­sis de­fence strat­egy.

“There’s no doubt that it has had some un­in­tended con­se­quences.

“The cri­sis has cast a very long shadow.”


The cur­rent re­cov­ery is one of the long­est on record – but also one of the weak­est. In the decade lead­ing up to the cri­sis, Canada’s econ­omy was grow­ing an av­er­age of al­most 3 per cent a year. Be­tween 2009 and 2017, growth av­er­aged just 1.7 per cent a year.

The global econ­omy has sim­i­larly slowed, grow­ing an av­er­age of 2.9 per cent a year since the cri­sis, down from 3.3 per cent a year from 1999 to 2008.

The cri­sis has also left deep wounds – af­fect­ing com­pa­nies, work­ers and, more broadly, con­fi­dence. “One of the last­ing lega­cies of the fi­nan­cial cri­sis is psy­cho­log­i­cal scar­ring,” says Craig Alexan­der, se­nior vice-pres­i­dent and chief econ­o­mist at Deloitte Canada. “Even though it’s been 10 years, peo­ple still re­mem­ber what a bad re­ces­sion looks like.”

Com­pa­nies, in par­tic­u­lar, re­main ex­traor­di­nar­ily risk-averse, and that is still weigh­ing heav­ily on their de­ci­sions. Cor­po­rate prof­its bounced back af­ter the cri­sis, but com­pa­nies are still re­luc­tant to spend and de­plete their cash re­serves. Cana­dian busi­nesses have not been spend­ing enough to re­place old ma­chin­ery and equip­ment, let alone make new in­vest­ments.

“All these com­pa­nies are be­hav­ing ra­tio­nally,” Mr. Alexan­der ex­plains. “But when all those busi­nesses act in the same cau­tious, risk-averse way, you end up with an econ­omy that is un­der-in­vest­ing.”

The slow pace of the re­cov­ery is typ­i­cal of the af­ter­math of a fi­nan­cial cri­sis, says McGill Uni­ver­sity econ­o­mist Christo­pher Ra­gan, a mem­ber of Fi­nance Min­is­ter Bill Morneau’s Ad­vi­sory Coun­cil on Eco­nomic Growth.

The combination of rat­tled busi­ness con­fi­dence and the delever­ag­ing of fi­nan­cial in­sti­tu­tions is like a dou­ble whammy for the econ­omy.

“It’s an un­usu­ally slow re­cov­ery if this had been a nor­mal re­ces­sion, but it’s a nor­mal re­cov­ery from a fi­nan­cial cri­sis,” he says.

The cri­sis isn’t en­tirely to blame for slower eco­nomic growth. De­mo­graph­ics are also at play. In 2011, the first mem­bers of the mas­sive baby boom gen­er­a­tion be­gan hit­ting 65 and re­tir­ing in droves. With each pass­ing year, more leave the work force, slow­ing the growth of the labour mar­ket, which is a key driver of growth.

On the sur­face, the job mar­ket ap­pears to have re­cov­ered strongly in North Amer­ica: Un­em­ploy­ment in Canada re­cently dropped to its low­est rate since 2007, while U.S. un­em­ploy­ment re­cently dipped to its low­est since 2000.

But the labour force has yet to get back to its pre-cri­sis state – and it may never. Many work­ers, par­tic­u­larly in man­u­fac­tur­ing, lost jobs that no longer ex­ist, ei­ther due to au­to­ma­tion or be­cause fac­to­ries moved else­where. Canada’s labour force par­tic­i­pa­tion rate – the share of the work­ing-age pop­u­la­tion that is em­ployed or ac­tively look­ing for work – re­mains lower to­day than it was in Au­gust, 2008, at 65.4 per cent ver­sus 67.4 per cent – the equiv­a­lent of about 590,000 fewer peo­ple in the labour force.

The Great Re­ces­sion also put a dent in global de­mand for many of the com­modi­ties that Canada ex­ports, send­ing the price of oil and other re­sources plung­ing. Prices for many of these com­modi­ties re­main be­low pre-cri­sis lev­els.


The pop­u­lar per­cep­tion is that gov­ern­ments bailed out bankers in the cri­sis while leav­ing peo­ple on Main Street to fend for them­selves. To an ex­tent, it’s true.

