Capital markets: The origin of crises

“THE INTERNATIONAL financial market itself is not the origin of crises. The speculative funds which are latent in the market only become active... when the elements of crisis are already present. Speculation follows these elements like a shadow.”

Such was the view of FE Aschinger at Swiss Bank Corporation when writing about times of serious crisis in financial markets for Euromoney during its first year of existence, 1969.

The wild swings in sentiment and sheer number of near-death experiences that have occurred in the 50 years since Aschinger wrote this belie the idea that financial crises are created by banks alone. But banks have certainly done their fair share to create the series of unfortunate events that have peppered the last half century.

These have varied in nature and severity, but in their most recent incarnation – the sub-prime mortgage crisis of 2007 onwards – have reached a scale and intensity beyond which anyone in 1969 could have imagined.

“In 2008, you would be lying if you said you weren’t scared,” recalls Jim Esposito, global co-head of the securities division at Goldman Sachs. “The entire global financial system was at risk. US policy makers demonstrated great wisdom and leadership in what was an extraordinarily challenging time.”

The initial response to any crisis in the markets over the last 50 years has almost always been incredulity – a sheer disbelief that such a thing could happen. In the first week of the 1987 crisis US Treasuries dropped 150 basis points. On Thursday October 22, 1987 spreads on US treasuries in London went from 2/32 to 1/4 and trading in the 10-year and long bonds went from between $25 million and $50 million to $5 million.

“You saw swap spreads changing 20 basis points within an hour,” Michael Rulle, head of swaps at Shearson Lehman told Euromoney at the time.

When the commercial paper market froze in 2007, there was similar bafflement that things could just stop. Dollar asset-backed commercial paper (ABCP) outstandings were down by $48 billion for the week ending August 15, 2007, down $77 billion for the week ending August 22 and down $59 billion for the week ending August 29.

The yield on 30-day CP went from hovering between 25bp and 75bp to an astonishing 356bp by August 20.

“We sat down early in the month and said: ‘How far can this thing spread?’” an ABS veteran revealed that September. “We knew that the short-term money markets would be impacted, but it seemed that the entire ABCP investor base getting up and walking on 30-day paper was something that just could never happen.” 

Euromoney’s Peter Lee was in New York at the time, speaking to the head of one repo desk. “Even the people at the Fed and the ECB don’t get what’s happening,” he was told. “Firms are almost closing down the doors. They’re refusing to finance any more collateral from their existing clients than they did previously, just when unsecured short-term funding is closing down and more collateral is coming out. And they won’t finance collateral even of the best quality from clients they have not previously dealt with.

“Think about that. We’ve got hedge funds who are saying: ‘Look, we have been in business for 10 years and we’ve paid $500 million in fees and commissions to Wall Street and you can’t give us a couple of days?’”

There was real fear in people’s voices. “I implore you to be precise in your terms when you write this,” he was asked. “It’s one thing to talk about disruption in correlation products, single-tranche and synthetic collateralized debt obligations, but I dread the consequences if investors are wrongly told that money market funds are no longer safe.”

It became readily apparent that they were not on September 16, when the $64.8 billion Reserve Primary Fund broke the buck, thanks to its $785 million CP allocation to Lehman Brothers, which had declared bankruptcy the day before.

In the week of September 15, money market holdings fell by almost $170 billion, about 5% of the entire sector.

Mandy DeFilippo, managing director and global head of risk management for fixed income and commodities at Morgan Stanley, had joined its capital markets group in London in the first quarter of 2007, having trained as a lawyer.

“After Lehman collapsed, there were days when very little work got done – everyone was distracted by what was going on,” she recalls. “They were next door to us. When they collapsed, we could see the TV cameras outside, watching and filming as people left with their boxes. Everyone was thinking: ‘What if that happens to us?’”

The start of 2007 may not have been the most fortuitous time to decide to enter the business.

“During the crisis, people often asked me if I regretted joining a bank,” DeFilippo recalls. “Actually, I didn’t – I felt privileged to be able to see what was happening from the front row, so to speak. Since I had only just started at the firm, the only risk I faced was losing my job. This seemed small compared to what my more senior colleagues were facing at the time.”

SEVERE FINANCIAL SHOCKS are now seared into the memories of those who were there. In 2007, the sheer scale of the market dysfunction was beyond anything bankers had dealt with for a very long time.

