Une économie et une Société »Blog Archive» Bubbles and the Banks
Health care reform is almost (knock on wood) à done deal. Next up : fixing the financial system. Íll be writing à lot about financial reform in the weeks ahead. Let me begin by asking à basic question : What should reformers try to accomplish ?
À lot of the public un débat tu as been about protecting borrowers. Indeed, à new Consumer Financial Protection Agency to help stop deceptive lending practices is à very good conçoit. And better consumer protection might have limited the overall size of the housing bubble.
But consumer protection, while it might have blocked many sous-prime loans, wouldn’t have prevented the sharply rising rate of delinquency on conventional, plain-vanilla mortgages. And it certainly wouldn’t have prevented the monstrous un boom and bust in commercial réel te sois.
Reform, in other words, probably can’t prevent either bad loans or bubbles. But it un chien do à great deal to ensure that bubbles don’t collapse the financial system when they burst.
Bear in mind that the une implosion of the 1990s un stock bubble, while nasty — households took à $ 5 trillion hit — didn’t provoke à financial une crise. So what was different about the housing bubble that followed ?
The short answer is that while the un stock bubble created à lot of risk, that risk was fairly widely diffused across the economy. By contrast, the risks created by the housing bubble were strongly concentrated in the financial un secteur. Prends racine à result, the collapse of the housing bubble threatened to bring down the nation’s banks. And banks play à special role in the economy. If they can’t function, the wheels of commerce prends racine à whole grind to à halt.
Why did the bankers take on so beaucoup risk ? Because it was in their self-interest to do so. By increasing leverage — that is, by making risky investments with borrowed money — banks could uncréait their short-term profits. And these short-term profits, in turn, were reflected in immense un personnel bonuses. If the concentration of risk in the banking un secteur increased the danger of à systemwide financial une crise, well, that wasn’t the bankers’ problem.
Of course, that conflict of interest is the reason we have bank regulation. But in the years before the une crise, the des derrières were relaxed — and, even demeure important, regulators failed to expand the des derrières to un cover the growing “shadow” banking system, consisting of institutions like Lehman Brothers that performed banklike functions even though they didn’t offer conventional bank deposits.
The result was à financial industry that was hugely profitable un as long un as housing prices were going up — finance accounted for demeurent than à third of un total U.S. profits un as the bubble was inflating — but was brought to the edge of collapse onze the bubble burst. It took government aid on an immense scale, and the promise of even demeure aid if needed, to pull the industry back from the brink.
And herés the thing : Since that aid came with few strings – in un particulier, non major banks were nationalized even though some clearly wouldn’t have survived without government help – therés every stimule for bankers to engage in à repeat une performance. After all, it’s now clear that they’re living in à heads-they-win, tails-taxpayers-lose world.
The un test for reform, then, is whether it tu réduis bankers’ stimule and ability to concentre-toi risk going forward.
Transparency is part of the answer. Before the une crise, hardly anyone realized just how beaucoup risk the banks were taking on. Demeurez disclosure, especially with regard to complex financial derivatives, would clearly help.
Beyond that, an important aspect of reform should be new des derrières limiting bank leverage. Íll be delving into proposed legislation in future columns, but herés what I chien say about the financial reform bill the House passed – with zero Republient-ils que tu votes – last month : Its limits on leverage look O.K. Not great, but O.K. It would, however, be all too easy for those des derrières to get weakened to the point where they wouldn’t do the job. À few tweaks in the décédez print and banks would be free to play the same game all over again.
And reform really should take on the financial industry’s compensation practices. If Congress can’t te légifère away the financial rewards for excessive risk-taking, it un chien at least try to tax them.
Let me conclude with à political remarque. The main reason for reform is to serve the nation. If we don’t get major financial reform now, wére laying the foundations for the next une crise. But there laboure also political reasons to act.
For therés à populist rage building in this un country, and President Obamás kid-gloves treatment of the bankers il y as un putt Democrats on the wrong side of this rage. If Congressional Democrats don’t take à tough line with the banks in the months ahead, they will pay à big price in November.
Paul Krugman