The panic following the collapse of Lehman Brothers a decade ago spread quickly and far, even to markets that were less vulnerable to developments in the U.S., such as Australia. That underscored the “global and instantaneous” impact of the crisis, according to Wharton Dean Geoffrey Garrett. Fearing a contagion, central bankers all across the globe responded with bailouts and regulatory reforms.

Today, the world is safer from a similar crisis, but other red flags loom, such as investors redeploying their monies in less-regulated markets and alternative investments such as private equity, Garrett said during a recent interview on the Knowledge@Wharton radio show on SiriusXM.

Is the next recession on the horizon? For sure, stringent financial sector reforms and increased personal accountability of executives at financial services firms bring a greater sense of security, Garrett said. The trigger for the next downturn could come from anywhere: a failure to forge a Brexit deal, or the fallout from the fragility of the Chinese markets. But the U.S. may not be as well positioned to respond adequately, as “we’ve fired all the bullets,” he cautioned.

Following are edited excerpts from his comments during the show:

The ‘Tsunami’ Reaches Australia

Timing is everything in life. I had returned to Australia, my native country, from the U.S. in early 2008. When I got there, everything was about the presidential election … and the rise of Barack Obama. But then suddenly this tsunami happened — the fall of Lehman Brothers on September 15, 2008. The remarkable thing about Australia is that it’s a country literally halfway around the world with one of the most tightly regulated banking sectors, and a banking sector with much less exposure to Wall Street than the European banks had. But even in Australia, the crisis was immediate. Credit markets froze in Australia almost overnight. The Australian government was saying, “Oh my God, the Australian credit market has frozen. What are we going to do?” That showed me that the crisis was both global and instantaneous. It was extraordinary.

“[Australia] is a country literally halfway around the world with one of the most tightly regulated banking sectors…. But even in Australia, the crisis was immediate.”

Global Coordination

Like in the U.S., there was an immediate and massive monetary and fiscal stimulus in Australia in response to the crisis. It was coordinated by the G-20, which we forget today as we’re putting up barriers to international collaboration. Back then, there was instantaneous and essential coordination of fiscal and monetary policies all around the world, including Australia.

… Australia actually avoided recession. Australia hasn’t had a recession for more than 25 years. But that was only because of the scale and scope of the response. In retrospect, it is remarkable how effectively and internationally coordinated the response was. The U.S. responded with the so-called TARP (Troubled Asset Relief Program) immediately in 2008. By early 2009, the G-20, at that time hosted by [the then British Prime Minister] Gordon Brown, led a global stimulus in response.

China [also launched a] massive infrastructure stimulus. [It] wasn’t their credit markets that were affected. But they thought they had to respond, and they responded in an enormous way. So yes, we’ve had a less strong recovery. It’s not the V-shaped recovery that the U.S. and the world economy were used to but … we averted a second depression.

… There is an enormous overhang [of the 2008 crisis] in at least two areas. The first overhang is with respect to stagnant incomes in the decade after the financial crisis. The other one is the fact that [the U.S.] fired all the bullets. Debt is a big issue in the U.S. Getting interest rates back to a so-called normal level is a big issue. Why? It’s because we fired every fiscal and monetary bullet we had. How we should reload for the next crisis is still a challenge.

How Much Safer Are We?

[The global financial system] is safer. The traditional finance system is much better regulated than it was before the crisis. One could argue about whether it’s overregulated. In the U.S., we have Dodd-Frank [Wall Street Reform and Consumer Protection Act of 2010], and at the G-20 level we have the Financial Stability Board (set up in 2009).

There have been big changes that were potentially overdue. Does that mean that the global system is safe [enough]? Well, we’re not so sure. In the U.S., we’ve had a rise of shadow banking or alternative investments, which are less regulated. Now think about other big potential financial risks to the system, [such as] debt that is sitting on state-owned enterprises and local governments in China. That wasn’t the cause of the [2008] crisis, but if you are looking at financial stress in the international system today, a lot of people point to problems on the Chinese balance sheet as something that we should all be concerned about. It would be very hard to regulate that out of New York or Washington.

“There have been big changes that were potentially overdue. Does that mean that the global system is safe [enough]? Well, we’re not so sure.”

Ensuring Ethical Conduct

[After the crisis], there’s been a lot of research and a lot of action to tie executive compensation and board compensation not to tomorrow’s share price, but to the long-run stock price. We’ve made personal performance compensation much better aligned with the long-term performance of a company. That’s a plus.

The biggest criticism [after the last crisis] was: “All these people in finance are innovating, but they bear none of the downside risk.” There’s still this structural reality, which is that finance professionals don’t personally bear the downside risk of a collapse in the financial system — which of course is why so many people say, “Hey, they’ve got to go to jail if they can’t pay the financial price.”

But then I go full circle on this, which is that you and I absolutely need people in finance to be innovative to take risks. We need them to generate higher rates of return on our retirement nest eggs, because we want them to be bigger, not smaller, when we retire.

A Recession Around the Corner?

The clock is ticking, so almost by definition we’re getting closer [to a recession]. But the investment professionals that I talk to say two things. First, most assets are expensive, and [second,] they don’t see many good new investments.

That tells us that the system is probably vulnerable to some kind of a correction. The question is whether it’s a correction or a crisis. That also means that all else equal, a smaller event could have a bigger precipitating impact.

“The system is probably vulnerable to some kind of a correction. The question is whether it’s a correction or a crisis.”

What would those events potentially be?… Could no Brexit, or a hard Brexit, really roil the global markets? I think not, because I’ve always thought that we were going to have something like a Brexit in name only, [where] there’s a formal deal but in fact not so many changes. The markets have probably already priced that in.

Have you read?

Have the markets priced in the increasing fragility of the Chinese markets? Probably yes, because Chinese investors — people with assets in China — have been trying to get their money out of the country for maybe 10 years.

I don’t think the markets have priced in the U.S.-China rift because they don’t yet know the potential scale of it. These are the two largest economies in the world; they’re incredibly interdependent. The rhetoric of the Trump administration … says we should unwind a lot of connections with China, because we think the whole structural basis of the Chinese economy is unfair. Now if that were to happen, that would be a big deal. But again, I look at the interconnections between the U.S. and China, and I say it can’t happen because the stakes are just too high.

I’m not predicting either the timing or the cause of a downturn, but if we go back to that first premise that assets are at historically high prices, of course we are vulnerable to a downturn –maybe a relatively small and unexpected event.