To our clients and friends

Last month marked the ten-year anniversary of the collapse of Lehman Brothers. We hosted a conference in our London office to discuss how the financial landscape has changed and what lessons have been learned (or not).

I had the pleasure to speak at the event along with Sarah Coucher, a restructuring partner in our London office, and our special guest, former UK cabinet minister Ed Balls. Ed gave his insights on the financial crisis from a UK perspective.

The financial crisis and the resulting Great Recession took a tremendous toll on the US: trillions of dollars of wealth were destroyed and nine million jobs lost. I addressed what things look like in the US ten years on from the demise of Lehman. And the economy looks upbeat indeed. Last month marked the longest bull market on record, with the S&P 500 Index hitting an all-time high. It has been a remarkable run since the end of the financial crisis with record level corporate earnings. Inflation has been manageable; unemployment is down from a high of 10% to its current level of 3.7%. The housing market is back with home prices up. The US economy seems to be churning at nearly full strength.

Yet there are some worrying signs that the lessons learned from the financial crisis are being forgotten with our surging economy. Three things in the US to be concerned about:

• Relaxation of Regulatory Oversight: In the wake of the financial crisis, legislation was passed by Congress to more closely regulate financial institutions. In May of this year, Congress voted to roll back parts of that law (Dodd-Frank) to limit stricter federal oversight to only the ten largest banks. There is under discussion the further loosening of bank regulation by relaxing the Volker Rule and easing capital requirements for banks. While our large financial institutions will certainly welcome relief from what they view as overly restrictive regulation, others worry that the lessons from Lehman are being forgotten as governmental oversight is being cut back.
• Risky Lending: The amount of risky lending in the US has increased enormously with less regulation and transparency. While US banks are clearly stronger than before the financial crisis, the less-regulated “shadow” banking system has grown enormously. Leveraged lending has migrated to investment banks, private-equity and hedge funds. Banks are still making these higher-risk loans, but they quickly sell them off to investors, have them packaged as collateralized loan obligations (CLOs) or sold to ETFs and mutual funds. This leveraged loan market is estimated to be as large as $1 trillion.  And US corporate credit quality has become increasingly “junky.”  As noted in a recent report from FTI Consulting, “US corporate credit metrics . . . are worse today than in mid-2007 when the previous credit cycle was peaking.  Currently, 56% of all S&P rated US corporate issuers are speculative-grade compared to 49% in 2009.”  So far defaults have been low, but that could change quickly if the economy falters or if interest rates rise significantly.
• Growing Federal Deficit:  It is predicted that new US tax cuts will reduce federal revenue by $1.5–$2 trillion over the next ten years.  When you add increases in spending, the Office of Management & Budget projects the deficit for fiscal 2019 to be over $1 trillion, bringing total US government debt to over $24 trillion. Within a decade more than 13% of the US budget will go to pay interest–$900 billion annually (more than funding for defense).   This puts us in unchartered territory: usually government borrowing drops during recoveries and expands during recessions.  This risk was put succinctly by Pulitzer Prize columnist Thomas Friedman in The New York Times “increasing the deficit when your economy is growing nicely is really, really reckless – because you may need that money to stimulate your way out of the next recession.”

So, as we discussed at our conference in London last month, are we shunning financial prudence in the US and ignoring relevant lessons from the financial shocks of 2008?  Time will tell.

On that upbeat note, I hope you find our latest issue of the International Restructuring Newswire to be of interest.

Howard Seife
Global Head
Financial Restructuring and Insolvency