Paul Volcker, Chairman of the Federal Reserve 1979-1987

Inviting the Next Financial Crisis

Editorial, The New York Times, August 25, 2018

The economy has come a long way from the dark days of 2008, when the collapse of Lehman Brothers and the bailout of big banks led to worldwide economic disaster. For much of the last decade, the economy has been growing and the stock market has been rising. But this steady climb is lulling bankers, lawmakers and regulators into repeating mistakes that contributed to that crisis and cost millions of people their jobs, homes and savings.

The financial system and economy are clearly on much firmer ground than they were a decade ago. The unemployment rate, which climbed as high as 10%, has fallen to 3.9%. The housing market, once crippled by foreclosures, has sprung back to life, with home prices scaling new heights in many parts of the country. Banks, once dependent on taxpayer dollars to keep their doors open, are raking in profits.

Much of the credit for the recovery belongs to the swift response from the Obama administration, the Federal Reserve and Congress. The Obama administration worked to stimulate the economy by nearly $1 trillion. The Fed pumped life into the system by lowering interest rates, buying bonds and rescuing financial institutions. Congress enacted the Dodd-Frank law, imposing tighter regulations on financial institutions and limiting their ability to take bet-the-farm risks with borrowed money. The law helped instill confidence in banks that had squandered their credibility by blowing billions on dubiously engineered investments that few understood and fewer could explain in plain English.

Yet, the crisis and the government response to it worsened longer-term trends that have caused wages to stagnate for most families while rewarding the top 1% with an ever-bigger slice of the economic pie. Obama officials and Congress clearly made a big mistake early in the recession by focusing more intently on saving banks and much less on helping families facing foreclosures and layoffs. Later in the recovery, the decision by Republican leaders in Congress to oppose every Obama proposal prevented the government from doing much to help people regain what they had lost. As a candidate, Donald Trump spoke about getting tough on Wall Street and looking out for “forgotten men and women” – rhetoric that won him the support of some working-class voters who had backed Mr. Obama. But he and his fellow Republicans in Congress have governed like conventional conservatives – going easy on Wall Street and gutting a range of protectionsfor those “forgotten men and women.”

Last year, Republicans claimed their biggest legislative victory of the Trump era, reducing federal revenue by $1.5 trillion over 10 years by slashing taxes on corporations and wealthy families. The legislation provides generous and permanent tax cuts to rich people in the investor class. The tax law will widen income inequality and encourage financial excesses by overstimulating an economy that is already nine years into a recovery.

Lawmakers and the administration, and even the Federal Reserve, which should know better, are also sowing the seeds for another crisis by unraveling the financial regulations put in place in the last 10 years. In May, Congress voted to roll back parts of the Dodd-Frank law by exempting banks with assets of up to $250 billion, up from $50 billion, from stricter federal oversight. This was supposedly done to help smaller, community banks, but the change was so sweeping that it would leave fewer than 10 big banks under the kind of supervision experts concluded was necessary after the crisis.

In addition, officials at the Fed and other government agencies have proposed relaxing the Volcker Rule, which restricts big banks from gambling with their depositors’ money on high-risk investments. The regulators also want to ease capital requirements for banks, which will increase profits for the likes of Citigroup and JP Morgan Chase by letting them operate with more borrowed money rather than capital raised from shareholders.

The speed with which officials are moving to undo financial regulations is stunning to economists who remember their history. “The last time we regulated in the 1930s, it took us 30 or 40 years to take off those regulations,” said Raghuram Rajan, an economist at the University of Chicago and former governor of the Reserve Bank of India. “This time we are doing it in 10 years.”  And the regulations that were dismantled and eliminated could have helped prevent or reduce the severity of the last crash.

With investors bidding up stock prices and pouring billions of dollars into money-losing start-ups as if nothing could go wrong, it is all the more frightening and infuriating that officials have so quickly tossed aside the lessons from the last crisis. In making life grander for the most comfortable Americans, the government is putting everyone’s economic prospects at greater risk.