Collapse of Lehman Brothers 10 years ago still looms over Canada's economy

Ten years ago oil was trading at more than $100 US per barrel, the loonie had risen well above parity with the U.S. dollar, and I Kissed a Girl had put Katy Perry on the map.

It was also a decade ago today when the fourth biggest investment bank in the U.S. — Lehman Brothers — filed for the largest bankruptcy in the country's history, setting off a chain of events that sparked the global financial crisis.

Lehman's exposure to a substantial amount of bad debt tied to subprime mortgages led to its demise. Investors pulled money out of the bank, causing its stock to plunge 93 per cent on the day it declared bankruptcy. 

The fallout from the great recession was widespread. Much has changed for the Canadian economy amid a recovery, but some key drivers have not recovered.

Douglas Porter, chief economist at BMO Financial Group, said the Canadian dollar is a classic example of the elements that "didn't come back." 

"At one point in 2007, it got up to $1.10 US. Now we find ourselves today at about 77 cents — I doubt it's going back to where it was," said Porter.

"Oil prices are probably not going to go back to $100 a barrel." U.S. crude oil prices have struggled to stay above $70 a barrel this year, currently trading in the $68 range.

"I think the longer-term interest rates are not going to get back up to kind of levels it was at before the crisis," he added.

Economists say the slow pace of recovery in Canada and much of the world since the global financial crisis is related to the depth of the last recession.

"I think it's safe to say that we're on much more stronger footing now, but this took longer than we would have imagined," said Bipan Rai, head of North American foreign exchange strategy at CIBC Capital Markets. 

"There is still a case to be made that we're still feeling the impact, given that wages still haven't recovered fully, which speaks partially to the degree of underemployment globally."

Job market problems

Unemployment rates around the world have been hitting record lows this year. In Canada, the rate hit 5.8 per cent in the first half of the year, which is the lowest level since the 1970s.

The U.S. rate is below four per cent, less than half the 10 per cent it jumped to in 2009. Across the pond in the U.K., it also hit four per cent, down from more than eight per cent six years ago.

But even with labour markets pushing beyond full-employment estimates, wages haven't followed suit, said Josh Nye, senior economist at RBC Economic Research.

"Relatively slow pay growth has puzzled policy-makers, leading them to revise estimates of just how low unemployment can fall before wages and inflation accelerate," Nye said. "That has been a factor keeping monetary policy accommodative so late into the [economic] cycle, even as these economies appear to be operating at full capacity."

The Bank of Canada has raised interest rates four times since it began its hiking cycle in July 2017, bringing the key policy rate to 1.5 per cent, but that is still, historically, considered low.

There's no sure things in life other than death and taxes, but I think the economic cycle is a sure thing, and at some point we will see an economic downturn.— Douglas Porter, chief economist, BMO Financial Group

Adam Tooze, author of Crashed: How a Decade of Financial Crises Changed the World, said it's extraordinary that it's been years since anyone paid interest rates.

"Huge quantities of debt have been contracted by borrowers of all kinds — corporations, governments around the world — on the assumption that interest rates were zero or near zero," Tooze said. 

"But, we're now moving back to something like normality, and we simply don't know how the world economy, which is constantly changing and undergoing massive growth in emerging markets, how that system functions within interest rates which are more like three, four, five per cent."

Economists, however, doubt central banks will raise interest rates rapidly or substantially to anyone's surprise. Porter said the Bank of Canada's increases are a "methodical process" under which rates will not be much higher next year than this year.

What lurks ahead

Meanwhile, some are describing the recovery that began in the summer of 2009 as "long in the tooth."

"This makes it a very long upturn, and there's no sure things in life other than death and taxes, but I think the economic cycle is a sure thing, and at some point we will see an economic downturn," Porter said.

A predicted time frame for this downturn in Canadian and international economies ranges from another year or two to more. Economists say the triggers could be much different this time around, because every economic cycle looks different.

"We can always be hit by some unforeseen shock, whether it's a spike in oil prices or emerging markets chaos, or a full-on trade war — lots of those things could tip the economy," said Porter "I do believe the possibility for ramped-up protectionism is the single biggest threat to the global economy."

Royce Mendes, senior economist at CIBC Capital Markets, added that central banks may not have enough ammunition this time to revive the economy, considering how low interest rates still are. 

Past recessions in Canada and the U.S. have required the central banks to cut interest rates by a lot more than they have the capacity to do right now, he said.

"It's looking more and more likely that the peak level of interest rates in this cycle won't leave monetary policy-makers that type of room to ease," Mendes said. "As a result, the burden will fall to governments to revive ailing economies."