A paper released by the Americans for Financial Reform suggests numerous reforms to ensure a safe and equitable financial system, especially in the face of future recessions or crises.
Two factors ultimately can lead to a collapsed financial cycle. The first is when too much leverage or debt exists in a large swath of the economy. The second is when asset prices outstrip an individual’s wage growth and subsequently their ability to afford rising costs.
In the post-crisis financial cycle, we do not see the extremes in financial leverage that we saw in 2008. However, asset prices are rapidly outpacing wage growth evidenced by growing income and wealth inequality. Our current financial cycle may not see wholesale collapse, but we could be headed for a recession.
A recession in our current financial cycle could lead to firms going out of business because of the high levels of corporate debt. High levels of corporate debt mitigate how much money is invested in the economy.
Consumer and financial debt are both at healthy levels though with consumer debt there are some highly leveraged sectors such as auto loans.
The paper notes the “backlash” to the financial crisis and proposes several reforms to mitigate a future financial crisis without ruining the credibility of the financial system. Reforms include providing liquidity to all economic participants instead of individual firms and more transparency and reporting to Congress.
Many recognize that a better response to the next financial crisis is needed. The paper suggests several ways to improve the response in the face of a future crisis:
- Discourage outlier accelerants to a crisis such as high-frequency traders by establishing a financial transaction tax to discourage socially wasteful high-frequency trading.
- Prioritize the general public when institutions are forced into receivership (nationalized).
- Improve the Federal Reserve’s capability to resource State and local Governments.
- Finally, a suggestion from former Federal Chairman Bernanke to allow for Government spending outside of the national debt to resolve the crisis.
Looking Toward the Next Financial Crisis
In response to the crisis of ’08-‘09, there are several misconceptions or disagreements about how the crisis was handled. Some hold that the response was a political response as opposed to necessary maneuvers from “technocrats.” By focusing the bailout on large financial institutions and corporate America, the response facilitated a wealth transfer from the working class to the wealthy. Bailouts could have prioritized the general public.
The framing of the response by Bernanke, Geithner, and Paulson indicates the response was so complex and viewed with such skepticism by Congress that action with the least amount of complexity was needed.
Virtually all key individuals directly involved in responding to the financial crisis recognize that the likelihood of another crisis is inevitable. Society barely escaped the last crisis and has yet to escape the backlash of the bailouts as wealth inequality increases and moral hazard threatens the credibility of our financial institutions.