Former U.S. treasury secretary Hank Paulson answers questions during a conference with former Federal Reserve chair Ben Bernanke and Timothy Geithner, former treasury secretary and president of the Federal Reserve Bank of New York during the crisis, at the Brookings Institution on Sept.12, 2018 in Washington.Win McNamee/Getty Images
In mid-September of 2008, as Henry Paulson stood face-to-face with one of the most dangerous financial meltdowns in history, his days were so hectic that he didn’t have time to fear he might screw it all up.
But at night, the U.S. Treasury Secretary would lie awake, stare into the darkness and become overwhelmed with doubt.
“In the night, little problems seem big, and big problems seem insurmountable,” Mr. Paulson recalled this week in Washington, during a panel discussion commemorating the 10th anniversary of the collapse of U.S. investment bank Lehman Brothers. “I would look into the abyss and see food lines, see another Great Depression.”
The crisis had been building since 2007, but Lehman’s bankruptcy filing on Sept. 15, 2008, was a pivotal event – the domino that toppled so many others. Within hours, failing investment bank Merrill Lynch was purchased in a fire sale by Bank of America, failing insurance giant American International Group was saved by a massive government rescue plan, and fears mounted about just how deeply and widely the financial system was infected with toxic assets. Markets went into freefall, and investors barred up their doors. Authorities around the world raced against time to stanch the bleeding, halt the spread and get fresh money flowing through a financial system that was in real danger of seizing up entirely.
Mr. Paulson looks pretty relaxed talking about it now. Sitting in an easy chair alongside two other key players in U.S. economic policy a decade ago – former Federal Reserve chairman Ben Bernanke and Tim Geithner, who was head of the powerful New York Federal Reserve when the crisis began and President Barack Obama’s treasury secretary when it ended – Mr. Paulson can live comfortably in the knowledge that he and his colleagues succeeded where and when it mattered most.
The crisis was certainly painful: In the ensuing months, stock markets lost half their value, central banks cut their interest rates to near zero, the North American auto industry required a government bailout and almost half a million Canadians and six million Americans lost their jobs. But the consensus is that the fiscal, monetary and regulatory policy moves made in the United States, Canada, Europe and elsewhere saved the world from an all-out collapse of the financial system – and a second Great Depression.
But a decade after the Lehman tipping point, it’s apparent that saving the world came at a price. The global economy, though healthier, has still not returned to normal.
Growth has been frustratingly slow. The global economy has never recovered all that it lost – has never gotten back on the trajectory it was on prior to the crisis. Growth in wages has been stubbornly weak. Business investment and trade growth have failed to recover. Interest rates set by central banks remain far lower than historical norms, which has encouraged excessive risk-taking in capital markets and has fuelled record global debts.
Some of these are old problems that proved hard to resolve, or returned as the economy and financial markets clawed their way out of the deep hole dug by the recession. Other issues were exacerbated by the crisis. But some of the world’s current set of economic ills can be linked to the unprecedented policy actions – fiscal, monetary and regulatory – taken to stave off total disaster during the crisis.
“When you’re in a crisis, by necessity you have to shorten your horizon. You don’t have the luxury of thinking about long-term structural consequences. The first priority was to stabilize the financial system,” says Tiff Macklem, dean of the University of Toronto’s Rotman School of Management, who, as second-in-command at the Bank of Canada a decade ago, played a key role in erecting Canada’s own crisis defence strategy. “There’s no doubt that it has had some unintended consequences.
“The crisis has cast a very long shadow.”
Bankers attend an emergency meeting at the London office of Lehman Brothers, in the financial district of Canary Wharf in London on Sept. 11, 2008.KEVIN COOMBS/Reuters
The slow growth train
The current recovery is one of the longest on record – but also one of the weakest. In the decade leading up to the crisis, Canada’s economy was growing an average of almost 3 per cent a year. Between 2009 and 2017, growth averaged just 1.7 per cent a year.
