We are happily experiencing the second-longest period of sustained economic growth in the nation’s history. After a slow start lasting over six years the economy is growing so strongly that former President Barack Obama wants to take credit for it even though many economists, including the Congressional Budget Office, say the current growth is largely due to Republican tax and regulatory reforms.
But booms do not last forever, and experts worry about the myriad things that might bring on a new recession. The Federal Reserve is still struggling to get back to normal operations after greatly extending itself 10 years ago to fight the worst market crash since the Great Depression. And the federal government is running huge deficits at a time when it should be balancing its books.
The 10th anniversary of the collapse of Lehman Brothers in September 2008 has led to a widespread discussion of what lessons, if any, the government and the finance industry have learned. The worrisome answer is probably not enough. The nation is still running risks that could lead to another crash, this time with a weaker safety net.
Among the doomsayers is Sen. Elizabeth Warren, D-Mass., who says recent deregulation moves by the Republican Congress and President Trump, such as lowering capital requirements for smaller banks and easing rules meant to separate the activities of deposit banks and investment banks, make a new financial crisis more likely.
But a fair question is how well the financial reforms championed by Sen. Warren and the authors of the Dodd-Frank regulatory reforms signed into law in 2010 by then-President Obama have performed.
The reforms forced banks to hold larger cash cushions, although there is a debate about whether the cushions are large enough to help the financial industry and the Federal Reserve ride through another sharp downturn.
But the reformers utterly failed to discourage further market concentration in the banking industry or to solve the “too-big-to-fail” dilemma. When bankers expect to be bailed out they are more likely to make risky loans with a higher rate of return. One check on reckless behavior would be, as Sen. Warren rightly argues, to prosecute bankers who cost the taxpayers money. But President Obama preferred to fine banks and let their decision-makers retire handsomely.
A look at recent financial industry data in the Financial Times found that America’s top five banks control 47 percent of banking assets, more than before the 2008 crash, and that the top 1 percent of mutual funds have 45 percent of assets. That is a pretty extreme concentration, and it has gotten worse since the enactment of Dodd-Frank.
Globally, shadow banks that escape formal banking regulation have grown even more, rising from a size of $28 trillion to $45 trillion. The Financial Times found that overall debt worldwide has soared by nearly 40 percent in relation to economic output in the last decade.
A lot of that debt is held in developing countries that are experiencing an economic slowdown that could lead to more defaults. Those would inevitably fall on American banks, which have a larger share of international finance than before the 2008 crash.
In short, the major Democratic reforms to the banking system have failed to reach their objectives, and the risks to that system have increased.
When, not if, the next market downturn will occur is notoriously difficult to predict. In theory, the Fed could undertake moves in advance to soften the impact, but in practice it almost always finds itself reacting after the event. The worry this time is that neither the overstretched Fed nor the heavily indebted U.S. Treasury is prepared to carry out a rescue on the scale that will likely be needed.