Eight years after Lehman Brothers failed and Wall Street nearly collapsed, banks are taking less risk and holding a lot more capital. But that doesn’t mean banks are safer. In fact, the risks of a big bank failing may actually be greater than they were leading up to the financial crisis.
That’s the surprising conclusion of a new Brookings Institution study by Harvard University economist Larry Summers and Natasha Sarin, a Harvard graduate student. They analyzed various financial metrics involving banks both before and after the 2008 financial crisis and found that markets today are pricing in the potential for major turbulence in the financial industry—perhaps even more turbulence than markets endured after Lehman failed, triggering financial contagion that required unprecedented intervention by Washington.
“There is a nontrivial probability of at least a major loss in equity value by a major institution sometime in the next few years,” Summers and Sarin write in the paper. Their findings “call into question the view of many officials and financial sector leaders who believe that large banks are safer today than they were a decade ago.”
The Dodd-Frank financial reforms of 2010 reined in a lot of the risks banks are allowed to take and forced them to hold more capital in case something goes wrong. On top of that, the Federal Reserve instituted new “stress tests” to make sure banks can survive dire economic developments, such as a 60% plunge in the stock market.
Summers and Sarin don’t argue that such regulations should be rolled back, as Donald Trump and some other Republicans do. Instead, they highlight new factors that seem to have created risks regulators didn’t foresee when reacting to the 2008 wipeout.
Super-low interest rates, for instance, have hammered bank profitability. So have new rules limiting what banks can charge for things like credit-card use and overdraft protection. Lightly regulated “shadow banks,” such as hedge funds, private-equity firms and online lenders, account for an increasing share of financial activity and represent a new competitive threat to traditional banks. And the intense regulatory focus on banks during the last decade suggests new rules further limiting what they could do are always possible.