“I have not seen outright fear and shock like this since 1987,” one securitization veteran told us in November of that year. “It has been hard to keep morale going. There are times when I feel like holding a pistol to my head and other times when I think everything is going to be OK. But I go home at the weekends hoping for a respite and open up the Sunday papers and every story is about me.”

Along with shock was the belief at the time that things would never be the same again.

“I remember Monday August 17, 1998, as if it was yesterday,” says one market veteran today. “When it came across the tape that Russia had defaulted, the markets went haywire. It was that black swan event: everyone knew that Russia was under pressure, but no one expected it to default.

“It set off crises across the government bond markets that led to LTCM and its proposed bail out by the banking system – the first time that banks were asked to come together and come up with a solution. This was very early in my career and I did not see a future for emerging markets – I assumed that the market had gone and would never be coming back.” 

Nine years later Guy Hands, chairman and chief investment officer of Terra Firma, was similarly blindsided.

“The liquidity crunch of 2007 was quite extraordinary,” he says. “We bid for EMI at the end of May 2007 and the slowdown started a few weeks after that. It went from everyone fighting over which deals they could do to trying to find a reason to say no. The market was just finished as we knew it.”

The reaction to crises reinforces something that is often forgotten in the global capital markets: despite their size and influence, these markets are driven by personalities. One banker who was working for a Wall Street firm in 2008 recalls just how much that influenced decisions at the time.

“My overwhelming memory is of the hatred that the other banks had for Lehman,” he tells Euromoney today. “There was no moment when any other bank wanted to help them, and that is why Lehman was let go. It was not part of the club. The banks would have saved anyone else, but they were not going to save Dick Fuld.”

Others recall Lehman’s reluctance to contribute to the joint rescue of LTCM and trace the animosity 20 years later back to that moment.

“Not saving Lehman was a big gamble on the part of other banks,” the banker emphasizes. “There was a big question about whether the system could survive the bankruptcy of a bank with $1 trillion of assets. They should have considered saving Lehman, but they decided to gamble with the consequences.”

The importance of individual personalities at the banks really matters when many in the workforce believe they are at risk of losing their entire net worth.

“I worked with and got to observe Lloyd Blankfein during two major crises, 1998 and 2008,” reveals Esposito. “I don’t think that there is a banker on the planet who handled the stress of these two challenging periods in a level headed and measured way like Lloyd did.”

EVERY CRISIS HAS BEEN has been the result of specific events at the time, but there are common themes to all crises: over-leverage, market indiscipline, reliance on fallible modelling and lazy banking.

Rising interest rates have contributed to many market seizures, particularly in 1987 and 1994, and over-leverage always exacerbates the outcome. When Southland Corp, owner of 7-Eleven convenience stores, had to postpone a $1.5 billion offering on November 10, 1987, both Goldman Sachs and Salomon Brothers were left with $100 million hung bridges as a result, a huge challenge at the time.

In 1998, LTCM had levered $4 billion of capital into $120 billion on its balance sheet and more off-balance sheet by the time that the Russian crisis hit. Banks didn’t understand LTCM’s position and had relied on the star power of fund manager John Meriwether.

“The scary part about LTCM is that it suggests that the world financial system has more structural flaws than any one country,” Henry Hu, banking and finance law professor at University of Texas told Euromoney in November 1998. “What worries me is that we’re in a new financial environment when you are hitting the outliers much more often than you might think. That’s when you want the models to work… and that is precisely when they fail.” 

Often, it is simply too much money chasing a particular strategy on a scale that is sufficient to tip the whole market over. This was the case with the tech bubble at the beginning of the 2000s.

“The problem we had in that goofy IPO market was that it was far too easy for bankers to get lazy when they saw that a deal was 20 times oversubscribed, with numerous 10% orders and no limit orders,” said Doug Baird, co-head of ECM, Deutsche Banc Alex Brown, at the time.

TheGlobe.com went public in November 1998, lead managed by Bear Stearns. It had a first-day pop of 606%, while in December VA Linux set a new record of 697% on its first day of trading. Around 40% of all deals between June 1999 and March 2000 for seven of the lead underwriters rose 100% or more on the first day of trading.

The result was a flight to junk.

“There’s certainly an argument that the barrier for IPOs was getting lower and lower,” Tim Gould director in ECM at Lehman Brothers told Euromoney shortly after the bubble had burst. “As that happened, venture capital firms reached further down too and looked to free up capital by turning over other holdings to the public in a hot IPO environment.”

The mother of all flights to junk was, of course, in the US sub-prime mortgage market. Total US household mortgage debt (excluding home equity loans) had reached $10.1 trillion by June 2008. This was largely due to securitization and is something that one of the earliest pioneers of the technique, Guy Hands, clearly resents.

“Securitization was almost the exact opposite of the bond market,” he tells Euromoney. “The bond market wasn’t an intellectual process when it started but became more intellectual as it became more complex.

“Securitization started off as rarified and almost philosophical. You spent hours debating with rating agencies who were terrified of getting something wrong. Everyone was emotionally committed. It was intellectually challenging. However, as time went on and more and more participants entered, then they didn’t have a feel for the assets. They didn’t care about the assets. People didn’t come into it because they liked the business. They came into it because they wanted to make money.”

It was very clear by the end of 2006 that something was very wrong – as our December cover story ‘Clever ways to do the dumbest things’ explained.

“I remember being at a meeting in December 2006 where our ABS guys said that they were expecting $26 billion to clear that month but that it would not be a problem and spreads would still be tighter at the end of the month,” recalled one US banker in November a year later, when the ABCP market had seized up and the full extent to which the market was reliant on it had become apparent. “I remember walking out at the end and thinking: ‘Oh my God, this market is going to blow; this is whacked.’”

The demand for mortgage assets to securitise had become insatiable.

“Bear Stearns is producing its own brand and increasing production organically without having to rely only on other originators,” Michael Nierenberg, senior managing director, mortgages, at Bear Stearns, explained enthusiastically in November 2006. “We believe that’s going to give us a competitive advantage in the marketplace. To start these businesses today is much harder if you don’t have the infrastructure and the expertise behind you.”

Not much more than a year later the bank failed.

“It’s the speed,” a shocked banker told us in mid 2007. “Countrywide was OK a week and a half ago, now analysts are talking about bankruptcy. The time from a hedge fund’s problems hitting the Wall Street Journal to liquidation is now about two days.” 

The failure of the structured investment vehicles (SIVs) was just the prelude to the shocking seizure of the ABCP market.

“The total level of complete withdrawal of every single investor across the ABCP market was unbelievable,” recalled an asset manager in late 2007. “They even stopped buying bank CP. They weren’t buying ABCP where the entirety of the underlying was trade receivables. It was crazy.”

Another manager of a large ABCP conduit with less than 80bp in sub-prime and more than 5% credit enhancement told us how no one even cared about the structure.

His bafflement was shared by another ABCP expert: “ABCP is less likely to incur losses than bank CP! There was a now-infamous Moody’s ABCP conference call shortly after the problems started where it rapidly became very apparent to me that six out of 10 investors on the call had absolutely no idea what the product was all about.”

And even if they did, their hands were tied by senior management. “If you are told by your boss to get the hell out, what can you do?”

SAMIR ASSAF, chief executive of global banking and markets at HSBC, remembers the astonishment: “We all understood that ABCP was a maturity mismatch, but how many of us assumed that the commercial paper market would completely stop functioning? Only a treasurer could understand that capital markets could dry up.”

As an ex-corporate treasurer himself, he emphasizes how important it was that HSBC decided to stand behind these vehicles.

“We all had our own SIVs and conduits,” he says, “but while other firms unwound theirs, we didn’t. We provided liquidity to support ours. This allowed investors to remain and get money out at the end of the assets’ life. With the mark-to-market of the SIV assets at the time, the net present value loss would have been billions if we had unwound them. We funded them, and after the last close the overall loss was less than $1 billion.”

It is important to remember the extent to which the market believed that distribution of risk via securitization had reduced, rather than amplified, risk.

“The CDO market has allowed originators to extend house ownership to a range of people whose FICO scores were too low, historically, to get on the property ladder,” Scott Simon, a senior member of Pimco’s portfolio management and strategy groups and head of mortgages and ABS, told Euromoney prior to 2007. “But it has also cut the danger of systemic risk in the banking system. The subordinate and equity risk on ABS CDOs has truly been spread around the globe. First to Europe and in more recent years, further east, to Asia.”

Unsurprisingly, one of the most ardent adherents to this belief was Lehman Brothers. Its 2006 Whinstone Capital deal for Northern Rock was the first instance of a collateralized synthetic CDS being used to provide protection to first-loss pieces in a series of securitizations.

