Did We Waste a Recession?

Author: Adam Davidson

Five years ago this month, before Lehman Brothers imploded and the global economy lurched to a halt, Fannie Mae issued a report that encapsulated the financial system’s biggest problem. The mortgage-finance company, which was wobbling on account of rising defaults, tried to reassure investors that it had $47 billion in capital, which was considerably more than the $30 million required by law. At the time, the report’s authors seemed to fear that some investors might think Fannie was too cautious. In any event, a month later, that protection seemed like a joke. Fannie may have conformed to the rules, but the rules didn’t conform to reality. The lender and its brother company, Freddie Mac, were declared insolvent and handed over to the U.S. government.

Remarkably, five years after the crisis, the health of the financial industry is just as hard to determine. A major bank or financial institution could meet every single regulatory requirement yet still be at risk of collapse, and few of us would even know it. Despite endless calls for change, many of the economists I’ve spoken with have lamented that the reports that banks issue about their finances remain all but useless. The sprawling Dodd-Frank Act, which rewrote banking regulation in 2010, didn’t resolve things so much as inaugurate a process of endless rules-writing by regulators. Meanwhile, the European Union is in the early stages of figuring out how it will change the way it regulates banks; and the gargantuan issue of coordinating regulations across borders has only barely begun. All of these regulatory decisions are complicated, in part, by a vast army of financial-industry lobbyists that overwhelms the relatively few consumer advocates.

Economists have also been locked in their own long-running arguments about how to make the banking industry safer. These disagreements, which are generally split between the left and the right, can have the certainty and anger of religious wars: the right accuses the left of hobbling banks and undermining prosperity; the left counters that the relatively lax regulation advocated by the right will lead to a corrupt oligarchy. But there actually is consensus on one of the most important issues. Paul Schultz, director of the Center for the Study of Financial Regulation at the University of Notre Dame, led a project that brought together scholars of financial regulation from the left, the right and the center to figure out what caused the financial crisis and how to prevent a sequel. They couldn’t agree on anything, he told me. But a great majority favored higher equity requirements, which is bankerspeak for the notion that banks shouldn’t be allowed to borrow so much.

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