Ten Years After Lehman—Lessons Learned and Challenges Ahead
IMF Blog, September 5, 2018
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- Authors: Christine Lagarde
- Published: September 5, 2018
Crisis impact and economic costs
- The collapse of Lehman Brothers provoked a broader run on the financial system, leading to systemic crisis.
- Twenty-four countries fell victim to banking crises.
- One study suggests that the average American will lose $70,000 in lifetime income because of the crisis.
- Public debt in advanced economies rose by more than 30 percentage points of GDP—partly due to economic weakness, partly due to efforts to stimulate the economy, and partly due to bailing out failing banks.
- Economic activity has still not returned to trend in most affected countries.
Causes and pre-crisis vulnerabilities
- Financial innovation vastly outpaced regulation and supervision.
- Reckless risk-taking by financial institutions in the United States and Europe included:
- relying less on traditional deposits and more on short-term funding;
- dramatically lowering lending standards;
- pushing loans off balance sheets through murky securitizations;
- shifting activity to the hidden corners of the financial sector subject to less regulatory oversight.
- Subprime mortgage market share in the United States reached 40 percent of overall mortgage-backed securities by 2006—up from almost nothing in the early 1990s.
- Globalization amplified contagion:
- European banks were major buyers of American mortgage-backed securities.
- Introduction of the euro led to large capital flows to the periphery as borrowing costs fell, financed by banks in the core.
- Regulatory arbitrage allowed financial institutions to demand lighter oversight by decamping to favorable jurisdictions.
- Groupthink among economists meant most failed to predict the crisis.
Immediate policy response and international coordination
- The G20 coordinated policies on a global scale.
- Country-level measures included capital support, debt guarantees, and asset purchases to limit banking sector drag on the real economy.
- Central banks slashed policy rates and later used unconventional monetary policy.
- Governments implemented large fiscal stimuluses to prop up demand.
- The IMF’s actions:
- Mobilized member countries to expand financial resources dramatically.
- Committed nearly $500 billion to countries hit by crisis.
- Pumped an unprecedented $250 billion of global liquidity into the system.
- Modernized lending frameworks for faster and more flexible responses, including moving to zero interest rates on loans to low-income countries.
- Engaged in a rethink of macroeconomics to better understand complex linkages between the financial sector and the real economy.
- These collective policies largely worked to avert a worst-case scenario.
Structural reforms achieved and remaining weaknesses
- Achievements:
- Banks have much healthier capital and liquidity positions.
- Off-balance sheet entities curtailed and brought under regulatory umbrella.
- Big banks face tighter regulation; leverage is lower.
- Subprime mortgage origination is largely gone.
- A big chunk of over-the-counter derivatives has been shifted to central clearing.
- Remaining challenges:
- Too many banks, especially in Europe, remain weak.
- Bank capital should probably go up further.
- “Too-big-to-fail” remains a problem as banks grow in size and complexity.
- Insufficient progress on resolving failing banks, especially across borders.
- Murkier activities are shifting toward the shadow banking sector.
- Continued financial innovation—including high frequency trading and fintech—adds to financial stability challenges.
- Substantial pressure from industry to roll back post-crisis regulations.
Culture, values, ethics, and diversity
- The financial sector still often prioritizes profit now over long-range prudence, and short-termism over sustainability.
- Ethical lapses have clear economic consequences; good regulation and supervision cannot do everything and must be complemented by reform within financial institutions.
- Greater female leadership in finance is recommended:
- Diversity reduces groupthink and sharpens decision-making.
- Research cited associates a higher share of women on the boards of banks and financial supervision agencies with greater stability.
- “If it had been Lehman Sisters rather than Lehman Brothers, the world might well look a lot different today.”
Current political economy and the unfinished legacy
- The system is safer, but not safe enough; growth has rebounded but is not shared enough.
- The political economy landscape has shifted, with a fading commitment to international cooperation—ironically undermining the cooperation that helped prevent a deeper depression after the crisis.
- New, post-crisis fault lines include:
- potential rollback of financial regulation;
- fallout from excessive inequality;
- protectionism and inward-looking policies;
- rising global imbalances.
- The true legacy of the crisis is still being written; how policymakers respond to these challenges will determine whether lessons from Lehman have been fully internalized.
Christine Lagarde, September 5, 2018