By Madalena Thirsk, Account Executive, Capital Markets, Aspectus
September 1844, a Bavarian man and his two brothers arrived in New York full of hope and aspirations for a new life in the land of opportunity. September 2008, 164 years later, their legacy – Lehman Brothers – would collapse into bankruptcy, triggering the biggest financial crisis the world had ever seen.
The collapse was largely due to the firm’s involvement in trading complex derivatives, such as mortgage-backed securities, and the subsequent exposure to the subprime mortgage market. When the market turned sour, the value of these securities plummeted. The credit default swaps (CDS) contracts linked to these securities then amplified the losses, leading to the firm’s collapse.
The crisis highlighted the importance of clear and transparent communication as a crucial tool for maintaining financial stability and managing market expectations. One and a half decades later, there have been notable improvements in the way central banks and regulators communicate risks surrounding derivative instruments. Take the issue of forward guidance as a prime case in point. Central banks, including the Bank of England and the Fed, have increasingly used forward guidance as a key communications tool. This involves providing guidance to financial markets and the public around the likely future path of monetary policy – helping to manage expectations and provide greater clarity on the central bank’s intentions.
Central banks have also become more transparent about their policy frameworks, objectives, and decision-making processes. They often publish detailed policy statements, meeting minutes, and economic forecasts to provide insights into their thinking. In fact, the vast majority of major central banks now hold regular press conferences following policy meetings to explain their decisions and answer questions from journalists. This practice allows for real-time communication with the public and the media.
Then there is the social media factor, which has grown in importance considerably since 2008. Central banks and regulators have largely embraced social media platforms as a medium through which to disseminate information and engage with the public. Platforms like X are now used to communicate policy decisions and provide updates on economic conditions. Meanwhile, sites such as LinkedIn play a vital role in sharing information to address global financial stability concerns that emerge in international forums.
These advancements in communication are intended to enhance transparency, build credibility, and manage expectations in financial markets and the broader economy. Clear, timely and effective communication helps reduce uncertainty, foster trust, and allow central banks and regulators to better achieve their policy objectives.
The US regional banking crisis earlier this year (which had a slight whiff of Lehman about it) should reinforce why central banks and watchdogs must maintain their commitment to public communication. And today’s anniversary is a timely reminder. The importance of providing clear guidance on policies, actions, and intentions concerning derivatives cannot be understated.