Kiwibank chief economist Jarrod Kerr witnessed the Global Financial Crisis (GFC) first-hand in the trading rooms of investment banks in Sydney and Singapore. Ten years on from the Lehman Brothers collapse, he recalls the mayhem of 2008 and ponders what we’ve learned.
I’d never seen anything like it, and I hope I never see anything like it again. History suggests I will live out the rest of my days with just one such story. But I still worry – blowing bubbles is in our nature.
The 2008 crisis started long before investment bank Lehman Brothers’ collapse. Working on the trading floor at JP Morgan when it bought moribund Bear Stearns for a song in March 2008, I first saw the unravelling through an American lens. JPMorgan’s hiring freeze had cancelled my planned move to London, so I jumped ship to Commonwealth Bank (CBA) around this time, witnessing Lehman’s failure from the trading floor of Australia’s largest bank. By 2010, the world looked to have recovered and I took flight to Credit Suisse Singapore. But while wounds may heal, battle scars remain. I saw the advent of negative interest rates and the regulatory aftermath on banks that ultimately sent me back to Australasia.
The Global Financial Crisis was savage and long. Everything I knew, everything I’d learned, was immediately redundant. The collapse of a 150-year-old behemoth bank was the largest in history and sent shock waves around the world. That bank, Lehman Brothers, had leveraged into subprime (high risk) mortgages and the bubble burst. ‘They let Lehman go? They didn’t bail it out! Who’s next??’, was the incredulous reaction. Equity markets melted, currencies traded violently, and interest rates nosedived to levels we never thought possible. Banks stopped trusting each other (and banking is all about trust). Markets that could never freeze, froze. You know the saying: ‘Until hell freezes over’. Well, we saw some pretty cold and desolate days. Many in the markets lost money, and sadly, I knew of people who took their lives.
We knew we were witnessing history, but at the same time, we were haemorrhaging. I vividly remember traders screaming, ‘The market’s broken, the market’s broken! I can’t get a price, any price!’. Screens and keyboards were smashed, and millions were lost. I still to this day struggle to believe the so-called ‘major banks’ refused to deal with each other. The fear of contagion crippled financial markets, and each bank was asking the same question of the other: ‘What dodgy exposure do you have?’ The market for bank bills, the short-term pieces of paper (IOUs) that banks buy off each other and which account for a large part of their funding, froze. An interest rate that was ‘always’ 7bps (percentage points) above the cash rate (OCR) sudden became 180bps above cash. That’s banker talk for ‘bloody hell, the cost of everything we do has just blown out’. Credit, the availability of money to do stuff like buy a home, is the oil in the economic engine and when it dries up the engine seizes. What we had was a recession, and it was a bad one. Bailouts came in a number of forms but many feared it wasn’t enough.
We worked 12, sometimes 20 hours a day as we sat mesmerised by what we saw on our screens. These zombie hours lasted for months. And we still get days like that, such as when the Swiss stepped away from their currency peg, or when the British voted ‘exit’, or when an ‘outsider’ became US President. If the market madness wasn’t enough, it felt like on any given day we could be axed and made redundant. Waves of redundancies across bank trading floors persisted for years after Lehman. Many of the traders and bankers I worked with before the crisis were ‘walked’, never to return. It took a while to catch up with me, but I was also made redundant in Singapore in 2013. And so I hightailed it back to Australia.
Although we looked like we had bounced back in 2009-10, the experiment that is the EU remained in recession and would give us Grexit, then Brexit, and who’s Nexit to ponder. In 2016, the US gave us Trump. We haven’t seen this level of populism (anti-immigration and anti-trade) since the 1930s. Prolonged crises have that effect.
