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Reflecting on Lehman’s Global Legacy

Authors: Heidi Moore, U.S. Finance and Economics Editor, The Guardian Daniel Gros, Director, Centre for European Policy Studies Farouk Soussa, Chief Economist for the Middle East, Citi
September 13, 2013


The collapse of Lehman Brothers five years ago, the largest U.S. bankruptcy in history, triggered a global financial meltdown that required repeated government interventions, especially in the U.S. and Europe. Central banks took on new responsibilities, pumping trillions of dollars to shore up the banking system and bolster a fragile recovery. Three experts weigh in on Lehman's legacy.

Daniel Gros of the Centre for European Policy Studies says that Lehman was wrongly seen by many in Europe as a U.S. problem, and policymakers worked "to contain the fall-out from the subprime crisis," wasting crucial time in the process. The impact was much more severe in the U.S., but the initial momentum to reform Wall Street has stalled, and the Guardian's Heidi Moore says banks today "are bigger, more complicated, harder to manage, on the wrong side of history and, evident to everyone, more than ever at risk of hurting everyone if they fail." Middle Eastern economies, especially in the oil-rich Persian Gulf, were relatively insulated to the financial tremors, Farouk Soussa of Citigroup says, because the regional banking system's lack of sophistication helped it avoid the toxic debt that brought down Lehman.

Lehman Brothers Photo: Toru Hana/Courtesy Reuters.

Heidi Moore, U.S. Finance and Economics Editor, The Guardian

When Lehman Brothers fell, it took with it an era: the era in which we believed that Wall Street had broad shoulders, that capitalism was self-cleaning, that the words "investment bank" described not just a corporate structure, but a way of life—flashy, fast, dominant, and above all autonomous.

Autonomy went with the bailouts five years ago. Now, Wall Street's shoulders are slumped, in a rumpled suit that doesn't attract attention or show too much wealth. The old investment banker, with his trimly tailored clothes and appetite for big deals and bonus skirmishes, is gone and replaced by a man glad to have a job and wary of his bosses, who are likely to be tight-fisted commercial bankers used to making money on the dime-slim margin between interest rates on deposits and loans. Bonuses have been dropping, and would have dropped even more, except that banks laid thousands of people off to conserve money to spread among those remaining.

Wall Street is a ghost, one that has seen its own passing once—in a fortnight when AIG, Lehman Brothers, Washington Mutual, and Merrill Lynch all met their makers in one way or another—and yet it has had no time or ability to grieve for its old self. At its wake, everyone said it was better off dead.

Yet it's hard to kill the spirit of the fight. The Wall Street of today reflects the awkward situation of the whiskey-swilling sophisticates of Mad Men in the 1960s, still enjoying two-martini lunches while ignorant that the ground has shifted beneath their feet. Not only is this new world not impressed with Wall Street as it once was, it is disdainful. Occupy Wall Street is criticized as not having done much, but it did one thing that still singes the average finance guy: it took away the prestige of being a banker. In an ego-driven business, that pride was crucial. The loss of it did more to drive men away from trading floors than even the dwindling supplies of money and adrenaline.

Wall Street, now just a small collection of commercial banks and giant mutual funds, with a few hedge funds nipping at their heels, has nevertheless used its last remaining forces to fight regulation. Money still speaks, even if a disgraced man is the one holding out the bills. Regulation has been a disaster, Dodd-Frank an embarrassment of unfinished rules and vague to-do lists, and yet Wall Street has the gall to claim there's too much of it. That may be right. There are too many rules, but none of them work.

The conventional wisdom is that Congress is dependent on Wall Street's knowledge to learn how to write rules that govern Wall Street; Wall Street is all too happy to oblige, but it will never work against its own self-interest. There's a deeper truth too: five years after Lehman fell, banks are bigger, more complicated, harder to manage, on the wrong side of history, and, evident to everyone, more than ever at risk of hurting everyone if they fail.

