Ten Years After the Financial Crisis, We Shouldn’t Be Complacent About Regulations

Ten years ago this month, the senior class at Swarthmore confronted graduating into one of the worst recessions in American history. The investment bank Lehman Brothers had just collapsed, setting off the financial crisis and the ensuing global economic contraction. By the end of 2009, unemployment reached 10 percent and real GDP had fallen 4.3 percent from its 2007 peak (Federal Reserve Economic Data). In contrast, barring unforeseen disaster, the class of 2019 will graduate into a strong economy and tight labor market. Indicators of economic well-being such as the labor force participation rate, homeownership, and real weekly earnings have rebounded since the recession, albeit slowly. In August 2018, unemployment among recent college graduates was only 2.2 percent according to Federal Reserve Economic Data.

Even though the class of 2019 will face very different economic realities than the class of 2009, the 10th anniversary of the financial crisis is an excellent opportunity to examine the work that still needs to be done to prevent another crisis. The current economic expansion shouldn’t lull us into thinking that it can’t happen again, or make us complacent about regulating the financial system. Instead, policymakers need to look at both risk factors that precipitated the 2008 financial crisis and new developments in financial markets that might lead to another crisis.

One of the major causes of the 2008 financial crisis was subprime mortgage lending, including risky and predatory lending practices. This was largely enabled by deregulation of the financial system, such as the repeal of the Glass-Steagall Act in 1999 and the failure to regulate the “shadow banking system.” After the financial crisis, some significant steps were taken to increase oversight on banks, such as the Dodd-Frank Act, which created the Consumer Financial Protection Bureau. Additionally, the Federal Reserve began doing “stress tests” on banks to ensure that they could survive some losses. The Trump administration, however, is currently making troubling moves towards deregulation of the banking system, including unwinding some of the Dodd-Frank regulations on small and medium-sized banks earlier this summer. Since many experts believed that Dodd-Frank did not go far enough when it was passed, it is worrying that the Trump administration is attempting to dismantle it, possibly increasing our vulnerability to another crisis. The Federal Reserve has also loosened some of its capital requirements for banks that are not “systemically important.” Having sufficient capital allows banks to withstand losses if there is a downturn. Together, these changes could enable more of the bad behavior and excessive risk-taking by banks that led to the 2008 financial crisis, so it’s worrisome that the government is walking back regulations on banks even though the economy is doing well.

Maintaining existing regulations, however, isn’t enough. We also need to consider risk factors that didn’t exist back in 2008. According to the New York Times, the value of corporate bonds has risen from 16 percent of GDP in 2007 to 25 percent of GDP in 2017 as companies take advantage of low interest rates to borrow. If the Fed were to raise interest rates significantly, companies may not be able to pay interest on their debt. Concerningly, student loan debt has doubled in the past decade, and is growing much faster than mortgage or credit card debt. The student loan market is still smaller than the mortgage market, so widespread defaults would not have the same disastrous effect on the economy as the housing crisis, but heavy student loan debt could prevent consumers from making important consumption choices such as homeownership.

Experts also cite cyberattacks on the financial system as a growing risk for the economy: over the summer, Federal Reserve chair Jerome Powell told members of Congress that the risk of a cyberattack keeps him up at night, while largely dismissing the risk posed by cryptocurrency.  Banks are also worried about the possibility of cyberattacks. The New York Times found that the number of successful data breaches in the financial system has been rising since the 2008 financial crisis.

Of course, odds are that the next financial crisis will be caused by something that most people don’t regard as risky, just as many experts didn’t see the 2008 financial crisis coming. It may be that many factors coincide in unpredictable ways that create the conditions for a crisis. The risk of another crisis, however, can certainly be mitigated by maintaining the sensible regulation enacted after the 2008 financial crisis, and paying attention to new aspects of the economy that could foment a crisis.

 

Laura Wilcox

Laura Wilcox '20 is from Alexandria, VA studying economics and math. She is passionate about central banks and monetary policy.

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