Stumbling Toward the Next Crash
LONDON â€" In early October 2008, three weeks after the Lehman Brothers collapse, I met in Paris with leaders of the countries in the euro zone. Oblivious to the global dimension of the financial crisis, they took the view that if there was fallout for Europe, America would be to blame â€" so it would be for America to fix. I was unable to convince them that half of the bundled subprime-mortgage securities that were about to blow up had landed in Europe and that euro-area banks were, in fact, more highly leveraged than America’s.
Despite the subsequent decision of the Group of 20 in 2009 on the need for rules to supervise what is now a globally integrated financial system, world leaders have spent the last five years in retreat, resorting to unilateral actions that have made a mockery of global coordination. Already, we have forgotten the basic lesson of the crash: Global problems need global solutions. And because we failed to learn from the last crisis, the world’s bankers are carrying us toward the next one.
The economist David Miles, who sits on the monetary policy committee of the Bank of England, may exaggerate when he forecasts financial crises every seven years, but most of the problems that caused the 2008 crisis â€" excessive borrowing, shadow banking and reckless lending â€" have not gone away. Too-big-to-fail banks have not shrunk; they’ve grown bigger. Huge bonuses that encourage reckless risk-taking by bankers remain the norm. Meanwhile, shadow banking â€" investment and lending services by financial institutions that act like banks, but with less supervision â€" has expanded in value to $71 trillion, from $59 trillion in 2008.
Europe’s leaders aren’t the only ones with these blind spots. Emerging-market economies in Asia and Latin America have seen a 20 percent growth in their shadow-banking sectors. After 2009, Asian banks expanded their balance sheets three times faster than the largest global financial institutions, while adding only half as much capital.
In the patterns of borrowing today, we can already detect parallels with the pre-crisis credit boom. We’re seeing the same over-reliance on short-term capital markets that ultimately brought down Northern Rock, Iceland’s banks and Lehman Brothers.
While the internationalization of the renminbi is opening up new opportunities for global investment in China, it is also increasing the exposure of the global economy to any vulnerability in its banking sector. China’s total domestic credit has more than doubled to $23 trillion, from $9 trillion in 2008 â€" as big an increase as if it had added the entire United States commercial banking sector. Borrowing has risen as a share of China’s national income to more than 200 percent, from 135 percent in 2008. China’s growth of credit is now faster than Japan’s before 1990 and America’s before 2008, with half that growth in the shadow-banking sector. According to Morgan Stanley, corporate debt in China is now equal to the country’s annual income.
Although sizable foreign reserves make today’s Asia different from the Asia that experienced the 1997 crash in Indonesia, Thailand and South Korea, we are all implicated. If China’s economy were to slow, Asian countries would be doubly hit from the loss of exports and by higher prices. They would face downturns that would feel like depressions.
And China’s banking system may not be Asia’s most vulnerable. Thailand’s financial institutions, for example, appear overdependent on short-term foreign loans; and in India, where 10 percent of bank loans have gone bad or need restructuring, banks will need $19 billion in new capital by 2018.
If the emerging markets of Asia and Latin America are hit by financial turmoil in coming years, will we not turn to one another and ask why we did not act after the last crisis? Instead of retreating into our national silos, we should have seized the opportunity to fix global standards for how much capital banks must hold, how much they can lend against their equity, and how open they are about their liabilities.
The Volcker Rule, now approved by American regulators, illustrates the initial boldness and ultimate weakness of our post-2008 response. This element of the Dodd-Frank financial reform law of 2010 forbids deposit-taking banks in the United States from engaging in short-term, proprietary trading. But these practices are still allowed in Europe. Controls are even weaker in Latin America and Asia.
International rules are needed for international banks. Without them, as the International Monetary Fund has warned, global banks will evade regulation “by moving operations, changing corporate structures, and redesigning products.â€
When I was chairman of the G-20 summit meeting here in April 2009, our first principle was that future financial crises that started in one continent would affect all continents. That was why we charged the new Global Financial Stability Board with setting global standards and rules.
Nearly five years on, its chairman, the Bank of England governor Mark Carney, has spoken of “uneven progress†in recapitalizing banks and making them disclose their risks. The G-20 plan for oversight of shadow banking is, as yet, only a plan. While the world’s $600 trillion derivatives market is being regulated with new minimum capital and reporting requirements, global financial regulators must “find a way to collaborate across borders,†Mr. Carney says.
In short, precisely what world leaders sought to avoid â€" a global financial free-for-all, enabled by ad hoc, unilateral actions â€" is what has happened. Political expediency, a failure to think and act globally, and a lack of courage to take on vested interests are pushing us inexorably toward the next crash.
Gordon Brown, a Labour member of the British Parliament, is a former chancellor of the Exchequer and prime minister.
A version of this op-ed appears in print on December 19, 2013, in The International New York Times.
