The Build up
There were many warning signs leading up to the crisis. For a start, property prices in the US had skyrocketed driven by subprime mortgages. Predatory and fraudulent lending had fuelled a housing bubble as early as 2000, but nobody seemed to take heed. Eventually, lawmakers told the Federal Reserve to write rules that would have put a stop to the worst practices, but by then it was too late.The mounting crisis turned into a full-blown crash nearly 10 years ago, when Lehman Brothers filed for the largest bankruptcy in United States history on September 15, 2008. Swamped with bad mortgages, it sustained heavy losses as housing prices dropped, and imploded after multiple acquisition deals fell through. The collapse set off a chain reaction of bank failures not just in the USA, but across the globe, as governments struggled to stem the crisis. Investor confidence sunk, as consumers fled the market, leading to a bear market.
In an effort to contain mounting home foreclosures in the US, the Federal Government enacted Home Affordable Modification Program (HAMP), which sought to modify distressed mortgages by offering financial incentives to both homeowners and lenders. Even as President Obama inked a stimulus package worth $787 billion in an effort to save jobs, it became clear that HAMP would have little impact as mortgage lenders lacked the financial muscle to modify loans on a large scale. Many argue that bailouts for homeowners should have been much more generous to avoid more foreclosures and to better stabilise neighbourhoods. Others, that alternative policy approaches such as moratoriums to aid distress and limit substantial foreclosures were never fully explored.
At the heart of the crisis was the behaviour of the Banks, largely a result of misguided and over-generous incentives unrestrained by good regulation. And yet, those Executives who were responsible were never truly held accountable for their actions. The mortgage brokers neglected due diligence, since they would not bear the risk of default once their mortgages had been securitised and sold to others. Not to mention the ratings agencies who judged subprime securities as investment grade ought to share the blame, too.
At the macro level, the global financial crisis was a missed opportunity to make the world economy more sustainable and change how it operates in an environment increasingly under pressure from unsustainable economic policies and instruments. Whilst corporate behaviour improved, governments didn’t take heed.
Underneath all that there have been serious lessons learned from the crisis. Aside from a transformative change of the financial services industry landscape, the crisis underscored the importance of clear and consistent communication. Today, many firms have reviewed their approach to doing business in a way that robustly anticipates and mitigates risks. Investors, too are more risk-averse, and take a long-term perspective of their decision-making.
There has been a standardisation of global regulatory systems. The Dodd-Frank Act gave more power to the Federal Reserve to regulate the system. Since then, we have witnessed widespread de-risking and deleveraging of US banks. The Consumer Financial Protection Bureau was another important initiative to protect the public. Similar initiatives have been rolled out in the advanced economies of Europe and Asia. No doubt, the world is a very different place and much safer to what it was before the crisis.
However the effects of the crisis are still being felt in the environment. Record lows for interest rates have hurt savings and investment returns; economic growth remains slow by historic standards and despite all regulatory changes, a lot of work is yet to be done to rebuild consumer trust.
America has come a long way since the Federal Reserve and the Treasury had to step in to save the banking system from going under. Corporate profits are at record highs, the unemployment rate is at an 18-year low and the Dow Jones Industrial Average has nearly quadrupled since its Recession-era nadir in 2009.
But, the crisis damaged consumer confidence and the global economy to the extent that battle scars are still visible in many countries. In the US, the recovery had deepened industrial and geographic divisions, with employment and wealth concentrated in the emerging tech hubs, whilst blue collar industries in the mid west have more than disappeared. In many ways workforce participation has yet to fully recover, and median wealth remains at well below the 1998 levels.
The financial crisis resulted from an excess of consumer debt in the housing market, which led to systemic credit risks in the banking system, as well as the asset management industry. New regulation has partially addressed this problem, but it still remains a matter of concern.
In the aftermath, risk management now plays a crucial role in the industry in addition to regulatory constraints, especially regarding liquidity and credit issues. But, there is no zero-risk asset today, as warning signs of a sovereign debt crisis brew. Many countries are over-leveraged, and the distinction between emerging and developed economies is no longer relevant. Sooner or later there will be other defaults with systemic impacts, leading to much greater market volatility than we have recently witnessed.
One of the more positive outcomes of the crisis was the (re)naissance of the financial technology industry (FinTech). Fintechs needed to (re)imagine, (re)design traditional finance, and offer consumers products that (re)built trust and confidence in the system. The emergence of digital products and services, driven by mobile technology made it possible to (re)invent disruptive technologies. While the rapid evolution of technology reduced the barriers to entry for many aspiring companies in the fintech space, the timing of these innovations were buoyed by a changing landscape in the perception of the financial services industry. For decades banks had little competition. It gave them a monopolistic power with no restraint to charge high transaction fees simply because consumers had few options in their choice of services providers.
There has been a paradigm shift in consumer mentality, demanding better and more innovative offerings. As the fallout from the financial crisis created huge unemployment in the sector, there was a shift in the workforce behaviour, too. The skills revolution ensured a growing demand for a more entrepreneurial approach to business. The evolution of technology ushered in new players such as Revolut and Monzo to disrupt the exiting banking model and market, offering better and more competitive services.
Today, FinTech growth is boundless. What may have started as an outlet of frustration with the monopolistic inefficiency of the banking industry, has become real. “Armed with funding, new technology and a mission to (re)create our relationship with money, FinTechs are set to take centre stage in a post-crisis world.” In due course, they will become the mainstream financial services providers. As they mature, competition will lead to greater innovation, creating products for better consumer experience.