Mary Altaffer/AP Photo
The Dow Jones news ticker is reflected on a window at NASDAQ just before the closing bell, October 6, 2008, in New York’s Times Square.
Fifteen years ago this week, Wall Street was on the verge of the worst collapse since 1929.
The cause was regulators’ indulgence of opaque securities that were highly leveraged and thinly capitalized, such as credit default swaps and bonds backed by high-risk subprime mortgages.
When bankers’ bets started going bad in 2007, the initial response of the Fed and the Treasury was to prop up the system by merging failed banks into bigger banks or having the government cover losses. In March 2008, when the investment bank Bear Stearns became insolvent, the Federal Reserve guaranteed its bad loans to facilitate its acquisition by J.P. Morgan.
Exactly 15 years ago today, the government took over the biggest players in the secondary mortgage market, Fannie Mae and Freddie Mac, which were underwater because the securities backing mortgages had plummeted in market value.
But a week later, on September 15, the Fed and the Treasury decided that enough was enough. They decided not to bail out failing Lehman Brothers. And that collapse triggered a full-blown financial crisis.
The Financial Crisis Inquiry Commission later found that most money center banks were literally insolvent. Had government not come to the rescue with even more bailouts, the collapse would have triggered another Great Depression. Yet these bailouts left existing executives in place and did not break up a single large bank.
Presumably, Congress acted to head off another repeat of speculative meltdown when it passed the Dodd-Frank Act of 2010. But 13 years later, old abuses are repeating themselves in new forms.
Dodd-Frank was supposed to put an end to banks that were “too big to fail.” But today the system is more highly concentrated than ever. The Treasury and the Fed were up to their old tricks when they encouraged the largest of the banks, JPMorgan Chase, to bail out the failed First Republic Bank, making JPMorgan even bigger.
The latest banking crisis involves regional banks that are overexposed to commercial real estate that keeps losing value. The Wall Street Journal calls this a “doom loop.” As a recent Journal story explained, banks not only overinvested in real estate loans. Between 2015 and 2022, banks’ direct lending to commercial real estate doubled, to $3.6 trillion, equal to 20 percent of their deposits. And banks more than doubled their indirect real estate exposure with loans to mortgage companies and to real estate investment trusts as well as mortgage-backed bonds. Now, with the property market in free fall, banks increasingly find that the collateral is worth less than the loans.
If this crisis spreads, the cause will be exactly the same as the cause of the 2008 collapse: regulators and examiners failing to look closely at risky fads in bank portfolios and failing to demand that risky investments be backed by more capital. As long as regulators are more concerned about coddling bankers than protecting the public, these periodic financial meltdowns will keep recurring.
