Remembering the Crash 2:The New World
Our recent blog considered the problem of marking a decade since the crisis of 2007-08 that had no clear beginning or ending, plus a multitude of complex layers and side-plots. No doubt 2018, more than 2017, will see column inches and broadcast hours filled by ‘ten years after’ content, inviting further reflection on the darkest days of the global financial meltdown.
Many will argue that, as the extraordinary ‘short-term’ measures are now fully grafted on to the global financial system, the crisis is still with us. In other words: we are still in a state of emergency, we’ve just got used to it. Others, influenced by big screen interpretations of the crisis such as Inside Job (2010) and The Big Short (2015), will take this opportunity to stress the lack of a full reckoning with the causes - and the individual perpetrators - of the crash, and the moral hazard created by the giant bail-outs.
It is certainly morally awkward that those gaining most from the changed landscape of quantative easing (QE) have included those with the most assets. This category includes financiers who, encouraged by the culture of the era, seem to have disregarded the traditional rules of lending. But if we can’t provide a satisfying moral ending to this story, we can at least reflect on the failure of imagination that led to the shock and take stock of what has changed.
A new perception of the banking sector is the most obvious and durable legacy of the crisis. While far from unique, the Royal Bank of Scotland is as vivid an illustration as any, given its long traditions of prudence. Once the world’s biggest bank, it is now about one third of the size it was in August 2007. For shareholders the destruction in value has been greater than this: adjusting for the dilution of the rights issue and consolidation today’s shares are worth less than 6% of a share from ten years ago. 71% of RBS is still owned by HM Government through its vehicle UK Financial Instruments. Like most UK banks, its shares have performed poorly in the post-crash climate, missing out on the long equity rally which has seen the FTSE All Share rise 26% ahead of its 2007 level. The banking sector is still down 54% from its pre-crisis high.
The banks are very different entities now, and huge strides have been achieved in reforming the sector mostly through strengthening balance sheets and divesting non-core activities. A culture of circumspection has replaced one of reckless expansionism. Meanwhile the failure of so many internal and external analysts to spot the manifold dangers that were realised in 2007-8 has left an enduring mark. For good and ill, retrenchment is likely to continue. Regulation looks set to increase, given what we learned about the limits of human understanding and responsibility in the era of computerised trading and complex product innovation.
Risk aversion is not the whole answer either, as banks that don’t lend, don’t earn. Bank profits have been compressed by low interest rates. The multiplier effect, where deposits generate more loan activity, has been curtailed. The ten-year recovery has not proved long enough to restore normal capital flows. Instead, the post-crisis decade has been defined by stimulatory monetary policies that have taken us through the looking glass into a world of near-zero central bank rates and some of the lowest bond yields in the history of UK finance. Through QE, central banks have stepped in to create artificial demand by buying up vast quantities of government bonds (around 60% of the current total in the UK), depressing returns to gilt investors. This support system, like the scale of UK indebtedness itself, has come to be thought of as normal, though it is anything but.
Bond market investors have benefitted meaningfully from successive rounds of QE. When the crisis started the 10 year gilt yield index was at 5.25% and the base rate was 5.75%. The equivalent figures now are 1.3% and 0.5%. Ultra-low interest rates and QE were deployed in the UK and elsewhere as emergency rescues amid the carnage of the financial crisis. For the time being at least they seem to be here to stay. But even those disadvantaged by this low-rate environment agree that a swift return to higher rates would hurt a large proportion of ‘just about managing’ homeowners.
Stock markets have benefitted from the willingness of investors to seek growth via relatively high-yielding equities, hitching a ride on the commercial acumen of listed companies. Speirs & Jeffrey remains positive on equities, but with a sceptic’s stance and with a strong wish for context via appropriate asset balance. The last ten years have seen the UK avoid the mass unemployment and prolonged recession that accompanied earlier financial shocks. We have learned to accept extreme measures as normal, so much so that politicians are able to shrug off the scale of our indebtedness, and gloss over its implications for the future. But the challenge of unwinding the UK’s extraordinary debt position is unprecedented, with huge implications for succeeding generations. A solution based on eroding debt through controlled inflation rather than politically unpalatable austerity, has not yet materialised.
How boldly and skilfully can the UK meet the challenge that the 2007-2008 crisis has left us? It may take another ten years before we know the answer to that.
Speirs & Jeffrey
7 December 2017