5 Failures 5 Years After Lehman Brothers

by Alyssa Oursler | September 16, 2013 1:27 pm

Yesterday marked five years since Lehman Brothers’ infamous collapse — an anniversary hardly worth celebrating.

President Barack Obama applauded recent progress during an ABC interview last night, pointing to economic growth, job creation and a banking system that works. And there are some bright spots from the past half-decade: new stress tests, the arguable success of automaker bailouts, better bank balance sheets, tighter credit and lending standards among them.

But the general sentiment is hardly sunny. The recovery has been so notably slow, and countless talking heads in the financial world maintain that not enough has changed to prevent another crisis.

Just consider these headlines: The USA Today editorial board wrote today that a “Lehman repeat could be just around the corner,”[1] while Michael Lewis, author of The Big Short, is already penning a book on the next crisis[2]. CBS has also published pieces noting that “Lehman is gone but new financial crises may await”[3] and that “Big banks are as risky as ever.”[4]

That’s because even five years after the Great Recession, our economy, reforms and our own memories are coming up short in several ways:

Slow Recovery: While the unemployment rate has been improving — falling from a high of 10% in October 2009, it still remains north of 7% and nowhere near the sub-5% we saw prior to the crisis. Long-term unemployment rates are still “unprecedented,”[5] part-time and low-wage work has made up a good chunk of the recovery, and many workers remain underemployed. Plus, government spending cuts have shrunk the public work force — a reality that, to some extent, has offset the private sector growth Obama applauded.

Meanwhile, the rebound of the housing sector — which burst back in the first half of the year — has largely been driven by cash purchases likely from investors and hedge funds, while more than 7 million homes remained underwater[6] at the end of the second quarter.

Dodd-Frank Failure: In 2010, a financial market overhaul was passed in the form of the Dodd-Frank Act. Unfortunately, tough lobbyist opposition has led to relaxed requirements[7], remaining loopholes and delayed rule-making[8]. Meanwhile, many banks remain “too big to fail.”[9] London Whale, anyone? CBS writer Charles Wilbanks[10] summed it up:

“Dodd-Frank … is by many lights a deeply flawed bill that failed to address fundamental issues, such as the conflict of interest between ratings agencies, the size of banks or their fundamental structure. In any case, it remains largely dormant, with more than half the rules yet to be written by the SEC. “

Still-High Compensation: One thing both the USA Today editorial board and author Michael Lewis noted was that the “bonus culture” of Wall Street played a large role in the crisis. As Lewis put it:

“For several decades on Wall Street, the short-term sensibility has been encouraged and compensated very highly …

It wasn’t that (those on Wall Street) been foolish and idiotic. They’d been incentivized to do disastrous things.”

Unfortunately, not much has changed. Sure, some firms have tried to link bonuses to longer-term metrics, but that doesn’t offset the danger of big-time compensation. As USA Today put it: “Bonuses are still at astronomical levels … (and) the continued widespread use of large bonuses in a highly leveraged industry, one that traffics in risk, is a toxic mix.”

Credit Dangers: Another area that remains largely unchanged: debt — concerning both ratings, as well as our appetite for and lack of knowledge about its risk.

To start, credit rating agencies[11] are still paid by the companies whose debt they’re supposed to rate, giving them a bottom-line incentive to loosen their standards. Then there’s the re-emergence of collateralized debt obligations[12]. These investment vehicles played a huge role in the Lehman Brothers collapse and in the AIG (AIG[13]) bailout, yet since then, little has changed concerning how they’re put together and sold.

And now, they’re making a comeback. CDOs are on pace to tally $88 billion this year — a fraction of $520.6 billion peak of 2006 that played a large role in the recession, but still the highest level since 2007 and more than 20 times the low of 2009. This is partly thanks to a search for yield amid low interest rates — a search that has upped risk appetites and apparently shortened investors’ memories.

Fannie and Freddie: Another overlooked detail in reforms is the fate of Fannie Mae and Freddie Mac, which were more or less left out of Dodd-Frank legislation. The two mortgage giants still own or guarantee most home mortgages in the U.S. — and still are controlled by the government, leaving taxpayers holding the bag if those mortgages don’t get paid.

While bills to wind down the entities have been introduced in recent weeks[14], there’s still no clear plan to reduce the government’s role in the mortgage business — and things might get murkier now that Fannie and Freddie are making billions in profits that go straight back to the Treasury[15].

Bottom line: The Great Recession offered America plenty of financial lessons, but many of them have been forgotten or outright ignored.

Source URL: https://investorplace.com/2013/09/5-failures-5-years-after-lehman-brothers/

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