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On September 15, 2008, the credit crisis turned into a crisis when New York-based investment bank Lehman Brothers collapsed. The ensuing global recession is still too recent in many people's memory to be considered a story. But 10 years later, the state of the financial system suggests that the crisis has been relegated to history books for many people in the sector.
In 2018, Wall Street is enjoying a new period of glory. Bonuses for bankers have returned to pre-crisis levels, commercial bank profits are at an all time high, the stock market is the longest in history, the US economy and the deregulation and tax cuts administration.
Regulators and policy makers around the world say that the measures taken in recent years have made banks safer than ever before, with more capital and targeted supervision informed by mistakes made before Lehman was dismantled. That said, there are still many potentially dangerous risks in the financial system. The aggressive financial engineering in the pursuit of profit is alive and well. Complacency can cause problems, as always.
The Financial Conduct Authority of the United Kingdom has just recalled that the beginning of a crisis can be sudden. "Most companies that failed, if not all, reported relatively robust financial situations until the moment they failed, with financial statements signed by their boards of directors and large investment firms. audit, "said Charles Randall, chairman of the UK regulator. said earlier this month.
On the occasion of the tenth anniversary of Lehman's bankruptcy, market watchers believe they are behind the next crisis.
Foreign company debt
According to McKinsey, the global debt of non-financial corporations has more than doubled in the last decade, reaching $ 66 trillion in the middle of last year. Two-thirds of this debt was in emerging markets, with the added risk that many of these companies took advantage of the low interest rates to borrow in US dollars.
As corporate debt has risen, the quality of credit has decreased. McKinsey analysts say a quarter of corporate issuance in emerging markets is at risk of default today, a figure that could quickly rise as interest rates rise sharply. US interest rates and the dollar are increasing as the record amounts of debt mature.
The current crisis in Turkey is an example of what can go wrong. The Turkish lira is in free fall against the dollar and investors are still not sure whether Turkish companies will be able to pay their dollar-denominated debt with the rapidly decreasing lira they generate in terms of income. Some European banks lent a lot to Turkish companies, putting them on strike in the event of a cascade failure.
China's debt also raises concerns, as it left the world's second largest economy with about 160 percent of GDP, the highest in the world. The Chinese government's ability to sustain growth, stabilize its over-indebted economy and wage a trade war with the United States will be put to the test and any slippage will reign in the global economy.
Guaranteed loan obligations
These seem strangely similar to the secured debt securities (CDOs) that caused so much chaos during the 2008 crisis. These assets are another example of securitization in which leveraged business loans (ie 39, ie debts of companies with a lower quality rating) are grouped and then divided into tranches. According to Bloomberg, there are other similarities with pre-crisis securitization practices: according to Bloomberg, the CLO documentation is long and complex and each CLO typically has more than 100 issuers grouped into a single product.
For the most part, people think CLOs are pretty safe. Even at the height of the last crisis, the first tranches have never failed. The argument is that this period is different because business loans are not as vulnerable to changes in interest rates as the subprime mortgage loans that underlie CDOs. But the same level of trust can not be applied to lower-rated CLOs, which are becoming increasingly popular because of the high returns offered. Bloomberg warns that the market boom may have gone too far now that CLOs target individual investors.
The issue of CLO has "exploded" in Europe and continues to grow in the United States, especially as 2016 deals are refinanced under better market conditions. At the end of the first quarter of this year, the CLO's US market balance was close to $ 550 billion, compared to just over $ 270 billion in 2008, according to the Securities and Markets Association. financial markets. The European CLO market is smaller than it was in 2009, but up from its 2015 low.
Non-bank mortgage lenders
Traditional commercial banks have reduced the number of mortgage loans they provide, particularly to low- and middle-income families, by applying stricter regulations. Non-banks intervened to fill the gap: in the United States, 56% of mortgages come from non-banks, compared to 35% in 2010. For example, Quicken Loans is now the largest issuer of real estate loans, surpassing Wells Fargo. The change in the landscape deserves careful consideration, as it has been shown that before the crisis, non-banking activities have contributed to the deterioration of lending standards (pdf).
Bank of the shadow
For non-bank banks, the global shadow banking sector accounts for at least $ 54 trillion, according to the most conservative estimate of the Financial Stability Board (pdf). It accounts for about 13% of the global financial system, but in China the shadow banking system accounts for more than a quarter of bank assets. In this sector, companies that are not banks and do not take deposits offer banking-type services and may pose financial stability risks. How? Since they are not banks, they do not have the same level of regulation.
