As I watched the heads of several major U.S. banks — JPMorgan Chase, Bank of America, and Citigroup — get grilled in front of Congress last week, I couldn’t help but be reminded of that familiar image of dejected essential financial institution heads on the hill after the 2008 crisis.
This time around, politicians didn’t want to know what Wall Street had done wrong, but what it intends to do right should there be another crisis, either geopolitical (yes, bank bosses would pull out of China if Taiwan was invaded) or financial .
All of this underscores that 15 years after the great financial crisis, there are still many risks in the market system – they just come from different places. Consider, for example, the current Treasury market liquidity concerns. As demonstrated by the October 2014 flash crash, September 2019 repo market pressures and March 2020 Covid-related dislocations, the ultimate “safe” market has become quite vulnerable in times of stress.
This is itself part of the legacy of 2008. The massive amount of quantitative easing required to drown out the financial crisis meant that the growth of the Treasury market reduced the ability or desire of buyers to hold T-Bills, surpassed. Deglobalization and decoupling between the US and China mean that the usual suspects, Asian nations, are looking to sell rather than buy government bonds while the Federal Reserve actively seeks to dump T-bills as part of quantitative tightening.
Meanwhile, the big banks, which have traditionally played key broker-dealer roles in the treasury market, say post-2008 capital requirements prevented them from doing that brokerage job as well as they had in the past. (Banks had hoped that the pandemic-era exceptions to certain capital buffers would be made permanent).
As a recent Brookings Institution report on the subject put it: “Without change, the size of the treasury market will exceed dealers’ ability to broker the market safely on their own balance sheets, leading to more frequent bouts of market illiquidity that… raise doubts about the safe haven status of US Treasuries.”
Consumer advocacy groups like Americans for Financial Reform are pushing for more transparency in pre-trade data and centralized clearing for Treasuries, which would help protect the $24 trillion US Treasury market, the largest and deepest in the world. to make it less fragmented and better regulated. Not surprisingly, banks are resisting not only more regulation, but also the capital requirements that they claim have made it difficult for them to hold more government bonds.
This brings us back to one of the central and still unanswered questions of the great financial crisis – why are banks so special? Yes, the big US banks are much safer and better capitalized than they were before 2008. But why bother with single-digit capital requirements when companies in other industries hold multiples?
Part of it is simply a desire to take on more risk and make more money. Within this, however, is a more nuanced and legitimate complaint, namely that banks are increasingly having to compete with less regulated market players such as major trading firms (aka high-frequency funds) that have entered the T-bill market, as well as fintech firms and private equity titans , which have become major players in sectors such as lending and housing.
This indicates another problem in the system. Financial “innovation” is still far ahead of regulation, just as it was before 2008. Private equity is known to have benefited greatly from buying up single-family homes, multi-family homes and even RV sites on a scale that banks could not have done post-crisis.
Since then, private equity has moved into healthcare (they want to streamline nursing homes, ominously) and even target some of America’s industrial gems — family-owned manufacturing companies. I shudder to think what these profitable, community-based companies will look like when the big funds are done stripping their assets and loading them with debt.
The SEC has proposed stricter rules for private funds, as well as better transparency and metrics on fees, which is clearly needed. Meanwhile, the Treasury is scrutinizing public comments on how to ensure we don’t get a T-bill flash crash. There are even moves to tighten regulation of regional banks, which play a larger role in the financial system. All of this is justified.
But it also points to the biggest question we’ve never answered after 2008 – who is the financial system supposed to serve? Wall Street or Main Street? I would argue the latter, but there is no silver bullet to fix a system that has strayed so far from productively brokering savings into investments. As everything has shown us, from an increasingly volatile T-bill market, to a home loan market now dominated by shadow banking, to the financialization of commodities, we still have a market system that all too often exists more to serve itself than the real economy.
We may need another crisis before this problem is finally resolved.
#financial #system #grappling #aftermath