The energy crisis should prompt an overhaul of regulations

It’s a measure of how jittery the world feels right now that we’ve been inundated with “Lehman moments” for the past few months. The implosion of China’s Evergrande late last year was described by many observers as a potential Lehman moment for China’s overleveraged property sector. The crypto meltdown in March was another.

Yet it is remarkable, even alarming, for a government minister to make the analogy. Finland’s Economy Minister Mika Lintilä compared the current energy crisis in Europe to the role of Lehman Brothers in the 2008 financial crisis last weekend, as he unveiled a package of loans and guarantees from 10 billion euros to protect the energy sector of his country.

Hyperbole or not, he was certainly right on one point. Without intervention, an existential crisis threatened many energy companies, putting pressure on the banks that lent to them or on the clearinghouses called central counterparty exchanges (CCPs) that intermediated these financing contracts. Such are the exorbitant prices and market dysfunction, triggered by Vladimir Putin’s invasion of Ukraine and his reduction of gas supplies to Europe.

If Finland and Sweden were the only ones to act a week ago, others have followed. European leaders met in Prague on Friday to discuss a coordinated rescue plan, including state guarantees and a range of other measures.

“The world should remember Lehman,” I wrote in March, “and prepare for a global financial and economic shock.”

Financial policymakers insist they have been absolutely prepared – not just for this shock, but for many more. They point to the robustness of the banking system in the face of Covid and now in the face of the energy debacle and galloping inflation.

This, they say, proves the success of post-2008 financial regulation, when capital and liquidity rules for banks were tightened. Elaborate mechanisms were then put in place to allow authorities to put failing banks into orderly liquidation, and most derivatives transactions were routed through supervised CCPs, rather than being executed under obscure over-the-counter transactions.

The banking system has indeed been robust, but largely thanks to government interventions before the economic strains hit the banks. Without Finland’s bailout, and a similar plan in Sweden the day before, the local Nasdaq clearing house, or the banks that are members of it, would have had to bear the stress. Likewise, in 2020 and 2021, extensive Covid relief packages granted to businesses around the world avoided the risk of massive defaults on bank loans.

It is tempting to dismiss such events as inevitable and exceptional, and deserving of exceptional government intervention. But more could still be done preemptively to mitigate their economic impact.

The 2008 financial crisis highlighted the critical nature of the banking system and triggered regulatory restructuring to better protect it in the future. But policy-making has been blinded.

Central counterparties were consciously turned into systemically important structures during this post-crisis crackdown, but regulators accepted the exchanges’ argument that tight collateral management made high capital levels unnecessary as buffers against the risk. The Nordic experience raises further doubts about this hypothesis.

In the central energy market itself, signals could and should have been drawn from post-crisis financial regulation. Around 2008, Libor and Euribor, borrowing benchmarks that had sometimes been casually calculated on the basis of imaginary transactions, proved dangerously manipulable and artificially expensive for banks, which had products linked to them.

Similarly now, the so-called TTF benchmark has turned out to be an erroneous gas price measure for electricity markets – in fact manipulated by Putin. Given the predominant role of Russian gas in this mechanism, its manipulation was predictable. Yet it is only now that EU policy makers are discussing a change

More generally, weak price regulation and energy hedging is eerily similar to the monitoring of flawed funding models of poorly supervised banks heading into 2008.

We are being punished now for not understanding the fragility of our energy systems. In addition to tackling this crisis, policymakers must be proactive in ensuring that all of our critical infrastructure – power, water, internet – is as rigorously regulated as banks were after 2008.

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About Wanda Dufresne

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