Almost a decade after the collapse of Lehman Brothers, this publication reflects on the lessons of that period and considers what the wealth management industry still needs to do.
As the month of August grinds towards a close it is tempting in this age of Trump, Brexit and Bitcoin to forget that almost 10 years ago global markets imploded. Lehman Brothers filed for bankruptcy on 15 September 2008.
And by a strangely neat piece of anniversary timing, 20 years ago saw Russia’s debt default and the Fed-led rescue of hedge fund Long Term Capital Management, and those events followed soon after the Asian financial crisis of 1997-1998, where pegged exchange rate regimes in a number of Asian jurisdictions snapped. Since then, Asian countries have loaded up on foreign exchange reserves and reduced reliance on short-term debt funding and, hence, cut exposure to swings in the dollar, although they are not totally immune. And with the 2008 drama, there were bailouts, regulatory changes and political upheavals, but the question is how much safer is the financial system as a result?
Arguably, the biggest casualty of 2008 was the loss of trust, and it appears that this has not been entirely regained. The Edelman Trust In Financial Services report, issued in March, showed that trust in the sector has stalled after recovering somewhat from the trough of late 2008. And the barometer shows that trust in financial services is greater in places such as China and Singapore than the UK and US, suggesting that the Western world has not fully repaired the damage. Separately, a poll of 2,250 adults from across the UK, to give a specific case (YouGov, Positive Money) in August 2018, shows that a strong majority have a negative view of banks’ work, believe that they got off lightly from the 2007-2008 crisis, and worry that they might cause another crisis. So there is still work to be done.
Policymakers certainly have not been idle. In the US and European Union, the passage of the Dodd Frank Act (2010, US) and various measures by certain EU countries (such as “ring-fencing” of retail/investment banking in the UK) and the new Basel bank capital rules, are designed to make the banking system more robust. A question remains, however, as to whether the reforms have just added new red tape to the banking sector, raising barriers to entry and making the banking industry more, not less, concentrated around a handful of firms. The US banking industry, for example, is dominated by banks such as Citi, JP Morgan, Bank of America and Wells Fargo, although there are a long tail of medium- and smaller-sized banks as well. Yes, some fintech upstarts are trying to get into the banking business – there is talk of businesses such as Amazon trying to do so – but so far banking in the Western world is not that much different than before the crisis.
The worry that some banks are still just too big to fail remains. Deutsche Bank’s woes of recent years, for instance, are particularly worrying for its home country of Germany simply because the Frankfurt-listed lender is so prominent – its fortunes are intertwined with the manufacturing companies that are the backbone of Europe’s largest economy. In the UK, ring-fencing reforms are scheduled to take full effect next year – time will tell whether they will really make a big difference.
Arguably part of the issue of learning from 2008 is that there is still so much debate on what caused the crisis. On the political “Left” there was much condemnation of capitalism and “greedy bankers” (as if greed had been only recently invented), while in parts of the “Right”, or the more classical liberal parts of it, the finger was pointed at the role of ultra-low central bank interest rates, and government backing for housing, fuelling housing market speculation and improvident lending. Depending on how one reads the lessons, the crisis required a major increase in regulation, or it required the harsh disciplines of free markets to take full effect. The latter view is not popular, but perhaps a system where some firms are allowed to go bust may be more stable overall.
The past decade has seen equity markets rally: the S&P 500 index of US stocks, for example, has climbed from the demonically low level of 666 on 9 March 2009 to over 2,861 last week. For almost a decade, equities have been mostly in a bull market, driven by ultra-cheap central bank interest rates and injections of credit, aka quantitative easing. This “financial repression” – forcing investors up the risk curve to find returns – has caused wealth management firms to throw away the asset allocation rulebook. This period has seen a shift into private capital sectors, such as private equity, with investors increasingly willing to shoulder illiquidity risk for returns. But a question remains how much longer can that process go on?
The regulatory juggernaut has certainly accelerated since 2008, and the bewildering alphabet soup of acronyms and terms bankers must contend with, such as MiFID II, AIFMD, CSR and FATCA, are a sign of how busy times have been. (There are the EU rules on investor protection, alternative investment fund rules, the cross-border agreements on sharing account data, and US rules concerning expats’ tax, respectively.) Compliance jobs, once a lowly-paid back-office role, have become increasingly prominent. Time will tell whether all this extra resource really has made banking safer. It is debateable whether it has improved the client experience all that much, even if good compliance can be a competitive advantage for firms that embrace it willingly rather than grudgingly. There are some signs that financial advice is getting more professional: the RDR programme of reform in the UK has shaken up quality, although it appears to have created an “advice gap”; and in the US, there is a shift towards fee-based advice and away from commission-driven sales.
Another big shift, but one that has not gone as far as some might have thought, has been the move towards onshore as opposed offshore, financial centres. Even allowing for some of the cant that such terminology involves (there is nothing necessarily questionable about being offshore, after all), there has been change. Politicians wanted money to fill their empty coffers after 2008, and the “Treasure Islands” of the offshore world were a tempting target. In truth, the raft of amnesties and disclosure programmes have tended to fall short of expectations, but then much of the money put into “tax havens” was already put to productive use in the world economy anyway, not simply parked in outer space. And the drive for transparency” has arguably hit some limits. There has, possibly, been a bit of swing back of the pendulum, with issues such as European Union data protection laws and the Edward Snowden leaks from the National Security Agency reminding people that legitimate client privacy is important. The rising incidence of cyber-crime attacks on banks and other institutions also reminds the public that privacy is worth defending, a point that the wealth management industry needs to remind people of.
If there is one single point that this publication can make to wealth managers it is that they can and must do a better job at explaining why the sector matters. Wealth creation is important for rising living standards, better jobs and stronger societies. In a free market economy, it means that entrepreneurs who build wealth are entitled to have their assets protected effectively, so that they can continue to grow. If one accepts that an open economy is a positive-sum game, then everyone gains if those who are good at building enterprise are nurtured. Wealth managers are a crucial part of the business ecosystem, and should be proud of doing their job. For a decade or more, wealth management has been under pressure along with the rest of financial services from a mix of political and cultural attack, sometimes with good reason. Ten years after the end of Lehman Brothers, it is perhaps time that the industry put forward its proposition with pride and confidence.