On October 30, 2015, Richard Squire of Fordham University School of Law, Eric Grossman of Morgan Stanley, and Richard Kim of Wachtell, Lipton, Rosen & Katz, discussed whether the United States is prepared for the next financial crisis. They believe it is already on the horizon. The panelists agreed that the US financial system is stronger today than it was in 2008, but that the country’s ability to respond to a crisis has been seriously weakened.
The panel made it very clear that Congress’s response to the 2008 financial crisis, the Dodd-Frank Wall Street Reform Act of 2010, failed to address the underlying cause of the crisis – the collapse of the housing market. Billed as an “anti-bailout” act, Dodd-Frank was a capitulation to special interest groups and populist anger, not a thoughtful response to serious economic issues. The drafters were so caught up in the narrative that Wall Street had “fleeced” Main Street that they ignored the facts. Most notably, all of the loans that had been made to struggling banks-none of which were actually insolvent- were paid back in full, and with interest, the only exception being the loans to nonbank institutions General Motors and Chrysler. The panel felt that the Dodd-Frank Act, and subsequent legislation like the Volker Rule, fails to address to causes of the crisis, illustrates Congress’s misdiagnosis of the underlying issues, and could have serious ramifications in the future.
It would have been bad enough if Congress had simply passed legislation that ignored the real culprit of the 2008 crisis. Unfortunately, the panel agreed that Dodd-Frank has also made things worse. The Fed played a major role during the last financial crisis. However, as a result of a fundamental misunderstanding of the role that a central bank must play during a liquidity crisis as a lender of last resort, Congress has significantly curtailed the Fed’s lending powers. As Mr. Kim, quoting former Federal Reserve Chairman Bernanke, put it, limiting the Fed’s lending power is like “shutting down the fire department to encourage fire safety.” Congress’s decisions ensure that the Fed will have a much more difficult job solving the next financial crisis.
The last major issue the panel noted was the regulators themselves. One of the strengths of the team that helped steer the country out of the 2008 crisis was that its members had real industry experience. Mr. Kim noted that today’s data-driven regulations, which do offer some improvements, require more tech savvy regulators, leaving less room for former financial industry heads. This trend, combined with the demonization of Wall Street, has decreased the number of regulators with a practical understanding of the banks and other financial actors. Mr. Kim felt that the regulators today also suffer from a lack of leadership that will limit their ability to respond during the next financial crisis.
Despite these many shortcomings and failures, the panel agreed that the financial system today is stronger than it was in 2008; it is better capitalized, and banks carry more liquidity and are less leveraged. However, Dodd-Frank had nothing to do with it. These types of improvements are the result of action taken by the banks before Dodd-Frank went into effect. According to the panel, the impetus for these changes was the implementation of the Comprehensive Capital Analysis Review, which forces banks to consider the worst possible scenarios, evaluate their chances of weathering them, and implement changes where necessary. Whatever the reason, there have been some positive changes and improvements to the financial system. But will it be enough?
The panel concluded with a prediction and a warning. There are already indicators of another financial crisis – Professor Squire all but guaranteed it. The housing policies that caused the crisis of 2008 were not corrected and history appears to be repeating itself. This time, though, things could be worse. Despite a stronger, better-capitalized financial system, the damage done to the Fed’s ability to respond to a crisis, the shortcomings of the regulators, and the lack of meaningful legislation, all mean that it will be harder to respond to the next financial crisis.