Can the global financial crisis of 2008 happen again?

Most of us look forward to anniversaries, especially happy ones, but the tenth anniversary of the 2008 global financial crises has brought back some painful memories and raised the question on whether it could happen again today and if any lessons have been learned.

The seeds of that former crisis lay in the belief that a low interest rate environment in the US and by extension to other financial markets could prolong a booming real estate mortgage market.

The problem is that the availability of cheap mortgage credit offered to many who could not financially afford it was a mirage which burst when interest rates began to rise, making the architect of low interest rates the former Federal Reserve Chairman Alan Greenspan admit in hindsight that he was sorry and his belief that the financial system would adjust itself.

But it did not and the spectacular collapse of blue chip names like Lehman Brothers in the US and Northern Rock in the UK shattered that belief, along with the grudging acceptance by the regulators that these financial firms would not be bailed out. A global panic ensued and the rest is history.

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A key element was that as more and more of these synthetic so-called derivative products were launched, with more and more deals that had no real economic substance to them sold, a run on toxic assets affected more solid investments, but in a panic, who is calm enough to sit back and distinguish between the two?

In hindsight, deals were done that should not have been done as the “Masters of the Universe” – the self-styled title these investment bankers gave themselves - only prompted them to seek ever more innovative financial products to make larger profits.

Once the crises became full blown, and the scale of the leveraged and derivative assets outstanding was revealed, the party was over. It would take years for inter party settlements to be sorted out, with huge losses incurred. On a personal level, the banking industry, its ethics, and those that worked in it became distrusted.

There are some ominous signs especially in inward looking trade policies and tariff wars, which could shake the confidence of major economies to invest more for future growth

Dr. Mohamed Ramady

Global economy

The result was that the global economy shrunk, international aid was cut back, people became disillusioned by the whole system leading to the rise of populist leaders wishing to “drain the swamp” like President Trump in the US as well as in Italy, Germany, Austria and France, and a distrust of the multilateral world order with the UK’s Brexit movement.

Bank regulations were reformed, higher bank capital ratios were mandated, and borrowing was tightened, despite a lurking suspicion that the old adage of “too big to fail” for some institutions will always be there to protect the largest from failing and creating a contagion in the market.

Can another global financial crisis happen again? There are some ominous signs especially in inward looking trade policies and tariff wars, which could shake the confidence of major economies to invest more for future growth.

There are indications that, despite those who do not believe in current warning signs, climate change and the severity of storm and unseasonal global weather pattern could create economic instability on a major scale that affects the global insurance sector.

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While more stringent regulations have been installed to ensure that banks and other financial institutions do not offer products that cannot be verified as to final output, the pace of technology and financial innovation that goes with it could create another hidden time bomb.

However, while European regulators are trying to ensure that there is more stress testing of their banks, in the US the Trump administration is trying to de regulate and loosen the Dodd–Frank Act to enforce stricter regulation following the 2008 crisis , especially by changing annual bank stress tests and rules on proprietary trading.

There are other hidden concerns too. The recent collapse of the Turkish lira has highlighted the issue of banks holding foreign corporate debts, estimated at around $ 66 trillion.

These are mostly in emerging markets which took advantage of low dollar interest rates to borrow but raising questions now on the credit quality of debt , especially in countries like Turkey that are trying to repay back these debts in depreciating currencies.

The oil industry

The US fracking oil industry is also highly leveraged with many companies trading at junk bond status and again the question arises on the viability of these companies if dollar interest rates rise further and oil prices fall sharply in the face of weaker oil demand due to worsening trade disputes.

Non-bank mortgage lending has increased over the past decade, with these lenders providing bank like services but without taking deposits and this is compounded by the rise of so-called shadow banking, representing around 13 percent of the global financial system, with a large percentage in China.

Not having learned from the mistakes of the earlier financial crisis, there are now Collateralized Loan Obligations (CLO’s), eerily reminiscent of the toxic Collateralized Debt Obligations, except that the CLO reincarnation is securitizing leveraged business loans into tranches.

Exchange Traded Funds are now very popular, tracking the performance of indexes, commodities or bonds and trade on exchanges, with around $ 5 trillion of these ETF’s traded today. But the ETF’s have been helped by a sharp rise in the US and other stock markets, but what happens of this bull run falters due to trade war uncertainties?

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Technology has also spawned a new breed of financial trading with High Frequency Trading (HFT) generating larger profits by posting trades faster than usual, but could aggravate market swings in times of stress.

The so-called Fintech – non bank financial technology that seems to be the flavor of the day – has expanded credit and bank loans but these are not collateralized and can cause heavy losses to Fintech companies if customers default in economic downturns, especially by poor credit borrowers exposed to international trade effects.

But some good also came out from the global financial tsunami, especially from among those that worked in the sector, especially those young aspiring graduates who had looked forward to a long and profitable banking career.

Finding themselves literally dumped on the street on a few moments notice as their banks closed down in bankruptcy, some have swapped business suits for more ordinary aprons and workers clothes and tried to make a new living in the real economy.

To their credit, many of these young people wanted and did create something out of their misfortune, swallowed their pride and hopefully achieved a happier and more ethical life instead of their earlier greed and bonus driven environment.

As for the older managers and their generation, they could also become our eyes and ears and ensure that they examine critically new banking and investment products to assess their risk, with many probably wishing they had the courage to do this when they were at the helm of their old institutions.

It is going to be a hard and long road but banking can and should once again become an honorable profession to aspire to for the service of the community.

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Dr. Mohamed Ramady is an energy economist and geo political expert on the GCC and former Professor at King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia and co-author of ‘OPEC in a Post-Shale World – where to next ?’. His latest book is on ‘Saudi Aramco 2030: Post IPO challenges’.

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Last Update: Wednesday, 20 May 2020 KSA 09:57 - GMT 06:57
Disclaimer: Views expressed by writers in this section are their own and do not reflect Al Arabiya English's point-of-view.
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