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How Much Do We Really Know About Bank Risks?

How Much Do We Really Know About Bank Risks?

Thursday, 9 July, 2020 - 07:00

Hey, remember the financial crisis? Or what some of us now call “the Good Old Days?” When, sure, all the money was on fire, but you could at least hug your parents without fear of putting them in the hospital?

One of the few upsides of the current nightmare relative to the previous one is that banking is no longer a runaway train dragging the economy over a cliff, but an apparent engine of stability. Not only are banks not failing, they’re still making loans and protecting deposits and doing all the other stuff we want them to do.

But behind that reassuring facade trouble may be brewing. Today’s healthy banking sector is no accident, and owes much to the work of regulators after the previous crisis. They made banks more transparent about their capitalization and periodically tested them against theoretical economic stresses.

But over time, stress tests have gotten less stressful, and risk levels have gotten less transparent, write former FDIC chief Sheila Bair and Thomas Hoenig. Some of this is meant to be temporary, to unburden banks during the latest crisis. But you can bet lobbyists will push to make the changes permanent. And that will raise the risk we’ll have to relive those Good Old Days all over again.

Of course, the other big lesson of both crises is that a blizzard of Fed cash hides a lot of ills, in banking and otherwise. Despite the worst economic downturn since the Great Depression, stocks are near all-time highs and credit markets are humming smoothly. Legendary hedge-fund manager and employee-recorder Ray Dalio recently argued it’s gotten so ridiculous that markets are no longer free but mere playthings of central banks.

Karl Smith and Robert Burgess respond that markets are still free, in fact; the Fed’s cash is just the grease that’s keeping them from locking up and collapsing.


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