Glen Hodgson is a senior fellow at the C.D. Howe Institute.
It’s been a decade since the collapse of Lehman Brothers sparked the 2008-09 global financial crisis and recession. The global economy is finally performing at a robust level, with solid output and employment growth in many regions and interest rates generally on the rise toward more normal levels. The acute pain felt during the financial crisis, and the protracted period of recovery, should have encouraged policy-makers and their voters to take meaningful steps to avoid a repeat performance. But have lessons been learned?
One positive outcome was the innovative application of monetary policy. Central banks were the reliable backbone of the policy response to the financial crisis; exceptional and prolonged monetary stimulus and financial market intervention was activated in many regions. Quantitative easing, or the exceptional creation of liquidity to intervene in financial markets and drive down long-term interest rates, was introduced and applied by central banks in the United States, European Union, Britain and Japan (but not Canada).
Central banks are now putting the monetary genie back in the bottle, shaping today’s environment of rising interest rates without impairing growth. By slowly restoring more normal monetary conditions, the capacity for central banks to intervene in the next economic downturn or crisis is being rebuilt – provided they maintain a high degree of operational independence, such as the Fed ignoring politicized comments on monetary policy from the Trump administration.
But in other areas, the voting public and the governments they elect are neglecting some necessary lessons. Fiscal policy is not ready to deal with the next financial crisis. Public debt burdens around the globe are still elevated, with no apparent plans to address them. The Trump tax cuts mean massive U.S. fiscal deficits ahead, heading toward US$1-trillion in 2020, and U.S. debt ratios steadily rising toward 90 per cent of GDP. In Canada, the federal government and some provinces, notably Ontario, have drifted into chronic fiscal deficits at precisely the wrong time in the business cycle. Ongoing fiscal deficits are adding little to current Canadian growth performance while building heavier current public-debt loads than necessary. Those debt loads will take off with the next crisis or recession, risking a return to the bad old days of the 1980s and early 1990s.
Performance is mixed on policy and business decisions that would help prevent future crises and market bubbles. To their credit, financial sector regulators around the globe increasingly expect so-called “living wills” to be drawn up by financial institutions – a contingency plan to use if the institution fails and needs to be broken up. There are financial consequences to these living wills, such as requiring higher levels of capital and tighter risk criteria that can affect profitability, but the risk of contagion and public bailout is also reduced.
However, many large firms, especially in manufacturing, still appear to be too big to fail. In the event of a crisis, affected firms could require public-sector bailouts once again, rather than the economy suffering significant negative ripple effects through complex supply chains and financial relationships – thus passing risk and responsibility from shareholders to taxpayers.
Some other preventive measures introduced after the crisis are facing a rollback. The United States is rewriting the so-called Volcker rule, which prohibits banks from engaging in profit-seeking trades with funds provided by customers. Lowering this regulatory bar could end up recreating one of the conditions that led to the financial crisis.
Only selective action is being taken to prevent or gently deflate bubble-like conditions. Canada has seen progressive reductions in the scope of available coverage from the Canada Mortgage and Housing Corp., returning Canadian mortgage markets toward more traditional terms. British Columbia’s government acted to stem the inflow of foreign capital into property markets. But other markets face property bubble risks and have yet to take specific action.
Perhaps the biggest emerging financial risk today is in the U.S. energy sector. Fracking firms in oil and gas have taken on massive debt loads and have issued a significant number of shares, but their underlying profitability remains questionable, owing to declining output performance over time. Solid energy prices are, for the moment, masking the effects of heavy debt and low productivity, but the fundamentals are not healthy for many fracking firms.
And international risks never go away. Issues regularly surface with emerging market debt and currencies that can spread to other locations if financial markets lose faith. Turkey’s currency and financial markets were under pressure last month, pushed aside in recent weeks with concerns about Argentina’s capacity to meet its debt service obligations. Venezuela is at the edge of a precipice, the Greek debt crisis was never actually resolved, and other international financial and geopolitical risks can be readily added.
Over all, only selective lessons have been learned from the 2008-09 financial crisis. There will be other financial crises – and those who don’t learn from history may well be condemned to repeat it.
Glen Hodgson