I’ve been taking a course on Corporate Governance. It’s surprisingly interesting, and covers the 2007 financial crisis in a lot of detail.
The professor makes the argument that the global financial system is not much safer than it was after the last big crash, despite the many reforms that were made and the tremendous amount of money spent by governments.
Without getting too detailed, an argument is made that banks are still too incentivized to take big risks as many are still too big to fail; that too many smaller financial institutions are exempt from more onerous requirements, that mortgages have too many exemptions; that changes were largely made at national but not global levels and the systems of different countries remain dependent; that many countries have staggering debt; that Chinese banks have moved in the opposite direction of more regulation and capital requirements…
This is without Trump watering down Dodd-Frank or Brexit volatility.
Wondering if anyone agrees or argues that the system is far safer today?
My sources believe that the system is /less/ safe, because the new regulations make the system more uniform and more narrow, without providing enough more protection.
The system is at present safer, because each crash cleans out the marginal and unsafe lending practices. When the next crash happens, even more of the system will be effected, and it will be even more tightly linked. The new regulations will ensure that the specific cause of the crash won’t be something specifically addressed by the regulations: there will be some new and interesting way of crashing.
The argument about the banks being too big to fail has never convinced me: America has bigger banks partly because the small banks were squeezed out by regulation. Because when the small banks failed, they failed all at once, because they were engaged in the same practices. And the sector was “too large to fail”, so they bailed it out, then regulated the sector out of competition. Going backwards to smaller banks again wouldn’t solve the problem: the sector would still be too important to fail. Like water or electricity.
Darwin’s Law about Survival of the Fittest means that craps players who bet the Field or Big Six are now in short supply. They’ve been driven out by their own loss of capital. Failing business models fail. This is applauded by fans of the free market. Lessons are learned.
But what lessons were learned by bankers in the wake of the 2008 Crisis?They learned that they’ll get their $100 million dollar bonuses even if the paper they created goes bad, that Uncle Sam will step forth, injecting enough cash to pay those huge bonuses. Stockholders have learned their lesson: Heads we win, Tails the taxpayer picks up the losses. As long as they’re betting on banks that are “in with the in crowd.” (What exactly did the managers of Bear Stearns do that made the insiders happy to turn them into a scapegoat?)
No, I am NOT proposing that the banks should have been forced into bankruptcy as a result of the 2008 Crisis. I am simply proposing that they should have been forced to expand their capital base to achieve clear solvency. This is what the duty of bank regulators has always been … until the U.S. bank regulators were in the pockets of the bankers. Either way, the U.S. taxpayer would have ended up owning a lot of bank paper. But why not let the taxpayer make a big profit on bank stock while bankers learn a lesson? Instead the banks gleefully unloaded their worthless debt paper onto the hapless taxpayer, and added to their collections of Lamborghinis and yachts.
Excess profits during the booms; then profit again with government help during the crashes. I’d say the banks have found a good business model for themselves and hope to repeat their success.
I’d add that the elimination of all those smaller banks mean that the survivors of 2008 now have more of everyone’s money in their hands, which will make the next crash even worse.
The only jurisdiction where senior bankers were jailed was Iceland, as far as I know. Should this happen more often for serious malfeasance? Would it have any value as a deterrent? Should big companies have been allowed to fail, with shareholders paying the price? (Our course claims the highest costs were not due to the bailout).
Governments were in a very difficult spot. It is hard to require banks to have more and better capital (make better loans) at the same time that there is no liquidity or even intrabank lending (get money flowing by making loans). Quantitative easing helped. Stricter restrictions on bailout conditions would have made sense.
The US banking system is safer. Higher capital ratio’s, and as mentioned excessively risky lending practices haven’t risen to the levels of 2007, it takes more time for that to happen. I also agree the shrinkage in small banks is neither here nor there. That had happened to a large extent, v long ago, even 10 yrs ago. And the whole problem is a herd mentality: whether it’s a herd of elephants or lemmings is not the key issue.
