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Sign upA financial crisis foreshadowed
Professor Richard Portes is concerned by warning signs
David Solomon Chairman and CEO of Goldman Sachs and Jamie Dimon Chairman and CEO of JP Morgan argue that the financial world is “substantially safer” and “fundamentally sounder” than before the financial crisis of 2008. And the Financial Stability Board has declared shadow banking no longer a risk to stability. But the markets think that banks are weak, especially in Europe. The ratio of European banks’ market value to book value is around 0.5 to 0.6 and their return on equity is negligible.
This could be a warning sign of another financial crisis. A crisis, like the 2008 crash, that made the financial sector seize up, required massive taxpayer-funded bailouts, and took large shares of GDP. After 2008, unemployment rose over 10% in the US and 25% in Greece and Spain. Public debt issued by governments, soared from 40% in the UK and US to 80-90% of GDP, where it remains today.
Types
Richard Portes, Professor of Economics at London Business School, has built a distinguished career studying the causes and consequences of crises, and he is concerned. Although he won’t be drawn on predictions, he has identified three types of crisis.
One is a systemic banking crisis, which is what happened in 2008. It started with Lehman Brothers and spread rapidly, to economies both large and small. As a result Iceland lost a whopping 40% of GDP.
The second is an exchange rate crash. That didn’t quite happen to Sterling after the UK referendum on EU membership. It lost 15% of its value against a basket of currencies. However, when the Indonesian Rupiah lost 75% of its value in 1997, many Indonesian companies with revenue in Rupiah but debt in US Dollars went bust.
The third is a debt default. A sovereign debt default in Greece 2012 saw private sector holders of Greek government debt lose 75% of their value. Italy came close to default in late 2011.
Shadow banks
In an early paper, ‘The Anatomy of a Financial Crisis', Professor Portes explored the links between these types of financial crash. He has also studied shadow banks, a wide range of organisations that take deposits or make loans but aren’t banks. These include anything from asset managers like BlackRock to hedge funds and pension funds. The difference is that they don’t guarantee deposits and there is no lender of last resort, like a central bank, to step in to bail them out. If a shadow bank fails, depositors and creditors are left with nothing.
