economy, crash
Is another economic crash coming? Photo credit: Charles Edward Miller / Flickr (CC BY-SA 2.0)

Financial crises tend to strike with all the subtlety of a Kansas tornado — out of the blue and with utter indifference to the mayhem they wreak. But the crisis itself — the moment when asset prices plunge, lending collapses, and the economy starts to contract — is not the moment when things go wrong; that’s just the moment when you notice. Things go awry long before, when few are looking.

What most folks don’t see is the sort of thing that happened on Tuesday, when federal financial regulators took what could prove to be a significant step toward the next crisis. It involves the Volcker Rule (after former Federal Reserve Chairman Paul Volcker), enacted as part of the 2010 Dodd-Frank law that was Congress’s response to the crisis of 2008. The law was intended to curtail “proprietary trading,” the polite term for banks betting with federally insured deposits for their own gain.

History is littered with disastrous proprietary trades, by banks and non-banks, that have wrought financial and economic havoc. Failed bets by Merrill Lynch and the late Lehman Brothers are partly what accounted for the financial calamity that ensued in 2008–09. The 1998 failure of the hedge fund Long-Term Capital Management rocked stock markets around the world.

But a rule change approved Tuesday by the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency — and now under review by three other federal agencies whose approval is needed — would weaken the Volcker rule in several ways. Volcker 2.0, as it’s being called, would narrow the scope of financial instruments subject to the rule and allow big banks to decide for themselves whether certain trades comply with the law. Future revisions could give banks more freedom to invest in risky hedge and private-equity funds. Assuming the other agencies approve the changes, they take effect on January 1.

Supporters of the revisions — which the four-member FDIC board approved by a vote of three Republican appointees to one Democrat — say they merely clarify and streamline a rule that has been too burdensome and complex, partly because it’s nearly impossible to distinguish proprietary trading from “market making,” as the industry calls serving clients.

Opponents fear they will eviscerate Volcker, which “will no longer impose a meaningful constraint on speculative proprietary trading by banks and bank holding companies benefiting from the public safety net,” says Martin J. Gruenberg, an Obama appointee and the FDIC board’s sole dissenting vote.

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Risky Bets With Other People’s Money

The details here are less important than the general drift of policy, which is easier to see if you take a long-term view. Banking is an inherently risky business, and investment banking in particular is a magnet for personality types eager to make high-stakes bets with other people’s money. Those bets occasionally go spectacularly wrong, threatening the financial system (the rarefied world where money is loaned and invested) and ultimately the real economy, where most people live, work, and consume.

These mishaps are not just occasional anomalies. Without adequate regulation, they are inevitabilities, as a long history of bubble-and-bust cycles shows. The late economist Hyman Minsky’s financial instability hypothesis explains why: Banks are always competing for greater profits, which generally requires greater risk. Unless restrained by external regulation, they are forced by the relentless logic of the marketplace to lower lending standards, dabble in the sort of derivatives that Warren Buffett famously called “financial weapons of mass destruction,” and do other things that push them across the invisible line between prudence and recklessness. New Deal measures that constrained risk-taking were meant in part to save banks from themselves. They worked fairly well until the 1980s, when regulation became a four-letter word.

The Volcker rule is only one area where the political puppets of Big Finance are paring back regulations aimed at reducing the chances of another crash. Others include easing “stress tests” of banks’ ability to withstand a crisis, and an easing of capital ratios, a key measure of bank health.

It should surprise no one that an administration dense with people from the world of Goldman Sachs is pulling down the Dodd-Frank safety net, or that a leader of the assault on Volcker is a former private-equity partner, Trump-appointed Fed board member Randal Quarles.

One hopes the hand-wringing prompted by Tuesday’s actions proves overwrought, but there’s a long record of disasters caused by unrestrained financial institutions, and there’s no reason to think that if they’re let entirely off the regulatory leash they won’t burn down the house again.

If and when the next crash occurs, don’t blame Wall Street for doing what it’s highly incentivized to do. To paraphrase the gun lobby, bankers don’t crash the economy; lax regulators do.

Related front page panorama photo credit: WhoWhatWhy


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1 year ago

There are no markets, only interventions.

Margaret Beresford
1 year ago

Unbelievable, you outline the current problem and MacKenzie read it but avoided understanding what was said…
Go back to the 2008 meltdown by proxy under Paulson and the rest of the gang. Global meltdown of only ordinary people’s assets and investment….But ‘and note’ never –repeat never those with ‘money’ like Paulson who is said to have raked millions in with his phony offer to help the naive general public’s of the world….Go down for good–many lost futures—Many now are being set up for the same slip down memory’s dip into poverty and idiocy… Please grow up and start reading and researching…All 5 banks are reported to have double digit trillions on derivative contracts…and have of late claimed —they can use depositors liquid assets to cover their gambling in derivatives….Now who is stupid?

