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Ten years after Lehman: can liberal democracy survive a new financial crisis?

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In recent weeks, media around the world have celebrated the tenth anniversary of a defining event in the global financial crisis: the bankruptcy and fall of Lehman Brothers, once one of the largest investment banks in the United States. Much of the media coverage described the developments that led to the crisis, the villains of the article, and the political exploits that pulled the global economy from the brink, preventing a repeat of the Great Depression. Yet the uncomfortable truth is that neither the structure of the financial system nor the political discourse surrounding it has changed enough to prevent another collapse of this type. In many cases, the lessons of 2007-2008 have been forgotten – or relegated to a distant, albeit macabre, history that has little to do with the present.

This complacency is visible in President Donald Trump’s abandonment of stricter US banking regulations introduced after 2008. In May of this year, Congress pass the first set of measures to significantly water down aspects of the 2010 Dodd-Frank Act. Additionally, Trump has appointed several officials who favor relatively lax regulation to head major financial watchdog agencies. As the Dodd-Frank Act gives these agencies wide latitude in enforcing financial rules, these appointments de facto weaken regulation.

Likewise, few major governments have actually taken to heart the threat posed by too-big-to-fail banks. The crisis has shown that it may be impossible to close large, heavily indebted banks without harming the economy as a whole – a fact that is forcing political leaders to bail them out. This lesson seems to have been forgotten in many parts of Europe. For example, there is growing political support for a merger between Deutsche Bank and Commerzbank, even though the combination of their balance sheets – around $1.5 trillion and $500 billion respectively – would create an institution worth around 60% of German GDP. THE BNP Paribas balance sheetthe largest bank in France, grew from around $1.6 trillion in 2007 to around $2 trillion in 2017.

Governments have also failed to address the challenges of financial complexity. One of the most striking aspects of the 2007-2008 crisis is that it revealed how few people understood the byzantine interconnections between global financial institutions. After the insolvency of Lehman and the subsequent stock market crash, there was widespread fear that the collapse of a major financial player would lead to the collapse of the entire system – even if the exact connections could not be discerned. through which this would occur. Part of the concern stemmed from the large market for over-the-counter (OTC) derivatives, non-standardized contracts between institutions that could trigger a payment default or changes in exchange or interest rates, and for which there was no central registry. In 2007, as the crisis began to erupt, the world’s outstanding balance of such derivatives stood at $507 trillion (for comparison, projected global GDP for 2018 is just under $90 trillion). dollars). In 2018, according to the latest data from the Bank for International Settlements, the outstanding OTC amounted to $531 trillion.

Another problem is that the European banking union remains incomplete. European policymakers have placed too little emphasis on resolving the well-known problems in the system that helped create and prolong the eurozone crisis. There is still no common deposit insurance system, while the common fund intended to recapitalize banks in the event of a crisis remains ridiculously modest.

It is difficult to find a country that experienced a serious banking crisis between 2007 and 2009 but did not experience an increase in the share of populist votes.

So while the global banking system is unlikely to experience another crisis anytime soon, it is nowhere near safe enough to rule out another global financial crisis in, say, the next decade. This would be worrying enough if we were only talking about the potential economic damage: the 2007-2008 collapse cost hundreds of billions of dollars in direct spending to save the banks and trillions more in lost output since.

Yet, although most people do not realize it, the financial crisis likely played a significant role in the erosion of Western liberal democracy. The economists Manuel Funke, Moritz Schularick and Christoph Trebesch have watch that, in advanced economies, for a long period beginning in 1870, the vote share of right-wing parties increased by an average of 30 percent (not percentage points) following financial crises. This effect is particular to financial crises and does not apply to recessions or macroeconomic shocks originating outside the financial system.

It is plausible that a financial crisis and resulting bank bailouts would create the widespread perception that a corrupt elite is exploiting ordinary citizens. Because the transfer of taxpayers’ money to indebted banks limits the state budget, budgetary austerity often follows a crisis. Austerity increases unemployment, as well as competition for increasingly scarce public goods such as health care, education and infrastructure. In some countries, such competition can exacerbate hostility between native-born and foreign-born citizens.

The opinions of many European voters reflect this interpretation of events. For example, in the run-up to the Brexit referendum, some British citizens expressed concern that migrant workers from Central and Eastern Europe had equal access to public schools and a strained National Health Service. tested by budget cuts. Similar concerns prevail in Berlin neighborhoods where the right-wing Alternative für Deutschland party enjoys strong support. A common complaint is: “The government has been telling us for years that there is no money to repair the school building. But for the banks and the refugees, there is suddenly money.”

Although the empirical work of the three economists has attracted criticism on several fronts, their broader argument appears to be true. While parts of the Trump insurrection and the Brexit vote can be considered populist, it is difficult to find a country that experienced a serious banking crisis in 2007-2009 but did not experience an increase in share of populist voices. This phenomenon extends beyond right-wing parties: left-wing populists like Podemos have filled the void in Spain, while the Italian political system has come under pressure from both fringes.

Of course, the populist rise is not limited to the global financial crisis. But the events of 2007-2008 appear to have largely contributed to the persistent political instability of Western democracies.

All of this raises a troubling question: Given that populists already have a significant foothold in most Western states, where would another financial crisis propel them? Ten years after the collapse of Lehman, it is high time that politicians treat finance as more than a technical and economic issue; Limiting financial sector excesses could prove essential to the survival of liberal democracies.

The European Council on Foreign Relations does not take a collective position. ECFR publications represent solely the opinions of their individual authors.

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