The View | Opinion: Nearly a decade since the 2008 crisis, it’s still derivatives, elite traders, and ‘too big to fail’
‘The outcome of the financial crisis has made bankers and regulators very aware of the ‘too big to fail’ dilemma. But it has also led them into an intellectual cul de sac’
When senior economic advisors yearn for the return to a simpler financial industry, free from uncertainty, volatility and calamity you can tell they are frustrated about how to deal with today’s challenges.
Gary Cohn, the ex-President of Goldman Sachs and President Trump’s current chief economic advisor said in a Bloomberg interview that he, “generally favours banking going back to how it was when firms like Goldman focused on trading and underwriting securities, and companies such as Citigroup Inc. primarily issued loans”.
He was not only referring to the Glass-Steagall Act, the 1933 law that clearly separated commercial banking from investment banking, but more predictable roles and definitions for bankers. It was repealed in 1999 as the investment banking world subsumed commercial banks, incentivised risk taking and hurtled the world to the new Great Depression known as the 2008 Global Financial Crisis.
The presence of Glass-Steagall regulation and the separation of US commercial and investment banks in the run up to the 2008 financial crisis would not have prevented or ameliorated the systemic collapse.
Seven years later, much scepticism remains about whether Dodd-Frank has solved the too-big-to-fail puzzle
The key institutions and their functions at the time of the crisis, Fannie Mae and Freddie Mac, were government owned organisations that heightened systemic risk by feeding the mortgage backed securities market. The time when a homeowner actually had a relationship with his commercial bank manager became ancient financial history as mortgages were packaged and sold. Risk was supposed to be safely diversified in the vast liquidity of the US dollar fixed income market.
Today, the outcome of the financial crisis has made bankers and regulators very aware of the “too big to fail” dilemma. But it has also led them into an intellectual cul de sac. They fear that allowing a systemically important financial institution to collapse could extinguish the entire international financial system. Yet, by acting as the lender of last resort or ultimate guarantor of banks it creates moral hazard and compromises risk management.