Ten years since the global financial crisis, world still suffers 'debt overhang'


Kevin Nixon, global and Asia-Pacific leader at Deloitte’s Centre for Regulatory Strategy, says there is a mantra of “we can never let this happen again”.

He says the Basel III reforms which aim to improve the banking sector’s ability to absorb shocks and increase transparency will prevent another Lehman-style collapse.

Under Basel, “big global banks hold five times more common equity than they did going into the crisis,” Mr Nixon says.

To avoid the potential of taxpayers bailing out troubled banks, global regulators now require a “recovery resolution plan” from financial institutions. Moves are afoot in Australia but the big four banks still don’t have plans in place.

“I don’t think anyone wants to deregulate Wall Street,” he says.

But Lord Turner says that’s exactly what Trump intends on doing.

“I’m concerned that the attack on Dodd-Frank is about undoing necessary regulation that was brought in after 2008,” he says.

Lord Turner says post-crisis reforms have largely stopped outrageous 100 per cent loan-to-value mortgages and rubbish products like synthetic CDOs.

But what one always sees over time, he says, is banks loosening credit standards.

“I would prefer higher [capital] buffers still,” Lord Turner says, and even goes as far as advocating banning loans above a certain level.


Lord Adair Turner (left) pictured with former British PM Gordon Brown, middle, and CBI president Sir Colin Marshall, says the world is suffering from “irrational exuberance” and “debt overhang”.

Janet Tavakoli, president of Chicago-based risk consulting firm, Tavakoli Structured Finance, and author of several books about the GFC, says regulations to prevent financial fraud have always existed. The problem is that regulators don’t enforce them.

After Enron’s bankruptcy the USA passed securities laws known as Sarbanes-Oxley that address the issues raised by financial fraud and overreach.

But “Sarbox and Dodd-Frank are cosmetic cover-ups of the fact that the USA chooses to not enforce its laws,” she says. “That’s why we keep seeing more of the same.”

Local lending limits

Locally, regulators are more attuned to risks. Although, as with their global counterparts, there are questions as to whether moves go far enough.

In March the Australian Prudential Regulation Authority imposed tougher limits on lending which saw some big banks increase their lending rates to borrowers – including to limit the flow of new interest-only lending to 30 per cent of total new residential mortgage lending.

Mr Eslake says APRA has clamped down, “for the most part successfully,” on risky lending.

“However, I doubt that all forms of risky lending or borrowing, or other types of investment vehicles, have been completely eliminated,” he says.

The heads of RBA and APRA declined to be interviewed for this story.

Both have made clear in public speeches that financial risks exist because of indebted households.

APRA has in recent years been running what it calls “stress tests” testing the development of crisis scenarios.

Its disclaimer about the tests is that it can’t actually with accuracy “predict the probability of a period of stress, let alone the precise scenario by which it will arrive”.

Nevertheless, it examines hypothetical cases of the housing market falling by about 40 per cent, and unemployment and interest rates rising.

Its 2014 stress test results found that “banks may well survive the stress, but that is not to say the system could sail through it with ease.”

Keen says these stress tests use the same “DSGE” models that in 2007 christened 2008 as a great year for the world economy.

“These models do not have a banking sector – or even money – in them,” he says.

He says they do not reflect the real economy. “Cascade events just aren’t possible in these models,” he says, “but they are in the real world, chain-reactions occur.”


David says Australian lenders are “chronically undercapitalised relative to the risks they have taken”.

He also believes banks are still issuing mortgages that are too large for borrowers to service over the life of the loans.

“For APRA to assume the Australian banking system can survive living within its own means despite its high dependency on cheap, and easy to roll over, foreign-derived debt is nothing short of hilarious,” Mr David says.

Mr Wilson says the four majors only have $162 billion of real equity to support their entire balance sheets. “A mere 5 per cent housing loss rate destroys 50 per cent of bank capital,” he says.

Limits on lending, while necessary, could be the very factor that tips us over.

JCP’s analysis shows the buffers mostly impact low-risk households that hold only 30 per cent of total mortgage debt of $1.6 trillion.

