A decade on from the GFC, the world is less equipped to cope with the next crisis

Wednesday, 5 September 2018

London went through an incredible boom before the global financial crisis.

OPINION: London in 2007 and 2008 was a wonderful time and place to be a Kiwi journalist. Everyone knows the term 'global financial crisis', but what defined the crisis was the incredible boom which came before it.

As informative as it is, anyone who has read The Big Short or watched the movie adaptation is left with the impression that it must have been terribly obvious that trouble was coming.

For a lucky few that is no doubt true, and if so they would have made handsome rewards for being ahead of the game.

For the most part though, the years leading up to the crisis were a huge party across the global financial system, which served to mask the problem.

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Debt levels among the world's leading economies are, by and large, far higher than they were a decade ago.

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* Treasury warns migration is falling faster than expected 'posing a risk' to growth**

Banks on both sides of the Atlantic reported larger and larger profits, on the back of writing loans that were more and more aggressive, not that the growing risk was clear at the time.

The City of London - second only to New York as the capital of capitalism - was overrun with lavish behaviour and hospitality.

Back in 2008, New Zealand benefited from its largest trading partner, Australia, avoiding recession and having almost no debt.

Ironically, looking back on it, the behaviour seemed to maintain the idea that the financial institutions were completely sound, because so much money was available.

As problems began to emerge in the United States, British bankers dismissed the sub-prime crisis as an American one, of dodgy lenders preying on people desperate to buy homes.

In fact, the system itself was largely rotten and had lost control of risk management on the quest for growth.

The penny did not drop suddenly. Weeks before the first major collapse in the United States in early 2008, the British banks continued to pay dividends, as if to attempt to maintain the facade that the issues facing the financial system were isolated elsewhere.

A decade on from the collapse of Lehman Brothers, the global economy is still growing strongly. But with interest rates lower than a decade ago and many major economies carrying much higher debt levels, it is unclear how the global economy would respond to another crunch.

Over the next eight months, the situation would become so dire that for a brief time were very real concerns that the banking system was in such a state that the cash machines would stop working, forcing a massive bailout from the British Government.

As exciting as it watch, it was completely overwhelming. But the core lesson was quite simple. Finance is, at its core, simply a confidence game.

Usually this works fine but it is prone to bouts of exuberance and irrational behaviour. When that comes to an end, it is usually chaotic.

Anyone who thinks 'it is different this time' is actually correct, but not in the way they might think.

Whatever causes the next downturn and whenever it happens, it will be different and probably more complicated than the last one.

This is not an attempt to validate or dismiss the current loss of confidence among New Zealand businesses. If anything, a period of consolidation - or to use the current Wellington buzzword 'transition' - which the confidence surveys are pointing to, is probably healthy.

But even though Finance Minister Grant Robertson is under immense pressure to fulfil the expectations Labour created while in Opposition, the Government has remained steadfast that it will meet its spending targets, to cut debt as a share of the economy to 20 per cent of gross domestic product.

For a variety of reasons, virtually every New Zealand commentator has either questioned the logic of maintaining the targets, or how realistic the targets are, myself included.

But the target has become one that is core to Labour's political credibility, in much the same way that John Key promised to never raise the retirement age while he was prime minister.

If the targets are abandoned, then what else is up for grabs?

There are deeper reasons to stick to the rules than political ones. Because when the day of reckoning comes, it will be different.

Different because house prices are now at such unaffordable levels in many places that they would surely be sensitive to any economic disruption, if they were not in such short supply.

To make matters worse, interest rates are already so low that some economists are speculating that if the Reserve Bank was to respond to a slowdown by slashing interest rates, in a bid to stimulate the economy, it may find that little of the money finds its way to households.

Debt levels among the world's leading economies are, by and large, far higher than they were a decade ago.

In the United States, as well as threatening to kick off a global trade war, Donald Trump's administration is running the kind of deficit which would be wise in a recession, but at the late stage of a long economic growth cycle, appears reckless.

Back in 2008, New Zealand benefited from its largest trading partner, Australia, avoiding recession and having almost no debt. This time Australia's debt is climbing and there are doubts about whether Canberra will have the discipline to return to a surplus, as the political state becomes more populist.

Conditions now may be benign, but when the next crisis does come, New Zealand would do well to have conspicuously low debt, both to avoid scrutiny of financial markets and to give the government of the time scope to respond.