The financial system still faces fallout from 2008

Watching the heads of several major U.S. banks — JPMorgan Chase, Bank of America and Citigroup — get grilled in front of Congress last week, I couldn’t help but be reminded of that familiar image of downed heads of financial institutions. of systemic importance on the Hill following the 2008 crisis.

This time, the politicians wanted to know not what Wall Street had done wrong, but what they planned to do right in the event of another crisis, either geopolitical (yes, bank executives would pull out of China if Taiwan was invaded) or financial. .

All of this underscores that 15 years after the Great Financial Crisis, there is still a lot of risk in the market system — it just comes from different places. Consider, for example, current concerns about Treasury market liquidity. As the flash crash of October 2014, the repo market pressures of September 2019 and the Covid-related upheavals of March 2020 showed, the ultimate “safe” market has proven to be quite fragile in times of stress.

This itself is part of the legacy of 2008. The huge amount of quantitative easing needed to mask the financial crisis caused the growth of the Treasury market to outpace buyers’ ability or desire to hold Treasury bills. Treasure. De-globalization and the decoupling between the United States and China means that the usual suspects, Asian countries, are looking to sell, not buy, Treasuries, at a time when the Federal Reserve is actively trying to get rid of Treasury bonds. Treasury in the context of quantitative tightening.

Meanwhile, the big banks that have traditionally played the key brokerage role in the Treasury market say they have been forced by post-2008 capital requirements to do that middleman job as well as they have in the past. (Banks had hoped that pandemic-era exceptions to certain capital buffers would be made permanent).

As a recent Brookings Institution report on the subject put it: “Without change, the size of the Treasury market will exceed the ability of dealers to safely intervene in the market on their own balance sheets, causing more frequent episodes of market illiquidity that will raise doubts. on the safe haven status of US Treasuries.

Consumer advocacy groups like Americans for Financial Reform are push for more transparency in pre-trade data, as well as central clearing of Treasuries, which would help make the $24 billion U.S. Treasury market, the largest and deepest market in the world, less fragmented and better regulated. Not surprisingly, banks are opposed not only to increased regulation, but also to capital requirements that have made it harder for them, they say, to hold more Treasuries.

This brings us back to one of the fundamental, and still unanswered, questions of the Great Financial Crisis: why are banks so special? Yes, the big US banks are much safer and better capitalized than they were before 2008. But why are they chafing at single-digit capital requirements when companies in just about any other industry have them? multiples?

Part of it is simply a desire to take more risks and make more money. But within that lies a more nuanced and legitimate complaint, namely that banks increasingly have to compete with less regulated market players, such as major trading firms (i.e. high-frequency funds) that have entered the treasury market, as well as fintech companies. and private equity titans who have become major players in areas such as loans and housing.

This highlights another problem in the system. Financial “innovation” is still ahead of regulation, just like before 2008. It is well known that private equity has benefited enormously from the ability to buy single-family homes, multi-family homes and even home parks mobile in such an important way. the banks could not have done it after the crisis.

Since then, private equity has shifted to health care (they want to streamline nursing homes, worryingly), and even targets some of America’s industrial gems – family-owned manufacturing companies. I shudder to think what these profitable community businesses will look like once the big money is done stripping their assets and over-indebting them.

The SEC has proposed tougher rules for private funds, as well as better transparency and fee measures, which of course is needed. Meanwhile, the Treasury Department is reviewing public comments on how to make sure we don’t get a flash crash in Treasuries. There is even pressure to tighten regulations on regional banks which play a bigger role in the financial system. All of this has merit.

But it also points to the biggest question we’ve ever answered in the wake of 2008: Who is the financial system supposed to serve? Wall Street or Main Street? I would say it’s the second, but there’s no silver bullet to fix a system that has strayed so far from the productive mediation of savings into investment. As everything has shown us, from an increasingly volatile treasury bill market to a housing loan market now dominated by shadow banks to the financialization of commodities, we still have a market system that , too often, there is more to serve than the real economy.

Perhaps we will need another crisis before this problem is finally solved.

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Don F. Davis