This week marks the 10th anniversary of the collapse of Bear Stearns, a major investment bank, and the onset of the global financial crisis and the worst recession since the 1930s.
Can it happen again? Are the banks still too big to fail?
The answer to both questions is yes.
The Dodd-Frank law only requires that banks now carry more capital to back up losses. If those reserves are overwhelmed, the bank shareholders take the losses.
Citigroup, then the nation’s largest bank, carried much more capital than the existing laws required in 2008. However, when it got in trouble, a federal bailout was necessary because the assets of the largest banks have few, if any, potential buyers in a crisis.
The Troubled Asset Relief Program (TARP), created by the Congress in 2008, authorized the Treasury Department to issue some $700 billion in U.S. bonds to purchase preferred shares and troubled assets from those banks. Ultimately, slightly more than $400 billion of this authority was used. Essentially, those funds carried us through the reorganization of the banks and avoided a complete collapse of the financial system.
The federal government may not be able to pull off such a trick again. Thanks to $1 trillion budget deficits – and its need to borrow so much of that money from foreigners – it simply may not have the additional borrowing capacity.
Indeed, Uncle Sam may set off the next crisis.
Already, U.S. IOUs held by the rest of the world exceed 45 percent of gross domestic product and within the next decade, that figure will surpass 60 percent. No major nation has crossed that threshold without enduring wrenching financial adjustments.
America prints the world’s money – foreign central banks hold U.S. Treasury bonds to back up their currencies, because most international transactions go through the dollar. However, bond markets no longer assign a premium to U.S. government bonds as compared to the securities of other low-risk sovereigns like Germany. That indicates international creditors are getting less confident about the U.S. dollar and debt.
As deficits keep soaring, we can expect investors to demand higher and higher interest rates on Treasury bonds. During the next recession that could well force huge tax increases or draconian budget cuts and send the economy into a death spiral. All that would spin defaults in mortgage and corporate debt, and loan defaults would deal a death blow to major banks.
The recent budget crisis required $300 billion in new spending to get enough Republicans and Democrats to sign on, because neither side was willing to even talk about cutting out the fat in programs that serve their cherished goals – income redistribution for the Democrats and tougher border controls and a stronger military for the Republicans. And both sides love pork – roasted, BBQ or grilled.
In 2017, entitlements and interest payments consumed about two-thirds of all federal revenue, and those are on track to take it all in less than 10 years. One in 20 working age adults receives a Social Security disability pension – about double the 1990 rate. Millions of adults who choose not to work receive Medicaid, food stamps and other entitlements benefits.
Entitlement outlays could be substantially reduced by more faithfully enforcing eligibility rules and imposing work requirements, but Democrats and Republicans from welfare-dependent states want no part of it.
Neither party is willing to entertain cuts to programs and departments that have outlived their usefulness. When outgoing Secretary of State Rex Tillerson asserted he could effectively run the State Department with many fewer people, Republican senators went apoplectic.
As the 2018 Trump budget suggested, entities and programs like the Appalachian Regional Commission, 18 other regional commissions and Community Development Block Grants, which permit governors and mayors to dole out patronage without levying taxes on constituents, have long outlived their usefulness but deliver votes to politicians on both sides.
It’s virtually impossible to address those issues with the rule effectively requiring 60 votes to win approval of bills in the 100-member Senate, House rules permitting the speaker to require bills be backed by a majority of his or her party before reaching the floor, and both houses having significant caucuses of rigid and uncompromising liberals and conservatives.
Congressional leaders from both parties indicate little interest in changing the rules to force better policy. And as we learned during the recent financial crisis, the bond market has a way of imposing tough reforms on recalcitrant politicians.
Americans are not going to like going through Greek austerity but the best glimpse of America’s future may be found by visiting Athens.