It's been a decade since the global financial crisis struck full force, and many of us are still having nightmares about its economic devastation.
One especially harrowing event was a call I took at the height of the crisis from the CEO of a major home-building products retailer. He said that one of his biggest suppliers was running out of cash, as no bank would lend to it and it could find no buyer for commercial paper. Commercial paper is a very short-term IOU that big companies sell to investors to provide short-term cash for such needs as making a payroll. If the supplier shut down, the CEO knew his company wouldn't be too far behind.
He was looking for my help to get his message to the Federal Reserve, the Bush administration, or anyone else who would listen. Wow!
Policymakers ultimately stepped up and quelled the crisis, but only after bailing out the nation's largest financial institutions, automakers, and homeowners. The Fed dropped interest rates to zero and took the unprecedented measure of buying long-term bonds to bring down mortgage rates and other borrowing costs. The Obama administration implemented a massive fiscal stimulus plan with temporary tax cuts and increases in government spending.
These and other measures helped restart lending in the nick of time for the CEO caller and his supplier, and they pulled through.
Despite all this, we are still paying a severe economic and political cost for the crisis. Although unemployment is back down from the 10 percent crisis peak, nearly all lower- and middle-income households are less wealthy today than 10 years ago. Stock prices and national house values are at record highs, but this has mostly benefited the wealthiest among us.
Because so many Americans were financially creamed by the crisis and haven't been able to fully recover, they are rightly upset, which is reflected in our politics. The chaos that President Trump is creating is fine by many of them, because it represents a full break from policies that had failed them. Not that I think Trump's policies will work for them. In fact, I'm confident those policies will make their troubles worse, though it will take some time for that to become clear.
Given the disturbing fallout from the global financial crisis, it is fitting 10 years later to ask whether we are any safer from suffering a future financial crisis. Have policymakers and regulators done what is necessary in the wake of the crisis to ensure that we won't have to endure such a nightmare again?
We are certainly safer. The odds of a similarly severe crisis any time soon are low, most important because of changes in regulation. Regulators are rightly wary of too-big-to-fail institutions — institutions that, if they fail, would take out the entire financial system. Regulators now require these behemoths to hold much more capital (the cushion to absorb losses on their loans and other investments), to be more liquid, and to follow more stringent risk management practices such as stress testing.
Policymakers also now have a cookbook for how to resolve failing too-big-to-fail institutions. While the recipe hasn't been tested yet in real life, there is good reason to believe it will work much better than the ad hoc approach taken during the financial crisis.
Moreover, the Fed, like most other central banks, now believes in the use of so-called macroprudential tools — additional regulation and oversight — to weigh against developing bubbles. For example, the Fed is nervous about all those high-end apartment towers going up in such cities as Philadelphia and warned lenders not too long ago to be more cautious.
But despite these reforms, we aren't safe. Interest rates remain exceptionally low, and global investors in search of a higher return are taking a lot more risk. This is evident in record-high stock prices and commercial real estate values. Bond investors are asking for less and less protection for lending money to less creditworthy municipalities. And house prices seem a bit lofty in some cities.
Risk-taking has also reappeared in the securitization market. Remember residential mortgage-backed securities, the financial instruments that cratered when homebuyers with subprime mortgages defaulted? This time, the problem may be securities backed by loans to highly leveraged companies.
Global investors can't seem to get enough of them as this collateralized loan obligation market has taken off. To meet the strong demand, lenders are significantly easing their underwriting standards on commercial and industrial loans to companies. Covenants on these leveraged loans — restrictions on borrowers to ensure they can repay — have also deteriorated.
Regulators are nervous. They have used macroprudential guidance to banks to rein in their leveraged lending, but an increasing amount of the most aggressive lending is being done by a mélange of private equity, mezzanine debt, and other institutions outside the banking system — and outside regulators' purview.