This is the very first article of a series reflecting on anniversaries of historical events. Examples include a reflection on 100 years since the end of WWI and 200 years birth of Karl Marx in 2018; 50 years since the last Beatles performance and 40 years of direct elections of the European Parliament in 2019. The aim of these articles is to give a brief overview of the events and reflect on them from a current perspective.
10 years – Crash of Lehman Brothers
The year is 2018, and people have more bank accounts than ever. Even though an increasing amount of people have begun to mistrust the banking sector. All of this growing mistrust can be traced back to the financial crisis in 2008.
167 years ago, three brothers started a small business in the U.S. leading over a century later to the biggest financial crisis since the Great Depression in the 1930s. The Lehman family emigrated from Germany to the U.S. in the 19th century and opened a small store selling everything customers wanted to buy. Smart investments, such as into railway lines after the American Civil War let to more wealth and drove the Lehman Brothers to New York to the Wall Street. For many decades the bank was one of the biggest financial houses in the world.
And then: 2008.
The bankruptcy of Lehman Brothers was the catalyst for months of turmoil and the reason the worldwide financial system was shaken to its core. The crisis was triggered by excessive debt levels in combination with low interest rates, enabling people to borrow money to spend on consumption. Meanwhile, financial institutions borrowed money as well as keeping a severe lack of reserve funds in their banks. The biggest investment banks in the area of real estate, such as Lehman Brothers, triggered the crash. Shortly after the crash many banks were nationalized after governments had to bail them out, many spending billions in the process.
The Netherlands experienced the worst recession in post war history and more than 100,000 people lost their jobs. For nearly 7 years, the Dutch economy was below its original level before the crisis showing lower investments and consumption levels. The government was forced to invest billions of Euros into Dutch banks which led to an increase of public debt of 200 billion Euros, almost 1/4th of its national GDP in 2008.
10 years after the crash, consumption, investments and unemployment are back to 2007 levels and public finances are restored. However, scars remain. While the economy is growing again, long term unemployment and high public debt remain. These scars increase awareness of the crisis and have hopefully increased the establishment of preventive measures.
But how likely is another financial crash and which risks should we be aware of in 2018?
While the financial crisis of 2008 was triggered by the crash of Lehman Brothers, other banks followed suit. Debt levels have since risen and are today higher than ever before. Additionally, next to high public debt, the financial system, emerging markets, and even potential trade wars should be considered as risks in 2018.
Obviously, the financial system was improved after the crisis in order to prevent a future crash. Examples of preventive measures include that banks have to keep a higher amount of money in their bank as a safeguard than ever before. Additionally, many banks are strictly regulated by the state. However, an issue remaining in the financial system are growing private hedge funds. Just like investment banks they invest money into a variety of firms, products or ideas. The problem of hedge funds is they are allowed to do so without any control by the state. Also, the risks resulting from an increasing monopolization in the banking sector should not be underestimated. As a result, a collapse of one bank has a greater worldwide influence than ever before.
Emerging markets, such as in Turkey and Argentina are at more risk. These countries have fragile economies and borrowing or printing money there is easy and cheap. This can easily lead to inflation and thus, political and social unrest as it can be seen in Venezuela.
The Lehman Brothers chief executive from 2008 runs a firm which offers investment advice to wealthy clients now. Someone, who was one of the responsible business men who triggered a worldwide crisis and enormous debt is back in a powerful position. How much then have we actually learned? Sadly, not that much. As can be seen by current trade wars we still focus too much on our national economies, not realizing the extent of our interconnected world. The preventive measures implemented in the past years only seem effective from the surface. Hedge funds in 2018 are a surprisingly similar equivalent to investment banks of 2008. Able to lend and invest money without regulation, we cannot know the current situation on Wall Street or other markets. However, what we do know is what is at stake. That is why it is important to reflect on how the 2008 bankruptcy of one investment bank snowballed into an international financial crisis. The most successful preventive measure is therefore to be aware of what caused the crisis in 2008 while knowing that the potential risks of today might very well turn into real consequences tomorrow.