No doubt the cri­sis would have been much worse with­out the ex­traor­di­nary in­jec­tion of cheap money into the global econ­omy by cen­tral banks. But the ben­e­fits of all that liq­uid­ity have not been spread equally across so­ci­ety, widen­ing the gap be­tween the mid­dle class and the very wealthy, par­tic­u­larly in the United States.

That’s be­cause low in­ter­est rates cre­ated a prop­erty and stock mar­ket boom, which boosted the wealth and power of share­hold­ers. But they also pun­ished savers, in­clud­ing pen­sion funds and their ben­e­fi­cia­ries.

“Low in­ter­est rates stim­u­late as­set price in­fla­tion, and that’s where the one per cent live,” ex­plains econ­o­mist Dan Ci­uriak, for­mer deputy chief econ­o­mist at Global Af­fairs Canada. “We’ve come out of the cri­sis with more or less full em­ploy­ment, but we have de­pressed wages, el­e­vated cor­po­rate prof­its and dis­torted in­come dis­tri­bu­tion.”

Low in­ter­est rates have also af­fected the rel­a­tive value of ma­chines ver­sus peo­ple in the minds of em­ploy­ers, ac­cord­ing to Mr. Ci­uriak. And that’s hold­ing back wage growth.

“Why pay for labour if you can buy a ma­chine with cheap money?”

Wages in the world’s wealth­i­est coun­tries are now grow­ing at a mea­gre 1.2 per cent a year, af­ter fac­tor­ing in in­fla­tion, ac­cord­ing to the Or­ga­ni­za­tion for Eco­nomic Co­op­er­a­tion and De­vel­op­ment’s re­cently re­leased an­nual em­ploy­ment out­look. That’s down from 2.2 per cent be­fore the fi­nan­cial cri­sis.

In­come in­equal­ity, par­tic­u­larly in the U.S., has grown much worse. But it has also be­come more pro­nounced in Canada, where there has been a “pulling away” of top in­come earn­ers from those in the mid­dle, says Dal­housie Uni­ver­sity econ­o­mist Lars Os­berg. That, in turn, has cre­ated envy and re­sent­ment among the mid­dle class, says Prof. Os­berg, who traces a di­rect line be­tween greater in­equal­ity and the global rise in pop­ulist po­lit­i­cal move­ments.

“If you gen­er­ate crap out­comes for peo­ple over a long pe­riod of time, they are go­ing to get pissed off with their po­lit­i­cal lead­ers,” ar­gues Prof. Os­berg, au­thor of The Age of In­creas­ing In­equal­ity.

Many Cana­di­ans are feel­ing a height­ened sense of eco­nomic in­se­cu­rity be­cause their wages are stag­nant and they’re wor­ried they won’t have enough money to re­tire, he adds. “Canada as a whole gained ma­te­ri­ally from eco­nomic growth,” Prof. Os­berg added.

“It’s just that the gains are shared out very dif­fer­ently. That mat­ters eco­nom­i­cally, but also po­lit­i­cally and so­cially.”

Un­for­tu­nately, govern­ment pol­icy-mak­ers didn’t pay a lot of at­ten­tion to in­come dis­tri­bu­tion be­fore the last re­ces­sion, says labour econ­o­mist Miles Co­rak, a pro­fes­sor at the City Uni­ver­sity of New York and the Uni­ver­sity of Ot­tawa. Now, they’re pay­ing the price.

“The fact that peo­ple are feel­ing more in­se­cure about the world is fer­tile territory for pop­ulism to grow,” Prof. Co­rak says.

Mr. Mack­lem agrees that the cri­sis ac­cel­er­ated in­equal­ity and helped fuel the rise of pop­ulism.

But he says it’s un­fair to blame it for ev­ery­thing that’s hap­pened to the econ­omy and the labour mar­ket dur­ing the past decade of re­cov­ery.

“A lot has hap­pened in 10 years,” Mr. Mack­lem says. “Tech­nol­ogy has changed dra­mat­i­cally – the pace of tech­no­log­i­cal change has ac­cel­er­ated, the world has gone mo­bile. Ar­ti­fi­cial in­tel­li­gence, ma­chine learn­ing, blockchain are fun­da­men­tally chang­ing the cost struc­ture of busi­nesses. Asia is an in­creas­ing share of the global econ­omy.”

