5.4 The financial crisis and its consequences

5.4 The financial crisis and its consequences

On 15 September 2008, the US investment bank Lehman Brothers filed for bankruptcy. Lehman and hundreds of other American banks were closed and liquidated. In 2009 alone, at the peak of the crisis, 140 banks closed in the USA. In order to get the situation under control, the US government and the Federal Reserve, the "Fed", initiated a package of measures. Important institutions were provided with equity capital. Because key interest rates were already very low in 2008, the central bank began purchasing bonds and secured securities (QE: quantitative easing). In this way, the collapsing property market could be supported and money made available for new investments. The programme quickly produced results. Within a few years, the US returned to positive growth rates.

Chart 39: Balance sheet expansion of the major central banks

In recent years, many central banks have followed the example of the US. The world has been flooded with money.

The low interest rate policy enforced in parallel also keeps bankrupt States and companies artificially alive. Although the worst expectations of massive inflation have not materialised, this policy of cheap money is not without its side effects.

Side effects of the low interest rate policy

The policy of the central banks means that politicians carry out fewer or no reforms at all. The savings or "austerity policy" usually initially costs votes and is usually carried out by politicians only when there is no other option.

There is no more leeway for interest rate cuts when the next recession hits. According to a study by the Federal Reserve of Boston in 2018, the US Federal Reserve cuts its interests in a recession by 5-6% on average. When interest rates are close to zero, central banks are deprived of an important tool.

Photo: Ben Shalom Bernanke, economist and former chair of the Federal Reserve.

The policy of the central banks should inflate asset prices to create wealth and demand. Ben Bernanke, the then Chair of the US Federal Reserve, put it this way:

and higher equity prices will boost consumer wealth and help increase confidence, which can also drive spending. Increased spending will lead to higher incomes and profits that, in a positive cycle, will support further economic growth.
Ben Bernanke in the Washington Post on 4 November 2010

The central banks have partly succeeded in this. Today, the result is often criticised by the left, which laments an increase in economic inequality and demands more redistribution. Surprisingly, the fact that the central banks are burdening small savers with low interest rates and attacking their pensions is of little interest to left-wing politicians.

Chart 40: Key international interest rates

Of particular importance is the impact of the cheap money policy on businesses. On the one hand, it is positive when companies and jobs are preserved in crises. On the other hand, a lasting preservation of weak companies ensures that economic change and growth forces weaken. Companies that only survive thanks to artificially low interest rates tie up valuable resources and prevent new growth. In recent years, the share of these so-called zombie companies in the western world has increased significantly. (see Chart 41)

Chart 41: Percentage of low-income companies

The share of zombie companies is particularly high in the south of the euro zone. A study by the OECD in 2017 found very high shares in Italy, Spain, Portugal and Belgium in the eurozone. A study by the Institut der Deutschen Wirtschaft in 2017 considers the situation in Italy, France and Spain to be particularly critical.

Chart 42: Share of non-performing loans in total credits as a percentage
Chart 43: "Bad loan" holdings before and after reduction in value of the fifteen large and middle sized banks

The situation is therefore usually particularly difficult in countries where banks also have to contend with non-performing loans, i.e. loans that are repaid late or have defaulted. (see Chart 42) The situation is particularly delicate in Greece. Italy too, which is regarded as a particular weak point in the eurozone, has a very high proportion of bad loans. Although the politicians point to an improvement, it hardly stands up to scrutiny. A study by the Flossbach von Storch institute of Italy's 15 largest banks shows that bad loans are written off and removed from the balance sheets (red pillars), but new ones are constantly being added (blue pillars). The pressure on banks' equity capital  is therefore likely to remain very high in Italy. (see Chart 43)

The central banks' policy not only ensures that zombie companies are preserved, but also ensure that new ones are created. Particularly in the US, many companies have taken advantage of low interest rates to take on debt and buy back their own shares. A share buyback can be more attractive for managers because it fuels share prices and thus increases performance-related remuneration. As long as interest rates are low, an exchange of equity capital for borrowed capital can also pay off in business terms. In this way, however, companies become dependent on low interest rates and cheap borrowed capital.

If many companies do this, the ability of the central banks to raise interest rates again will be limited. Raising interest rates is much more difficult the higher the unproductive social debt levels. Central banks that can no longer raise interest rates are also no longer in a position to create leeway for future rate cuts. Such leeway is important, however, to stave off recessions. In order to avoid this dilemma, more and more central bankers are demanding the abolition of cash. A cashless economy would allow them to push interest rates far into negative territory. Another side effect of low interest rates is that they worsen the banks' earnings situation. Banks earn money from the difference between the interest rates they get from the central bank and those they pass on to customers. If the margin is low, the banks suffer. The low interest policy operated by the ECB therefore plays a major role in particular in the plight of the European banking sector.

I think the Fed is making a mistake. They are so tight. I think the Fed has gone crazy.
US president Donald Trump on 10 October 2018

As early as 2014, the Fed stopped its security purchase programme. After having carried out several interest rate hikes as a result, fears are growing that there are too many companies that either cannot cope with higher interest rates anyway or that are now so indebted that they can no longer cope with them. The most important US interest rate, the Fed Funds Rate, is currently 2.25-2.5%. While the Fed had actually announced that it would raise interest rates further, it is now back-pedalling In particular, US President Trump had complained loudly about the Fed chairman Jerome Powel, personally appointed by him, and even threatened to get rid of him.


List of references for the used photos and charts: