The Impact of the Financial Crisis Over a Decade Later
The financial crisis of 2008 was the first time the world had seen the cracks in the Fiat money system established after Nixon’s abolishment of the gold-backed US dollar in 1971. I find it fascinating how a seemingly isolated issue in the sub-prime US mortgage market had far-reaching consequences in other financial systems. In response to the 2008 financial crisis, for example, the UK Government issued a bank rescue package totalling £500 billion to save banks like Lloyds and the Royal Bank of Scotland. But the question you probably want answering is: why?
The answer is that financial institutions are much more closely connected to each other since governments removed restrictions on being able to move money around the world. UK banks like Northern Rock had expanded rather aggressively after the unfortunate events of 9/11 and turned to international money markets to fund its rapid growth. So, when problems in the US sub-prime mortgage started to spread to Europe, UK banks were beginning to run short of money to meet their losses. Consequently, what became known as a liquidity crisis followed: banks didn’t have enough money in the form of cash – known as liquid assets – to operate as a safety in the occurrence of a bank run. Unfortunately, what was feared finally came to be as on the 14th of September 2007, the first UK bank run for over 140 years was triggered on Northern Rock.
A further issue to add to this absolute mess was that the legal framework for bankrupt banks was wholly unsatisfactory in two ways. Unlike present-day where any money in a bank up to £85,000 is protected under the Financial Services Compensation Scheme (FSCS), only deposits of £2,000 would be protected back then, so people were left very unhappy. Once this news got out then, it followed that what happened with Northern Rock happened to many banks across the UK. Why is that a big problem? Well, all businesses rely on some form of debt finance to function – mostly loans from banks - so when the banking sector fails, it pulls down the rest of the economy with it. Consequently, the UK ended up running through a recession which lasted for five quarters: the deepest UK recession since the Second World War.
So, another question: why should you care? Well, problems from the 2008 recession still impact us today. It probably would be useful for me to reiterate the scale of the crisis to you, readers. The crisis required a write-down of over $2 trillion from financial institutions alone, while the lost growth resulting from the crisis and ensuing recession has been estimated at over $10 trillion, which was estimated to be around one-sixth of the total GDP in 2008.
Many of the direct effects of the crisis still remain active concerns: debt levels across advanced economies, while declining, are still far above where they were before the crisis. Similarly, although unemployment in Mediterranean Europe has begun to decline, it still remains incredibly high – over 15% in Spain and 20% in Greece.
Both the framework and the administration of the economy have also changed profoundly. Both the political power and balance sheets of central banks have reached unprecedented levels as they have taken on an increased role in regulating the financial system. Consequently, control measures were put in place in the form of implementing monetary policy management and employing new tools such as quantitative easing and bank ‘stress testing. ’Perhaps less known, and less tangibly, the credibility of economists and bankers remains tarnished. As the Queen famously asked of distinguished economists at the London School of Economics during the height of the crisis, it is still unclear to many observers how so many economists so badly misjudged such a critical risk within their own profession. Additionally, the combination of recovery of financial assets, capital injections of banks, and bailouts from governments created an impression that the people above us prioritised lining their own pockets more than the needs of individuals. This combination of scepticism of both the motives and accuracy of the economics profession has had profound political effects, most notably the failures of economic analysis to be persuasive in the Brexit referendum or in response to protectionist platforms such as those of Bernie Sanders and Donald Trump. Indeed, a year ago, there was controversy when the chief economist of the Bank of England went so far as to claim the economics profession remains in an ongoing state of crisis.
Nevertheless, it seems that the impact of the financial crisis keeps bringing new economic challenges as we enter a new decade. Technology has created new markets for data while threatening mass unemployment and an end to a manufacturing-based development model. The Bank of England is offering its lowest Bank Rate in a long time, hitting a solid 0.1%, in hopes that it will make people borrow more credit, thus making the economy grow. However, it must be noted that central banks are cautious when doing this, as inflation and bank rates are inversely correlated: as bank rates lower, inflation gets higher, and vice versa. Central banks tend to manipulate the rate of inflation by setting and adjusting bank rates, constantly increasing and decreasing them to grow and decline the economy to meet inflation targets.
To summarise, it is clear that the financial crisis still impacts us today, and although it sounds like the government has control over the situation, the lowering of the bank rate by the Federal Reserve in America is what kickstarted the financial crisis in 2008. So, with time, we will see whether governments have learnt their lesson, or whether we will fall down the same rabbit hole from over a decade ago.
By Declan Larkin