The global economy has similarly slowed, growing an average of 2.9 per cent a year since the crisis, down from 3.3 per cent a year from 1999 to 2008.
The crisis has also left deep wounds – affecting companies, workers and, more broadly, confidence. “One of the lasting legacies of the financial crisis is psychological scarring,” says Craig Alexander, senior vice-president and chief economist at Deloitte Canada. “Even though it’s been 10 years, people still remember what a bad recession looks like.”
Companies, in particular, remain extraordinarily risk-averse, and that is still weighing heavily on their decisions. Corporate profits bounced back after the crisis, but companies are still reluctant to spend and deplete their cash reserves. Canadian businesses have not been spending enough to replace old machinery and equipment, let alone make new investments.
“All these companies are behaving rationally,” Mr. Alexander explains. “But when all those businesses act in the same cautious, risk-averse way, you end up with an economy that is under-investing.”
The slow pace of the recovery is typical of the aftermath of a financial crisis, says McGill University economist Christopher Ragan, a member of Finance Minister Bill Morneau’s Advisory Council on Economic Growth. The combination of rattled business confidence and the deleveraging of financial institutions is like a double whammy for the economy.
“It’s an unusually slow recovery if this had been a normal recession, but it’s a normal recovery from a financial crisis,” he says.
The crisis isn’t entirely to blame for slower economic growth. Demographics are also at play. In 2011, the first members of the massive baby boom generation began hitting 65 and retiring in droves. With each passing year, more leave the work force, slowing the growth of the labour market, which is a key driver of growth.
On the surface, the job market appears to have recovered strongly in North America: Unemployment in Canada recently dropped to its lowest rate since 2007, while U.S. unemployment recently dipped to its lowest since 2000.
But the labour force has yet to get back to its pre-crisis state – and it may never. Many workers, particularly in manufacturing, lost jobs that no longer exist, either due to automation or because factories moved elsewhere. Canada’s labour force participation rate – the share of the working-age population that is employed or actively looking for work – remains lower today than it was in August, 2008, at 65.4 per cent versus 67.4 per cent – the equivalent of about 590,000 fewer people in the labour force.
The Great Recession also put a dent in global demand for many of the commodities that Canada exports, sending the price of oil and other resources plunging. Prices for many of these commodities remain below pre-crisis levels.
Employees at Lehman Brothers, a 158-year-old Wall Street investment bank, are escorted out of the New York office building during the collapse. Lehman was choked by the credit crisis and falling real estate values, and filed for Chapter 11 protection before sliding into bankruptcy on Sept. 15, 2008.Mary Altaffer/The Associated Press
Winners and losers
The popular perception is that governments bailed out bankers in the crisis while leaving people on Main Street to fend for themselves. To an extent, it’s true.
No doubt the crisis would have been much worse without the extraordinary injection of cheap money into the global economy by central banks. But the benefits of all that liquidity have not been spread equally across society, widening the gap between the middle class and the very wealthy, particularly in the United States.
That’s because low interest rates created a property and stock market boom, which boosted the wealth and power of shareholders. But they also punished savers, including pension funds and their beneficiaries.
“Low interest rates stimulate asset price inflation, and that’s where the one per cent live,” explains economist Dan Ciuriak, former deputy chief economist at Global Affairs Canada. “We’ve come out of the crisis with more or less full employment, but we have depressed wages, elevated corporate profits and distorted income distribution.”
Low interest rates have also affected the relative value of machines versus people in the minds of employers, according to Mr. Ciuriak. And that’s holding back wage growth. “Why pay for labour if you can buy a machine with cheap money?”
