Ten years after the financial crisis, the world is still hooked on debt

Lessons have been learned from the crash but its macro-economic cause is too large to legislate for

Next Thursday is the tenth anniversary of the start of the financial crisis, the banking implosion that changed the world, and the way we think about economics, finance and money alongside it. Have we learned the right lessons from this earthquake, such that we can prevent variant forms of it happening again, and if we can’t prevent them, are we at least better equipped to mitigate their crippling costs? On both counts, sadly no.

I was on holiday in Italy on August 9, 2007, and barely noticed the first tremors – the news that the French bank, BNP Paribas, had frozen three of its funds because of an inability to value the complex, mortgage-backed securities that were on their books. Relaxed and filled with the joys of life, I returned to write a column which to this day still shames me.

This was no more than a midcyclical squall, I said, and provided central banks were ready to give markets the liquidity they sought, it would soon blow over. The next day I went to lunch with the chairman of one of Britain’s major banks; within minutes he had shaken me out of my sun-induced complacency. The money markets were basically closed, he told me. Those reliant on wholesale funding would soon be forced onto Bank of England life support. There was already an effective run on banks seen as most vulnerable. Some would go bust. We were at the beginning of a classic banking crisis, he ventured; only time would tell how serious.

Over the next several months, a new world opened up before us. Financial journalists were left scrambling to make sense of collateralised debt obligations, credit default swaps, conduits, capital buffers, liquidity ratios, lender of last resort facilities, and much else besides – all stuff we and the public had previously taken for granted or didn’t know about at all.

Today, the immediate causes of the financial crisis are relatively well understood – reckless, bonus-driven investment bankers, complicit credit rating agencies, excessive leverage in the banking system, out to lunch regulators, undue focus in economics on market fundamentalism, and any number of other financial system weaknesses which in the good times had gone largely unremarked on.

Many of these deficiencies have now been addressed, albeit in unnecessarily heavy handed ways in some cases. Bankers have been brought to heel, credit rating agencies dethroned, banks recapitalised, terrified regulators awoken from their slumbers, and policymakers have become more cognisant of the risks posed to economic wellbeing from financial instability.

But the elephant in the room, the big macro-economic causes of the crisis, are still very much with us. More worrying still, there may be little that can be done about them, for the underlying fault can be summarised in a single word: globalisation. I don’t mean by this simply the free movement of capital across borders, a phenomenon that has come to act like a lightning rod, such that trouble in one market quickly spreads to other economies. I mean the much wider disinflationary forces globalisation has brought to western economies.

These began to gain traction from around the mid-1990s onwards, leading to what became known as the “Great Moderation”, a prolonged period of exceptionally tame inflation and consequent declining interest rates. Many of the conventional characteristics of the economic cycle – whereby rising demand would run up against constrained supply, causing wages and prices to rise, and then central banks to act against them with higher interest rates – went out the window. A combination of emerging markets, mainly Chinese, production and mass migration had made supply virtually limitless.

The apparent abolition of “boom and bust” gave bankers the confidence to take on ever-greater levels of financial risk. By acquiring leverage, they could make fantastical returns – 25 per cent plus. Ever more egregious levels of pay among bankers seemed to become eminently affordable.

Governments were only too happy to go along with the free for all, particularly in New Labour Britain, where “light touch regulation” was worn as a badge of honour. Credit became a politically convenient substitute for the lack of any meaningful wage growth.

Revisiting these big macroeconomic causes of the crisis today, it is obvious that little has changed. If anything, the situation has got worse. Since the crisis, we seem to have got permanently stuck in a low growth, low wage vortex, with negative real interest rates to match. Fighting the crisis with the same thing that caused it – debt – made some sense in its early stages, but that we should still be taking the steroids ten years later promises only to create even greater levels of financial instability.

Hopes of a pick-up in wage and productivity growth have been repeatedly frustrated. Much the same phenomenon is seen across the West, but it is particularly bad in the UK, where real wages remain significantly below pre-crisis levels. Similarly, expectations of a rotation out of consumer led growth into investment and export led expansion have been constantly dashed.

It’s true that private sector debt in Britain and the US has eased, at least in proportion to output, but this is more than made up for by the growth of public debt. In China, responsible for much of the post-crisis growth in the world economy, we have meanwhile seen credit expansion of historically unprecedented proportions. Chinese private, non financial sector debt as a proportion of GDP is now as high as it was in Japan just before the property bubble burst in the late 1980s. It makes the build up in credit seen in the UK and the US ahead of the financial crisis look positively benign.

What is more, come the next recession or crisis, there is nothing left in either the fiscal or monetary locker to throw at it. Public debt is at record peacetime levels, and money could scarcely get any cheaper. Persistently low interest rates have generated further, leveraged “reach for yield” by investors, making the world particularly vulnerable to renewed, speculative asset price booms and busts. So enjoy the summer while it lasts; winter won’t be long in coming.