On 15 September 2008, Lehman Brothers, the fourth-largest investment bank in the USA, filed for bankruptcy. Although the credit crisis had been building since mid 2007, the demise of Lehmans was a pivotal event in the unfolding of the financial crisis and the subsequent severe recession in most developed economies. Banks were no longer seen as safe and huge amounts of government money had to be poured into banks to shore up their capital and prevent further bankruptcies. Partial nationalisation seemed the only way of rescuing several banks and with it the global financial system.
A deep and prolonged recession followed (see Chart 1: click here for a PowerPoint). In response, governments pursued expansionary fiscal policies – at least until worries about rising government deficits and debt caused a lurch to austerity policies. And central banks pursued policies of near zero interest rates and subsequently of quantitative easing. But all the time debate was taking place about how to reform banking to prevent similar crises occurring in the future.
Solutions have included reform of the Basel banking regulations to ensure greater capital adequacy. 
The Basel III regulations (see Chart 2) demand considerably higher capital ratios than the previous Basel II regulations.
Other solutions have included proposals to break up banks. Indeed, just this week, the Lloyds Banking Group has hived off 631 of its branches (one sixth of the total) into a newly reformed TSB. Another proposal is to ring-fence the retail side of banks from their riskier investment divisions. In both cases the aim has been to avoid the scenario where banks are seen as too big to fail and can thus rely on governments to bail them out if they run into difficulties. Such reliance can make banks much more willing to take excessive risks. Further details of the new systems now in place are given in the Robert Peston article below.
But many critics maintain that not nearly enough has been done. Claims include:
• The Basel III rules are not tough enough and banks are still being required to hold too little capital.
• Rewards to senior bankers and traders are still excessive.
• The culture of banking, as a result, is still too risk loving in banks’ trading arms, even though they are now much more cautious about lending to firms and individuals.
• This caution has meant a continuing of the credit crunch for many small businesses.
• Higher capital adequacy ratios have reduced bank lending and have thus had a dampening effect on the real economy.
• The so-called ring-fences may not be sufficient to insulate retail banking from problems in banks’ investment divisions.
• Banks are not being required to hold sufficient liquidity to allow them to meet customers’ demands for cash in all scenarios.
• Banks’ reliance on each other still leaves a systemic risk for the banking system as a whole.
• Fading memories of the crisis are causing urgency to tackle its underlying problems to diminish.
• Problems may be brewing in less regulated parts of the banking world, such as the growing banking sector in China.
The following articles look at the lessons of the banking crisis – those that have been learned and those that have not. They look at the measures put in place and assess whether they are sufficient.
Lehman Brothers collapse, five years on: ‘We had almost no control’ The Guardian, Larry Elliott and Jill Treanor (13/9/13)
Lehman Brothers collapse: five years on, we’re still feeling the shockwaves The Guardian, Larry Elliott (13/9/13)
Five years after Lehman, could a collapse happen all over again? The Observer, Larry Elliott and Jill Treanor (15/9/13)
Five years after Lehman, all tickety-boo? BBC News, Robert Peston (9/9/13)
What have we learned from the bank crash? Independent, Yalman Onaran, Michael J Moore and Max Abelson (14/9/13)
We’ve let a good financial crisis go to waste since Lehman Brothers collapsed The Telegraph, Jeremy Warner (12/9/13)
The Lehman legacy: Lessons learned? The Economist (9/9/13)
The dangers of debt: Lending weight The Economist (14/9/13)
The Lehman anniversary: Five years in charts The Economist (14/9/13)
Questions
- Why did Lehman Brothers collapse?
- Explain the role of the US sub-prime mortgage market in the global financial crisis of 2007/8.
- In the context of banking, what is meant by (a) capital adequacy; (b) risk-based capital adequacy ratios; (c) leverage; (d) leverage ratios?
- Explain the Basel III rules on (a) risk-based capital adequacy (see the textbook and the chart above); (b) non-risk-based leverage (introduced in 2013: see here for details).
- Explain and comment on the following statement by Adair Turner: ‘We created an over-leveraged financial system and an over-leveraged real economy. We created a system such that even if the direct cost of bank rescue was zero, the impact of their near-failure on the economy was vast.’
- Under what circumstances might the global financial system face a similar crisis to that of 2007/8 at some point in the future?
