On balance, the financial sector got away lightly with the near collapse of the global economic system, which came to a head 10 years ago this Saturday when US bank Lehman Brothers filed for bankruptcy.
Across western economies, the public picked up the bill as states stepped in to nationalise banks to avert a collapse of the capitalist system. In the decade since, wages have remained flat and inequality has grown, while banks have largely got back to work. It is little wonder the public perception of the financial system remains so poor.
Critics claim regulators and governments have not gone nearly far enough to force a reshaping and shrinking of the financial sector. While the market-oriented orthodoxy that dominated pre-crisis might not have been meaningfully questioned, things have changed to a degree. Capital requirements for banks are tighter and stress tests suggest banks which were in dire straits 10 years ago, such as Royal Bank of Scotland, are better provisioned for a future shock.
However, some argue the level of equity capital across the banking system is still too low. In its report Plan to end too big to fail, published in January, the Federal Reserve Bank of Minneapolis estimated the chance of the need for a bailout in the next century under current capital requirements to be two in three.
Real estate lending was a major contributor to the global financial crisis, but in this area of the banking system, there does seem to have been change, with the excesses of the last cycle, so far, not repeated.
It is difficult now to comprehend a market in which financing commercial real estate at 98 percent loan-to-value was considered a good idea. At the height of the last cycle, freely available debt was fuel to the commercial property sector. Credit enabled investors to get their hands on as much real estate as possible, with little equity at stake. Banks competed to satisfy borrower demand with highly leveraged and evermore complex facilities, further pumping up property prices. The consequences, as we all know, were a burst bubble and years of mopping up the mess.
The European commercial real estate debt market in 2018 is far healthier than when Lehman fell. Equity is driving investment, with debt in the supporting role, where it should be. Regulation has curbed banks’ ability to write risky loans, resulting in healthier balance sheets. Writing excessive amounts of real estate debt simply does not make sense for them. An alternative lending sector has emerged, spreading financial exposure to real estate debt.
Certainly, there are concerns risk is creeping back in. As lenders attempt to deploy increasing amounts of debt capital into a market with diminishing returns, some may be encouraged too far up the risk curve. A relaxing of financial covenants in some deal structures has also been spotted. The high value of European property should also be closely monitored, even if lenders remain strict about their maximum loan-to-value levels.
The 10th anniversary of the Lehman bankruptcy should prompt reflection from those active in financing property today. This cycle is not yet over, and mistakes are bound to be made in the debt space. The point, however, is that Europe’s real estate finance industry is in better shape to absorb such mistakes.
If banks maintain lending discipline and enhanced risk is concentrated in the private debt space, this property cycle should conclude without a shock to the financial system. Keeping the lessons of 2008 front-of-mind in 2018 remains essential.
For more on our coverage of the 10th anniversary of Lehman’s collapse, click here.
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