Trump's reversal of Wall Street regulations risks another Lehman Brothers but 'on a larger scale'
Donald Trump and the Republican Party's efforts to dissolve many of the new regulations imposed on major Wall Street banks in the wake of the worst financial crisis are most stunning because they ignore such glaring and recent lessons.
These include: 1. bank self-regulation ends in tears since the crisis was caused by a lax enforcement of rules, not an excess of them; and 2. bankers will push financial risk to the limit if they know taxpayers will bail them out regardless.
"There are few precedents in modern political history for such a rapid and fundamental reversal of course," writes Paul Lee, a regulation lawyer at Debevoise & Plimpton LLP and a member of the adjunct faculty of Columbia Law School in a blog.
On Friday, the House of Representatives passed the curiously named Financial Choice Act, which repeals many important provisions of the Dodd-Frank law enacted in 2010 to deal with the aftermath of the financial crisis. That's a lightening-speed reversal of direction, in historical terms.
"Consider the significant reform enactments dating from the Great Depression, such as the Securities Act of 1933, the Federal Deposit Insurance Act, and the Glass-Steagall Act. The basic construct of these enactments remain in place with the exception of certain parts of the Glass-Steagall Act, which were repealed only in 1999, 66 years after their initial enactment," Lee adds.
Simon Johnson, a professor at MIT and a former chief economist at the International Monetary Fund, tells Business Insider the latest proposal is "a dangerous plan for financial deregulation [where] the primary beneficiaries would be the big banks."
In particular, Johnson worries "the proposal to rely on bankruptcy for large banks is pure fantasy - this would risk a repeat of what happened with Lehman Brothers, but on a larger scale." Lehman's failure in September 2008 accelerated the financial crisis and led to a deep global financial shock with widespread economic repercussions, including the loss of millions of jobs.
Why is it lunacy to abandon rules intended to prevent another financial crisis so quickly after experiencing the worst meltdown in generations?
"Thanks to Wall Street reform, U.S. banks have a greater capacity to absorb losses during periods of stress, increasingly rely on stable sources of funding, undergo rigorous stress testing, plan for their orderly failure and don't make swing-for-the-fences bets," argues Gregg Gelzinis, a special assistant on the economic policy team at the liberal Center for American Progress, in an opinion piece.
"Large, complex nonbank financial companies that pose financial stability risks, such as AIG, now face enhanced regulation and oversight," he writes. "Consumers are now better protected from toxic products in the financial marketplace, and perverse incentives and predatory practices in the housing and securitization markets have been significantly curtailed."
These are all good things, and they are not, as some bankers would have the public believe, constraining economic activity or lending. In fact, much of the evidence suggests a recent tightening in commercial and industrial lending has been driven primarily by a lack of demand for loans, not a backlog due to regulatory hurdles.