But the next crisis could come from some very different direction than US mortgage lending. It probably will. Are all other potentially dangerous financial situations (Eurozone’s chronic problems, growth of Chinese debt, growth of rich country govt debt generally, etc.) safer now than 2007? Not necessarily. But it’s very hard to factor out hindsight in determining what will cause a global financial crisis and what will be contained and muddled through as a national, industry etc issue.
I am not a banker and certainly not an economist, so take what I am about to say with a big barrel of salt. What I would have done in 2008 was to force the banks, in return for the bailout, to issue a big pile of paper to give to the government. This would have the effect of diluting the shares of all the stockholders of course. The next time, they might watch a bit more closely. They are still ahead of where they would have been had the banks been allowed to fail. And now the government would have been in a position to sell those stocks and make a big pile back. Maybe they could have indemnified some of the poor people whose houses went under water.
Examples? In the old days, after the New Deal and before deregulation, banks served a narrow niche and were considered rather boring. And things were very stable.
Much of the growth of big banks come from them swallowing up smaller banks. I’ve not heard that this was due to smaller banks failing, and I think it is more due to deregulation and is akin to the growth of a few large players in other sectors.
The too large to fail banks were also engaging in investment strategies previously not allowed, which let them grow when times were good.
When small banks fail they get merged with other banks and the depositors are protected. That does not cause the crisis which happened when a giant bank failed. There was a requirement for more capitalization and stress tests, but we’ll see of the additional regulation, which the banks fought, mostly successfully, helps the next time.
Huh, somehow I thought this thread was already in Great Debates. I have a hard time imagining an objective measure of economic stability, so that’s a much better fit. Moving.
We are also less safe now because governments responded to the last crisis by expanding the money supply, lowering interest rates, and racking up mountains of debt. They basically shot all their bullets, and now we have fewer tools left to deal with the next crisis.
Look at America’s debt, which is now about 22 trillion dollars. In 2008 it was about 9 trillion dollars. If the next crisis involves inflation, the stsndard tool for combating it is now unavailable to the government, because increasing interest by even one percentage point will result in an additional 220 billion dollars in debt service when the debt matures. And I believe a large percentage of the U.S. debt is held in short term instruments, as in about 20% matures in less than a year, and about 40% is in bonds that mature between 1yr and 10 yrs. That’s from a chart Inhave that’s three or four years old. I’m guessing it’s even worse now. The more debt the government carries, the more incentive to trade safety for a slightly better interest rate.
In Canada, when the last crisis hit we were actually running surpluses, and had lower taxes (giving more room in the tax code to raise revenue or pay down debt if necessary). Today our taxes are higher, our economy weaker, and we have a huge debt. We are in a much worse position to handle the next crisis.
Finally, the response to the last crisis, which saved the bankers and CEOs from the consequences of their actions, was the motherlode of moral hazards that incentivized more of the same behaviour.
I’m sure you’ll agree that whatever the benefit of racking up debt during the downturn was, racking up debt today during prosperity is worse. And I agree that it might tie the hands of the government when the next crisis hits.
I also agree that we should have used a regulatory neutron bomb in 2009, where the banks survived but their leaders did not (figuratively, I mean.)
Yep. Running big deficits at a time of full employment is about as stupid as it gets.
I could get behind a ‘bailout’ law that says that any company that receives a government bailout in lieu of bankruptcy must replace its CEO and its entire board of directors. If we are going to bail out companies, we have to figure out how to counteract the inevitable moral hazards and distortions bailouts create.
Recall that it was exactly twenty years ago that the U.S. Treasury demand for long bonds had dried up, forcing the yield curve into inversion and consternating federal financial planners like Greenspan. We don’t have that problem today! :rolleyes:
Neither Greenspan nor his optimistic detractors mention the big elephant in the room: Mounting debt creates an incentive to inflate the dollar debt away.
The U.S. Dollar will remain the world’s currency safe haven. Until suddenly it isn’t.
