Kevin Lynch is vice-chairman at Bank of Montreal and former clerk of the Privy Council of Canada.
As anniversaries go, it is hardly one to celebrate, but it is certainly one to remember and learn from – a decade ago, Sept. 15, 2008, to be precise, Lehman Brothers filed for bankruptcy, triggering the worst financial crisis of our lifetimes.
Much has been written about how a bunch of lousy U.S. mortgages – collateralized, packaged and leveraged beyond comprehension – brought the global economy to the brink of another great depression and wreaked incredible destruction to economies, societies and individuals, not to mention trust in the capitalist system itself.
So, 10 years on, where are we? The global economy is experiencing synchronized and strong growth for the first time since the financial crisis. After extraordinary policy easing by central banks, monetary normalization has begun, led by the U.S. Federal Reserve and the Bank of Canada. Governments, central banks and international institutions have expended enormous efforts to reform financial systems, to rebuild systemic trust and to reboot devastated economies. So, is it “mission accomplished”?
It all depends on how you define the mission.
Decrying the dangers of policy complacency at the World Economic Forum in Davos this year, Christine Lagarde of the International Monetary Fund warned that we still face a long list of structural growth inhibitors, economic and social vulnerabilities and geopolitical risks. These range from poor productivity, excessive inequalities, protectionism, populism, declining international co-ordination, growing trust deficits and financial fragilities. So, the economic “repair job” is certainly not complete.
Notwithstanding the broader economic context, are we done with the financial sector repair job? Again, it depends.
We learned a lot from the postmortems of what happened a decade ago. We understand which regulations were ineffective and why, what were the crisis amplifiers and where there were shock absorbers. To a certain extent, it was relearning the basic principles of finance: adequate buffers for solvency; sufficient firm and system liquidity; the need for transparency to properly evaluate risks; the dangers of excessive leverage; and clear accountability for risks within financial institutions and across the financial system. Perhaps most tellingly, we learned the hard way how incredibly interconnected and globalized the financial system had become while regulation and oversight remained predominately national.
The size and complexity of the financial sector repairs required new and revitalized repair shops: The Financial Stability Board was created, the G20 at the leaders’ level was born, the IMF found new purpose, new national regulatory agencies were established, the Basel Committee on Banking Supervision was reinvigorated and central bankers became the new guardians of the financial universe. Taken together, their actions have re-established and modernized the core financial stability framework but, in so doing, a hugely complex set of prescriptive regulations, with growing differences across countries, has come into being.
The regulatory policy challenge for governments is to learn from the past, while not attempting to navigate the future using the rear-view mirror. This requires building resiliency into systems from a forward-looking perspective, not one of hindsight, employing sophisticated foresight mechanisms in a world of profound and rapid change.
What would such a foresight lens capture today that might reshape regulatory policy thinking?
The structure of our economies is now very different than at the time of the financial crisis, transformed by technological change, the demographics of aging societies and the rise of Asia. Pervasive globalization and rapid growth in emerging market economies mean that we are now in a multipolar world where China, the second-largest economy, is asserting its place to be a global regulatory rule maker.
The technology revolution is certainly transforming financial services. The prevalence of mobile communications and digitization have moved banking online, Fintechs are attempting to disintermediate banking functions, e-commerce is changing how people shop and pay, distributed ledgers and crypto currencies are challenging clearing systems, and massive data vaults combined with AI-driven data analytics may blur the line between financial service providers and info-techs. Data privacy, data security, data rights and data usage are rapidly becoming central issues for the financial sector, although regulatory authorities today may lie elsewhere.
At the macroeconomic level, slowing potential growth, increasing debt levels and rising interest rates will exacerbate latent financial fragilities. These fragilities include global debt levels at more than 230 per cent of GDP – well above pre-crisis levels – and rising debt interest costs for firms, households and governments as monetary normalization picks up pace.
The financial crisis led to two great losses of confidence. One was the erosion of trust in the financial system and public institutions in many Western countries. The other was the perception of the supremacy of the Western market capitalism model in the eyes of many emerging market countries. The former may be easier to regain than the latter.
What’s required is a global financial order with clear and effective rules of the game for how the financial system will work in a highly interconnected, multipolar world that is in the midst of a technological revolution. Where this consensus is to be found in the world of a U.S. administration that attacks multilateralism and international co-ordination is the question. Perhaps Canada, which has the credibility of being one of the few Western countries to have avoided the worst excesses of the financial crisis, could lead in building a new global consensus.