Government dysfunction could doom us to a never-ending financial crisis when the next one hits
One day, whether it’s next year or in the next decade, there will be another financial crisis.
It probably won’t be as bad as the last one, which cost Americans trillions of dollars in wealth, caused nine million to lose their homes, and almost took all of Wall Street over the precipice.
But no matter where it begins, I think the next crisis will be defined by the inability of governments to act as decisively as they did after the fall of Lehman Brothers 10 years ago. Though regulation of mainstream financial institutions has greatly improved, budgetary and financial constraints as well as toxic politics may well tie the hands of regulators and central bankers in a way they didn’t the last time around.
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Another crisis is inevitable, because booms and busts are rooted in the primal human emotions of fear and greed. Economist Hyman Minsky observed that as past crises fade from people’s memories, financial markets become prone to new bursts of binge borrowing and speculative excess.
Robert Aliber, professor emeritus at the University of Chicago Booth School of Business, estimated there have been more than 40 banking crises over the last three decades. Some of those were local, but others, like the Asian/Russian financial crisis of 1997-98, resulted in contagion as panic spread.
A few weeks ago, I wrote about four pundits who “called” the last financial crisis before it happened. Each thought the next crisis would come from somewhere different: emerging-market debt, low-quality corporate debt, Italy, and the shift in risk from the traditional to the shadow banking system.
But they all saw debt as the likely culprit, the way subprime mortgages were in the last crisis. And indeed, the world’s total household, corporate, and government debt hit $247.2 trillion in the first quarter, 318% of global GDP, according to the Institute of International Finance. That’s way up from $177.8 trillion in the pre-crisis first quarter of 2008.
The sheer size of that debt means governments will be hard pressed to put out the next wildfire. In October 2008, Congress passed the Troubled Asset Relief Program (TARP), which helped the U.S. Treasury stop a selling panic by pumping an estimated $440 billion of capital into shaky financial institutions by buying shares. Taxpayers ultimately broke even.
In early 2009, Congress passed and President Obama signed the American Recovery and Reinvestment Act, which pumped over $800 billion into the economy. That and the bailout of the auto industry, which began under President Bush, helped stabilize a collapsing economy and set the stage for a very slow, painful recovery that has picked up steam over the last year or so.
Meanwhile, the Federal Reserve slashed the federal-funds rate from 5.25% in July 2007 to around zero in January 2009 and kept it there for almost seven years. It also embarked on three rounds of aggressive bond buying, called “quantitative easing,” that added $3.6 trillion to its balance sheet. The Bank of Japan and European Central Bank followed suit.
Finally, in July 2010, President Obama signed the Dodd-Frank Act, which made big banks hold more capital, undergo regular stress tests, and devise liquidation plans. It also forbade them from making certain speculative trades for their own account. In March, Congress rolled back some Dodd-Frank restrictions for “smaller” banks (those with under $250 billion in assets), but the bill’s co-author, former Rep. Barney Frank, recently said that “90-plus percent of that law is going to remain on the books.”
Who can imagine a similar response to the next crisis? In the fiscal year ending September 2008, the federal budget deficit stood at $458 billion. Plunging tax revenue, the stimulus, and other measures pushed it to $1.4 trillion in fiscal 2009, but by fiscal 2015 it had declined to $438 billion. It’s been heading up ever since, and now, because of Congress’s wild spending spree and the Trump tax cuts, the Congressional Budget Office projects trillion-dollar annual budget deficits as far as the eye can see.
With interest rates rising and federal interest expenses poised to soar, the government will have far less ability to administer shock treatment to a flagging economy than it did a decade ago.
And even after several increases, the fed-funds rate is barely over 2% and, by current projections, won’t hit 3% until the end of 2019, all things being equal. That would be much lower than the 5.25% before the last crisis hit, so Chairman Jay Powell better pray the current stock-market turmoil is temporary. Meanwhile, the Fed’s balance sheet hasn’t shrunk much at all. It recently stood at $4.2 trillion, and the central bank may have little appetite for future rounds of QE, especially since the last rounds didn’t do much good.
And finally, don’t count on Congress to come to the rescue again. Even in 2008, 95 Democrats joined 135 Republicans in voting down Treasury Secretary Hank Paulson’s first request for TARP funds. That was even before the Tea Party rebellion and the rise of the Berniecrats, creating more polarization in Congress than we’ve seen since Reconstruction. Throw in President Trump’s poisonous lying and fearmongering, and you’ve got a toxic mix that will likely make it impossible for Washington, D.C. to act at a future moment of grave peril for the economy.
That’s why I think it doesn’t matter where the next financial crisis begins — because the government’s inability to act decisively may ensure it never ends.
Howard R. Gold is a MarketWatch columnist and founder and editor of GoldenEgg Investing, which offers exclusive market commentary and simple, low-cost, low-risk retirement investing plans. Follow him on Twitter @howardrgold. He will be moderating a panel at #SABEWNYC18 on Oct. 25 on how journalists can spot the next financial crisis.
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