- Key insight: Many of the same signs that might have predicted the financial crisis nearly two decades ago are back, including sweeping deregulation, lax underwriting standards and opaque new financial products.
- What's at stake: Cumulative deregulatory effects are steadily reducing the financial system's margin for error.
- Forward look: Today's environment hardly argues for reducing controls. Asset valuations remain elevated, private credit continues to expand and lending increasingly emanates from opaque non-depository financial institutions.
Nearly two decades after the global financial crisis of 2008, we may be on the verge of a repeat. Today's regulatory environment shows all the warning signs: excessive leverage, market concentration, weakening underwriting standards,
Yes, today's financial system is stronger than it was in 2008, thanks in large part to reforms that increased bank capital, strengthened supervision, and improved market transparency. Yet many of those very same protections are now being rolled back or even eliminated.
The changes extend across nearly every pillar of the post-crisis regulatory framework. Current proposals from the SEC and Federal Reserve would
Pressure to deregulate tends to build when markets appear strongest. Rising asset prices, abundant liquidity and years without a major crisis create the impression that safeguards can be relaxed. Yet those are often the very conditions under which financial excesses accumulate.
Frankly, today's environment hardly argues for reducing controls. Asset valuations remain elevated, private credit continues to expand, and lending increasingly emanates from opaque non-depository financial institutions.
Supporters of the several proposals that reduce capital adequacy rules in the banking industry argue that the relaxed requirements will encourage lending and stimulate economic growth. That claim is far less convincing than it first appears. Little evidence exists that today's banks lack the capacity to finance productive investment under existing capital standards. Recent experience suggests that additional balance-sheet flexibility is just as likely to support share repurchases, dividends, acquisitions, or other financial activities as it is to expand lending. Bank capital must not be viewed simply as money awaiting deployment; it is the banking system's risk shock absorber. It protects depositors, reassures investors and reduces the likelihood that isolated problems become systemic failures.
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Bank regulation is not the only area where safeguards are being weakened. Recent SEC proposals dramatically expand the number of public companies eligible for scaled disclosure requirements by raising the threshold for full reporting. Among other things, the SEC changes would also reduce public company financial reporting obligations, eliminate auditor attestation of internal controls for many companies, shorten disclosure histories, and make it easier for new and unseasoned public companies to register securities offerings with fewer disclosures and established reporting obligations.
Disclosure requirements are often portrayed simply as compliance costs, but they serve a much broader purpose. They reduce information asymmetry, improve price discovery, strengthen corporate accountability, and allow investors to compare risks using reliable, standardized information. Weakening, or in many cases eliminating, those requirements may reduce costs for issuers, but they also reduce the quality of information available to the market. Weaker disclosure standards could increase fraud risk, reduce investor confidence, and ultimately raise — not lower — the cost of capital.
Financial crises rarely originate from a single rule change or an isolated failure of a financial institution. They emerge when weaknesses across various parts of the financial system become interconnected.
Today, the extent of such connections is becoming increasingly difficult to ignore. Banks are more deeply linked to private credit markets and other non-bank financial intermediaries than ever before. Financial innovation continues to create increasingly complex relationships among regulated institutions, investment funds, securitization markets and private lenders. These individual developments do not guarantee another financial crisis. But taken as whole, they greatly increase the risk of misdiagnosing emerging vulnerabilities and reducing the financial system's capacity to absorb shocks.
Once again, the long history of U.S. markets setting the standard for investor protection and market integrity faces a threat. These cumulative deregulatory effects are steadily reducing the financial system's margin for error. History rarely repeats itself exactly, but it often begins the same way: with the conviction that this time is different.
