We should be asking whether the banking reforms go far enough
Letter to the Editor

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Branch of the Bank of America in Beatty, Nevada, USA.

Article Highlights

  • Ample and reckless financing provided by the American financial system over many years

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  • European Central Bank right to fear a sovereign Greek default now could result in a major European banking crisis

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  • If there was a time global banking system needed an enhanced safety net for banks that are too big to fail, it's now

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Steven Rattner’s spirited defense of Jamie Dimon's position in his row with Mark Carney is curious. For it comes at the very time that European events are pointing to the real likelihood of a second Lehman Brothers-style global banking crisis within the next year or so. If ever there was a time that the global banking system needed an enhanced safety net for banks that are too big to fail, it has to be now. Similarly, it would seem that this is the time to be thinking about not only more effective banking regulatory reforms, but deeper reforms of the global banking system that might minimize the possibility of yet another banking crisis down the road.

"A possible second Lehman Brothers-style banking crisis has to raise the sort of questions that Mr Rattner is asking about the adequacy of global banking supervision." -- Desomond Lachman

The 2008-2009 US-led subprime banking crisis could not have been as acute as it was without the ample and reckless financing provided by the American financial system over many years. So too is the case with the present European sovereign debt crisis. In the absence of an extended period of overly-generous provision of bank credit at low interest rates, the Greek government would not have been able to finance its excessive spending. Nor would the Irish and Spanish property bubbles occurred to anywhere near the degree that they did without reckless bank lending.

The European Central Bank is right to fear that a sovereign Greek default now could result in a major European banking crisis. For it is difficult to see how a Greek default will not trigger real contagion to Portugal, Ireland, and Spain at a time when the European banking system appears to be undercapitalized. The International Monetary Fund has recently suggested that Europe’s banks could be short of at least €200bn in capital needed to deal with a wave of potential defaults in the European periphery.

Before dismissing the pressing need for an enhanced safety net for the large banks that are too big to fail, Mr Rattner might have wanted to consider how exposed the US financial system is to the European banking system. In a recent study, the Fitch rating agency estimated that the US money market industry was exposed to Europe to the tune of $1,200bn. The US banks’ exposure to Germany and France is in excess of $1,000bn, according to numbers from the Bank for International Settlements. This exposure should be of deep concern to US bank regulators particularly since the intensification of the European crisis seems to be occurring at the very same time that a double-dip recession in America could put added strain on its banks’ balance sheets.

A possible second Lehman Brothers-style banking crisis has to raise the sort of questions that Mr Rattner is asking about the adequacy of global banking supervision. However, we should also question whether the 2009 banking sector reforms went nearly far enough. Instead of placing undue reliance on all-too-fallible bank supervisors and regulators, should we not now be considering doing something serious about the perverse incentives to overly risky bank lending, as well as to the ‘too big to fail’ problem in the US and global banking systems.

Desmond Lachman is a resident fellow at AEI.

 

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About the Author

 

Desmond
Lachman
  • Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund's (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and the multilateral lending agencies.
  • Phone: 202-862-5844
    Email: dlachman@aei.org
  • Assistant Info

    Name: Emma Bennett
    Phone: 202.862.5862
    Email: emma.bennett@aei.org

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