Four reasons another crash is on the cards

In 2009, former Chair of the Federal Reserve Alan Greenspan pointed out that if banks are “too big to fail, they’re too big” – a lesson that should have been obvious from the massive bail outs. Yet in the years since the crash the sector has grown even more concentrated. Just six banks now manage half of the assets of the entire banking industry. To take just one example, JPMorgan has amassed a huge $2.56 trillion in assets, nearly double what it had at the end of 2006. The ‘moral hazard’ is obvious: banks which are ‘too-big-to-fail’ can seek high-risk, high-return strategies in the knowledge that the government will have to rescue them in times of crises.

2. The regulations are getting weaker

In the wake of the crash, politicians and pundits promised tighter regulation to prevent future crises. Democrats in America pushed through the Dodd-Frank Act in 2010, introducing mandatory stress tests and significant capital requirements for all big banks. In the eight years since, the sector’s formidable lobbying power has been employed to water down these reforms. A record $2 billion was spent by Wall Street on the 2016 US election cycle, and earlier this year, the largest two banking lobby groups – including 48 of the largest banks – combined to create the Bank Policy Institute to lobby the Trump administration for a roll-back of regulations. Just this week the Wall Street Journal revealed that the Federal Reserve was considering redefining the definition of a ‘big bank’ in order to lower regulatory costs for more regional financial institutions.

3. The debt is riskier

A decade of loose monetary policy has seen excessive risk spread outside the banking sector, with the share of corporate bonds with a BBB rating (one above junk) reaching nearly 50% in both US and Euro Areas, significantly higher than the pre-crisis peak. Corporate bonds, debts securities used by companies to raise finance, make attractive investments because of the high-yields they offer; but they do so precisely because they are very risky. One of the major causes of the last crash was the highly rated bonds that turned out to be riskier than advertised. But even if bonds are correctly classified, if low-rated bonds make up too much of the market, the risk of crisis in the event of a slump is heightened.

4. Consumers keep borrowing

Consumers, too, have been making the most of loose credit. Concerns have already been raised about unsustainable borrowing in the auto finance industry, from which UK households borrowed almost £32 billion in 2016. These finance arrangements allow people to acquire a vehicle for a period, paying monthly fees, before handing it back, trading it, or buying it outright. Lenders make these loans on the hope that the resale value of the car will rise against estimates, should consumers decide to return the vehicle. The industry claims that it is secure: sub-prime consumers only account for 3% of the market and data from the second-hand market allows them to calculate the value of depreciation on a car to within a few pounds. Supposedly, this prevents them from under-pricing loans and finding themselves stuck with a fleet of cars worth little more than scrap.

But there is reason to be sceptical. The credit-scoring policies used remain secret in the UK, and let’s not forget, Wall Street and the City – on the back of complex mathematical modelling – assured us of the safety of their new financial products before they imploded. An economic downturn could lower demand for used cars at the same time as reducing the ability of consumers across the country to meet the terms of their deals. Particularly worrying, almost half of Britons who have taken out car finance deals confess that they don’t understand the small print of their own deals.

More generally, household debt in the US is at an all-time high of $13.2 trillion. This may have been sustainable through the long era of low interest rates – 2018 was the first year that rates rose above 0.5% since 2008 – but as rates rise consumers may struggle to meet debt obligations. That could be all the shock required to start another negative spiral.

If Morgan Stanley are to be believed, there’s a recession coming around 2020 – there’s no way of knowing if it will cause damage on the scale of 2008, but as these four risks show, we’re not much less vulnerable. The global response to 2008 was to put the pre-2008 world on life support, rather than deal with the fundamental structural problems that led to the crash. This time around, those short-term fixes might not be available – in 2009, central banks had the headroom to cut interest rates, but today rates are still rock bottom – and with international leaders locking horns over tariffs and Syria, the prospects for global action are even gloomier.