Some Unfinished Business of the 2008 Financial Crisis

Now that Warren Buffett has opined in The New York Times that a meltdown was avoided and the economy is now out of the emergency room, it may be a good time to consider how many issues remain unresolved in the aftermath of the economy’s near death experience last fall.  An overview of these issues was provided earlier this year in Jamie Dimon’s letter to shareholders of JPMorgan Chase & Co. (available at www.jpmorganchase.com).  Set forth below is a partial list of the issues identified by Jamie Dimon, all of which, to one degree or another, could fuel a future crisis:

 

·         Poor underwriting standards that expanded the housing bubble

·         Use of poorly designed financial products (like option ARMs)

·         Poorly constructed securitizations

·         Unrealistic ratings provided by rating agencies

·         Dishonesty by some participants in mortgage markets

·         Excessive use of leverage by various market participants

·         Unbalanced reliance on short-term financing to support illiquid, long-term assets

·         Money market funds problems in responding to unforeseen demands for liquidity

·         Lax terms for the financing of liquid assets 

·         Lack of regulation of mortgage brokers

·         Lack of regulation of excessive derivatives activities by insurers

·         Inadequate regulation of Fannie Mae and Freddie Mac

·         An inadequate resolution process for failure of investment banks

·         Pro-cyclical regulatory policies

·         Excessively low interest rates and risk premiums

·         Compensation practices that rewarded bad behavior

·         Lack of a sound energy policy leading to high energy prices

 

The Obama Administration has delivered to Congress a comprehensive package of financial regulatory reform legislation that addresses many of these issues.  As was pointed out in an earlier article here, the reforms involved are politically difficult because of the interests of market participants, regulators and Congressional committees in preserving existing regulatory jurisdictions and objectives.  Whatever legislation ultimately emerges from Congress is unlikely to fully cure all the imbalances in our economy and our financial system.  Although such major reforms require careful deliberation, there is a risk that the 2008 financial crisis could recede into history with little being done to protect against a repetition of the kind of events that placed the financial system and the economy at risk of collapse.