“The borrowers who need the buffers don’t have them,” Wilson says. “Needless to say, the system looks vulnerable.”

Flawed incentives

Another problem highlighted during the crisis was the big pay packets received by Wall Street bank chiefs who behaved badly.

And post crisis, a lack of accountability for their mistakes.

In the US, pay packets of bank CEOs are akin to those of celebrities, and “virtually all the dangerous practices remain in place”, says Randall Wray, a senior scholar at the Levy Economics Institute of Bard College in New York.

He has authored several books criticising orthodox monetary theory and policy and says “the whole thing will again collapse”, even if it’s sometime off.

Wray points out that “no top executive of any of the fraudulent financial institutions was prosecuted.”

“No lessons were learned – except that no crime is too big if you work at a too big to fail institution,” he says.

“If anything, the bigger the fraud, the bigger the bonus.”


JPMorgan’s Jamie Dimon “got a pass”, says Janet Tavakoli. Photo: AP

Tavakoli says after the crisis, bankers simply connected, gave huge campaign contributions to Congress and were “protected”.

Financial executives are still not held accountable, she says, pointing to JPMorgan Chase’s London Whale debacle in 2012 as another example of executives getting away with bad behaviour.

“JPMorgan CEO Jamie Dimon got a pass after the London unit that reported directly to him made credit derivatives bets and lost $6 billion representing years of profits for that unit,” she says.

“It was the poster child for worst practices in risk management. Jamie Dimon had signed off on documents stating risk management was fine. Yet he wasn’t held accountable under Sarbox regulations or anything else.”

White says there needs to be more and tougher prosecutions of financial criminals, including tougher fines and prison.

“Here the problem is assigning individual blame and also proving the intent to commit a criminal act rather than simply a stupid one,” he says.

Navidi says “flawed incentives, lax personal liability laws and skewed ethics” encourage risk taking.

And, “US banks have become even larger and more systemically important and have the luxury of operating with an implicit guarantee by taxpayers,” she says.

Taking responsibility


Wayne Swan says governments should not be seen “simplistically as guardians against individual irrationality”. Photo: Alex Ellinghausen

The GFC raised questions about who was ultimately to blame when things turn sour.

Former treasurer Wayne Swan defends the massive stimulus package he and former prime minister Kevin Rudd and the then treasury secretary Ken Henry pulled together to stop Australia plunging into recession.

But Swan concedes there’s a “moral hazard” whereby “if banks expect they will be bailed out, they may engage in riskier behaviour”.

He says governments should not be seen “simplistically as guardians against individual irrationality”.

Swan says ultimately everyone has a role to play.

“Governments in setting the policy framework to promote growth in incomes and economic stability, banks to do their due diligence in lending and ensure they meet lending and regulatory standards, regulators to enforce those standards and individuals to be honest in their disclosures and prudent in their approach to debt,” he says.


As economist Hyman Minsky explored in his work on financial instability, there is such a thing as macroeconomic risk.

Eslake says governments will always feel obliged to “step in” to protect depositors in the event that any bank is at risk of failing – as they did in Australia. The political consequences of failing to do so – large numbers of people losing potentially all their life savings – are simply too great, he says.

Lord Turner says even if regulators had spotted the problems before they occurred in 2007-08 and tried to stop it, they would have faced intense lobbying from banks, and media stories saying such moves will send us into recession.

He criticises regulators who pretended things were rosy when they weren’t. But overall, he blames an “intellectual failure” that accepts excessive debt so long as the economy keeps ticking on.

“You have to understand the dominance of bad economic ideas, which did not allow us to critically analyse how bad it was [before the GFC],” he says.

“It’s very difficult when everyone believes one thing – they can’t see the problems coming.”

Levy says as economist Hyman Minsky explored in his work on financial instability, there is such a thing as macroeconomic risk, and individuals cannot protect themselves from it.

“Had we left all to individuals to handle in 2008, we would be desperately foraging for food or dead,” Levy says.

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