Since the 1980s, financial crises have erupted about once a decade. The last one erupted in 2008. And there are disturbing parallels between the 1980s debt crisis in Latin America, the 1990s financial crisis in Asia, and the deepening financial turmoil in emerging markets such as Turkey today. Which is why it is surprising that the subject of the next crisis was missing from this year’s agenda at the annual economic policy symposium, in Jackson Hole, Wyoming.
In late August, the U.S. Federal Reserve (the central bank of the United States) convened its annual symposium to take stock of worldwide economic trends and flag potential problems. Much discussion focused on the Fed’s intentions on interest rate policy. After remaining for several years at near-zero levels, central banks are cautiously increasing interest rates in order to quell potential inflationary pressures. There was a debate between inflation hawks who advocate raising interest rates more aggressively, and doves favouring moderate increases if any, on the grounds that economies are still recovering from the crisis, while wages have continued to languish.
At the symposium, the theme for this year’s gathering of central bankers, economists and financial experts was “changing market structure and implications for monetary policy”. Among the invited speakers was Bank of Canada Governor Stephen Poloz. But this year’s symposium was more remarkable for what it did not address. Absent from the agenda ten years after the Global Financial Crisis, was whether we are prepared for the next one. Rather than learning from past crises, we are repeating past mistakes, particularly by loosening financial sector regulations.
The last crisis affected countries in different ways. Canada’s financial system appeared to be somewhat more resilient than that of the United States or many European countries. It is true that no bailouts were necessary, but Canadian banks, which had also increased their exposure to risk in a deregulated and globalized environment, were supported by government in other ways. As the global crisis intensified the federal government provided Canadian banks with an injection of liquidity amounting to $69 billion, while the Bank of Canada provided access to $41 billion in low-interest loans.
During the symposium, Fed Chairman Jerome Powell seemed intent on rehabilitating Alan Greenspan’s reputation as a calming force on financial markets. This curious perspective may be of concern as Greenspan, who served as Fed chair from 1987 to 2006, is now seen by many as complicit in the buildup to the crisis. Under his watch, during the presidencies of Clinton and Bush, regulations introduced in the 1930s aimed at limiting the risky behaviour of banks (such as the Glass-Steagall Act) were loosened or abolished. Greenspan was a firm believer in the efficiency of liberalized financial markets and their ability to regulate themselves, and in so doing, to stimulate economic growth and prosperity. History teaches us otherwise. During the Great Depression of the 1930s and the recent Global Financial Crisis we have learned that financial excesses induced by deregulation can precipitate economic devastation. After the crisis erupted, Greenspan changed his tune. In Congressional hearings in October 2008, he admitted that he had put too much faith in free markets, and was mistaken in the belief that the financial sector could regulate itself.
Is the wheel coming full circle? In May, President Trump signed into law a bi-partisan bill rolling back some of the Dodd-Frank bank regulations enacted in 2010, aimed at curtailing financial speculation and excessive borrowing and lending by banks.
Other ominous signs of financial fragility are on the horizon: the Turkish debt crisis, and possible spillovers to other emerging market economies such as Argentina and South Africa. These countries borrowed in US dollars when interest rates were very low. But now that interest rates are likely on their way up, along with a rising US dollar, those debts are looking less sustainable. The global economy has been here before—whiplashed by a rising interest rate and US dollar. Whether this augurs a repeat of the “Asian” financial crisis of the late 1990s, or the Latin American debt crisis of the 1980s, remains to be seen. Meanwhile the S&P500 index is at a historic high. The more it climbs, the greater the chance of a significant stock market correction—or worse.
There are also newer threats to financial stability. In its most recent Financial System Review, the Bank of Canada refers to the potential for cyber attacks to disrupt the financial system as a key vulnerability. Equally, household indebtedness and housing market imbalances “remain elevated and are expected to persist for some time.” The Canadian housing sector has been a source of concern for the Bank for much of the past decade. Unlike the U.S., Canadian house prices did not experience a substantial drop in the crisis, but have kept rising. On the positive side, mortgage rules have been tightened, and this has helped to cool Canadian housing markets and household borrowing.
The next financial crisis is coming, sooner more likely than later. And Canada has no reason to be complacent, given its own vulnerabilities. The next crisis may be mitigated, rather than prevented, but only if the lessons of the Great Depression and the Global Financial Crisis are taken seriously, with much tighter, not looser, financial regulations.