Lessons from global financial crisis that shouldn’t be lost
A lesson learned should lead to meaningful changes by individuals and institutions. That has largely been the case in the decade since the financial crisis almost tipped the global economy into a prolonged depression that would have devastated livelihoods for at least a generation. But there are also consequential lessons that haven’t been sufficiently internalised; and some that were not foreseen at the time of the crisis but are now urgent and important.
Here’s a summary scorecard of post-crisis accomplishments, unfinished business and unintended consequences.
Accomplishments
● A safer banking system. Thanks to strengthened capital buffers, more responsible approaches to balance sheets and better liquidity management, the banks no longer present a major systemic risk in most advanced countries, and especially the US. That doesn’t mean every country and bank is safe; but the system as a whole is no longer the Achilles’ heel of market-based economies.
● A more robust payments and settlement system. The strengthening of the banking system has been part of a highly successful, broader effort to minimise the risk of “sudden stops” in the payments and settlement mechanisms at the core of the global economy — that is, a loss of trust in counterparts that freezes even the most basic financial transactions, paralysing economic interactions.
● Smarter international cooperation. At the top of the “to-do list” are steps such as improved harmonisation of strengthened regulation and supervision, more timely and comprehensive information-sharing, and greater focus on the challenges of monitoring internationally active banks.
Slippages
● Still-elusive inclusive growth. It took far too long for policy makers in advanced countries to realise that the great recession caused by the financial crisis had important structural and secular components. An excessively cyclical mindset initially impeded the design and implementation of the measures needed to generate high and inclusive growth. By the time mindsets evolved, the political window had narrowed. Most advanced countries have yet to adopt measures to durably boost growth.
● Misaligned internal incentives. Judging from headline-grabbing incidents of inappropriate behaviour and processes in recent years, the sticks and carrots in place in some financial institutions need work. These institutions still contain pockets of improper risk-taking and other unsuitable conduct.
● A scarcity of “patient” balance sheets. Putting challenged and damaged securities in ring-fenced balance sheets was key to containing the huge financial disturbances. This involved reliance on large public balance sheets, though their use was increasingly met by social and political pushback. Concerns about distributional effects, including favouring corporate profits at the expense of wages, Wall Street at the expense of Main Street, and the rich at the expense of the poor, have added to what is now a reduced availability of these tools for use in future crises.
Unintended consequences
● The big got bigger, the small more complex. Although progress has been made on what to do when a bank fails, especially a large one, the market structure that emerged from the financial crisis involves significantly larger institutions, particularly USbased ones. The same phenomenon of the big having gotten bigger can be seen in asset management. It has come at the expense of a gradual hollowing out of the middle of the distribution of financial firms.
● Risk has morphed and migrated to underregulated areas. This change in market structure is connected to another phenomenon: the morphing and migration of risk to non-banks. This dynamic is particularly notable in the extent to which, benefiting from years of ample global liquidity and unusually low financial volatility, there has been an over-promising of liquidity provision and excessive volatility-selling in its many forms.
● Reduced policy flexibility. There is limited “dry powder” to rely on in the event of a crisis because interest rates are still floored at zero or below in much of the advanced world outside the US, central banks’ balance sheets are already large, and debt levels are significantly higher than before the global financial crisis. This suggests that, even if there is sufficient political will, the ability to crisis manage and recover may be diminished.
Renewed efforts by both the public and private sectors are needed to deal with longstanding challenges that received inadequate attention in the aftermath of the crisis, and to understand and address some of the major unintended consequences of 10 years of crisis management and prevention.