Column: Five years after Lehman

Sep 12 2013, 01:32 IST
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SummaryThe world financial order has opted for better regulation and stronger institutions

Indiscriminate household borrowing supported by banks (through sub-prime lending), with repackaging from Wall Street (to spread the risk across institutions) after getting a nod from credit rating agencies in an unregulated environment with tacit political support (as it led to economic booms), was what constituted the Lehman crisis in 2008. Five years on as the financial world looks back on September 15, which was more catastrophic than 9/11, are we in a better state today?

There are ten pictures that meet the eye in the periscope as one looks back on how things have turned out and how we have moved. First, the concept of investment banking has changed and it is no longer sexy to be an investment bank as it is now associated with all kinds of negatives. Several of them have turned into commercial banks with better regulatory oversight. In fact, a recent estimate drawn on the market value to book value for two top banks—Goldman Sachs and Morgan Stanley show that this ratio came down from 1.8 times to 1.11 times and 1.4 times to 1.02 times respectively between the onset of the Lehman crisis and the first week of September 2013. The 12- month forward EPS delivered a P-E multiple of less than 12 for both of them. Such has been the moderation.

Second, the world of financial derivatives which came as part of the financial engineering revolution has been looked at with circumspection. The ABS, MBS, CDO, CDS, etc markets have all become less prominent than they were at that time when home loans were multiplied through securitisation. Regulators are putting structures in place before going for them in a big way.

Third, the regulatory world has moved ahead with Dodd Frank talking of single regulators and the Volcker rule distinguishing client trading from proprietary positions. This, combined with the Basel III version where focus is more on liquidity than capital, has meant that the financial world is more cautious than before. The benefit of the crisis has been that we have started putting systems in place before the markets.

Fourth, the credit rating agencies did come in for some criticism, and there has been a fresh set of regulations in place to eschew conflict of interest in their operations. This has been hastened with the sovereign debt crisis where similar questions have been raised. But more importantly, the door appears to have been

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