A decade on unlearned lessons


TEN years ago this month that the once mighty US investment bank Lehman Brothers collapsed and the international financial system went into meltdown. The warning rumbles of this volcanic global eruption had been felt for over a year as doubts began to spread about the real value of trillions of dollars of securitized debt that banks had sold to investors and each other.

At the heart of this disaster was the realization by banks and other lenders that once they had made a loan, they could sell on that credit and its expected returns and lend the same money all over again. But this so-called “securitization” brought in its train clever investment bankers who hoovered up multiple loans, put them together and repackaged them into new marketable securities, giving them various names but most particularly “Collateralized Debt Obligations” (CDO). The weakness in this process, which was unclear to virtually everyone, most egregiously to financial regulators, was that as bought-up loans were sliced and diced to make new investments, the relationship with the collateral provided by the original borrower became ever more opaque. And, to their eternal discredit, the big international ratings agencies such as Moody’s and Standard and Poor, gave these new investments top marks in terms of their quality and repay-ability.

They argued that because the risk was being shared between a range of loans, the chance of a default that could undermine the value of a CDO was significantly reduced. Had investment banks been scrupulous in their choice of loans they packaged up, this might have been true. But they were not. They mixed in US sub-prime mortgages, housing loans which should never have been given to borrowers who had little chance of repaying. The idea that a property itself secured the value of the loan was always a nonsense since the house-price collapse that followed the financial market collapse slashed property values.

Total disaster was only avoided by governments stepping in and bailing out the great majority of financial institutions while pumping cheap money into the markets. The economic cost to the ordinary man in the street has been severe. But public anger has been less at the failure of a rotten financial structure, than the absence of widespread prosecutions of the bankers who should have known better than to let this catastrophe arise.

Ten years on and public fury at these individuals, most of whom have retired with their many millions, is still acute. But this anger ought actually to be directed at the fact that, though regulators stepped in and stopped some of the worst financial market practices, there has been no root and branch review of how these markets work. The ruins have been rebuilt using significant parts of the old decayed masonry. Investors have driven stock markets, not least the US Dow to new highs but then they had to put their money somewhere. Among more canny players, there is an underlying caution, a lack of confidence that enough has been done to reconstitute the markets. US banks are pressing to once again be allowed to trade on their own account. Sub-prime loans, for automobiles this time, are being securitized and snapped up by eager investors chasing yield. A decade after Lehman Brothers, it is perhaps very remarkable how little has really changed.