- Why is there an underlying conflict between increasing banks’ required capital adequacy and ensuring a sufficient supply of credit to consumers and business? What multiplier effects are likely to occur from an increase in the capital adequacy ratio?
The 2020 Olympics has just been awarded to Tokyo, beating Madrid and Istanbul. Concerns over the safety of the games in Tokyo, with the city being perceived as relatively close to the Fukushima nuclear plant, were overcome with the help of an address by the Japanese Prime Minister, Shinzo Abe. So, what are the economic implications of this latest development in the sporting world?
When London was awarded the 2012 Olympic Games, estimates suggested that it would generate a £16.5 billion contribution to GDP. With many new construction projects, there was the inevitable injection of government expenditure. This led to the creation of new jobs and thus successive employment multiplier effects were generated. This is also likely to be true for Tokyo, with current proposals suggesting that ten new permanent sites will be built to host the various sports of the Games. This will undoubtedly generate new jobs and will provide an almost certain boost to the construction industry. This, in turn, will generate further multiplier effects across a multitude of industries and across the rest of the country.
There will also be further economic effects, for example on Japanese investment and stocks and shares, with a boost in confidence and optimism. A Tokyo-based fund manager, Hiroshi Fujumonto, said:
Olympics-related stocks are yet to fully price in the decision, even though they’ve already outperformed … In the short term the entire Japanese share market will get a boost from celebratory buying and expectations for the event’s economic impact.
This was also confirmed by Shinzo Abe, when he commented after the victory was announced that ‘I want to make the Olympics a trigger for sweeping away 15 years of deflation economic shrinkage.’ 
The Japanese economy has been struggling for many years and this may be the much needed boost to the country’s optimism, infrastructure and economy.
As the world’s third largest economy, this economic boost is also likely to have knock-on effects on other countries across the world, though it is more likely to be the long-term impact that is important here. Just as it was with the London Olympics, the final effect and cost will only be known some years after the Olympics are held, but for now the work will start for Japan.
Olympics 2020: Tokyo wins race to host games BBC Sport (7/9/13)
Tokyo Olympics win seen boosting infrastructure, recovery Bloomberg, Yoshiaki Nohara and Satoshi Kawano (8/9/13)
Tokyo wins bid to host 2020 Olympic Games Telegraph, Ben Rumsby (8/9/13)
Tokyo chosen as ‘safe pair of hands’ to host 2020 Olympics Financial Times, Benedict Mander (8/9/13)
Japanese bid’s passion earns Tokyo the 2020 Olympic Games Guardian, Owen Gibson (7/9/13)
Olympics 2020: Why Tokyo is a ‘safe pair of hands’ to host Games BBC News, David Bond (8/9/13)
Questions
- What is the multiplier effect and how is it calculated?
- How can the overall economic benefits of the Olympic Games be estimated?
- Which industries in Tokyo are likely to be the ones that benefit from the Olympic Games?
- Outline a cost–benefit analysis of the Olympic Games.
- Why are share prices likely to go up in Japan based on this news? Look at both the demand and supply factors that will affect share prices.
- Is it possible that there will be wider multiplier effects on other countries besides Japan?
House prices in the UK are rising and the rise seems to be accelerating – at least until the latest month (August). They are now growing at an annualised rate of nearly 4%. This is the fastest rate for three years (see chart below: click here for a PowerPoint of the chart).
This may be worrying for Mark Carney, the Governor of the Bank of England, who is committed to avoiding a new house price bubble. 
The problem is that, under the recently issued forward guidance, the Bank of England is set to retain the current historically low Bank rate of 0.5% until unemployment has fallen to 7%. But that could be some time – probably around two years.
So what can the Bank do in the meantime and what will be the consequences?
The following article from The Guardian looks at the options.
Article
How can the Bank of England prick the house price bubble? The Guardian, Patrick Collinson and Heather Stewart (30/8/13)
Data
Links to house price data The Economics Network, John Sloman
Questions
- What constitutes a housing price boom? Is the UK currently experiencing such a boom?
- What factors have led to the recent house price rises? Have these factors affected the demand or supply of houses (or both)?
- Who gains and who loses from rising house prices?
- Explain the policy adopted in New Zealand to curb house price inflation.
- Consider the merits of this option?
