Financial crisis: 10 years on

MICHAEL G JACOBIDES

In the lead-up to the crisis, banks started leveraging themselves up to the hilt. As they sought external funds, their capital became a tiny proportion of their total assets. That was fine when things were going well, but with the credit crunch and the great financial crisis (GFC), the sources of funds dried up.

Banks pretended that risk would go down simply because instruments such as collateralised debt obligations (CDOs) were tradeable. They had blind faith in “the market”. Since then, banks have been prevented from expanding too far and engaging in the sort of folly that meant that firms such as the Royal Bank of Scotland would spend years in the red.

That’s fine as far as it goes – but I’m worried about what will happen in the next downturn. And I firmly believe that there will be another downturn; we are due for contraction any time now.

The credit environment will be different. Regulators are much more aggressive about pushing the banks to offload low-quality debt, which means they will no longer be able to hold loans with companies in trouble, so now we have a new generation of potential players who will be involved in the secondary market for those loans.

That fundamentally changes the environment for companies who are struggling – how are they going to get fixed? We won’t see the results of what we have created until tougher times are upon us.

And when might that be? The huge monetary intervention by central banks means we are supporting things that might otherwise not be so healthy. Remember, central banks are holding 15% of outstanding bonds on their balance sheets – that’s unprecedented. Central banks are providing enormous support to the capital markets.