Wage growth,
top income earners vs the median
Real annual earnings
Average of top 1 per cent
(based on tax records)
50 percentile (based on surveys)
145
Index, 1995= 100
140
135
130
125
120
115
110
105
100
1995
‘97
‘99
‘01
‘03
‘05
‘07
‘09
‘11
THE GLOBE AND MAIL, SOURCE: OECD
Wage growth, top income earners vs the median
Real annual earnings
Average of top 1 per cent (based on tax records)
50 percentile (based on surveys)
145
Index, 1995= 100
140
135
130
125
120
115
110
105
100
1995
1997
1999
2001
2003
2005
2007
2009
2011
THE GLOBE AND MAIL, SOURCE: OECD
Wage growth, top income earners vs the median
Real annual earnings
50 percentile (based on surveys)
Average of top 1 per cent (based on tax records)
145
Index, 1995= 100
140
135
130
125
120
115
110
105
100
1995
1997
1999
2001
2003
2005
2007
2009
2011
THE GLOBE AND MAIL, SOURCE: OECD
Wages in the world’s wealthiest countries are now growing at a meagre 1.2 per cent a year, after factoring in inflation, according to the Organization for Economic Cooperation and Development’s recently released annual employment outlook. That’s down from 2.2 per cent before the financial crisis.
Income inequality, particularly in the U.S., has grown much worse. But it has also become more pronounced in Canada, where there has been a “pulling away” of top income earners from those in the middle, says Dalhousie University economist Lars Osberg. That, in turn, has created envy and resentment among the middle class, says Prof. Osberg, who traces a direct line between greater inequality and the global rise in populist political movements.
“If you generate crap outcomes for people over a long period of time, they are going to get pissed off with their political leaders,” argues Prof. Osberg, author of The Age of Increasing Inequality.
Many Canadians are feeling a heightened sense of economic insecurity because their wages are stagnant and they’re worried they won’t have enough money to retire, he adds. “Canada as a whole gained materially from economic growth,” Prof. Osberg added. “It’s just that the gains are shared out very differently. That matters economically, but also politically and socially.”
Unfortunately, government policy-makers didn’t pay a lot of attention to income distribution before the last recession, says labour economist Miles Corak, a professor at the City University of New York and the University of Ottawa. Now they’re paying the price.
“The fact that people are feeling more insecure about the world is fertile territory for populism to grow,” Prof. Corak says.
Mr. Macklem agrees that the crisis accelerated inequality and helped fuel the rise of populism. But he says it’s unfair to blame it for everything that’s happened to the economy and the labour market during the past decade of recovery.
“A lot has happened in 10 years,” Mr. Macklem says. “Technology has changed dramatically – the pace of technological change has accelerated, the world has gone mobile. Artificial intelligence, machine learning, blockchain are fundamentally changing the cost structure of businesses. Asia is an increasing share of the global economy.”
Mr. Bernanke, who was chairman of the U.S. Federal Reserve from 2006 to 2014, bristles at critics who say central banks' aggressive easy-money policies – including the Fed’s use of quantitative easing, which involved buying financial assets in order to directly inject money supply into the financial system – handed wealth to the elites of Wall Street while leaving out the masses.
“Yes, [QE] supports asset prices,” he said at the panel discussion in Washington. “But it also has contributed to 16 to 17 million new jobs. What is more important for the middle class than job creation?”
Government spending, not monetary policy, is the best way to deal with inequality, he argued.
“The Fed has a single tool, basically: interest rate policy,” Mr. Bernanke said. “Its job is to stabilize employment and keep inflation close to target.”
A decade ago, as Lehman Brothers went bust and the fragile financial system was teetering, fund investors wondered how bad it could get. The S&P 500 plunged 4.6 per cent on Sept. 15, 2008 and would incur worse losses in the ensuing months.Seth Wenig/The Associated Press
Low rates, and the damage done
But in doing that job, the world’s central banks have kept interest rates so low for so long that they have spawned a massive build-up in debt.
The Institute of International Finance calculates that total global debt – government, corporate and consumer – stood at a record US$247-trillion in the first quarter of this year. That’s almost 40-per-cent higher than in the first quarter of 2008 – a debt burden that was a major contributor to the financial crisis.
The global debt-to-GDP ratio stands at 318 per cent, up more than 30 percentage points since the Lehman collapse.
