Troubling Signs of a New Financial Crisis
No one can predict what or when the next financial crisis will be, but one can spot troubling trends. Policies and practices that contributed to the last crisis—dubbed the Great Recession it was so severe—have started to reappear.
Too much debt fuels every financial crisis. So where can we find easy credit—too much borrowed money chasing too few sound investments—now? Economy watchers for months have focused on the market for bonds backed by pools of high-risk corporate debt known as collateralized loan obligations, or CLOs. They are high-risk because the borrowers already have too much debt, and they often use what they borrow for risky endeavors like buying back stock or paying dividends, both of which can make management look good without adding long-term value for shareholders. These bonds are cousins to those backed by the pools of consumer mortgages that caused the crisis a decade ago—risky mortgages that saddled consumers with too much debt. Bloomberg News alluded to that past crisis in a recent headline summing up today’s CLO market: “Combine risky leveraged loan pools with unsuspecting investors. What could go wrong?”
But another trend that’s received less attention is equally troubling: Rising consumer debt and decreasing oversight of lenders, the very combination of ingredients at the root of the crisis ten years ago.
Trump appointees have gutted many commonsense financial safeguards for consumers in favor of buyer-beware policies. Many of the jettisoned safeguards were adopted in the wake of the last crisis in recognition that, because rank-and-file consumers account for sixty to seventy cents of every dollar spent in the economy, hobbling consumers with too much debt eventually hobbles the economy. This, as we saw in 2007, can have catastrophic results. As presidents George W. Bush and Barack Obama realized too late, the remedy for the Great Recession wasn’t to give consumers more credit but instead reduce their debt.
That lesson has been lost on Trump and his team. They’ve decided, for example, that payday lenders—the legalized loan sharks of finance—as well as some mortgage lenders don’t have to determine whether a consumer has the ability to repay a loan before making it. Gutting the “ability to repay” standard defies logic: No lender should make a loan if it’s unlikely a borrower can afford it. Yet we now see a return to the topsy-turvy reasoning that underpinned the subprime mortgages of the last crisis, when lenders, with the blessing of regulators, decided they didn’t have to check if a person could afford a home loan because they could always repossess the borrower’s house in case of default. We all know how that turned out.
In addition to removing the “ability to repay” standard, Trump and his allies in Congress have killed an Obama-era rule that would have required financial advisors to act as fiduciaries—that is, in the best interest of customers—when advising soon-to-retire employees about where to put their 401k money. Instead, these advisors—with this administration’s blessing—can enrich their own pockets at the expense of retirees.
There are a string of other telltale signs that indicate lax regulation—in combination with easy credit—in this administration’s policy. It’s a toxic mix that’s dressed up in the usual buzz words that presage financial train wrecks—promises of “more access to credit,” “innovation,” and of “more choice for consumers.” We heard those words aplenty in the run-up to the Great Recession, when “innovations” and “greater access to credit” drove millions of Americans into financial ruin and put taxpayers on the hook for potentially $24 trillion in bailouts.
Researchers at the Federal Reserve Board recently concluded that student loan debt, which has more than doubled to $1.5 trillion in the last decade, is seriously crimping the housing market, which in turn is a mainstay of the economy. They found that “a $1,000 increase in student loan debt . . . causes a one- to two- percentage-point drop in the homeownership rate for student loan borrowers during their late twenties and early thirties,” which, in 2014, the most recent year available, translated into 400,000 “individuals” whose debt kept them out of the market.
Despite such evidence, Trump’s education secretary, Betsy Devos, recently declared that her federal agency’s authority preempts state officials when it comes to policing against abuses by student loan servicers and debt collectors. At the same time, Trump appointees at the Consumers Financial Protection Bureau have turned what was an office that policed against such abuses into one that merely offers information. No one seems to mention that the companies pushing imprudent loans to students often put taxpayers at risk at the same time.
The Trump regime also has proposed relaxing capital cushions for many federally insured banks, raising potential risks to taxpayers. And one of Trump’s top bank regulators now offers a new federal charter for non-bank financial firms (the term “non-bank” alone should sound alarm bells). The purpose? To allow these federally chartered lenders to bypass states’ consumer laws against abusive lending practices. It’s a replay of what happened in the mortgage crisis, when federal bank regulators told their state counterparts to shut up and sit down because state consumer protection laws didn’t apply to federally chartered banks. (Never mind that in throwing out “ability to pay” rules for pay-day lenders the Trump administration cited the need to respect state law.)
Nothing sums up Trump’s upside-down world of financial oversight than the federal regulator pushing the new charter, Comptroller of the Currency Joseph Offing. He has called the banks he is supposed to oversee “his customers.” A recent Vanity Fair headline, “Trump wants to give loan sharks easier access to the poor” is only partly right. He’s giving abusive lenders more access to the middle class, too. Consumers—and investors—should beware, for themselves and the economy.
Kathleen Day worked for thirty years as a business journalist with the Washington Post, Los Angeles Times, and USA Today before joining the Johns Hopkins Carey Business School as a professor of financial crises in 2013.