A decade after Lehman collapse, risks persist in US financial system

A man leaves the Lehman Brothers headquarters carrying a box in New York on September 15, 2008.

On the brink of crumbling a decade ago, America's financial system was saved by an extraordinary rescue that revived Wall Street and the economy yet did little for individuals who felt duped and left to suffer from the reckless bets of giant banking institutions.
The government intervention shored up the banking system, allowed credit to flow freely again and helped set the economy on a path toward a painfully slow but lasting recovery from the Great Recession.

In the process, though, millions endured job losses, foreclosures and a loss of financial security and struggled to recover with little outside help. For many, faith in homeownership, the financial markets and a government-provided security net never quite felt secure again.

Even with the economy roaring this year, 62 per cent of Americans say the country is heading in the wrong direction, according to an August survey by AP and the NORC Centre for Public Affairs Research.

Still, by pretty much any measure, the picture was far bleaker a decade ago. Home prices had sunk and mortgages were going unpaid. Layoffs had begun to spike. The tremors intensified as Lehman Brothers, a titan of Wall Street, surrendered to bankruptcy on September 15, 2008. Stock markets shuddered and then collapsed in a panic that US government officials struggled to stop.

Desperate, the government took steps never tried before. It flooded the economy with $1.5 trillion in stimulus over five years. To keep loan rates low, the Federal Reserve slashed its benchmark rate to a record-low near zero and bought trillions in Treasurys and mortgage bonds. Stricter rules were passed.

Stocks not only recovered; they soared. Unemployment plunged from 10 per cent to the current 3.9 per cent, near a 50-year low.
The stock market gains, though, flowed mostly to the already affluent. Homeownership, the primary source of wealth for most American households, declined. While risky mortgages are much less common, student debt has exploded.

Banks are a lot bigger
Ten years ago, American taxpayers had collectively rescued the nation's biggest banks to the tune of $700 billion. The bailout triggered public anger and calls for the government to break up the nation's biggest banks. It didn't. A decade later, the largest banks are even bigger than they were then. They've long since repaid their bailouts. JPMorgan Chase, Wells Fargo, Bank of America - all giants before the crisis - are still the nation's largest.

Politically, banks are once again exerting outsize influence in Washington, persuading the Republican-led Congress to begin easing the tighter regulations that were imposed on them after the crisis. And profits have never been higher. The Federal Deposit Insurance Corporation says the nation's banks earned $60.2 billion in the second quarter - an industry record.

The government now applies "stress tests" to the largest financial institutions. The idea is to assure the financial world that the banking system remains sound and that any crisis can be contained.

Under the tests, the government has generally found that the nation's 35 largest banks could withstand a plunging stock market, cratering home prices and surging unemployment. Not everyone sees the tests as rigorous enough.

Less homeownership
When the financial crisis erupted, the Census Bureau reported that nearly 68 per cent of Americans were homeowners. That figure sank as millions faced foreclosure, spiking unemployment left many without savings for a down payment and homebuilders scaled back construction.

Just 64 per cent of Americans owned homes as of mid-2018.

The downturn sent US home prices tumbling, but the Case-Shiller index of home prices began recovering in early 2012. Home values have been climbing at roughly double the pace of wage growth in recent years. The result is that many would-be buyers can't afford a home they would want and must instead rent.

In most areas - and without adjusting for inflation - home prices nationally are at or above what they were in 2008. The proportion of homeowners who owe more on their mortgage than their home is worth has returned to near-normal levels. And foreclosures are back to a more typical pre-crisis rate.

Those who survived the housing meltdown in good standing have prospered. Average 30-year mortgage rates plunged from roughly six per cent to as low as 3.3 per cent, according to mortgage buyer Freddie Mac. Some people used the lower rates to refinance their mortgages and save money. As a result, the Census said the median monthly cost for a homeowner was $1,491 in 2016 - roughly $170 less than in 2010.

Safer mortgage lending
Before the crisis, many lenders offered a bevy of risky loans that frequently cleared borrowers for financing even if they had no proof of income or no money for a down payment. Many such loans were interest-rate time bombs that let buyers pay little in the first few years of homeownership and that then smacked them with a hefty mortgage payment increase.

Banks had little incentive to ensure that borrowers had the means to afford payments. That's because the lenders promptly bundled and resold the home loans to Wall Street via what was then a vibrant, private secondary market for home loans.

Ten years later, it's a different story. The underwriting rules that banks must follow for their loans to be considered "qualified" to be bought by the government have been tightened.

The rich got richer
Income inequality has worsened over the past decade. Much of the increased wealth gap reflected the nature of a recovery that depended on a stock market boom made possible, in part, by the Fed's slashing rates to near-zero to help pull the economy out of its tailspin.

Because wealthier Americans own the bulk of US stocks, they reaped the benefits. They were also less likely to lose a house and more likely to keep a job. Research has found that they also spent more on education for their children. That helps set up another generation of income inequality because investments in schooling tend to lead to higher future incomes.

Last year, the top five per cent of households earned an average income of $385,389, according to the Census Bureau. That is 6.26 times more than the average income of $61,564 for the middle 40 to 60 per cent of households. Back in 2008, the top five per cent made 5.88 times more than middle-income Americans.

This recovery is radically different from the aftermath of the Great Depression. The proportion of wealth controlled by the top 10 per cent began to decline after 1932, a trend that stretched for decades until 1986. But after the Great Recession, the proportion of wealth held by the top 10 percent rose.  - AP