Each year on the Master of Finance core course on Financial Institutions and Markets, I do a session on the Great Financial Crisis of 2007-09. One thing I emphasise is the many different causes of this highly influential event, which helps to explain why people continue to argue about it.
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Whether what is often called the Global Financial Crisis of 2007 to 2009 will look like a world historical event to people in a hundred years, it certainly looks important in 2024. The GFC, as it’s often abbreviated, ended a period of optimism about the effectiveness of lightly regulated financial markets; it damaged the prestige of the US economic system, particularly in China, which had until then been inclined to copy many features of the US financial system; and it triggered a political reaction in the US which contributed to the growth of populism.
Such large, complex events as the GFC tend to have multiple causes, including what we might call structural background factors and shorter term specific triggers.
For example, one of the most important events in European history was the First World War, which broke out in July 1914. Several new books were published to coincide with the one hundredth anniversary of that sad event in 2014, including one called the Sleepwalkers by my distinguished colleague at St Catharine’s College, Professor Sir Christopher Clark, the Regius Professor of History at Cambridge University.
You might think that historians would by now have come to some sort of agreement on what caused what was originally known as the Great War, which ended empires, led to the Russian revolution and paved the way for the even worse Second World War.
But no, even with far more information, including official papers, letters and diaries that reveal more of the private thoughts of the key decision makers, there are still differing views of the role of background factors – such as the growing economic power of Germany and rivalry with Britain, the belated industrialisation of Russia, the sense of grievance in France over the Franco-Prussian war – and the specific actions of those countries’ leaders.
It’s in the nature of major historic events that people will see different causation, even with the same facts, which are of course always incomplete. Another example is the French revolution of 1789, perhaps even more important for world history than the First World War, not least in showing that old, traditional monarchies and empires could be overthrown.
France in the latter part of the 18th century suffered from a system of government that was widely seen as in need of reform, not least because it didn’t produce enough tax revenue. France had supported the American revolution against Britain, mainly on the principle of my enemy’s enemy is my friend. But in doing so, France had come to the point of national bankruptcy.
Much as France had fought with Britain for centuries, there was some admiration for Britain’s constitutional monarchy, in which the king’s power was constrained by parliament, which represented the major landowners (though not the rest of the population). It also allowed far higher levels of taxation.
So there were structural reasons for change.
But the actual revolution broke out in part because of a sequence of very bad weather, both summer and winter, which led to poor harvests and a big rise in the price of bread, the main source of nutrition.
People may be unhappy with a generally unsatisfactory situation but if they are unable to feed their children, they are likely to turn revolutionary.
But historians continue to argue about whether revolution was unavoidable, whether it might have been less violent and led to reformed monarchy rather than a republic, and how much of this was a result of the character of the key people involved, including King Louis 16th himself.
So big historical events tend to be complex and open to interpretation.
The global financial crisis, which should really be called the great US financial crisis, is therefore still a topic of debate. We can point to background factors that helped to create the conditions for a real estate boom: short term rates were held down by a Federal Reserve reacting to a mild recession in 2001; long term rates were held down by foreign demand for US treasury bonds, not least from China.
There were changes in financial technology that played a part, chiefly the use of tranched or structured credit which allowed real estate loans to be backed by a range of complex securities. The demand for these securities, which were typically rated as AAA or very low credit risk, was high because there were very few other AAA securities available, owing to the shareholder revolution in corporate America that led to leveraging up of many companies’ balance sheets.
And we can point to the very high leverage of banks and investment banks themselves, including an excessive dependency on very short term funding, which meant that even a technically solvent financial institution could be driven out of business very quickly if the markets turned against them, as happened to Lehman Brothers in September 2008.
Ideas matter too: there was a widely held belief that unregulated financial markets would rationally allocate risk in a way that would increase stability and resilience. This turned out to be seriously misplaced.
One lesson from all of this is to be cautious about drawing simple lessons from events such as the GFC. It’s important to study it and be aware of what went wrong but there will rarely be only one key lesson, which if we only learned it would magically prevent any future financial crisis.
Sadly, financial crises have a very long history, and that history is unlikely to be over just yet.
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