“The key theme of the year in Europe was the disintermediation of risk into the capital markets,” John Dziadzio, managing director and head of European structured finance origination at Lehman in London told us in 2006. “This deal set the tone for proving that the large banks can do a real economic risk transfer transaction. We had been pitching the idea to Northern Rock for two to three years and tailored the structure to meet its specific requirements.”

The last 10 years have demonstrated the extent to which this kind of financial structuring disguised the true risk that investors had exposed themselves to.

Belief in financial modelling was severely damaged, but it is wrong to think that before this it had been rock solid. As early as November 1998, Ethan Berman, chief executive of RiskMetrics Group, which had been set up by JPMorgan, told us how exposed such models were to illiquidity.

“The typical VaR model doesn’t take liquidity risk into account,” he pointed out. “Such models would tell you they should only be used in liquid markets.”

The lesson seems to have been learned – at least for now.

“The 2008 memory is etched into my generation’s brain,” Goldman’s Esposito believes. “Fortunately, these lessons won’t soon be forgotten. Investors prefer simple and liquid products.”

BECAUSE OF THE banking industry’s pivotal role in the financial system, when crises strike, the consequences for the rest of the economy are often catastrophic. Looking back at the last decade, it is easy to forget that until the financial crisis of 2007 the concept of global seizure was still seen as something that really could not happen.

“People talk about systemic risk, but has the system ever been close to breakdown?” Paul Volcker, who was chairman of the Federal Reserve from 1979 to 1987, asked Euromoney in June 1999. “We’ve seen systemic risk, we haven’t seen a systemic breakdown. There is systemic risk when you have conditions that threaten contagion. 1982 was certainly a systemic crisis in the sense that the large banks had so much of their capital committed to loans in Latin America. You could argue that the [1997/98] Asian crisis was systemic, but a much lesser one, because the banks were not as exposed. There were tensions in the [US] domestic market because of Long-Term Capital Management. The things were related, in that LTCM was hit by spread risk. It was the combination of these two effects which made it more serious.” 

Even after the global financial crisis (GFC) of 2007 the nature of systemic risk is still up for debate. Bank of England governor Mark Carney discussed this with Euromoney in November 2012.

“In these [recent] episodes there were fundamental issues of conduct and troubling issues of oversight, be it risk management or operational oversight,” he said. “It is not truly accurate to say they prove something systemic. A common aspect in several cases is that the people involved did not appear to take into account wider societal norms or the implications between what they did and their institution’s ultimate relationship with the real economy.”

One of the reasons that prior crises were relatively contained was the speed with which central banks habitually flood the monetary system with cash to prevent contagion. The quantitative easing that has been witnessed since Lehman collapsed is the most extreme and far-reaching exercise in damage limitation that there has ever been; and the challenge of unwinding this stimulus is the most important one facing markets today.

The dynamic has, however, been a recurring theme throughout the last 50 years of Euromoney coverage.

After Black Monday in 1987, the Fed immediately lowered key rates and pumped money into the system.

“From a Washington standpoint, the only reason the market didn’t fall apart even more was the intervention of Washington and the Fed to save the Street from itself,” said Donald Coxe, chief portfolio strategist at Wertheim Schroder in our November 1987 issue.

In the same article, Gary Brinson, head of First Chicago Investment Corp, observed: “The Fed has pumped huge amounts of money into the system, and it makes you think there should be some kind of liquidity crisis that hasn’t happened yet.”

After the 1987 crash Peter Cohen, chairman of Shearson Lehman Brothers, worried about Washington’s ignorance of “what capital markets are all about, how they reflect psychology and sentiment.

“There is a combination of distrust and lack of understanding between Washington and our industry that will persist,” he predicted, accurately. President Ronald Reagan gave a speech in October 1987, after the crash, highlighting how the economy was strong and had little to do with Wall Street. Successive crises thereafter have shown how tenuous that position can be.

Cutting rates and printing money will always be welcomed in a banking crisis. Raising rates is, however, a far more delicate exercise – as the Fed’s current challenges emphasize. Investors had piled into bonds as the Fed cut rates at the start of the 1990s to bail out banks burdened by highly leveraged loans and bad commercial real estate lending. But when they hiked them in 1994 the result was the ‘Bond market massacre’.

