The Exchange

Lehman Brothers, Five Years Later

The Exchange

By Rob Nichols

Five years ago this week, investment bank Lehman Brothers filed for bankruptcy in the midst of a systemic financial tsunami that impacted thousands of financial institutions – big and small –across the country and around the world. In Washington, we’re still having a healthy debate over the source of the 2008 crisis. To some, it was government policy run amok, with mortgage groups Fannie Mae and Freddie Mac fueling an artificial government-backed bubble for more than 25 million shaky mortgages. To others, the blame for the crisis lay with regulations failing to keep pace with financial innovation, particularly in the area of credit derivatives.

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While the crisis-era investigations and research continues, the industry has also been working vigorously to rebuild itself and the American economy from the rubble of 2008. As a result, credit – the lifeblood that keeps our economy working – is once again flowing, supporting American businesses and jobs. Large banks approved more small-business loans in July than they have in any month since before the recession. Equity markets are showing signs of strength, and American businesses have been able to rely on American financial institutions when they look to access global credit markets.

A healthier, more stable banking system

Large financial institutions have also been working alongside regulators to make themselves and the financial system stronger, more transparent, more resilient and more accountable. Specifically, capital, which protects banks from unexpected losses, has doubled since 2009. Liquidity, holdings of cash and liquid securities, has also doubled since 2009. Leverage has been reduced, in some cases cut in half. Asset quality is far stronger, with problem loans and loan losses falling to their lowest levels since early 2008. Risk management, internal controls, and governance procedures have been significantly enhanced. And compensation structures at most banks have been reformed to closely align the personal incentives of bank employees with the long-term performance and safety and soundness of the employing institution. Together with near record levels of capital, such improvements make for a far healthier and more stable banking system.

Additionally, large financial institutions are subject to annual stress tests by the Federal Reserve and have also submitted “living wills” to regulators to detailing how companies could be dismantled without significant market disruption or taxpayer intervention in the event of a future failure. It has been reported that America’s biggest financial institutions could now withstand a crisis worse than the one suffered in 2008.

Managing risk

Despite these improvements, risk is ever-present – in every single mortgage, every business loan, every hedge and every investment – including U.S. treasuries. It is also essential. We need financial institutions to take risks if they are going to provide the capital and liquidity that keeps the American economic engine running. We need to make sure they have the tools to hedge those risks, and we need to make sure that our system is strong enough so that if the worst happens, large firms can fail safely without cost to the taxpayers.

Along those same lines of preventing taxpayer exposure, thoughtful work is now underway in Congress to rewire our system of mortgage finance. While forging an agreement on reforming and unwinding Fannie Mae and Freddie Mac will be difficult, in this new push, both Republicans and Democrats are starting with the same intentions. Both are very focused on ensuring that homeownership remains within reach for American middle class families. At the same time, both parties are keenly aware of the need to protect taxpayers from unwanted exposure to the inevitable ups and downs of the real estate market.

Five years after the worst financial crisis since the Great Depression, our future is bright. America has the energy, the brainpower, the creativity, and yes, the financial resources, to make an even stronger comeback. To achieve this goal, we need to make sure that our financial services sector is in a strong position to help America’s citizens and businesses access the capital they will need to thrive in a complex and interconnected global economy. While some would like to see our largest firms shrink or be broken up, an ecosystem as large and diverse as the U.S. economy needs financial institutions of all sizes, charter types, and business models if we are going to continue to lead as an economic engine of the world.

Rob Nichols is President and CEO of the Financial Services Forum

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