Watch out for tipping points. The London (and now UK) riots started after the shooting death of one suspected criminal – tragic, but not normally the trigger for widespread carnage. The death of one man was the catalyst for the Arab spring uprisings. In finance, the death of one firm turned a serious US problem into the worst global recession in decades.
There are three striking parallels between the Lehman and London tipping points. First, a flammable environment, ready for a spark. In London, it was partly rising youth unemployment (the rate for 16-17 year olds has increased one-third to 36 per cent in the last four years) and perhaps increasing social inequality. In the US, it was an increase in overall leverage, base rates that slowly ratcheted up over five years, and reckless lending.
Second, group psychology. A disturbance turns into a riot when a crowd gels into a mob – people affirming and fuelling each other’s irrational frenzy. That describes both rampaging youth and bankers furious to keep up with rivals’ investments in risky high-yield securities. The assumption was that if others paid a high price for an asset, it must be worth it – or more. Then the financial mob turned and there was a frenzy to sell.