Exchange-traded funds
Over the last decade, it's hard to imagine another area of finance that has grown as fast and as fast as ETFs. They have all sorts of interesting features: you can track the performance of a hedge, a commodity or an obligation, and trade the fund for an exchange as you would with an action. There are ETFs for almost everything, from biblically responsible business baskets to indexes that focus on gender equality. They have supposedly democratized investments by making it cheaper to invest in passive funds. The global ETF market is now about $ 5.1 billion, up from $ 700 billion a decade ago. By 2020, EY expects global ETF assets to total $ 7.6 trillion (pdf).
But the growth of ETFs has been supported by a long bull market. What happens when it ends? There are some concerns about synthetic ETFs, which do not actually hold the underlying securities, but instead attempt to replicate the index using swaps and derivatives. In the event of a crisis, it is difficult to know what would happen to these ETFs if the counterparty to this agreement, usually an investment bank, had failed.
There is also concern that ETFs will inflate equity values (paywall). And there is evidence that ETFs are also worse than flash crashes, which are becoming more common. In assessing the large US crashes in 2010 and 2015, the Securities and Exchange Commission found that ETFs experienced "more severe volatility" than common stocks.
High frequency trading
Michael Lewis introduced CDOs and credit default swaps in the common vernacular with The big court, exposing greed and stupidity on Wall Street in the run-up to the financial crisis. In 2014, Lewis published Flash Boys, a book on high frequency trading (HFT), focused on a small group of companies that used technical knowledge to generate profits by sending transactions faster than usual. The amount of HFT performed today is lower than in 2009, and companies are struggling to generate profits as a stimulus from the central bank after the crisis calmed markets and reduced volatility.
But it has not completely disappeared and remains a source of concern. The German Bundesbank warned that HFT aggravates market fluctuations during stress. Goldman Sachs researchers said HFT would aggravate sales as companies would withdraw their cash from the market at the worst time. They said that instant collisions were a sign that something is probably not happening in the current state of trade and that HFT could also contribute to the "fragility of the market".
Fintech
There has been a rapid increase in the number of non-bank financial technology companies with a better user experience than traditional banks, but without the same regulation (pdf). More and more financial technology companies are providing credit or facilitating loans to their clients. For example, in the United States, personal loans have exploded thanks to financial technology companies. The outstanding amount of fintech debt is about $ 120 billion, up from $ 72 billion a decade ago. Fintech companies such as Lending Club, Prosper and Avant account for around one-third of these loans, compared to less than 1% in 2010. These loans are unsecured and can cause heavy losses for businesses in the event of economic failure. all the more so as they are often used by borrowers with lower credit ratings and to refinance other types of debts.
fracking
The American fracking industry has exploded so much that America is producing enough oil so that the country is now a formidable player in the global market. But Bethany McLean, the author of South America: the truth about fracking and its change in the world, says that financial risks are hiding below the surface. The fracking industry in the United States has been able to grow so quickly thanks to extremely low interest rates. This is unsustainable, she says, because interest rates are rising and fracking companies have hundreds of billions of dollars in debt. This is even worse because for many of them, the cost of operations is higher than what they receive from production. McLean compares it to the Internet bubble that burst at the beginning of the century. "As long as investors were willing to believe that profits would come, everything worked – until it did not," she wrote.
Banking deregulation
For more than a year, the US-led Republican Congress has been striving to loosen the banking rules and dismantle the Dodd-Frank Act, the law marking the reinforcement of regulation after the crisis. 2008. Earlier this year, thousands of small and medium-sized lenders were exempted from parts of Dodd-Frank. The Federal Reserve and other regulators are considering easing the borrowing limits of the larger banks, changing the annual stress tests and changing the Volcker rule that limits proprietary transactions. At the same time, the Office of Consumer Financial Protection, which is headed by one of its toughest detractors, is putting an end to new investigations, freezes hiring and prevents the collection of data from banks.
IMF research shows that deregulation usually marks the beginning of a crisis. For 300 years, there has been a perpetual cycle of booms followed by deregulation, crises and re-regulation.
Something else
Crises are difficult to predict. Although the risks are numerous, the chances are high that the next crisis will be felt by few people. The assurance that banks are stronger than before and that the financial system is closely linked to the rest of the world is hardly comforting in the face of other facts: Between 1970 and 2011, there were 147 banking crises, 218 currency crises and 66 sovereign crises (pdf). More will follow.
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