In the middle of the greatest financial crisis since the Great Depression, we also embarked on the greatest financial experiment since the Great Depression. Central banks started printing trillions of dollars to lower interest rates, and fuel asset prices (such as equities) and growth everywhere. The US Fed expanded its balance sheet from US$900 million to US$4.5 trillion dollars. That’s a lot of zeros. It purchased government bonds and mortgage-backed securities – the stuff that blew up. China owns $1.1trn in US debt. If you think that’s a lot, the Fed owns $2.3trn. Other central banks like the BoJ (Japan), ECB (Europe) and SNB (Swiss) purchased all sorts of things such as equities and other countries’ assets. In 2016 we ended up with the lowest interest rates in the history of mankind. Some, like the ECB, are still printing truckloads of cash today.
Negative interest rates are normal now in Switzerland and large parts of Europe. I worked for the first Swiss bank to offer negative interest rates to Swiss families. The money poured in the door, because fear drives us to do interesting things. The theory was that negative interest rates could never happen because people would refuse to accept them and instead start spending and investing for return, but we had to throw those textbooks out the window. Bank systems were not designed to handle negative rates, so they got redesigned.
When you’re scared you pay for safety, and negative interest rates are the price of safety. It’s like holding a safety deposit box: It costs you to rent, offers you no return, but hides your cash in a safe place. Unfortunately, this mindset can persist. When the earthquake and tsunami hit Japan in 2011 there was not only devastation but a significant loss of wealth, because negative rates are not new to Japan and the cash that some families had hidden in their mattresses literally washed away. These stories also happened closer to home. I remember hearing of one wealthy individual walking into an Australian bank in 2008 and asking for his money, all of it. He had over $10m in change. It took a while to get the cash together, and he left with it and buried it in his backyard for all I know. That’s how bank runs start.
So what have we learnt from the crisis? Banks need to be better regulated, hold more capital, and lend appropriately. Speculation and excessive leverage (risk-taking) are bad and fuel bubbles. Great, so we’ve made significant changes and our banks are much stronger. Unfortunately, this is not the first financial market crisis we’ve gone through and we’ve learned these lessons before.
The smell of money drives most of us to do and believe extraordinary things. We can’t help ourselves, we love a bubble. Tulip mania took hold in the Netherlands, until 1637. A sniff of a quick windfall and people happily paid five times the price of a house for one tulip bulb, and some used their house as collateral to do it. Then there were the US railroad stocks (the dotcom stocks of the day) that caused a global financial crisis in 1857. And what about the Australian banking crisis of 1893? These crises were eerily similar to 2008. And let’s not forget the roaring 20s, the first Black Monday, the Great Depression, the populist surge, the vicious trade wars, and the eventual world war that defined the 20th century.
But that was then, this is now. Let’s stick with gold, it’s safe. Buy Bre-X, Canadians know Indonesia well. ‘Preposterous’ idea that… Ok, let’s get a bunch of economists to run an arbitrage fund called LTCM. Not a good idea, it blew up in 1998. Perhaps we should load up into dotcom (not Kim) stocks. Another great idea, until 1999. Ok, maybe we should just pin our ears back and buy cryptocurrencies? It’s still a good idea, even though no one can value them… One or two of those cryptos may change the world and make a motser (Australian slang for cha-ching), but the rest will most likely die a miserable death.
The point is that bubbles are blown by excessive leverage, speculative euphoria, and the belief prices can’t fall. But the reality is, if it has a price, it can fall. When you hear of ordinary people becoming ‘professional cryptocurrency day traders’, sound the alarm.
Today, we’re still in an age of regulation in response to the mayhem that led to Lehman’s demise. Banks hold more capital, but 10 years on regulators are still debating if it’s enough. The cost of capital is higher post-crisis, so the cost of banking is higher. The industry change reminds me of a Top Gear episode. Cars today are not necessarily faster than those produced in the 1980s. They have more safety features and they’re more fuel efficient, so they’re heavier and slower. But they still crash.
Are we safer today, than we were in 2007? Yes, definitely. Will we have another financial market crisis? Yes, definitely. Just hopefully not for quite some time.