A KEY objective of the Dodd-Frank financial regulation law was to equip government to anticipate, and control, threats to the banking system such as the one posed by overheated subprime mortgage lending before the crisis of 2008. One such tool is the designation of systemically important financial institutions, whether banks or non-banks (such as insurance companies), as big enough to shake the system if they fail. The Trump administration’s proposal to adjust that rule in such a way as to effectively exclude non-banks has drawn fire from former officials, including several who feel that they’ve learned a lesson from having failed to anticipate the 2008 collapse . On May 13, former treasury secretaries Timothy F. Geithner and Jack Lew, plus former Federal Reserve chairs Ben S. Bernanke and Janet L. Yellen, warned Fed Chair Jerome H. Powell and Treasury Secretary Steven Mnuchin that “these amendments amount to a substantial weakening of the post-crisis reforms.”
The admonition comes at a time of explosive growth in high-risk corporate debt known as leveraged loans, which some, including Bank of England governor Mark Carney, have analogized to subprime mortgages. Ms. Yellen has expressed worry that defaults on leveraged loans could exacerbate the next recession. At just under $1.1 trillion outstanding, leveraged loans expanded 20.1 percent in 2018, almost twice as fast as bank lending and faster than any other segment of the $31 trillion in household and corporate debt, according to the Federal Reserve. What’s more, by several measures, expansion is increasingly occurring among the riskiest borrowers. In part, this was a response to previous deregulation under the Trump administration, as The Post’s Damian Paletta has reported. And the ultimate source of the leveraged lending is precisely the non-bank sector, whose supervision would now be further relaxed.
Could this all come crashing down, taking the U.S. financial sector and the economy with it? Probably not is the answer Mr. Powell gave in a May 20 speech. Mr. Powell cited statistics showing that, for all its recent expansion, leveraged lending is not disproportionate to the overall economy’s growth and is still growing at only a third of the rate that subprime mortgages expanded at the height of the boom. Most important, Mr. Powell correctly noted, is the fact that major U.S. banks are far better capitalized now than they were before 2008, rendering them less vulnerable to the contagion a leveraged lending collapse might set off.
It took some guts for Mr. Powell to say this, given the price he will pay if his confidence, hedged though it was, is not borne out. His point about bank capital is worth emphasizing, however: For all the elaborate protections in the 2010 Dodd-Frank law, including the various mechanisms for anticipating crises, money tends to flow through the cracks of even a tightly regulated system. Capital is the ultimate backstop. The question for the Trump administration is, if you could have a robust early-warning system for the safety and soundness of non-bank institutions, why would you soften it? Better safe than sorry.