A very important piece by Frank Partnoy:
American citizens are well aware of the toll [the pandemic] has taken on the economy: broken supply chains, record unemployment, failing small businesses. All of these factors are serious and could mire the United States in a deep, prolonged recession. But there’s another threat to the economy, too. It lurks on the balance sheets of the big banks, and it could be cataclysmic. Imagine if, in addition to all the uncertainty surrounding the pandemic, you woke up one morning to find that the financial sector had collapsed. You may think that such a crisis is unlikely, with memories of the 2008 crash still so fresh. But banks learned few lessons from that calamity, and new laws intended to keep them from taking on too much risk have failed to do so. As a result, we could be on the precipice of another crash, one different from 2008 less in kind than in degree. This one could be worse.
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I have a checking account and a home mortgage with Wells Fargo; I decided to see how heavily invested my bank is in CLOs. I had to dig deep into the footnotes of the bank’s most recent annual report, all the way to page 144. Listed there are its “available for sale” accounts. These are investments a bank plans to sell at some point, though not necessarily right away. The list contains the categories of safe assets you might expect: U.S. Treasury bonds, municipal bonds, and so on. Nestled among them is an item called “collateralized loan and other obligations”—CLOs. I ran my finger across the page to see the total for these investments, investments that Powell and Mnuchin have asserted are “outside the banking system.”
The total is $29.7 billion. It is a massive number. And it is inside the bank.
It is a distasteful fact that the present situation is so dire in part because the banks fell right back into bad behavior after the last crash—taking too many risks, hiding debt in complex instruments and off-balance-sheet entities, and generally exploiting loopholes in laws intended to rein in their greed. Sparing them for a second time this century will be that much harder. If we muster the political will to do so—or if we avert the worst possible outcomes in this precarious time—it will be imperative for the U.S. government to impose reforms stringent enough to head off the next crisis. We’ve seen how banks respond to stern reprimands and modest reform. This time, regulators might need to dismantle the system as we know it. Banks should play a much simpler role in the new economy, making lending decisions themselves instead of farming them out to credit-rating agencies. They should steer clear of whatever newfangled security might replace the CLO. To prevent another crisis, we also need far more transparency, so we can see when banks give in to temptation. A bank shouldn’t be able to keep $1 trillion worth of assets off its books. If we do manage to make it through the next year without waking up to a collapse, we must find ways to prevent the big banks from going all in on bets they can’t afford to lose. Their luck—and ours—will at some point run out.
Will the Banks Collapse? – The Atlantic
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