Could our current circumstances trigger a financial crisis as bad as the 2008 Great Recession? Is enough being done to prevent another financial crisis before it is too late?
I would argue that we are heading into difficult times. The public interest may again be at risk. It is worth noting that risks often emerge where they are least expected. We learned that in 2008. Although it can be difficult to predict what may spur a crisis in the financial system, we can determine what action might be necessary to protect the public from another Great Recession.
In my view, the following four actions are necessary before it is too late. They are simple but important precautionary measures to insure that we avert another crisis.
One, instead of weakening the Dodd-Frank legislation we need to restore it back in substantial measure and to strengthen it.
Earlier this year, in May 2018, a revision of Dodd-Frank became law that weakens federal oversight of banks with up to $250 billion in assets. Basically, those institutions are now exempt from Dodd-Frank’s enhanced prudential standards such as stress-testing, resolution planning, and heightened risk management requirements.
This new law needs to be seen in the context of what is actually happening in the marketplace. The US corporate debt as of the end of 2017 is more than 40 percent higher than its 2008 peak, and is at its highest level relative to US GDP. Corporate debt continues to lever up as though the 2008 crisis never even happened. The total household debt as of the end of 2017 stood at $13–15 trillion, in comparison to $12.68 trillion as of the end of 2008.
And we are seeing the same patterns that we saw in the buildup to the 2008 crisis. The Wall Street Journal, in an article on August 24, 2018, lamented the fact that major financial institutions such as American Express and Goldman Sachs are “among those behind an onslaught of unsolicited mailings offering unsecured loans, known as personal loans, as large as $100,000…. The second quarter marked the first period that lenders mailed out more offers for personal loans than credit cards, a much bigger market.”
The deregulation in the bill also makes is easier for banks with assets of $10 billion or less to be exempt from the Volcker Rule that prohibits them from making investment profits using customer funds. This change in law can now enable banks to make risky investments using their own capital, thereby putting such capital at risk. This again has the same seeds of the problems that we saw before.
Crackdown on Shell Companies
Two, address the dark corners of international finance, including the use of shell companies. The recent trial of Paul Manafort illustrates the necessity of this point best: Money flowed from Ukraine into shell companies in Cyprus and the Caribbean, and eventually to the United States. The trial has been an invaluable public lesson in the ways through which shell companies facilitate tax evasion, money laundering, and how political corruption works.
Shell companies not only contribute instability to our financial system, but they also further inequality abroad. According to James Henry, a former McKinsey economist and now part of the Tax Justice Network, the amount invested through offshore financial-secrecy vehicles like trusts and shell companies is now $25-35 trillion, or 10–15 percent of the world’s private financial wealth. This puts such wealth outside the reach of regulators, tax authorities, and money-laundering controls. This in turn undermines the rule of law, compromises tax collections globally, and enables extreme wealth inequality. And history teaches us that extreme wealth inequality often contributes to political and economic instability.
Rein In Corporate Misconduct
Three, there is need for greater accountability for corporate misconduct. Unlike in Europe, hardly any executives in the United States were held legally accountable for misconduct that led to many of the decisions that resulted in the 2008 financial crisis (in fact, only one executive ended up going to jail over the crisis). It is surprising that there were not more instances of misconduct subject to prosecution, in spite of all the bail-out money that was provided. It was an opportunity that could have been used to address both corporate misconduct and the short-term aspect of executive compensation. And the opportunity was lost. If compensation is driven by short-term decision-making it can affect financial stability over the long-term. Corporate boards have an important responsibility in this regard.
Get Corporations Out of Politics
Four, and perhaps most important, we need to take a closer look at the connection between corporate donations and political legislation. Only when the politicians are emancipated from the need for corporate donation can they regain the ability to control corporate abuses and bring more stability to the financial system. This will also require the engagement of a more activist public to ensure that our politicians can be freed from the burden of Citizens United. And if that can happen, it would go a long way in restoring trust and confidence in our financial system.
In summary, the time for action is now. The need to protect the public is urgent. And the four necessary actions are clear. Let us see what we can do to be sure that we can avert or at least manage another crisis.