- Could borrowers find ways around this measure?
- Are there any other options open to the Bank of England?
In our blog How sustainable is UK consumer spending? we considered concerns of some commentators that consumer spending was growing unduly quickly given the absence of any sustained growth in disposable income. The Second Estimate of GDP, Q2 2013 reports that the economy grew by 0.7 per cent in the second quarter of the year, with household expenditure growing by 0.4 per cent.
Because household spending makes up about two-thirds of aggregate demand in the UK it is important to keep an eye on it. The latest figures show that the real value of consumer spending by British households has risen in each quarter since 2011 Q4. In other words, the volume of household purchases has risen for seven consecutive quarters. Over the period, the growth in real consumer spending has averaged 0.4 per cent per quarter.
The chart helps to demonstrate the stark turnaround in the growth in consumer spending. Over the period from 2008 Q1 to 2011 Q3, real consumer spending typically fell by 0.4 per cent each quarter. As we noted in our previous blog, this was a period when the global financial system was in distress, with the availability of credit severely dampened, but also a period when households were concerned about their own financial balances and the future prospects for growth. Over the same period, real GDP typically fell by a little under 0.3 per cent each quarter. (Click here to download a PowerPoint of the chart.)
The real value of consumer spending has yet to return to its 2007 Q4 peak (£242 billion at 2010 prices). In 2013 Q2 the real value of consumer spending is estimated still to be 3 per cent below this level (£235 billion at 2010 prices). These figures are mirrored by the economy at large. Real GDP peaked in 2008 Q1 (£393 billion at 2010 prices). Despite the back-to-back quarterly increases in real GDP of 0.3 per cent in Q1 and 0.7 per cent in Q2, output in 2013 Q2 (£380 billion at 2010 prices) remains 3.2 per cent below the 2008 Q1 peak.
While real consumption values are below their 2007 Q4 peak, the concern is whether current rates of growth in consumer spending are sustainable. In particular, should this growth cause the household sector financial distress there would be real pain for the economy further down the line. Some commentators argue that the latest GDP figures are consistent with a more balanced recovery. In Q2 economic growth was supported too by other parts of the economy. For instance, we saw a 3.6 per cent rise in export volumes and a 1.7 per cent rise in gross fixed capital formation (i.e. investment expenditure).
Nonetheless, it is the protracted period over which consumer spending has been growing robustly that concerns some economists. Hence, we will need to continue to monitor the growth in all components of aggregate demand and, in particular, changes in household consumption, income, saving and borrowing.
Data
Second Estimate of GDP, Q2 2013 Dataset Office for National Statistics
Articles
New articles
UK economic growth revised up to 0.7% BBC News, (23/8/13)
UK GDP revised up to 0.7pc in second quarter: reaction Telegraph, (23/8/13)
UK rallying faster than thought as exports leap boosts GDP Independent, Russell Lynch and Ben Chu (24/8/13)
UK economy expanding faster than first thought, GDP revision shows Guardian, Heather Stewart (23/8/13)
Growth upgrade points to ‘sustainable’ recovery Telegraph, Philip Aldrick (23/8/13)
Previous articles
UK wages decline among worst in Europe BBC News, (11/8/13)
Squeezing the hourglass The Economist, (10/8/13)
UK first-quarter growth unchanged BBC News, (28/5/13)
Summer heatwave triggers shopping spree in ‘Wongaland’ economy Telegraph, Steve Hawkes and Steven Swinford (15/8/13)
Retail sales data better than expected as UK economy enjoys summer bounce Guardian, Heather Stewart (15/8/13)
Mark Carney is banking on you to keep spending Telegraph, Philip Aldrick (10/8/13)
NIESR upgrades UK economy but warns on consumer spending Telegraph, Philip Aldrick (2/8/13)
Consumers ‘expect better economy’ Belfast Telegraph, (4/8/13)
Questions
- Explain what you understand by a ‘sustainable’ economic recovery.
- What are the expenditure components that make up Aggregate Demand?
- Explain what you understand by consumption smoothing.
- Why would we would typically expect consumption growth to be less variable than that in disposable income?
- Would we expect consumption growth to always be less variable than that in disposable income? Explain your answer.
- What impact do you think the financial crisis has had on consumer behaviour?
