THE most dramatic moment of the global financial crisis of the late 2000s was the collapse of Lehman Brothers on September 15th 2008. The point at which the drama became inevitable, though – the crossroads on the way to Thebes – came two years earlier, in the summer of 2006. That August house prices in America, which had been rising almost without interruption for as long as anyone could remember, began to fall – a fall that went on for 31 months (see chart 1). In early 2007 mortgage defaults spiked and a mounting panic gripped Wall Street. The money markets dried up as banks became too scared to lend to each other. The lenders with the largest losses and smallest capital buffers began to topple. Thebes fell to the plague.
Ten years on, and America’s banks have been remade to withstand such disasters. When Jamie Dimon, the boss of JPMorgan Chase, talks of its ‘fortress’ balance-sheet, he has a point. The banking industry’s core capital is now $1.2 trillion, more than double its pre-crisis level. In order to grind out enough profits to satisfy their shareholders, banks have slashed costs and increased prices; their return on equity has edged back towards 10%. America’s lenders are still widely despised, but they are now in reasonable shape: highly capitalised, fairly profitable, in private hands and subject to market discipline.
The trouble is that, in America, the banks are only part of the picture. There is a huge, parallel structure that exists outside the banks and which creates almost as much credit as they do: the mortgage system. In stark contrast to the banks it is very badly capitalised (see chart 2). It is also barely profitable, largely nationalised and subject to administrative control.
This post was published at David Stockmans Contra Corner on August 25, 2016.