Banks are safer today, as Voyager stated, because they’re required to hold more capital, and to undergo stress testing to ensure that capital is adequate to meet high-risk scenarios. From the Bank of England:
Here’s a link for bank stress testing in the US.
Banks are also required to know their group-wide counterparty exposure. Unknown counterparty exposure was one of the causes of the liquidity crisis in 2008, which was a significant factor in the fall of Lehman Brothers. Basically with Bear Stearns, and then even more so with Lehman Brothers, different sections of the mega banks knew which financial obligations they held, such as loans but including many other types of financial instruments. However, they didn’t know their overall exposure. Therefore they couldn’t assess whether it was safe to make interbank loans. The liquidity freeze was because every bank was scared to make loans to other banks, because they didn’t know the how bad they’d be affected if those other banks went bust. That’s why the government had to step in.
However, just because banks are safer, that doesn’t mean there aren’t other risks. From what I’ve read, the big current risk is in the shadow banking system, which is largely unregulated.
The derivatives market has expanded hugely since 2008. Risks, and risk weighted valuations are notoriously difficult to calculate for derivatives. And most derivatives are held within the shadow banking system. Keep in mind that CDO’s, Collateralised Debt Obligations, were another big factor in the 2008 crisis. CDO’s are a type of derivative.
The other big global risk is China. One economist worried about China is Paul Omerod.
In the US at least, corporate leadership incompetence can sometimes be punished under the Sarbanes-Oxley Act.
The act basically requires CEO’s and CFO’s of publicly held companies to make affirmative statements about their business reporting, and makes them criminally liable if their statements are untrue. So, for example, a CEO is required to affirm that his business’s annual report is accurate, and he can be prosecuted if the annual report is fraudulent. This is supposed to make them ensure that their public reporting is true, and remove the excuse that they’re not responsible for fraudulent activities because they didn’t know about it. Theoretically, if a publicly traded financial institution is conducting high-risk activities – the investment equivalent of long-shot betting – while maintaining a public façade reporting that they’re being prudent and careful, then that company’s leadership could be prosecuted under Sarbanes Oxley if everything went pear-shaped.
Saying that, last I checked, which was around three years ago, there had been very few prosecutions under Sarbanes-Oxley.
Thanks for moving the thread. I did do a search back a year or so, but I’m sure the topic is discussed occasionally.
The shadow banking system was a major cause of the crash. I’m not sure how much better things are in this regard.
Certainly the capital requirements and individual bank shutdown procedures seem helpful. But credit rating companies and auditing accountants can still be in significant conflict of interest. And the fact so much bailout money went to bankers bonuses shows that some dubious lessons were learned.
Derivative markets are better regulated. But I’m sure many company boards have members who get little independent information, or are happy to rely on executive summaries.
It will be interesting to see what happens after the next festival of deregulation. Canadians are proud of their “reaction” to the crisis, but were in a fortunate position now ruined by people and institutions piling on debt.
There’s an old saying that generals always plan for the last war. Then they are surprised when the next war doesn’t look like the last one. The same is true for regulators - they regulate based on the last crisis. So we write all kinds of new rules to prevent the exact mechanism of the last crash.
But crashes and crises happen because the complex system that is the global economy gets way out of whack and needs to correct. The failure will then come at some weak point. Strengthen the weak point, and all you’ve done is cause the next failure to be at a different weak point. Maybe the banking system will be fine this time, but real estate will collapse. Or perhaps the stock market will crater. Or inflation will finally show up in a big way. Or a war will break out, or something like that.
When a system is deeply unbalanced, it’s going to correct. You can’t regulate that away. Global debt is out of control at all levels - federal, state, municipal and individual debt are at record levels. China is slowing down and showing signs of major trouble. The U.S. economy seems to be doing well but it’s also borrowing money like mad to do it. Canada’s growth just went off a cliff and is now 0.1%. Canada is also borrowing money as fast as it can at just about ecery level.
That which can’t continue indefinitely, won’t. You can’t predict when the crisis will hit or where or how, but unless we start unwinding the mistakes we keep making, one is certainly coming,