Government debts are almost double their pre-crisis levels, largely the result of massive injections of spending during the recession in order to stimulate their near-paralyzed economies. In Canada, net federal debt has topped $650-billion – up almost $200-billion from pre-crisis levels.
For the private sector, the decade of low borrowing costs has been like debt rocket fuel. Debt in the financial sector is at a record high, while non-financial-sector corporate debt is up more than 60 per cent. Household debt, too, in the world’s advanced economies is at record highs.
In Canada, the influence of low-for-long interest rates has been most evident among consumers. The ratio of household debt to disposable income stands at a near-record 169 per cent – 20 percentage points higher than when the crisis hit.
A lot of that represents mortgage debt. Low wage growth plus skyrocketing housing prices in many markets equals much bigger loans for many families. The resulting double-barrelled problem – overburdened household balance sheets and unsustainably high real estate values – now stands as the biggest risk to Canada’s economic and financial stability.
University of Ottawa political scientist Jacqueline Best argues that at the root of the problem was an over-reliance by policy-makers on the blunt instrument of interest rates to get the global economy back on course, as many governments withdrew their fiscal stimulus too soon.
“Central banks are not designed to do that kind of heavy lifting on their own,” she says. “If you put all the weight on monetary policy, you end up creating all sorts of perverse incentives.”
Now that central banks have begun to increase rates – especially in the United States, whose rates heavily influence global debt markets – the cracks in this huge global debt wall have begun to show, particularly in some emerging markets. Over the summer, we’ve seen Argentina, Turkey and Venezuela teeter toward crisis.
Experts warn that this global debt mountain is probably the biggest source of risk. And the return of interest rates to more normal levels by the world’s central banks – a process that is expected to be a key theme over the next few years – represents a serious test for the post-crisis economy.
“Where we expect [the next threat of crisis] to come from, reasonably, now, is excessive tightening of monetary policy – which would cause significant currency valuations, increase in the cost of financing [and] capital flow moves that would leave heavily indebted sovereigns and corporates at risk,” said IMF head Christine Lagarde in an interview produced by the agency to mark the Lehman anniversary.
Low-for-long interest rates also fuelled increased risk-taking in capital markets, as investors have sought out returns wherever they can find them in a low-yield environment. In the stock market, where the U.S. benchmark S&P 500 index has surged more than 50 per cent in the past three years despite political turmoil and rising interest rates, which usually weigh down equities, the word “bubble” has become a routine part of the conversation.
Meanwhile, more than US$3-trillion of corporate bonds – roughly half of the investment-grade corporate bond market – is now made up of securities rated BBB by the bond-rating agencies, just one notch above junk status.
“This is the junkiest corporate bond market in recorded history,” says David Rosenberg, chief economist at Toronto-based investment firm Gluskin Sheff + Associates Inc. “It’s triple what subprime [mortgage debt] was at the peak of the last cycle. This classifies as a huge debt bubble. And ultimately, what ends these bubbles is the Fed raising interest rates.”
Work to be done, fences to mend
But it’s not all gloom and doom. Despite of the warts, the global economy looks as good as it has in years. And the financial crisis did result in important safeguards – most notably, increased capital-reserve requirements at the world’s banks – that better cushion financial institutions against the kind of shocks that set the dominoes falling a decade ago.
Still, if the financial crisis taught us anything, it’s that crises are near impossible to foresee, let alone avoid. And complacency in good times – allowing the economy’s problems to fester – can leave the system more vulnerable to a shock and more damaged by its impact. Still grappling with the aftershocks of the crisis, many central banks and governments have less firepower to deal with what may come next.
And politically, there are some badly damaged fences to mend. Faith in governments and institutions remains badly shaken. Populism and trade protectionism continue to intensify because too many people feel insecure, cheated and left behind.
It’s hard to shake the perception that Wall Street bankers won. They got a bailout and went back to business as usual.
Out on Main Street, the reverberations of the financial crisis are still rippling outward.