Mr. Ber­nanke, who was chair­man of the U.S. Fed­eral Re­serve from 2006 to 2014, bris­tles at crit­ics who say cen­tral banks’ ag­gres­sive easy-money poli­cies – in­clud­ing the Fed’s use of quan­ti­ta­tive eas­ing, which in­volved buy­ing fi­nan­cial as­sets in or­der to di­rectly in­ject money sup­ply into the fi­nan­cial sys­tem – handed wealth to the elites of Wall Street while leav­ing out the masses.

“Yes, [QE] sup­ports as­set prices,” he said at the panel dis­cus­sion in Wash­ing­ton.

“But it also has con­trib­uted to 16 to 17 mil­lion new jobs. What is more im­por­tant for the mid­dle class than job cre­ation?”

Govern­ment spend­ing, not mon­e­tary pol­icy, is the best way to deal with in­equal­ity, he ar­gued.

“The Fed has a sin­gle tool, ba­si­cally: in­ter­est rate pol­icy,” Mr. Ber­nanke said. “Its job is to sta­bi­lize em­ploy­ment and keep in­fla­tion close to tar­get.”


But in do­ing that job, the world’s cen­tral banks have kept in­ter­est rates so low for so long that they have spawned a mas­sive build-up in debt.

The In­sti­tute of In­ter­na­tional Fi­nance cal­cu­lates that to­tal global debt – govern­ment, cor­po­rate and con­sumer – stood at a record US$247-tril­lion in the first quar­ter of this year. That’s al­most 40-per-cent higher than in the first quar­ter of 2008 – a debt bur­den that was a ma­jor con­trib­u­tor to the fi­nan­cial cri­sis.

The global debt-to-GDP ra­tio stands at 318 per cent, up more than 30 per­cent­age points since the Lehman col­lapse.

Govern­ment debts are al­most dou­ble their pre-cri­sis lev­els, largely the re­sult of mas­sive in­jec­tions of spend­ing dur­ing the re­ces­sion in or­der to stim­u­late their near-par­a­lyzed economies. In Canada, net fed­eral debt has topped $650-bil­lion – up al­most $200-bil­lion from pre­cri­sis lev­els.

For the pri­vate sec­tor, the decade of low bor­row­ing costs has been like debt rocket fuel.

Debt in the fi­nan­cial sec­tor is at a record high, while non-fi­nan­cial-sec­tor cor­po­rate debt is up more than 60 per cent. House­hold debt, too, in the world’s ad­vanced economies is at record highs.

In Canada, the in­flu­ence of low-for-long in­ter­est rates has been most ev­i­dent among con­sumers. The ra­tio of house­hold debt to dis­pos­able in­come stands at a near- record 169 per cent – 20 per­cent­age points higher than when the cri­sis hit.

A lot of that rep­re­sents mort­gage debt. Low wage growth plus sky­rock­et­ing hous­ing prices in many mar­kets equals much big­ger loans for many fam­i­lies. The re­sult­ing dou­ble-bar­relled prob­lem – over­bur­dened house­hold bal­ance sheets and un­sus­tain­ably high real es­tate values – now stands as the big­gest risk to Canada’s eco­nomic and fi­nan­cial sta­bil­ity.

Uni­ver­sity of Ot­tawa po­lit­i­cal sci­en­tist Jac­que­line Best ar­gues that at the root of the prob­lem was an over­re­liance by pol­icy-mak­ers on the blunt in­stru­ment of in­ter­est rates to get the global econ­omy back on course, as many gov­ern­ments with­drew their fis­cal stim­u­lus too soon. “Cen­tral banks are not de­signed to do that kind of heavy lift­ing on their own,” she says. “If you put all the weight on mon­e­tary pol­icy, you end up creat­ing all sorts of per­verse in­cen­tives.”

Now that cen­tral banks have be­gun to in­crease rates – es­pe­cially in the United States, whose rates heav­ily in­flu­ence global debt mar­kets – the cracks in this huge global debt wall have be­gun to show, par­tic­u­larly in some emerg­ing mar­kets. Over the sum­mer, we’ve seen Ar­gentina, Turkey and Venezuela teeter to­ward cri­sis.

Ex­perts warn that this global debt moun­tain is prob­a­bly the big­gest source of risk.

And the re­turn of in­ter­est rates to more nor­mal lev­els by the world’s cen­tral banks – a process that is ex­pected to be a key theme over the next few years – rep­re­sents a se­ri­ous test for the post-cri­sis econ­omy.

