United States: stability stronger after crisis

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Interview with Nicolas Vèron, senior member of the Bruegel think tank and professor at the Peterson Institute for International Studies in Washington DC.  

What is Obama’s legacy to the finance industry?


The most important thing came very early in his presidency: the stress tests programme of early 2009, which restored trust in the US banking system. It was a spectacular success. The US banking system was functioning normally by the end of 2009. In Europe, by contrast, the crisis started at the same time (mid-2007), but more than eight years have passed, and the entire system is still fragile.

What mistakes did Obama and his staff make after the Lehman Brothers collapse?

Remember that Lehman happened in mid- September 2008 while Bush was still president. Obama was elected in early November, and took office on 20 January 2009. I struggle to identify major financial sector policy mistakes that were made after his inauguration. The Dodd-Frank Act could have been better on several counts. It could have simplified the US regulatory architecture by merging some federal agencies. And parts of the Dodd-Frank Act are unnecessarily complicated. A few of Obama’s appointments have been questionable, such as Mary Schapiro at the Securities and Exchange Commission (SEC) and Jim Kim at the World Bank. Some initiatives have also been lacking: for example, it would make sense for the US to move towards greater recognition of International Financial Reporting Standards. The Obama administration has also stalled on the important but difficult question of housing finance reform. But all these issues are of comparatively lesser importance to what the Obama team got right, especially in the first months of his presidency.

How has the financial system changed since 2008, especially in the US?

The most obvious difference with the precrisis landscape is the elimination of large, independent broker-dealers (often referred to in Europe as investment banks) as an important category of market participants: Lehman Brothers has gone bankrupt and its US operations have been absorbed by Barclays; Bear Stearns has been bought by JP Morgan Chase; Merrill Lynch was bought by Bank of America; and both Goldman Sachs and Morgan Stanley are now regulated as bank holding companies. Simultaneously, large asset managers have grown in size and influence. … The separation between the financial and non-financial sectors has also been strengthened as both General Motors and GE have gotten rid of their respective financial arms. Fannie Mae and Freddie Mac, the two large housing finance agencies, have been nationalized. Market concentration in the banking sector has increased, but the US system remains much less dependent on banks, and especially on large banks, than the financial system in Europe. This is a strength [that] has not in any way been fundamentally altered by the crisis and its aftermath.

Large, interconnected banks dominate the US banking system even more now than before the crisis. Then there is the shadow banking industry; non-banks now account for more than 70% of assets and contribute to systemic risk. Is the system safer than it was in the past?

This description is affected by a European bias. The US has always been more market-based, and that was actually a factor of resilience in the crisis. In contrast to banks, hedge funds and private equity funds absorbed a lot of losses without recourse to public guarantees. In the first years of the crisis, European banks developed a narrative according to which they offered more stability than the American market-based system. But the past years have actually demonstrated the opposite. The current discussions in Europe on promoting a capital markets union and diversifying its own system away from the banks’ dominance are thus, in effect, a recognition that the US has fared better. Banks (in Europe and the US) do a lot of lobbying to depict shadow banking as something sinister and threatening, but the truth is that Europe needs more nonbank finance and more developed capital markets while properly monitoring systemic risk.

The IMF believes the US is safer than it was before the financial crisis. However, new threats to the system have formed over the past few years – like big banks growing even bigger – and efforts to safeguard the system have not been fully implemented. So what was Obama’s effect, ultimately? Only a transformation of risk?

Systemic risk is never eliminated; it can only be managed – and there will always be financial crises. There is an acute sensitivity to the power of big banks in the US public discourse. It has been there, in various forms, since the very beginning of the country. But in comparative terms, the degree of market concentration in the US banking sector was and remains lower than in almost any other country in the world. This comparative perspective is important, especially for Europeans. For example, the US has the problem of too-big-to-fail banks, but in Europe the crisis revealed that – with very few exceptions – no bank is allowed to fail, no matter how small. Fortunately, European reforms, and especially a banking union, will bring the situation in the EU closer to that in the US in this respect. For all the controversies, there is more market discipline and less moral hazard in the US financial system than anywhere else in the world. Of course, this is no reason for the US to be complacent. And the authorities’ tools to monitor and analyse risk can still be improved, especially through internationally coordinated efforts for better data collection and sharing.

In 2012, Obama called the $25 billion-mortgage settlement with the big banks a victory for regular folks, and said it was only a beginning. Yet it seems that things have changed since then.

There have been huge settlements and fines imposed on banks in the US. Some have also affected European banks, including the likes of HSBC, Standard Chartered, BNP Paribas and ING, for not complying with US restrictions on the financing of terrorism, drug trade or hostile countries. One might criticize this as a form of neo-imperialism. But at the same time, as a French citizen, I am not particularly proud of the role BNP Paribas played in financing the brutal Sudanese government, which undergirded the unprecedented amount they had to pay last year. That said, these huge settlements also have their dark side. They are not as transparent as a full judicial process, and there might be unhealthy incentives for the authorities to milk the defendants financially without putting any bankers in jail.

A few months ago, Obama spoke to a group of Wall Street executives, urging them to change the way they do business. Have they done that?

The truth is that the US consensus remains that finance should remain a commercially driven sector, even as it is regulated by public authorities. In other words, banks and other financial firms will continue to seek profits, and individual greed will remain a powerful engine of the system. That is very different from Europe, where a large part of the financial system remains in public hands (as in Germany) or controlled by public shareholders (as in Italy), and where EU law has introduced a cap on bank executives’ bonuses, something the US is not even considering. One may debate whether this commercial and capitalist orientation is a good or a bad thing, but what is clear is that the European system, which is definitely more hybrid, has fared worse since the beginning of the crisis in mid-2007. The Chinese system, even less commercial and capitalist than Europe’s, is experiencing huge problems as well. That said, some of the asymmetries in the US system are being addressed by the Consumer Financial Protection Bureau (CFPB), a new agency that was created by the Dodd-Frank Act to defend the interests of retail customers of financial services. … Europe should consider creating an equivalent.

And now, the million-dollar question: what is the biggest problem of the US financial system today? And how can it be solved?

Monitoring and analyzing systemic risk is a constant challenge. The framework for housing finance in the US has not been properly reformed. Disclosures and financial transparency can and should be further improved. Some post-crisis reforms, such as the decision to mandate central clearing for many derivatives trades, may have unintended consequences and possibly backfire. Financial stability is never achieved on a permanent basis. Having said that, at this point I see more immediate unresolved imbalances and problems in Europe’s financial system than in the US.  


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