The most important lesson of Lehman is that financial regulators, policy makers, and politicians should never tell themselves, “It can never happen here.” Financial crises are an equal opportunity menace that can strike rich and poor countries alike.
When a long, credit-fueled boom drives up stock and house prices to previously unimagined levels, never assume “This time is different.” Look closely, usually, it is not. The aftermath of deep systemic financial crises is almost invariably long and painful, with prolonged high unemployment and soaring government debt.
Believe it or not, when compared to other deep financial crises around the world since World War II, the horrible experience the United States has suffered looks remarkably familiar, not just qualitatively but quantitatively.
The good news is that the world has been living with deep financial crises for centuries, and we are still here. This one is in a healing phase as well, with the main challenge the political polarization that is poisoning reasoned debate and hollowing out the center.
The looming debt ceiling debacle in Washington does not reflect different attitudes towards debt. Had Governor Romney become president and the Republicans controlled the White House, there is little doubt that in the short term, deficits would have risen not fallen, as Romney tried to put his growth plan into effect. No, the debt debacle reflects a constitutional struggle for power between Congress and the Presidency.
Another piece of good news, sort of, is that we are not likely to have another deep financial crisis in the United States anytime soon because we are still recovering from the last one. The memory of the public, the government, and investors of the last crash, is the best vaccination against another one.
One cannot necessarily say the same of Europe, where there are sharp disagreements, notably between France and Germany, about how just how far and how fast political integration should go. These battles have made it hard to agree on much-needed write-downs of debt in Ireland, Greece, Portugal, and Spain.
Emerging markets are also vulnerable, especially those where politicians saw no need for economic reform when China’s boom was lifting prices of their commodity exports and industrialized countries’ woes were chasing capital into faster growing developing nations. With China slowing, and capital starting to flow back to rich countries, emerging markets are starting to look uncomfortably shaky.
Last but not least, have we figured out how to better regulate the financial system? Yes, and no. Surely, our regulators are more attuned to potential problems, and our politicians more aware. Unfortunately, the system itself has not changed nearly enough.
All the heroic (and sometimes quite imaginative) efforts after Lehman were fundamentally directed at maintaining the status quo. Instead, we need to move to a world where financial institutions fund themselves more like other firms, and don’t rely so much on debt. The need for real reform of the financial system is one lesson that, unfortunately, we haven’t quite learned.
Kenneth Rogoff is a professor of economics, at Harvard University and coauthor of “This Time It’s Different: Eight Centuries of Financial Folly.”