Their generation

It is now 10 years since the first indications of the looming financial crisis began appearing on our radar screens and its aftermath was the main thrust of Janet Yellen’s speech at Jackson Hole last Friday. Some people saw the crisis coming, having warned about problems in the US housing market since at least 2005, but most of us did not. Looking back at some of the material I produced in summer 2007, I did point out the risks which were emerging in the financial sector, but that is all they were – factors that could potentially disrupt the outlook. They were treated as the equivalent of an event on the outer reaches of a fan chart: a theoretical possibility but one we did not set much store by. By the end of the year, I was paying far more attention, pointing out that risk assessments were too low and that investors were too optimistic about earnings prospects, with the result that I expected a sharp market correction. This did happen, but not for the reasons I anticipated.

Looking back at what I wrote in late-2007/early-2008, I had almost forgotten how concerned I was about the state of the economic and financial environment. But however concerned I might have been, I never saw the Lehman's bankruptcy coming. When the Queen asked academics at the LSE why nobody saw the financial crisis coming, their answer was they trusted that risk management tools were adequate. My response would have been that nobody expected the Fed to pull the plug on a major financial institution, having always ridden to the rescue hitherto (my assessment of the Lehman problem one week before the final collapse was not one of my better forecasts). More than any single financial event in the previous 80 years, this was the one with the most far-reaching consequences. It was a signal to the markets that financial institutions could no longer rely on central banks to bail them out and that they had better start getting their houses in order.

Fast forward to 2017, and many of the problems which emerged then continue to echo. Admittedly, banks have deleveraged and have been wrapped up in red tape to the point that they pose far less of a risk than a decade ago.  But they are less profitable and employ fewer people (no great loss there, say the general public). Not surprisingly, Yellen’s main thrust was the changed landscape in the financial world. She did touch on the question of whether the new regulatory environment has adversely affected growth and concluded that although “material adverse effects of capital regulation on broad measures of lending are not readily apparent, credit may be less available to some borrowers, especially homebuyers with less-than-perfect credit histories.” But her main conclusion was “our more resilient financial system is better prepared to absorb, rather than amplify, adverse shocks … Enhanced resilience supports the ability of banks and other financial institutions to lend, thereby supporting economic growth through good times and bad.”

But the macro environment has changed in other ways. Interest rates in Europe remain at immediate post-crisis levels, the full consequences of which we will only find out when we retire and cash in our pensions. There has also been a permanent loss of income in the sense that it remains below where it would have been had the pre-2008 trend continued i.e. we are less well off than we would otherwise have been. Unemployment in many parts of Europe is still too high and dissatisfaction with the status quo has mounted, culminating in the Brexit vote and the election of Trump. In some ways, this is an echo of the first half of the twentieth century, with electorates seeking populist solutions to complex and deep-seated economic problems. It is almost miraculous that we did not see more of this in continental Europe given the magnitude of the euro zone crisis. But the election of Emmanuel Macron as French president is a sign that European electorates have not given up on 70 years of integration and that the high water mark of populism may (I say that very cautiously) have passed.

But what have we learned? Most obviously, perhaps, self-regulation is an inadequate defence mechanism. Banks cannot be relied upon to police themselves (nor can politicians for that matter). More generally, the policy of laissez-faire which has dominated the Anglo Saxon world for the past 35 years, may have reached its limit. A policy of creating incentives to encourage people to take risk has arguably been carried too far. It surely is no coincidence that younger voters, who have been severely disadvantaged by current economic circumstances, have flocked to politicians such as Macron and Jeremy Corbyn who offer a message of hope and inclusivity.

This may be viewed by many as hopelessly naive but we should not dismiss this groundswell of support. Just as people of my generation were fed up with the limits of the post-1945 settlement, so a new generation is finding that the system of which they are now part does not necessarily work for them, and they want change. It will take time to work its way through, but we are going through a period of change every bit as radical as the early 1980s – if not more so. Ours will be a world shaped by different economic forces to those which have operated over the last three decades.