“Too big to fail” financial firms, those that would crash the entire financial system and global economy if they failed, were at the core of causing and spreading the financial crash of 2008. That was the worst meltdown since the Great Crash of 1929 and caused the worst economy since the Great Depression of the 1930s.
A second Great Depression was only avoided due to unprecedented and incredibly costly government and taxpayer bailouts for those “too big to fail” global financial giants like JP Morgan Chase, Citigroup, Bank of America, Goldman Sachs, Morgan Stanley and many others. While most people think of the $700 billion Troubled Asset Relief Program when they think of bailouts, that was only the tip of the bailout iceberg, which totaled in the trillions.
Worse, the 2008 financial crisis caused massive economic destruction across the country in lost jobs, homes, savings and so much more. That is going to cost America more than $20 trillion in lost GDP, which, of course, doesn’t include the political and social costs, which also continue to reverberate to this day.
While steps have been taken to mitigate the harms megabanks and other enormous financial institutions can cause, that work is quickly being unwound by the current administration, putting the country at risk for another crash like the one we saw just a decade ago. Change under the guise of "reform" is now moving in the wrong direction.
The Dodd-Frank Act, the 2010 post-crisis response from a Democratic Congress and the Obama administration, had three primary goals. First, prevent such a horrific financial crash from happening again, primarily by regulating too-big-to-fail financial firms so that they could fail without catastrophic consequences and bailouts. Second, protect consumers and investors from financial predators and scams. Third, refocus finance away from high risk, socially useless gambling and back to the business of lending to the real economy, helping it grow, create jobs and prosperity, which is why finance is supported by taxpayers and the government in the first place.
Prior to the Trump administration, which effectively merged the White House with Wall Street and initiated a tsunami of mindless financial deregulation, goals two and three were largely achieved and the first was well on its way to being realized.
Regarding goal three, lending at the too-big-to-fail firms has steadily increased, putting them back in the business of supporting the real economy, while their Dodd Frank-prohibited proprietary and other socially useless trading (much of the so-called “FICC” activity) has decreased. Proving that Dodd-Frank and its rules worked, these financial institutions have at the same time nonetheless recently posted annual record or near-record increases in revenue, profits and bonuses.
Regarding goal two, the Consumer Financial Protection Bureau, created under Dodd-Frank, has been the most successful consumer protection agency in the history of the country. In just six years, it has required the financial industry to return more than $12.4 billion ripped off from more than 31 million hard-working Americans. There was finally and for the first time — at least until recently — a very effective consumer cop on the Wall Street beat. Additionally, although incomplete, the SEC and CFTC got back in the business of protecting investors through more and better enforcement, regulation and whistleblower programs.
The issue of too big to fail financial firms, goal number one, however, remains a work in progress. The Obama administration finalized and largely implemented rules reducing the danger and risk from “too big to fail” bank and nonbank financial firms. For example, large financial firms have been required to have much more capital and liquidity while eliminating or reducing their highest risk activities, including proprietary trading. They are required to undergo annual stress tests and have living wills, so they are structured for resolution in bankruptcy to reduce, if not eliminate, collateral consequences. A backstop liquidation authority has been developed and stands ready as a last resort if all that fails.
Moreover, the shadow banking system, from money market funds and repos to securities lending and hedge funds, has much more transparency and regulation. The same is true for the derivatives markets, which have varying amounts of reporting, clearing, margin and exchange-like trading. Finally, the Financial Stability Oversight Council, backed up by the newly created Office of Financial Research, was established to focus specifically on nonbank SIFIs, ending the two-tier system of regulation, which incentivized regulatory arbitrage and the explosive pre-crash growth of the shadow banking system.
Pre-Trump, did that mean that too big to fail (or too big to manage, too big to jail or too big to regulate) was ended? No. The largest financial firms were still so big, interconnected, complex and crucial to the everyday workings of the financial system that no one would likely allow any one of them to fail.
Nevertheless, tremendous progress had been made under the Obama administration to reduce the risk from the country’s biggest, most interconnected firms, and the financial system was much stronger and safer by the end of 2016 than it was in 2008. For example, in 2008, the biggest banks were so leveraged that they had virtually no quality capital, but now they have between 5% and 10% of capital (although that is still too little). As Bear Stearns, Lehman and others proved, they also had little actual liquidity. But now they are required to have considerable high-quality liquid assets. In 2008, the banks were freely trading unregulated, dangerous, high-risk derivatives and structured products for themselves and their clients, but now that’s regulated and allowed for clients only.
However, since the Trump administration, the Dodd-Frank law and many of its implementing rules have been rolled back to varying degrees, jeopardizing Main Street taxpayers, consumers and investors, our financial system and the economy. For example, FSOC has been effectively shut down; OFR has been neutered; CFPB has abandoned consumers and now seeks to instead protect financial predators; banks are being allowed to reduce their capital and liquidity and engage in more proprietary trading; and plans are in the works to reduce the strength and value of stress tests and living wills. Maybe worst of all, enforcement across the board has been dramatically reduced, which rewards and incentivizes high risk if not illegal behavior. (The fact that not one Wall Street executive or supervisor was held accountable for the 2008 crash created an intolerable moral hazard and only exacerbates this corrosive culture.)
As legislative, regulatory and judicial deregulation continues, the very pillars of financial stability, consumer protection and revived lending are being systemically weakened by the Trump administration. Contrary to the rhetoric, all these actions make the problem of too-big-to-fail firms worse and greatly increase the likelihood of another financial crash and more taxpayer bailouts. If this continues, as all indications suggest, the Trump administration, the financial industry and its lobbyists will snatch defeat from the jaws of financial reform victory, with Main Street American families the victims once again.