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What we learned from the Lehman collapse Add to ...

On September 15, 2008, the $639-billion Wall Street investment bank, Lehman Brothers Holdings Inc., collapsed in a bankruptcy filing more devastating than any the world had ever seen. The aftershocks were swift and far-reaching. Stock markets plunged. Credit stopped flowing. In the United States, the Lehman debacle knocked an already stumbling economy to its knees. America lost almost 500,000 jobs in October, 2008, the month after the collapse. Before the hemorrhaging stopped, it would lose a total of 8.8 million. that’s equal to the population of Tokyo. Tokyo, for that matter, was not spared. Japan was rocked by the economic reverberations, as were China, Brazil, Russia, Germany, Britain, Canada and other major economic powers. The Lehman crash made a mockery of the notion of the great decoupling — the presumption that the global economy was no longer tied to the economic fate of the United States. Even in the varnished language of the International Monetary Fund, you can hear the alarm in their statement a month after the Lehman implosion: “The world economy is entering a major downturn in the face of the most dangerous financial shock in mature financial markets since the 1930s.”

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Most observers call what followed the Great Recession. But why didn’t we end up in a Depression, as so many had feared when the stock market entered free fall and millions were laid off in the U.S., Canada and around the world. There is no shortage of memoirs, fly-on-the-wall reportage and academic analysis. And while the definitive account has yet to be written, consider this the first chapter on the lessons we learned — so far.

Maybe not everyone needs a home
Alberto and Rosa Ramirez, Mexican-American strawberry pickers in California, obtained a loan in 2005 to buy a $720,000 house. The couple made less than $15,000 a year, and they were not required to put any money down.

There’s no need to continue with this story, as recounted by Princeton University economist and former U.S. Federal Reserve vice-chairman Alan Blinder in his new history of the Great Recession, After the Music Stopped. We know how the story ends. The Ramirez family and thousands of others are the human face of the collapse. Yet before the crisis, Alberto and Rosa could just as easily have been the face of George W. Bush’s “ownership society.”

In 2005 and 2006, Bush and his Treasury secretary at the time, John Snow, thought they had orchestrated something special. The home ownership rate — the percentage of homes that are owner-occupied — was at record levels and pushing toward 70%. (U.S. house prices had increased by about 25% between 2003 and 2005.) It apparently occurred to no one in the Bush administration that maybe that was too good to be true. The home ownership rate was only about 64% a decade earlier, in line with historical norms. “These price increases largely reflect strong economic fundamentals,” Ben Bernanke observed in October, 2005, when he was the head of Bush’s Council of Economic Advisers.

There was nothing magical about the “ownership society.” Home buying and prices were being fuelled by the low interest rates the Fed had engineered, terrible underwriting standards and perverse incentives that drove real estate agents to sign up as many mortgage holders as they could. Mix in a little fraud that preyed on America’s obsession with property and its reckless relationship with credit and you have a recipe for the mother of all housing busts.

“In retrospect, the bipartisan consensus to promote housing went too far,’’ Snow said in written testimony to the House Committee on Oversight and Government Reform in October, 2008. “There was a push for too much of a good thing. Those excesses eventually came home to roost.’’

Too much home ownership only gets at part of the problem. Lehman’s collapse, and the crisis in just about every other major economy, can trace its origins to the arcane financial instruments banks employed to fuel the great real estate bubble of the early 2000s. For decades, governments had helped banks and other lenders to securitize mortgages — bundle them up into real estate securities that could then be sold off to investors. These allowed everyone from grandmothers in Norway to municipalities in Greece to own a piece of the American Dream. So complex were those securities that it was getting increasingly hard to see the dodgy loans at the bottom of them.

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