Are we ready for the next crisis, a decade after Lehman Brothers?
IT HAS been 10 years since the collapse of one of the US largest investment banks, Lehman Brothers, which was induced by investors’ lack of understanding about risks from their investments, such as securities backed by subprime mortgages.
During that time, US GDP dropped sharply to -2.8 per cent in the fourth quarter of 2008, significantly lower growth compared to +2.0 per cent from previous year. In a matter of days, US equity market faced continual selling pressures and plunged by over 40 per cent before hitting a rock bottom in five months.
The crisis originated in the US irrefutably had an impact on Thai economy where GDP in the fourth quarter dropped from +4.5 per cent in 2007 to -2.0 per cent after Lehman Brothers went bankrupt. SET index continued free-fall sessions, wiping out over 40 per cent of market cap within a month.
Since then, there have been multiple rules and regulations imposed, especially on financial institutions including commercial banks and investment banks to minimise the chance of future financial crisis occurring and the impact it can inflict on the economy if it emerges.
However, no matter how strict the regulations are, an economic downturn, which is part of every economic cycle, is almost unavoidable. Eminent organisations ranging from hedge funds such as Bridgewater Associates to investment banks like Goldman Sachs have reported that their crisis indicators are sending some signals. Our primary concern should, therefore; focus on the severity of the impacts from the crisis.
To gauge crisis intensity, we should first identify the potential causes of the forthcoming crisis.
One of the factors that raised the most concerns is the rise in leverages, exacerbated by ample market liquidity injected from extremely loose monetary policy. According to IMF’s Global Financial Stability Report in October 2017, leverages of G20 countries, which includes G7, 12 emerging economies and European Union, has grown tremendously since 2006, especially debt by general government and non-financial companies which stood at around 70 per cent and 65 per cent to GDP respectively in 2016, while the overall debt was around 260 per cent to GDP. These highly leveraged entities will be adversely impacted by the uptrend in global interest rate depending on their debt service sensitivity to changes. More importantly, a significant rise occurred among Chinese non-financial companies of which total borrowing increased by $14.4 trillion from 2006 to 2016.
Exploding debt level in China is now increasingly alarming since the Chinese government continues to pursue deleveraging schemes which have already triggered a series of corporate defaults and worsened the credit outlook among Chinese firms. Additionally, the undesirable impact could be further intensified by the trade war inflicted by the US government.
Despite these risks, it is very unlikely that crisis this time will be as deleterious as the last time.
Goldman Sachs believed that the outcome with long period of low returns across financial assets is more likely than a decline in growth of financial assets’ returns. Nevertheless, a concern raised by Ray Dalio, a renowned hedge fund manager, was that the future crisis will aggravate the existing wealth gap between the rich and the poor as currently almost half of world total wealth are held by 1 per cent of the global population, according to the latest Credit Suisse Global Wealth reports. Thus, the next economic fallout could trigger social upheavals.
We also have to keep in mind that this time, monetary as well as fiscal policy space of many major countries are more limited compared to that in the previous crisis. Given current zero to negative policy rate of Japan and EU as well as scant effectiveness of quantitative easing programme, there is almost no space for further monetary expansion.
On the other hand, prevailing high government budget deficits and public debts leave no room for further fiscal expansion. This means that central banks and governments are less equipped to fight a severe crisis.
Even though there is no indicative sign of economic crisis inflicted from the Thai financial market, it is undeniable that the crisis inflicted from other countries will also affect the Thai economy as well as the financial market. Therefore, it is crucial for Thai firms to prepare for the next crisis.
Views expressed in this article are those of the author and not necessarily of TMB Bank or its executives.
Biz Insight is co-authored by Duangrat Prajaksilpthai and Poon Panichpibool. They can be reached at [email protected]