“On February 4, 1994, the Fed started to raise rates and it became the worst year of my career apart from 2008. There was a complete collapse in confidence,” recalls Martin Egan, global head of primary markets and origination at BNP Paribas.

DISSATISFACTION WITH the government response to financial crises is, not surprisingly, a constant throughout the last half century. In bankers’ eyes, the central banks can only do too much or not enough. The events of 2007 and 2008 clearly reinforced this position.

“[Secretary Hank] Paulson and [Fed chair Ben] Bernanke had six months after the crisis struck to prepare for Bear Stearns, for which the Lehman solution was the right one,” Charles Dumas, director at Lombard Street Research told Euromoney in December 2008. “They were not ready. They then had another six months to get ready for the next round of crises. They were still not ready and tried to distract attention by holding a gun to the head of Congress.

“They have been bouncing off the walls for 15 months and the world is going to pay a huge price,” he predicted, correctly.

One former colleague of Paulson recalled watching him urge Congress to support his Troubled Asset Relief Program.

“I worked with him for seven years,” he told Euromoney. “This is not a man known for his patience or tolerance of fools. And when I saw him having to take these idiotic questions and saw his veins starting to pop, I half expected him to leap across the table and start pounding heads.”

Matthew Westerman, director at MW&L Capital Partners, recalls his early experience of getting funding into banks after a crisis.

“One of the first assignments I had was dealing with the Bank of England in order to get banks in the ‘queue’ to do fundraisings in the late 1980s,” he says. “When the financial crisis hit in 2007 we went to see one of the senior civil servants in HM Treasury and suggested that we needed to do something similar. When we walked in to his office and saw that he didn’t have either a Bloomberg screen or a Reuters terminal on his desk, we knew at that point that this was not going to be an altogether satisfactory conversation.” 

Regulation of the banking sector is another issue that can best be described as contentious. The industry has paid a price for its inability to regulate itself, something that has been at the heart of most crises over the decades.

In November 1998, Chris Goekjian, chief executive of Credit Suisse Financial Products, told Euromoney that where the market made a mistake with LTCM is that it lent cash with no initial or minimum haircut.

“We’d like the regulators to push the market in this direction as it will be difficult for the market to do this on its own, given the competitive pressures on the business,” he admitted.

Regulators have been more than happy to oblige since 2008, to the ire of many in the industry.

“Regulators need to raise their game,” declared Svein Andresen, member of the Financial Stability Board secretariat at the Bank for International Settlements at the ABS conference in Cannes in June 2008 – holding the door through which a very large horse had already bolted. “The weaknesses that have come to light were suspected for a long time. Exhortations to firms are not enough to change behaviour.”

The terrorist attacks in the US on September 11, 2001 had been a rare example of an immediate and unanticipated shock to the financial system, and unsurprisingly the central banks immediately poured money into the system to provide liquidity. But the situation was different due to the highly charged political atmosphere.

Many argued that shorting should be banned and investors were urged to buy the US market for patriotic reasons. This call to arms was, inevitably, greeted with scepticism by the banks – the firm belief that the market would self-correct held sway.

“We did not have a corporate policy that came out and said: ‘You can’t short sell’,” explained Dean Barr, global chief investment officer Deutsche Asset Management in New York at the time.

“I agree with George Soros to some extent that shorting facilitates buying and liquidity in the marketplace, so I think it’s important that New Yorkers were able to get capital function. I don’t want to denigrate a rallying cry to buy US stocks or to avoid short selling, but capitalism works, and those forces are much more profound than any patriotic call to buy.”

Nevertheless, it is the kind of measure that regulators continue to turn to. On Friday, September 19, 2008, the SEC banned the short selling of 799 financial services company stocks.

“The Commission is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets,” declared SEC chairman Christopher Cox at the time. “The emergency order temporarily banning short selling of financial stocks will restore equilibrium to markets.”

It didn’t. Speaking to this magazine in 2009, ECB president Jean-Claude Trichet was keen to emphasize the extent to which the crisis had been anticipated.

“On August 9, 2007, we were the first central bank to identify that we were starting to see a hugely turbulent period as a consequence of abnormal behaviour in financial markets. That day we lent €95 billion for 24 hours to the market at a fixed rate. Before this, we had said publicly already back in 2006 – as did other central banks – that global financial markets were under-assessing the quantity of risk and underpricing the unit of risk, so that there was a need for a correction. By saying that, we tried to prepare markets so that the coming change would be as smooth and efficient as possible.” 

