Financial History 143 Fall 2022 | Page 36

mortgage market and the decline of home prices triggered a wave of defaults by borrowers , which inflicted enormous losses on universal banks , securities firms , insurance companies and investors . Financial and economic crises erupted on both sides of the Atlantic . The boom-and-bust cycle of the 2000s bore a striking similarity to the disastrous events of the 1920s and early 1930s . Universal banks were leading players in both cycles and were at the center of the calamities that followed .
Bailouts During the Great Recession and the Inadequacy of Post-Crisis Reforms
The US , UK and EU provided more than $ 12 trillion of capital infusions , guarantees and emergency loans to support financial institutions during the Great Recession . Government agencies bailed out large universal banks and shadow banks with the prominent exception of Lehman Brothers . Authorities rescued money market funds , commercial paper and repos , even though those instruments were not regulated as deposits and were not covered by deposit insurance . The US , UK and EU effectively wrapped their safety nets around their entire financial systems , going far beyond their traditional practice of protecting banks and bank depositors .
Central banks reduced short-term interest rates to zero or below and adopted “ quantitative easing ” ( QE ) policies . Under QE policies , central banks purchased vast quantities of government bonds , mortgagebacked bonds and other debt securities to push down longer-term interest rates and reduce borrowing costs for governments , businesses and consumers . Central banks in the US , UK , EU and Japan expanded their balance sheets from $ 4 trillion to $ 15 trillion between 2007 and 2019 .
In 2009 , the United States and other Group of 20 ( G20 ) nations endorsed a series of technical reforms designed to improve the effectiveness of financial regulation . The recommended reforms included higher capital and liquidity requirements for banks and new procedures for dealing with failures of systemically important financial institutions . Congress adopted most of the G20 ’ s recommendations when it passed the Dodd-Frank Act in 2010 . The UK , EU and other developed nations approved similar measures .
In contrast to the reforms of the 1930s , the United States and most other developed nations did not change the structure of their financial systems after the Great Recession . The Obama administration and Congress rejected proposals to break up the biggest US banks , and they did not seriously consider the possibility of enacting a new Glass-Steagall Act . The Obama administration ’ s decision to preserve the financial system that caused the Great Recession revealed the formidable political clout that universal banks and large shadow banks still possessed .
Implementation of the G20 ’ s reform agenda weakened on both sides of the Atlantic as memories of the Great Recession faded and the financial industry lobbied for more lenient treatment . The Obama administration failed to complete several of Dodd-Frank ’ s important mandates before President Obama left office in January 2017 . Congress and federal regulators repealed or watered down a number of Dodd-Frank ’ s key provisions during President Trump ’ s term . Reform efforts also lost much of their momentum in the UK and EU after 2016 .
Shortcomings in post-crisis reforms have perpetuated a “ global doom loop ” in which ( 1 ) governments and central banks backstop financial markets and provide “ too-big-to-fail ” treatment to universal banks and large shadow banks , ( 2 ) universal banks and large shadow banks underwrite huge volumes of private-sector and public-sector debts with support from the easy-money policies of central banks and ( 3 ) investors and creditors take speculative risks based on their expectation that governments and central banks will continue to protect universal banks , shadow banks and financial markets against serious disruptions . The global doom loop has created a toxic web of mutual dependence among governments , central banks , universal banks , shadow banks and investors . It has also enabled universal banks and shadow banks to underwrite dangerously high levels of debt for corporations , households and governments .
Bailouts During the Pandemic Crisis , Rising Inflation and Global Debt Problems
During the first quarter of 2020 , the rapid spread of the COVID-19 pandemic ignited a worldwide financial panic . Markets froze for most government bonds and nearly all private debt obligations . Universal banks and shadow banks were unable or unwilling to maintain liquid trading conditions for government bonds and private-sector securities . Financial conditions stabilized only after governments and central banks provided comprehensive backstops for financial institutions and financial markets and supported their economies with massive fiscal stimulus programs .
The size and scope of governmental responses to the pandemic crisis went well beyond the measures taken during the Great Recession . Congress approved $ 5.2 trillion of fiscal stimulus programs between March 2020 and March 2021 — a response that was over four times as large as Congress ’ s stimulus programs during the Great Recession . Worldwide government stimulus efforts totaled $ 16 trillion by March 2021 .
Governments and central banks propped up financial institutions and financial markets with emergency backstops that far surpassed their actions during the Great Recession . The Fed quickly reactivated the emergency facilities it used during the Great Recession to support large financial institutions and short-term wholesale credit markets , including loans for universal banks and shadow banks and guarantees for commercial paper , money market funds and repos . The Fed cut shortterm interest rates to zero and supercharged its QE program by pledging to buy unlimited amounts of government bonds and mortgage-backed securities . The Fed more than doubled the size of its balance sheet — from $ 4.3 trillion to $ 8.8 trillion — between March 2020 and December 2021 .
In addition , Congress , Treasury and the Fed created novel lending and bond-buying programs to support small , mid-sized and big businesses . As a practical matter , the federal government avoided the need to bail out large financial institutions by rescuing their creditors and customers instead . The unprecedented scope of the federal government ’ s backstops meant that the resilience of universal banks and shadow banks was never given a real-world test in 2020 .
Other leading central banks followed the Fed ’ s lead by cutting interest rates and expanding their QE programs . During 2020 and 2021 , the combined balance sheets of central banks in the US , UK , EU and Japan expanded from $ 15 trillion to $ 25 trillion . With assured backing from governments and central banks , corporations around the world issued record amounts of new bonds .
34 FINANCIAL HISTORY | Fall 2022 | www . MoAF . org