1 year ago

First off, even if we disagree, I appreciate the discussion.

Second, you might be surprised to hear this but I fully agree with you that the big banks are making money at the hands to the general public. Unfortunately, the bailouts set the precedent that big banks are allowed to privatize gains but socialize losses. And in no way is that what I mean by “free market”. That is what’s called “crony capitalism”. And you’re absolutely right that the banks have been doubling down on these dangerous strategies. But why wouldn’t they? While the music is still playing, they make a fortune. And when things ultimately go bust, they can just say “bail us out again”.

In 2008 these banks should’ve all gone under (like Lehman). It would have been a major shock (and the average person would’ve gotten crushed too because they’d lose their deposits) but what they did instead (lowering interest rates to basically zero and more than quadrupling the money supply) is going to cause even greater pain. It will ultimately cause a massive rise in prices and possibly even hyperinflation.

Btw, the debt is much larger than $22 trillion. That figure is just for the so-called “funded liabilities”. The unfunded liabilities are MUCH larger. Economist Laurence Kotlikoff said back in around 2012 that the U.S. is $222 trillion in debt. Meanwhile our politicians are still spending money on these evil, immoral, unjust wars and they’re still promising things like “medicare for all” (among many other things).

This is unfortunately going to be a disaster of epic proportions and we Americans are going to have a front row seat.

1 year ago

Last figure I came across, 22 trillion in US debt. It looks like the plan to keep making stuff we didn’t need to keep the big lie going might actually have run out its long leash. Perhaps the manipulators will trick us with more financial “devices” with a temporary leash extension. It’s not the “Next” financial crisis, its the end of a hopelessly rigged system and its gonna be increasing painful the longer we pretend.

1 year ago

How come there is zero discussion in this article about free market capitalism being the solution instead of “we need the government to save us”?

The article mentions the FDIC (which guarantees deposits up to $250,000). If there were no FDIC insurance, however, people would be a LOT pickier about which banks they’d be willing to put their money into. There would also be publications that investigate banks to help aid people in their decision. In other words, the free market would be the “regulation” on these banks. That’s just one example of a free market solution over big government. There are many others. And let’s not forget that regulation means higher fees for the customer as the bank has to hire compliance workers, and that charge is passed onto the bank’s customers.

Jeff Clyburn
1 year ago
Reply to  MacKenzie

Because humans are not rational actors, as the high priests of your ideology insist they must be in order for free markets to actually work…. this has long been fleshed out, to the point that it’s baffling you’re not aware of the flaws of the “privatize everything” model.

When left to its own deregulated devices, “capitalism man” has repeatedly shown how callous and unethical it always is. … how many Iran-Contra, Savings & Loan, Enron, Deepwater Horizon and Too Big To Fail TARPy rescues do you need to endure before that prospect seems less appealing to you?

1 year ago
Reply to  Jeff Clyburn

I think you’re missing my point. “Too Big To Fail TARPy rescues” are not “free market” but rather a government intervention into the market that (perversely!) rewards businesses that should have been allowed to fail (and eventually be replaced by sustainable ones). In short, corporatism is NOT free market.

You write that “’capitalism man’ has repeatedly shown how callous and unethical it always is.” While I don’t disagree with your point, I also don’t understand why you tied “callous and unethical” to “capitalism”. Shouldn’t it be tied to “human nature”? Surely you’re not suggesting that these same people would suddenly become “caring and ethical” under some other type of system (e.g. socialism)?

I’ll assume that you’re saying that, whatever the system, “callous and unethical” people need to be reigned in. On that point, we agree. What we disagree on, however, is the “how”. I’d rather have the public reign these people in (e.g. by taking their business elsewhere) rather than some governing body, which I see as being far more susceptible to corruption (e.g. the revolving door between government and big business that we’ve seen all too often).

Again, when the average person today decides which bank to put their money into, do they ever look into the bank’s business practices (e.g. “is this bank engaging in risky behavior?”) A big reason why they’re not doing so is probably because of stuff like FDIC insurance (which guarantees their deposits up to $250,000). Of course, FDIC insurance isn’t going to work in the event of a systemic shock to the banking system (because they don’t have anywhere near enough money to insure all of those deposits).

In short, I think the best regulation comes from the free market. But, again, I appreciate the discussion.

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