Despite widespread accusations of regulatory overshoot, 10 years after the gravest financial crisis to hit the markets in Euromoney’s 50 years, the broad consensus is that the official response was the right one.

“I have always been vocal saying that regulators were right to put in backstops on liquidity and leverage,” says Assaf. “The market needed to focus more on liquid and transparent assets and rely less on models for pricing.”

That has been achieved. What hasn’t is the successful withdrawal of the stimulus on which the system relies in times of crisis.

“After the GFC, there has been a massive infusion of central bank liquidity into the system, which pushed asset prices up for a decade to make sure that the world grew,” explains Tyler Dickson, co-head of banking, capital markets and advisory at Citi in New York. “Now it is being carefully withdrawn, and we have to be careful to remember – the thing that we put in all our disclaimers – that history is not an indicator of future financial performance. No one expected the 1987 crash, no one 1998 LTCM, and no one predicted the dynamics around 9/11.”

THE CHAOS WROUGHT by highly structured products has certainly driven the capital markets towards simplicity and transparency since 2008. The eternal question, however, is how long this discipline can hold up.

How long will it be before greed again overtakes fear and some of this financial engineering makes its way back into the markets? Many would argue that it is already here. Every crisis changes things: some temporarily but others permanently.

“After 1987, then the internet bubble, and the fall in interest rates, we saw the first signs of the de-risking of pension portfolios,” explains Assaf. “The shift from equity to fixed income started from 2000 onwards. In the US, the 10-year yield fell to 2% to 3% and you needed 7% to 8% to break even.”

This change has persisted, and it is pension funds and insurance companies that have been behind the huge pools of capital driving the markets today.

“The whole mantra after the crisis was to hold liquid assets with transparent pricing,” Assaf continues. “The crisis was not about bad assets, it was about illiquid assets with non-transparent pricing.”

The caution in today’s markets is in large part due to the number of people working in them that have vivid memories of the 2007/08 financial crisis.

“[Those of us who lived through the crisis and are still in the industry] got used to the idea that the boom times don’t go on for ever – and because of that, we became a lot more resilient in the face of uncertainty in the markets,” says DeFilippo at Morgan Stanley. “Frankly, at this point, I don’t think anyone – including the younger generation who joined post crisis – doesn’t get that it doesn’t go on for ever. This might not be obvious from the outside, but from the inside it certainly changes the way that banks behave. Post crisis, we have seen risk management functions (both first and second line) develop significantly within banks, to a greater extent than before. As a result, there is more consistent internal review and scrutiny in relation to day-to-day business conducted at banks today.”

The early years after the crisis also saw much more specialization – with many investors sticking to their knitting.

“Pre-crisis, there was a significant amount of leverage in the financial system that provided excess liquidity to a lot of participants,” says Citi’s Dickson, “so a lot of people crossed over from their core competencies and extended into other areas. When the leverage came out of the system, there was a violent recalibration and investors moved back into line and asked themselves: ‘What am I tracking to?’ So, you had an explosion of passive investment and a change in the landscape of active investment: it used to be hedge funds with informational advantages but now it is alternative pools of capital or alternative investments.

“Post crisis there has been a natural evolution of the marketplace and, while still global, it has elements of super-regionalization. The notion that there is one single global equity market is not the case. There are pools. A global dollar bond market yes, but look at leveraged finance – it is very regional. In Asia, the market is much more equity-based, for instance. The financial crisis proved that all these things are interrelated but that you also have to look at regional differences and discrete idiosyncratic regional risk around distinct asset pools.”

IN ADDITION TO driving a much more disciplined attitude to risk, financial crises are also a great advertisement for proper hedging. It is important to learn this early on in one's career.

“The lesson I learned [after 1994] was that you have to be much more aggressive in risk management,” says Egan. “Throughout the 1980s, the market pretty much went in one direction, but the market moves in 1994 were very aggressive and a lot of money was lost because people had open unhedged risk. After this, we started to be much more rigorous about risk management and saw the evolution of more aggressive hedging.”

But the dislocations that were brutally laid bare in 2007 were simply too much for many firms.

“The basic lesson was that nominal numbers count,” says HSBC’s Assaf. “Don’t rely only on VaR or net risk. Gross risk counts. You can say that you are flat if you have $100 billion hedged with $100 billion, but that is nonsense if one side becomes illiquid. Liquidity is key.”