- To what extent do you think the current growth in consumer spending is sustainable?
- How important are expectations in determining consumer behaviour?
Household spending makes up about two-thirds of aggregate demand in the UK. Understanding its determinants is therefore important to understanding short-term economic growth. The real value of consumer spending by British households has risen in each quarter since 2011 Q4. Over the same period real disposable income has flat-lined. This suggests that the British household sector has stepped up attempts to smooth their longer-term spending profile despite the current absence of growth in their real incomes.
When viewed over many years, disposable income and consumer spending grow at very similar rates. After stripping out inflation we find that over the past 50 years both have grown at about 2½ per cent per annum. However, if we measure growth from one quarter of the year to the next we tend to find that consumption growth is less variable than disposable income. This is known as consumption smoothing.
Chart 1 shows the quarterly percentage change in consumption and disposable income since 1998. (Click here to download a PowerPoint of the chart).The variability in the disposable income series is generally greater than that in consumption so helping to illustrate consumption smoothing.
Consumption smoothing is facilitated by the financial system enabling us to either borrow to supplement our spending or to save to enjoy more spending in the future. The financial system can help households to avoid large variations in their spending over short periods.
Consumption smoothing does not prohibit falls in consumption nor periods when it is more variable than income. Over the period from 2008 Q1 to 2011 Q3, real consumption typically fell by 0.4 per cent each quarter while disposable income was flat. This was a period when the global financial system was in distress. Sharp contractions in credit meant that the financial system was no longer able to support economic activity as it had previously. Furthermore, households too looked to repair their balance sheets with economic uncertainty acting as an incentive to do so.
What is interesting is the extent to which British households are spending again. Since 2011 Q4 the real value of spending has typically expanded by 0.4 per cent each quarter while income growth remains largely absent. One might argue that this just demonstrates a willingness for households to engage in consumption smoothing. With credit conditions still tight, the growth in spending has been aided by a decline in the saving ratio. 
This can be seen from Chart 2.
In 2009 Q2 the proportion of income saved hit 8.6 per cent having been as low as 0.2 per cent in 2008 Q1. In 2013 Q1 the saving ratio had fallen back to 4.2 per cent. (Click here to download a PowerPoint of the chart.)
It is of course all too easy to over-interpret data. Nonetheless, there be will concern if households look to maintain consumption growth at rates substantially greater than those in disposable income for too long a period of time. Consumption smoothing could become a real problem for future economic activity if it was to result in a financially distressed household sector. Hence, an important question is the extent to which current rates of consumption growth are sustainable. Future consumption and income trends will therefore be analysed with enormous interest.
Data
Quarterly National Accounts, Q1 2013 Dataset Office for National Statistics
Articles
UK wages decline among worst in Europe BBC News, (11/8/13)
Squeezing the hourglass The Economist, (10/8/13)
UK first-quarter growth unchanged BBC News, (28/5/13)
Summer heatwave triggers shopping spree in ‘Wongaland’ economy Telegraph, Steve Hawkes and Steven Swinford (15/8/13)
Retail sales data better than expected as UK economy enjoys summer bounce Guardian, Heather Stewart (15/8/13)
Mark Carney is banking on you to keep spending Telegraph, Philip Aldrick (10/8/13)
NIESR upgrades UK economy but warns on consumer spending Telegraph, Philip Aldrick (2/8/13)
Consumers ‘expect better economy’ Belfast Telegraph, (4/8/13)
Questions
- Explain what you understand by consumption smoothing.
- Why would we would typically expect consumption growth to be less variable than that in disposable income?
- Would we expect consumption growth to always be less variable than that in disposable income? Explain your answer.
- What impact do you think the financial crisis has had on consumer behaviour?
- To what extent do you think the current growth in consumer spending is sustainable?
- How important are expectations in determining consumer behaviour?
On 15 September 2008, Lehman Brothers, the fourth-largest investment bank in the USA, filed for bankruptcy. Although the credit crisis had been building since mid 2007, the demise of Lehmans was a pivotal event in the unfolding of the financial crisis and the subsequent severe recession in most developed economies. Banks were no longer seen as safe and huge amounts of government money had to be poured into banks to shore up their capital and prevent further bankruptcies. Partial nationalisation seemed the only way of rescuing several banks and with it the global financial system.
