More than eleven years after the collapse of Lehman Brothers and the start of the Global Financial Crisis (GFC), financial markets are yet to return to anything approaching normal. On the one hand, markets are again booming. In July 2019, the Dow Jones closed at a record high of 27,359 points, whereas stock markets around the world have also reached unprecedented highs. Housing prices have also more than recovered from their collapse in 2008. In large cities around the world, real estate prices have literally exploded. Prices for urban residential real estate in Germany, for example, have seen yearly increases of more than 8.5% since 2015 (Bundesbank, 2019). At the same time parts of the financial sector are again making large profits after having been bailed out by the taxpayers in 2008.
Despite these apparent trends, something still seems to be fundamentally wrong with financial markets. Advanced economies today are stuck in a world of ultra-low interest rates, a situation that might persist for many years to come. The global debt burden is increasing steadily, leading some commentators to argue that we could soon face another global financial crisis. The driving force behind the debt increase – as has been the case since the 1950s – is private debt issued by the financial system rather than the public debt of governments. Global debt reached an all-time high of $184 trillion in nominal terms, the equivalent of 225 percent of GDP in 2017. Since the financial crisis, this development has been driven to a large extent by the rise in private debt in emerging markets, in particular by China (IMF, 2019). The ultra-low interest rate environment seems for some commentators to be the only means to sustain this massive private debt overhang and to ensure at least some economic growth (Turner, 2017, 2019).
However, this “New Normal” affects the interest rate margin from which banks draw their profits. The risk of insolvency cannot be underestimated, implying a potential need for further government bail-outs – more than a decade after the crash many financial institutions still remain “too big to fail.” This is particularly the case in Europe, where banks are very big and still suffer from the effects of the GFC and the Euro crisis. Some large German banks have been labelled “zombie banks,” because they are effectively insolvent but can roll over and expand their debts with the help of government guarantees (Kane, 2017). The situation seems to be even more dangerous in Italy, which has been experiencing a hidden banking crisis for several years now. New research shows that such crises can cause substantial credit contractions and lasting economic damage (Baron et al, 2019).
Another risk lies in the steadily increasing size of the financial sector relative to the economy as a whole since the 1960s (Greenwood and Scharfstein, 2013; Phillipon, 2015). Yet it is questionable if finance’s increasing share of GDP is justified by what it contributes to long-term economic progress. Indeed, it has been suggested that finance’s increasing share has been achieved at the expense of investment in other sectors of the economy as well as in public goods such as education (Temin, 2018). In that sense, financialization might be contributing to the global productivity slowdown, but also to the rise in inequality and the development of rentier capitalism: Some privileged parts of the population live from asset gains without actually creating wealth themselves. Allowing finance to grow out of proportion to the rest of the economy has been described ‘as eating the family cow in order to have a steak for dinner’ (Temin, 2018); that is, a short-term gain comes at a long-term loss.
A number of experts have also argued that the increasing volatility in financial markets and asset prices has increased the risk for another financial crisis, especially as financial spillovers from the financial sector to the real economy and back have both increased in magnitude since the global financial crisis (Agénor and Pereira da Silva, 2018). The US Federal Reserve injected funds directly into the financial market in September 2019 in an attempt to reduce the rates at which banks are lending to each other. Such a move – the first in ten years – is a clear indication that risk of a next financial crisis is growing.
Together with his colleagues, Moritz Schularick (Jorda et al. 2015) has argued that leveraged housing bubbles have emerged as a particularly harmful phenomenon, and many market observers today are issuing warnings of a housing bubble, including in Germany (Deutsche Bank, 2019b; Financial Times, 2019).