Daniel Gros, Director, Centre for European Policy Studies

The bankruptcy of the U.S. investment bank Lehman Brothers five years ago is seen as the beginning of the Great Financial Crisis and thus the cause of the Great Recession, from which the world has not yet fully recovered. However, this view is mistaken. If the U.S. authorities had saved Lehman, the crisis would have unfolded anyway, but it would have taken a different path and the blame game would involve different players.

It is an illusion to think that a global crisis starts just because one bank becomes insolvent. The failure of a single large institution can lead to a systemic financial crisis only if the system had been rendered unstable through an earlier credit boom. By 2008, banks on both sides of the Atlantic had become overleveraged, thanks, in part, to an excessively lax monetary policy, but also because this period of low inflation and stable growth had generated the illusion that risk had disappeared from the markets.

In the United States, banks were overleveraged because they had lent to subprime U.S. home buyers; in Europe, banks had overextended themselves by lending to overextended construction companies in Spain and Ireland and to an even more overindebted Greek government. All this powder was primed to explode. Lehman provided the spark that ignited the conflagration, but it was not the cause of it.

In Japan, a similar increase in leverage had taken place during the late 1980s. But no bank was allowed to fail; there was thus no acute crisis, but the economy lost decades anyway.

If the U.S. Treasury had somehow saved Lehman Brothers (perhaps by finding a buyer from Europe), financial markets would not have tanked in the autumn of 2008, but sooner or later the markets would have discovered that banks on both sides of the Atlantic had too little capital to cover the inevitable losses from the lending to subprime U.S. households, European building companies, and peripheral governments.

It is unlikely that the German government would have continued forever to finance the Greek government's excess spending and to guarantee all of its accumulated debt. The default of Greece or of a large Spanish building company might then have provided a different spark for an acute crisis. And in this case, Europe would have been blamed for sending the world economy into recession.

The political significance of Lehman was that it lulled European policymakers into believing that the recession of 2007–2008 was a U.S. crisis, and that all they needed to do was protect European banks from the fallout from the subprime crisis. The feeling of superiority did not last long, and resulted in a crucial loss of time. Moreover, the supposedly U.S. origin of the crisis resulted in a temporary loss of influence for the United States in international forums and facilitated the shift of influence toward the G20.

Farouk Soussa, Chief Economist for the Middle East, Citi

Overall, the direct impact of the collapse of Lehman Brothers on the economies of the Middle East was not as severe compared to other emerging markets. Dubai is often cited as the one hardest hit. This is partly true. The shock waves that Lehman sent through global financial markets exacerbated the liquidity crunch in the UAE banking system, exposed the overindebtedness of government-related entities, and accelerated the collapse of the real estate market. Arguably, however, all this would have happened even if Lehman had not collapsed: it is often forgotten that the liquidity crunch at the heart of Dubai's troubles began months before Lehman, as the bet on the dirham de-pegging unwound during the summer of 2008.

Kuwait, and not Dubai, was arguably hardest hit by the collapse of Lehman. There, a slew of large investment companies had mushroomed during the precrisis boom, borrowing short in wholesale markets and investing the funds in global assets of all sorts. When Lehman failed, funding for these companies dried up and their assets fell in value, leading to widespread insolvencies. The banking sector was heavily exposed to investment companies, and the situation threatened to snowball into a major crisis had it not been for the effective intervention of the government. But the cost was great, and the impact on the economy significant.

Sovereign wealth funds were also hit by the Lehman bankruptcy. Their investments in global assets suffered as financial markets retreated, and some even faced painful margin calls where assets were leveraged. But this was short-lived, the losses were absorbed by the vast funds, and the rebound in oil prices since has made the episode a receding memory.

Indeed, beyond these isolated trouble spots, the linkages between the Middle East and the global financial system were quite weak, protecting the region from Lehman's failure. Regional banks had very little exposure to global markets, and dependency on wholesale funding was limited. Ironically, it was the lack of sophistication of Middle Eastern financial systems that saved them from the worst.

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