Some believe New Year’s festivities serve little purpose, but for millennia people have celebrated days getting longer, which explains our fascination with New Year’s celebrations. Even though winter cold chills the bones, spring lies around the corner. By watching nature, our ancestors planned for the future. In the Information Age perhaps we should take a hint. Five years ago the world was gripped by an unforeseen, by most, and arguably the worst financial crisis since the 1930s.
Since then it seems as if we learned a pitiful small amount. A wise man noted, “Those who cannot remember the past are condemned to repeat it.”
When the next financial crisis hits, hopefully it won’t shock the system as profoundly as the Great Recession.
One huge mistake we failed to appreciate is how interconnected markets are and we should understand there are known unknowns. Hey, a broken clock is right twice daily. When Lehman Brothers’ bailout failed, the ripple effect pressured the oldest American money market fund since it held copious Lehman debt.
Immediately, a 21st century run on the bank ensued; think George Bailey but not confined to Bedford Falls. Increasing the intensity were highly leveraged hedge funds with suddenly sketchy balance sheets. I’m no George W. Bush fan but his signing of the Troubled Asset Relief Program (TARP) ameliorated the crisis, at least in the short term. By the Federal Reserve injecting liquidity, the financial system stayed afloat. Since both the Bush and Obama teams thoroughly bungled TARP administration, Americans might be reluctant to go down a similar path again.
Wachovia and Merrill Lynch going bankrupt could have blown up the world’s financial underpinnings. We have a tool to make sure taxpayers will not be on the hook down the road. A proposal, under Dodd-Frank legislation, would require large U.S. banks to maintain 6 percent “leverage ratios” or face limits on the bonus payments to employees and dividends payments to stockholders.
Staunch Republican and former FDIC head Shelia Barr, along with Ronald Reagan’s Federal Reserve (Fed) chair Paul Volcker, support this common-sense regulation. Too Big to Fail (TBTF) banks oppose it citing international banks’ lower capital requirements. In 2006 and 2007, TBTF banks had leverage ratios under 3 percent, only slightly higher today at 4.3 percent. When faced with losses, these banks, Too Big to Fail, did not have sufficient capital to absorb their losses. Because of this foolishness, millions lost their jobs, Gross Domestic Product plummeted and the Walton County economic engine, South Walton, virtually stopped.
Don’t fall for the international bank hogwash; it’s nothing more than a smokescreen. Of the top 20 banks bailed out by the Fed, see above, nine were foreign. In the American International Group fiasco, 10 of the top 16 banks with Fed lifelines were overseas institutions. With well-capitalized U.S. banks, when the next crisis hits (and there will be one), the Fed won’t feel compelled to backstop the global system. U.S. banks could perhaps scoop up undercapitalized foreign cousins; cue Adam Smith’s invisible hand.
Sure banks would have to hold more capital, but they could still make loans to credit-worthy borrowers. Someone described insanity as doing the same thing but expecting different results.
Buz Livingston, CFP, has a Blue Mountain Beach based fee-only, hourly financial planning and investment management firm. For more information, visit or come by our new office at 2050 Scenic 30A, M1-Unit 230, Redfish Village.