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14 September 2018

Lessons learned from the Lehman col­lapse

Guest contribution by Olaf Scholz in the 14 September 2018 issue of the Frankfurter Allgemeine Zeitung

Lehman Brothers Building in New York City
Source:  picture alliance / dpa

It is ten years since the collapse of US investment bank Lehman Brothers on 15 September 2008. This bankruptcy marked the start of the global financial crisis, the effects of which can still be felt to this day. The beginnings of the crisis are deeply rooted in the structures of the US economy. Capital in search of ever-higher returns and the deregulation of financial markets created a fertile environment for trade in securitised subprime mortgages. Years of stagnating incomes meant that many lower- and middle-income Americans had to enter into high levels of private debt to finance their private consumption and housing – and thus keep the domestic economy afloat.

As in many previous crises, there came a point when the bubble burst, bringing the economy to the brink of collapse. Policy-makers had to intervene forcefully. Countries around the world made enormous sums of money available to stop banks from going bust. Nevertheless, nearly 40 million jobs were lost worldwide as a result of the crisis. People saw the value of their savings and pension entitlements plummet, and millions of homes were foreclosed. It is estimated that the German federal government alone has incurred costs of just over 30 billion euros to date with its measures to stabilise the German financial sector. The costs to the German Länder (states) are likely to be similarly high. Precise figures will not be available until all the measures have been completed some years from now.

When the crisis hit the real economy, it became clear how far German institutions, both private and public, had moved away from the real task of banking – financing and hedging the risks of the real economy. Instead, they were carrying toxic debt that was often kept off their balance sheets. Faced with the impending insolvency of several financial institutions, the German government at the time had to prevent a complete collapse of the German financial sector. Did we do everything right? Of course not. With the benefit of hindsight and experience, we have to admit that perhaps we should have done more to force German financial institutions to accept state support for their own protection, and then subsequently gradually reduced the state’s influence over these banks again, just as US authorities did. That was something neither policy-makers nor the financial sector were ready for at the time. We are wiser now.

From the outset, we pursued a two-pronged approach. Our aims were (a) to stabilise the financial sector and (b) to contain the turbulence in the real economy and society at large. I was Labour Minister when the disastrous events began to unfold in the autumn of 2008. We introduced an economic stimulus package worth around 80 billion euros to stabilise domestic demand, partly financed by debt. We took a number of measures to shore up the labour market in these tumultuous times, including an extension of the reduced-hours compensation benefit and a programme to provide training for workers who would otherwise have been made redundant. I firmly believe that our workforce is the key to maintaining our high innovative capacity and productivity. That is how we ultimately managed to emerge from the crisis stronger than before.

Our achievements are now widely recognised, but our actions were highly controversial at the time. Leading economists argued that this kind of state intervention would delay the necessary restructuring of the economy. Others considered counter-cyclical financial and economic policies to be too risky, arguing that debts piled up in this way could never be reduced because the state always gave in to popular wishes, even in good times. Both of these theories have been proven wrong. I mention this as a reminder of how difficult it can be – even for experts – to predict the future.

After 2008, Germany was in a much more favourable financial situation than many other countries. The debt levels of some European states rose dramatically as a result of the bank rescue measures. Subsequently, when these countries had to stimulate their economies during the euro crisis, their financial capacities were quickly exhausted. As a result, some countries got into difficulties themselves, as declining credit ratings put pressure on their bonds on the markets. They had to go through adjustment programmes involving far-reaching reforms in order to obtain financial assistance from international partners. These programmes were ultimately successful in terms of their overriding objective of restoring access to the capital market. However, the citizens of these countries suffered a great deal as a result. In addition, we must not forget how important it was that the European Central Bank put its unequivocal support behind the euro, taking steps that were unusual for Europe at the time. Only the purchase of government bonds put an end to speculation and betting on the markets.

What lessons can be learned from the past ten years? The most important overarching lesson is this: the more freely capital, goods, services and workers move in the globalised world economy, the more firmly the sovereign (welfare) state needs to protect its citizens during crises.

Taking a closer look, the first lesson is that any return to national insularity would, in my view, be a mistake. The German economy benefits more from open markets than almost any other. At the same time, no single country is able to enforce rules that can reduce the risk of new crises. That is why we need to work together to establish intelligent rules and create well-funded welfare state institutions to counteract rising income inequality and wealth disparity. Europe needs a high capacity for innovation and reliable international partners. However, this does not preclude intervention in globalised markets. One example of a sensible restriction on the free movement of capital is the regulation of capital flows that merely serve the purpose of making short-term speculative profits without covering the financing needs of the real economy or hedging interest rate or exchange rate risks.

The introduction of a financial transaction tax would be one possible response to this. This has been the subject of intense debate among our international partners for years now, giving us a taste of how difficult it will be to shape the global world order in a way that is more socially just. But that is exactly what we need – an intellectual, international debate on how our social market economy should evolve in the digital economy.

The second lesson we can draw from the Lehman collapse is that our prosperity is based not on financial alchemy, but on real products and services. The key challenge for Europe is to remain innovative and competitive in increasingly competitive markets. Germany’s vehicle scrappage incentive scheme was an adequate instrument during the crisis, but now we need to take steps to ensure that innovative products and services, such as intelligent mobility schemes, are developed and established in Germany, too. This, in turn, requires massive investment in research, development and infrastructure – by the state, but above all by private companies.

My third point is that the crisis also had a socio-political and democratic dimension. The crisis cost us dearly in the most important of all political currencies: trust. Many people have lost confidence in the ability of national and European institutions to take action. They have had to endure severe cuts, and some people remain sceptical about how the state will behave if the going ever gets tough again. Will it protect them from harm any more effectively than it did ten years ago? One of the core complaints of the protest movements that emerged in 2009 was that states had somehow found enough money to save the banks, but not enough to address the concerns of the people. Acclaimed economists such as Joseph Stiglitz spoke of the gap between the ‘1 percent’ and the remaining ‘99 percent’. This might be something of an over-simplification. But it is true that the rise in inequality over the past decades was one of the causes of the crisis. And, in some countries, greater inequality is also one of its consequences.

The collapse of Lehman Brothers and its consequences disrupted the life plans of millions of people – and shattered a fundamental tenet of Western democracies: that people controlled their own destinies with the protection of the state. Policy-makers must avoid a repeat of this disaster. They must create a framework in which people have the freedom to live the life they want for themselves. That is what our citizens expect of us.

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