All the ingredients for another financial meltdown still linger
Kirsty Wigglesworth, Associated Press
Five years ago, the world of finance and economics changed forever.
At least that’s the story.
It started with a sad milestone in Wall Street history: the fall of the House of Lehman.
Between Sept. 13 and Sept. 20, 2008, Lehman Bros., the legendary 158-year-old Wall Street firm, wobbled, stumbled and finally ceased to exist. In the conventional narrative, the failure of Lehman and the equally storied trading outfit Bear Stearns was part of an epic, once-in-a-generation meltdown in which global financial markets collapsed simultaneously in ways that nobody could have possibly foreseen.
But some people did foresee the disaster. I was one of them.
In July 2007, soon after the Dow Jones industrial average crossed 14,000 for the first time, I wrote a column for the Los Angeles Times with the headline “14,000 reasons to be skeptical.” My point was that if you looked through the euphoria and focused on the wild flows of capital and massive increases in debt, it looked like a classic bubble. And history does not treat bubbles kindly.
Although I didn’t know the bubble would burst immediately, within a month the Dow had fallen more than 1,000 points to less than 13,000. From there, the rout was on.
By the time the real crisis hit and Lehman and Bear Stearns imploded, the Dow was below 10,000. The S&P 500 index was down almost 30 percent. The market was waiting for more bad news.
But that was five years ago. Surely in the intervening half a decade we’ve made the necessary changes to create safer financial markets that aren’t as susceptible to damaging excess and are insulated enough that they can’t crush the overall economy?
In a word, no. Indeed, there have been practically no structural changes in our financial system at all. The systemic risks of another bubble booming and busting remain as acute as they were five years ago. All that’s different, for now, are the surrounding economic conditions.
Bubbles develop when a glut of capital ends up chasing increasingly scarce assets. In 2007 and 2008, the bubble was in corporate and consumer debt. As interest rates fell, investors turned more and more to riskier ventures in the hunt for yield.
This was readily apparent in the private-equity business, where banks were throwing so much money at takeover deals that the private-equity partnerships couldn’t put it all to work. Banks usually are pretty staid investors, and private-equity funds typically have to go searching for cash. This was definitely a dramatic turn of events.
The bubble also was clear in consumer debt markets. Remember zero-down-payment subprime mortgages? They were a pretty good clue. Remember when the average household debt increased for two straight years, peaking at $18,285 in the fourth quarter of 2007? Another hint. The idea that millions of people were watching TV shows with names like “Flip This House”? Dead giveaway.
With historic amounts of capital moving in increasingly risky directions, it was only a matter of time before the system caved in on itself. That’s essentially what happened.
Today, capital is not racing through the economy. Household debt is down 12% from its peak in 2008, as Americans pay off their ballooned credit card debt and auto loans. Corporate spending is only just beginning to rebound from a dismal retrenchment that severely depressed wages and further squeezed consumers.
The sense of mania and euphoria of five years ago has been replaced by a somber hopefulness. The S&P 500 is near its all-time high. But with the economy the way it is, we don’t feel like celebrating.