So what can we learn from crises past to try to halt their inevitable return? That there is no single cause and no uniform cure. The market always fails to heed the early warning signals and always overreacts when things go wrong. Crises always come with a siren call for a change to the bonus culture as well.

“Aberrant hiring practices and inordinate bonuses will go out of the window. It’ll also get margins back in certain businesses where rampant competition has just destroyed them.”

A post-2008 mea culpa by a contrite bank chief executive? No, we were told this by Cohen at Shearson Lehman in 1987.

Every time the capital markets experienced a convulsion over the last five decades, the expectation was that banking culture would change – but it never did. By 2007 the excesses were ingrained.

There is a sense, however, that post-2008 the regulatory framework of banking has changed so much that things really are different this time. The focus on conduct, discipline and governance is more intense today than it has ever been. It is hard to imagine that standards could return to the laxness of the pre-crisis environment but – in these markets, unfortunately – not impossible.

It is certainly true that – so far – the capital markets have had a remarkable ability to recover from the damage they so habitually inflict on themselves.

“For me, the period 1999 to 2004 is all about the internet and telco bubble and the explosion of it,” says Jean François Astier, global head of capital markets at Barclays, who was working in venture capital at the time. “As a VC, I can assure you that I saw valuations drop 80% to 90% and I saw investments I had made in 2000 to 2001 fall to 10 cents on the dollar by 2002. But the world recovered.”

Paul Tregidgo, former vice-chairman of debt capital markets at Credit Suisse, agrees that while things seem apocalyptic at the time, there always seems to be a way out.

“On October 19, 1987, towards the end of the day when eventually the 500 point mark was hit on the Dow’s 20% collapse, what you heard was the oddest muted roar from the trading floor – a mixture of awe and disbelief, and an overriding sense that we just have no clue where we go from here. The rarest of sentiments on the Street,” he tells Euromoney today. “It was existential. Everyone asked themselves if we were still going to be open tomorrow. But you did what you always did: you just came in and then got on with it.”

No matter how bad things seem at the time, bankers never shed their belief that the industry will reinvent itself, recover and boom again.

“I started in 1994 at CSFB on its graduate programme,” recalls Allegra Berman, global co-head of HSBC Securities Services. “Most of the newbies didn’t know what had hit them. We were wet behind the ears, but we saw a lot of other houses letting go of all their graduates. So, we quickly realised that we were in a pretty cut-throat and highly dynamic industry, where things could turn on a dime.”

Westerman sees being quickly exposed to this type of environment as a huge benefit: “In one sense I was extraordinarily lucky. I joined at a hugely bullish time (1986, Big Bang and the deregulation of the UK financial markets) but in just one year it looked like everything was over with the 1987 crash. But these things do come back – you have to make a career judgement. I think you are better off mentally joining in bad times rather than good. If you like it when times are bad, then you will definitely like it when times are good.”

That is not to say that an event on the scale of the sub-prime mortgage crisis should be seen as the cost of doing business. Some crises are simply too damaging to ever dismiss as a learning curve.

“By 2007 I had seen 1998, LTCM and the tech bubble,” says Berman. “What was different this time was that it had been quite a long time since the last crisis, so people who had joined the industry in, say, 2002 had not experienced anything like it and other people had forgotten. They really didn’t know what had hit them: It felt existential.”

Perhaps the most frightening thing about the sub-prime mortgage crisis is that it is still not really over.

“There is yet to be a severe price paid or day of reckoning for the extraordinary amount of central bank money that has been put into the system,” warns one banker. “Any time we get to a place where we feel like volatility is picking up, the market has a gyration and is given a sedative.”

Not only has this left markets dysfunctional and utterly reliant on central bank money, but it has also left the central banks themselves with little or no ammunition for the next time that the markets spin out of control.

“2007 was probably inevitable,” Hands tells Euromoney. “The decisions made post-9/11 in terms of how the west would deal with that problem in terms of military and economic activity meant that we would get 2007. Pumping the economy and encouraging people to go for growth was jingoistic. Goldman Sachs reached 190 leverage – when you look at it with hindsight – how was it allowed? It was possible because the world was benign.

“If we had a crisis today it is much more difficult to see how you pull that bump forward. If the cycle turns it will be much worse and much harder to recover from.”