openpolitics.com

A big financial-firm collapse in near future is exceedingly unlikely, but another crisis isn’t

.. Bear and Lehman were the manifestation of deeper economic forces that since the 1970s have produced crises roughly every decade. They are still at work today: ample flows of capital across borders, mounting debts owed by governments, corporations and households, and ultralow interest rates that nurture risk-taking in hidden corners of the economy.

By the early 1980s, though, deregulation had allowed capital to flow freely within and across borders and crises became a regular occurrence: the Latin American debt crisis that began in 1982,

• the U.S. commercial real estate and savings and loan crisis of the 1980s,
• the Asian and Russian financial crisis of 1997-98,
• the dot-com bubble of 1998-2000,
• the U.S. mortgage crisis of 2007-2009 and
• the European sovereign debt crisis of 2009-2013

.. Bear was both facilitator and victim of a housing bubble inflated by low interest rates and huge inflows of foreign capital—a “global saving glut” as then-Federal Reserve Chairman Ben Bernanke put it.

.. It arranged mortgages that financed the housing bubble while borrowing heavily with short-term IOUs.

.. When those mortgages went bad, Bear’s creditors yanked their funds—a de facto run on the bank.

Most of the regulatory effort since has been to ensure the largest financial institutions such asJPMorgan Chase & Co., which bought Bear Stearns in a fire sale brokered by the Fed, don’t succumb to anything similar:

• thicker buffers of capital to absorb losses,
• more reserves of cash and liquid assets to pay off skittish creditors,
• restrictions on trading and compensation that incentivize risk-taking, and
• new procedures for winding down failing institutions without taxpayer bailout or a chaotic bankruptcy.

Hyun Song Shin, research chief at the Bank for International Settlements, warned in a 2014 speech against the tendency to “focus on known past weaknesses rather than asking where the new dangers are.”

.. bond markets are growing at the expense of banks in supplying credit, enabling business and government debt loads in many countries to surpass their precrisis peaks.

.. Emerging markets have borrowed heavily in dollars, which leaves them vulnerable should the dollar’s value rise sharply

.. Total U.S. debt, at around 250% of GDP, still stands at crisis-era peaks while debt levels in China have caught up and passed the U.S.

.. Crises surprise because they usually start with an assumption so sensible that everyone acts on it, planting the seeds of its own undoing:

• in 1982 that countries like Mexico don’t default;
• in 1997 that Asia’s fixed exchange rates wouldn’t break;
• in 2007 that housing prices never declined nationwide; and
• in 2011 that euro members wouldn’t default.

.. the equivalent today might be, “We will never see higher inflation or higher growth.” If either in fact occurs, the low interest rates that have raised household stock and property wealth to an all-time high relative to disposable income won’t be sustainable.

.. A 1.5 to 2 percentage point increase in real interest rates, which he isn’t forecasting, would be small by historical standards but could potentially make the debts of Italy or Portugal unsustainable.

.. Central banks know this, of course, which is one reason they are wary of raising interest rates too quickly—while nervous that if they raise them too slowly, the problem will get worse.