The clouds hanging over financial markets were inevitable, but they were also preventable. While markets step back from the edge anticipating additional financial shoes to drop throughout the economy, you may be wondering how this could have happened so soon after financial systems were inoculated against such things after the 2008 global crisis. The better question is, why did it take so long given the massive missteps that have occurred?
Like it or not, the U.S. banking system is designed to absorb and lever financial risk. The fragility built into the system enlarges credit availability and allows the economy to grow and prosper — until risk becomes overwhelming and everyone looks for refuge. This current crisis was baked into the system when governments convinced themselves they could print money to spend their way out of problems, and because global central banks kept interest rates unusually low, traversing between strangely labelled economic theories such as “anti-fragmentation,” “quantitative easing” and “quantitative tightening.”
The causes of financial panics can’t be packaged into pithy tweets or catchy political slogans. Like the 2008 crisis, today’s problems are the result of a complicated mixture of executives willing to take risks in an economic environment bludgeoned by governmental irresponsibility and distorted by out-of-date regulation. Those actions over more than a decade left banks with few practical alternatives but to invest customers’ short-term deposits in longer-term instruments whose rates of return would inevitably become anemic as interest rates rose. Only the best managed banks can survive that kind of sustained abuse, particularly when the financial regulatory apparatus is old and broken.
As the Fed ponders reinstating rules on banks the size of Silicon Valley Bank (SVB) that had nothing to do with its failure, we can only hope that some policymakers have the courage to admit that restrictive rules tacked on to obsolete systems of oversight will only guarantee more disasters. This will happen because these rules reinforce the outdated regulation that allowed FTX to fly beyond the limits of government oversight and incentivized SVB to stockpile high-quality investments such as U.S. Treasuries while whistling past the massive Savings & Loan-type interest rate and duration risks that were being created.
Perhaps the Financial Stability Oversight Council’s statements this week that shadow banks need to be regulated will finally get some traction. But some of us remember the report by the Vice President’s Task Force in 1984 that called for study of that same approach — nearly 40 years ago. The bromide of more and bigger regulation should have lost its credibility more than a century ago, when soon-to-be President Herbert Hoover declared that the creation of the Federal Reserve had rendered future bank panics impossible.
Federal Reserve Vice Chair Michael Barr will no doubt maneuver his way through the thicket of excuses and admissions starring him in the face as he heads the Federal Reserve’s self-examination, and the U.S. Congress will once again respond by giving the Fed even more power. But shame on us if we accept more flowery rhetoric that doesn’t lead to modernization of the country’s arcane financial regulatory systems. That would be an economic death sentence.
Two simple but critical steps can start us on the path to financial stability.
First, there are simply too many regulators around the world overseeing too narrow a slice of the financial landscape armed with too few resources. In the United States, banks with a national footprint start their day by having to satisfy somewhere around 160 federal and state regulators all aimed at an industry that has shrunk from 30,000 to 4,500 banks in the last century. Most financial services today have migrated to nonbank financial companies, digital asset issuers and exchanges, and fintech lenders that are not nearly as regulated.
Second, regulation of financial services companies must transition to a real-time basis armed with tools that can stay ahead of the complexities of a technology-driven economy. That requires more collegial, shared regulatory responsibilities between the public and private sectors and the supervision of all companies that move money as intermediaries — not just banks. The key components of such real-time oversight must include the use of resources such as artificial intelligence. But unfortunately, financial regulators have barely scratched the surface in these areas, forcing them to rely on more guesses and bets than a stable financial infrastructure should tolerate in the 21st century.
Had these improvements been put in place 20 years ago, large government databases analyzed by powerful supercomputers running sophisticated algorithms could have provided regulators with more reliable, predictive information to decipher the bank failures, economic collapses and cryptocurrency concussions that we are dealing with today and that lay ahead of us. In my book on financial panics, I explain how such data in the hands of global regulators in the early 2000s would have raised red flags, providing them with the opportunity to order Fannie Mae and Freddie Mac to stop buying subprime mortgages, Bear Sterns and Lehman Brothers to reduce their balance sheet risk and AIG to stop trying to insure all of Wall Street with credit default swaps.
It is ironic that at a time when the capabilities of artificial intelligence are mesmerizing the world, the regulation of the country’s economic well-being still lags decades behind. FTX, SVB and Credit Suisse are the canaries in the financial coal mine signaling us not only that troubling economic storms are ahead, but that the country’s geopolitical statute hangs in the balance.
Let’s hope that policymakers see that, reject the easy answer of writing more rules and focus on structural and technological solutions that can create real economic stability. That is the best way for the U.S. to continue to use economic power to counterbalance some of the bad things its adversaries would like to see happen in the world.
Thomas P. Vartanian was the general counsel of the Federal Home Loan Bank Board and FSLIC (1981-83) during the savings and loan crisis of the 1980s and 1990s. He is the author of “200 Years of American Financial Panics” (2021) and “The Unhackable Internet” (2023), and is executive director of the Financial Technology & Cybersecurity Center in Washington, D.C.