The legitimacy of capitalism was undercut, and is unsteady still.
August 11, 2017
Anyone who worked in finance at the time will have vivid memories of August 2007. Earlier that summer, when Bear Stearns liquidated a hedge fund subsidiary specialising in mortgage assets, it could have been anomalous. But then a major US mortgage lender went bankrupt and French bank BNP Paribas froze withdrawals from three mortgage-linked funds. Something was going badly awry in US housing credit. The question was who was exposed and by how much. Those who set about trying to find out made a frightening discovery: nobody seemed to know.
That opacity helped to transform the deflation of an asset bubble into a global credit crisis. In the preceding years, global imbalances and low real interest rates sent capital hurtling into the US housing market, which was seen as a one-way bet. A newly minted mortgage-asset securitisation industry had turned the borrowed capital into very liquid but little-understood securities.
When house prices tumbled, it became clear that it was hard to assess the value of these securities, or even who stood to absorb the losses. Market participants could only conclude that it was dangerous to own bank securities generally or to extend even short-term credit. The freeze in money markets hit global banks that had leveraged their balance sheets to astonishing levels. They could not bear the strain.
The rest - bank bailouts, recession, central bank intervention - is history. The history is unspooling still, and not just in easy monetary policy and swollen central bank balance sheets. This week, two US home rental companies announced they would merge, forming a company worth $20bn. Between them, the companies rent out 82,000 homes, mostly in Florida and the Southwest, the epicentres of the US housing crash. This is not coincidental. The financiers behind the two companies bought many of the houses at bankruptcy auctions in the wake of the crisis. The merger will consolidate the large profit they have already made.
Financial crises end because market prices for tainted assets are established and credit flows again. In this case, only dramatic action by government made that possible. The merger is a small example of the success of that intervention. Commodity groups that nearly went under are in a sweet spot, and infrastructure companies enjoy rock-bottom financing costs. Corporate profits are near all-time highs.
The legacy of the crisis and the response also have a darker aspect, however. The people who owned those rental homes a decade ago, and lost them to the crisis, have had a bad 10 years. Jobs have returned in the US, but real wages in the US have been stagnant. The country’s output is a fifth or a sixth lower than it would be had the crisis not occurred. Productivity growth has been weak. This basic economic pattern holds in much of the western world. The delirious ascent of bond and equity markets, supported by co-ordinated accommodation by central banks, has done little to help the people whom the crisis hurt the most.
Meanwhile, the financial system looks a lot like the pre-financial crisis one. Yes, banks are better capitalised than they were, and the pure investment banks that depended on short-term financing are gone or absorbed into deposit-funded institutions. But despite years of hand-wringing about too big to fail, the big banks are more dominant than ever. If malfeasance played a role in the crisis, virtually no one has been successfully prosecuted for it. Billions in settlements paid by banks for their bad behaviour - money supplied by the stock and bond markets - does little to diminish the sense that no one has been held accountable.
The uneven nature of the recovery compounds the most important legacy of the crisis. The moral credentials of capitalism were tarnished. Free trade and globalisation are suspect to many leaders of the right and the left. Trust in political, financial, and economic elites is diminished and know-nothing populism appears to have become a permanent feature of the political culture of the west.
Capitalism invites crisis and brings wrenching changes. The pre-crisis failures of leadership, prescience, and stewardship were real. All the same, open capitalism is the only way forward and it requires leadership that acknowledges hard choices, rather than selling easy outrage. The financial crisis is over. The crisis of legitimacy goes on.
Copyright The Financial Times Limited 2017