The 2008 sub-prime mortgage crisis exhibited significant shortcomings in our financial system and showed us the range of uncertainties that the world is exposed to courtesy, globalization. Nearly a decade after the crisis, the world is still struggling with meagre amount of growth, trade wars, constrained government budgets and an emerging market slowdown. Not only has this made our whole financial system fragile, it has also reduced the level of public faith in our institutions. Although market indices are hitting new highs, with companies crossing the $3 trillion mark, some structural problems continue to dangle over the global economic landscape, with the potential for a future catastrophe.
Take education, it’s every student dream to get his education from the bests out there, but the bests are also costly. The cost of higher education in United States that hosts some of the best institutes for higher studies, has increased dramatically over the last decade. To prevent an explosion of anger among their constituents, politicians expanded the US student loan program by reducing regulation. Soon, the education loan industry grew more than tenfold, from 100 billion to around 1.2 trillion – almost as much as the GDP of Indonesia. This rapid acceleration of student debt, fueled the growth of several subpar universities as well, further trapping vulnerable students into a cycle of economic dependence and low skill growth. Since Lehman therefore, we have created a second pseudo mortgage crisis, only this time we are playing with skills and lives of future generations far more directly.
In the Economic Survey 2018, the then Chief Economic Advisor of India Dr. Arvind Subramanian, hinted at a bubble in the Indian stock markets. Explaining the run-up in stock prices, the survey points out that earnings expectations in India are bloated, and have fueled the stock market boom. In early 2016-17, signs emerged that the long slide in the corporate profits/GDP ratio – a measure of how much contribution private investment and growth is making to an economy – might finally be coming to an end, atleast in the US. Investors reacted to this news with enthusiasm, sending up share prices in anticipation of a recovery they hoped, at long last, lay just ahead. Accordingly, the ratio of prices to current earnings rose sharply as well – indicating that share prices were not entirely backed by fundamental growth. However, since the global financial crisis, corporate earnings to GDP ratio has been sliding, falling to 3.5% compared to 9% in US – and the expected recovery never really came.
Then there’s the trade war, Trump’s arrival on the global economic stage has brought in a lot of uncertainty. First, his style of economic management is all about state control over capitalism, unlike the centrist liberal order of the state being controlled by capital (read: the tweet about Carrier).
Second, he believes global trade must work on the principle of absolute, and not comparative advantage. He wants to win on all fronts, and no trading system would work like that. The world accepts the WTO order because when one country loses on one aspect, say America losing on manufacturing, they gain on another, in America’s case, services and intellectual property. This is why he’s out to compete with the likes of China, Europe and even Canada through tariffs, which makes global trade another potential breaking point for the world. In fact, some of the trade moguls say that the trade war has officially begun. With US continuously nudging various economies around the world with its zero-sum game policy, the million-dollar question for the pundits is – Will the trade war lead to a collapse of the WTO world order and depress global growth?
And lastly, our beloved tech giants and blue chip companies. A recent study by the National Bureau of Economic Research in the US argued that 50% of the unicorns (a startup with a valuation of US$ 1bn or more) were overvalued. The age of unicorns peaked a few years ago when there were 53 of such companies. Since then, the startup age has unraveled. VCs have reported huge losses in their startup portfolio, which shows some signs that the startup bubble might eventually pop in the coming years – putting billions in jeopardy.
So what to do?
The global crisis shook both the financial system as well as public’s confidence therein. Discussions and philosophies challenging the role of our institutions, for better or worse, have now taken the forefront. Capitalism as an ideology is under challenge, from populists such as Trump and Tsipras on the left and right, as well as from self-proclaimed socialists such as Bernie Sanders. The future of finance also poses significant challenges and hurdles as we transcend into a community driven by algorithmic decisions and functions. Most importantly, the bedrock of upward mobility – employment – seems to be under threat from automation.
As far as the global financial system is concerned, its resilience will depend on a technology friendly legislative and regulatory environment. For a decade, central banks around the world have been trying to manufacture a recovery. Prima facie, the role of the central bank is very simple. It has to ensure there’s adequate cash in the market through its monetary and fiscal policy. But across the world, Quantitative Easing, a structured process of printing money, has failed at accomplishing this goal. A decline in real interest rates (difference between interest rates being offered by banks and inflation) should have been a warning sign before the crisis. Household spending, which because of the decline in real interest rates was already low, completely collapsed after 2008. This means that in the future, central banks will have to watch such indicators with great care.
But a crisis can occur in the upcoming fin-tech industry, which currently exists in a regulatory grey area. Fin-tech refers to industries that predominantly employ technological solutions to offer limited financial services – such as Paytm in India, Apple Pay or PayPal in US, etc. While these companies have increased consumer choices, in addition to making services faster, cheaper and efficient, the regulatory infrastructure is weak. For instance, the payday and auto loan industry in the US is booming on sub-prime loans coming primarily out of these fintech companies. Another upcoming technological innovation is blockchain (read more) – a distributed ledger that can create a perfect record of ownership, without the costs of having an intermediary to do so. Blockchain possesses immense potential in the field of financial markets. With may young minds already working on it, blockchain can help mitigate various risks involved in OTC (over the counter) and bilateral contracts. Across the OTC markets, blockchain could significantly decrease risk and increase efficiency in swaps, bonds, commodities, unregistered securities, syndicated loans and repos and other instruments. An interesting effect of the technology that could spur support from regulators is the increased transparency that it brings. Since blockchain is ideal for tracking and tracing, it could improve auditing and regulatory reporting. The cost of not being able to migrate to blockchain will only increase as the number of transactions increase. However, at the same time, blockchain presents a considerable problem for states. As decentralization increases, it can also spin off cryptocurrencies – independently created currencies (read more) – that have significant security and tax implications.
Getting Stuff Right
The regulatory framework that emerged post crisis is comprehensive, but it lacks a sense of financial responsibility. In the coming years, a new approach, that increases partnership between industry and regulators will be necessary. This partnership will have to lay down appropriate actions on part of all stakeholders, through greater use of industry standards as well as rules laid down by governments. The new approach will also require the industry to undertake greater efforts at assuming responsibility for the "greater good" and benefits of their consumers. The new approach also requires a further evolution in our understanding of the financial culture so as to recognize it as a bona-fide profession that should be governed by the right incentives, behavioral drivers and internal oversight, instead of being brushed aside as a profession full of greed and disregard for common people. The industry needs to examine whether it has the right type of employees as well. The reason for the success of the service industry is that they are able to position the right employee for the right customer, this is a lesson that Asset Management Companies and Investment Banks could borrow.
Trump and his ilk may make the future of capitalism appear bleak, but this is a system that has survived 5 centuries and evolved substantially, it’s hard to imagine that it will vanish out of thin air.
About The Author
Sarthak Agarwal is a student of Management Studies at the Shaheed Sukhdev College of Business Studies, Delhi University. He has won several national and international level business and strategy competitions, and also runs a blog where he decodes and explains articles published in The Economist Magazine.