In early 2007, the worst financial crisis in almost 80 years began to unfold, coming to a head 18 months later with the collapse of Lehman Brothers and shock waves felt around the world. Desperate government measures saved us from Great Depression II, and officials vowed “never again” would we face the same risks. Politicians and central banks embarked on a broad process of national-level reform and international coordination—all intended to reduce the chance that very large banks could collapse.
A decade later, the global financial system has in some ways become safer as a result of these efforts. In other ways, however, the structure has not changed much—and may even have become more vulnerable. But, instead of completing the reform process, policymakers on both sides of the Atlantic seem determined to undo most of the measures underpinning what progress has been achieved.
The past decade has yielded three main accomplishments. First, some financial firms failed, and for good reason: Their business models were bad, they were badly run, or both. At the same time, stronger financial firms expanded their market share.
Instead of completing the reform process, policymakers on both sides of the Atlantic seem determined to undo most of the measures underpinning what progress has been achieved.
Second, the funding of banks shifted away from debt and toward equity. More than one prominent bank before the crisis had less than 2 percent of its funding from equity—meaning that it was more than 98 percent financed by debt. That does not happen today.
Third, there are now restrictions on the activities of the largest banks. The so-called Volcker Rule prevents proprietary trading—a form of in-house speculation—by US-based banks. In other countries, bank supervisors have become more skeptical about supposedly sophisticated risk-taking. Caution is in the air.
Unfortunately, all of these achievements may prove ephemeral. Powerful people want to remove restrictions on banks in the United States and the United Kingdom. For example, the Volcker Rule can be expected to come under great pressure from Goldman Sachs and its many alumni now serving in senior US government posts.
Gary Cohn, a former Goldman Sachs president and chief operating officer who now heads President Donald Trump’s National Economic Council, says that we should reduce capital requirements (meaning allow more debt and less equity funding at banks) in order to boost the economy. This is exactly what happened in the early 2000s. If Cohn gets his way, the consequences will be similar: disaster.
Since 2008, the global financial system has become more concentrated in important ways. The biggest US banks did well relative to their competitors, including large European banks. As a result, in key markets—and throughout the world’s essential financial infrastructure—banks such as JPMorgan Chase remain far too big to be allowed to fail.
Finance sometimes seems complicated, but what is at stake is quite straightforward. US Senator Jack Reed recently summed it up well:
“My constituents don’t need fancy Wall Street calculators or formulas to understand that there is a value and a benefit to reforming Wall Street and keeping reckless greed in check. There is a value and a benefit to protecting consumers and their hard-earned wages. And there is a value and a benefit to keeping a family in their home and avoiding foreclosure.”
Government officials’ views on policy are shaped by how they see the world—and what they have experienced. If someone was dramatically hurt by a financial crisis, that person is less likely to want to go through the same thing again.
But if someone did really well—by buying assets on the cheap at the bottom of the cycle, for example, or expanding market share—it seems reasonable to suppose that they are less likely to favor caution. Reed made precisely this point in speaking to the suitability of Steve Mnuchin—a former Goldman Sachs executive vice president—as Treasury Secretary:
“[A]n individual who made his fortune aggressively foreclosing on his fellow Americans does not possess the right values, in my view, to be our Treasury Secretary. Based on his record, I am not convinced Mr. Mnuchin is capable of draining the swamp, and I fear he may end up further rigging the system in favor of the 1 percent at the expense of working-class Americans.”
But the Senate confirmed Mnuchin, which suggests that we are about to come full circle. As James Kwak and I documented in our book 13 Bankers, financial deregulation in the 1980s and 1990s led to a real-estate boom in the early 2000s; that set the stage for the 2008 financial bust, which in turn gave rise to a new wave of reform in 2010 and after. The reforms were serious, but they did not go far enough, and they can be rolled back without much difficulty. The Trump administration is poised to do exactly that.
The big banks will get bigger. Capital levels will fall. And reasonable risk-management practices will again become unfashionable. Powerful people do well from booms and busts. The rest of us can expect deeper inequality and more crisis-induced poverty.