Did the world learn from the global financial crisis?

CONCERN: House prices here are beginning to fall. Banks are also starting to raise their mortgage and other interest rates.
CONCERN: House prices here are beginning to fall. Banks are also starting to raise their mortgage and other interest rates.

It is now 10 years since the global financial crisis of September 2008 that precipitated a significant recession in many developed countries. It seems reasonable to ask what, if anything, have we learned from this experience?

The crisis had its roots in bad (called sub-prime) loans in the US housing market on which a mountain of debt instruments had been built. When those loans went bad, the mountain collapsed.

The situation had largely been created by bad economic policy, as the US Federal Reserve held interest rates down for too long, flooding the world with liquidity, initiating a global search for better investment yields, that was in turn accommodated by investment banks such as Lehman Brothers that created a spate of high risk debt investment products.

 The cry in response was “deleveraging” – debt should be significantly reduced, and quickly, by governments, corporates and households. However, today global debt is significantly higher than it was at the time of the GFC – the IMF suggests by some 12-percentage points relative to world GDP.

Ironically, the policy response of monetary authorities to the GFC was to flood the world with even more liquidity, pushing interest rates down to near zero, even negative, and holding them there mostly since. This has been reflected in the fact that the balance sheets of the central banks of the G7 countries are now three times as large as they were at the time of the GFC.

While the US housing market is not so stretched this time, the key pressures now are the explosion in Chinese debt, and in the debts of many emerging and low income nations, at a time when their economies are performing poorly.

The management of these debts is now a major global policy challenge, especially as the US Federal Reserve is seeking to push up interest rates, in turn strengthening the US dollar. This accentuates the debt burdens of the emerging countries, where about half their debts were borrowed in US dollars, and many have to roll over a significant proportion of their debts in the near term.

The flood of liquidity has also produced “bubbles” in stock and property markets, with potential complications and corrections in bond and currency markets.

All up, there is now a significant risk of another debt-driven GFC, with global policy authorities and governments with little capacity to respond.

For example, the valuation of the US stock market has exceeded its pre-1929 peak, and stands at nearly 150 per cent of US GDP.

On the plus side, most global banks have been recapitalized in response to the GFC, so are in better shape than then, but there are still pressures on some bank balance sheets in Europe, for example Spanish banks exposure to Turkey, where its economy is collapsing, and in Italy, and so on.

All up, there is now a significant risk of another debt-driven GFC, with global policy authorities and governments with little capacity to respond.

In Australia, our major debt pressure point is household debt, having reached the highest level in the world, at more than 120 per cent of GDP, and approaching 200 per cent of household disposable income.

This reflects the struggles of many to buy a house, and/or to just meet the rising costs of living, at a time where their wages have been flat-lining, at best. Many households have been running down their savings and increasing their debts to survive.

Pressures are mounting here as house prices have begun to fall, and our banks are beginning to raise their mortgage and other interest rates, reflecting their increased cost of funds globally as the Fed raises US rates.

Our Reserve Bank is mostly powerless to act, and the Banking Royal Commission has focused attention on the “sub-prime” nature of much of our bank mortgage books, where it has been revealed that our banks often lent borrowers much more than they could afford.

The big global surprise post-global financial crisis has been that economic growth and inflation have stayed so subdued, even as the world was flooded with additional liquidity.

So, any significant corrections in stock, bond and property markets – that is another global financial crisis – could easily precipitate a global recession.

Disturbingly, this could be triggered by the debt problems of emerging countries, or by Trump’s totally misguided trade war, and his compounding of global geo-political tensions.

John Hewson is a professor at the Crawford School of Public Policy, ANU, and a former Liberal opposition leader.