“Where we ex­pect [the next threat of cri­sis] to come from, rea­son­ably, now, is ex­ces­sive tight­en­ing of mon­e­tary pol­icy – which would cause sig­nif­i­cant cur­rency val­u­a­tions, in­crease in the cost of fi­nanc­ing [and] cap­i­tal flow moves that would leave heav­ily in­debted sov­er­eigns and cor­po­rates at risk,” said IMF head Christine La­garde in an in­ter­view pro­duced by the agency to mark the Lehman an­niver­sary.

Low-for-long in­ter­est rates also fu­elled in­creased risk-tak­ing in cap­i­tal mar­kets, as in­vestors have sought out re­turns wher­ever they can find them in a low-yield en­vi­ron­ment. In the stock mar­ket, where the U.S. bench­mark S&P 500 in­dex has surged more than 50 per cent in the past three years de­spite po­lit­i­cal tur­moil and ris­ing in­ter­est rates, which usu­ally weigh down eq­ui­ties, the word “bub­ble” has be­come a rou­tine part of the con­ver­sa­tion.

Mean­while, more than US$3-tril­lion of cor­po­rate bonds – roughly half of the in­vest­ment-grade cor­po­rate bond mar­ket – is now made up of se­cu­ri­ties rated BBB by the bond-rat­ing agen­cies, just one notch above junk sta­tus.

“This is the junki­est cor­po­rate bond mar­ket in recorded his­tory,” says David Rosen­berg, chief econ­o­mist at Toronto-based in­vest­ment firm Gluskin Sh­eff + As­so­ci­ates Inc.

“It’s triple what sub­prime [mort­gage debt] was at the peak of the last cy­cle. This clas­si­fies as a huge debt bub­ble. And ul­ti­mately, what ends these bub­bles is the Fed rais­ing in­ter­est rates.”


But it’s not all gloom and doom. De­spite of the warts, the global econ­omy looks as good as it has in years. And the fi­nan­cial cri­sis did re­sult in im­por­tant safe­guards – most no­tably, in­creased cap­i­tal-re­serve re­quire­ments at the world’s banks – that bet­ter cush­ion fi­nan­cial in­sti­tu­tions against the kind of shocks that set the domi­noes fall­ing a decade ago.

Still, if the fi­nan­cial cri­sis taught us any­thing, it’s that crises are near im­pos­si­ble to fore­see, let alone avoid. And com­pla­cency in good times – al­low­ing the econ­omy’s prob­lems to fes­ter – can leave the sys­tem more vul­ner­a­ble to a shock and more dam­aged by its im­pact. Still grap­pling with the af­ter­shocks of the cri­sis, many cen­tral banks and gov­ern­ments have less fire­power to deal with what may come next.

And po­lit­i­cally, there are some badly dam­aged fences to mend. Faith in gov­ern­ments and in­sti­tu­tions re­mains badly shaken. Pop­ulism and trade pro­tec­tion­ism con­tinue to in­ten­sify be­cause too many peo­ple feel in­se­cure, cheated and left be­hind.

It’s hard to shake the per­cep­tion that Wall Street bankers won. They got a bailout and went back to busi­ness as usual.

Out on Main Street, the re­ver­ber­a­tions of the fi­nan­cial cri­sis are still rip­pling out­ward.

A lot has hap­pened in 10 years. Tech­nol­ogy has changed dra­mat­i­cally – the pace of tech­no­log­i­cal change has ac­cel­er­ated, the world has gone mo­bile. TIFF MACK­LEM, DEAN OF THE ROT­MAN SCHOOL OF MAN­AGE­MENT


ormer U.S. ed­eral Reser e oard chair­man Ben Ber­nan e spea s at the con­fer­ence along­side Mr. Gei­th­ner. He says that the ed’s o is to sta ili e em­ploy­ment and eep in­fla­tion close to tar­get.’


ormer U.S. trea­sury sec­re­tary Tim Gei­th­ner re­sponds to ues­tions at a con­fer­ence in Wash­ing­ton mar ing the 10th anni er­sary of the fi­nan­cial cri­sis.


Traders work in the prod­uct op­tions pit at the New York Mer­can­tile Ex­change in 2008. A decade ago, as Lehman Broth­ers went bust and the frag­ile fi­nan­cial sys­tem was tee­ter­ing, fund in­vestors won­dered how bad it could get.

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