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Lessons from the Financial Crisis

The Honorable Sheila C. Bair

(CFA Institute) – Roughly seven years removed from the outbreak of the global financial crisis, there is still much to be learned about what caused the crash and how better to prevent similar meltdowns from occurring in the future.

Sheila C. Bair, who chaired the US Federal Deposit Insurance Corporation (FDIC) during the crisis and currently serves as chair of the Systemic Risk Council (SRC) as well as president of Washington College, provides an insider’s view into the origins of the crash and discusses how the system can be made more stable, during a Take 15 interview with Ron Rimkus, CFA.

According to Bair, one of the root causes of the crisis was excess leverage created in large part by easy credit and the embrace of easy money among central bankers. “You had very accommodative monetary policy prior to the crisis,” she says. “Credit was readily available. You had a misguided notion that the good times were there forever, that we had mastered cycles,” she says.

This thinking created a false sense of security, both within the finance sector and among the bodies designed to monitor it.

“You didn’t really need regulations anymore,” Bair explains. “So banks started taking on more and more leverage. Capital rules were changed to let them take on more and more leverage, and borrowers started taking on more and more leverage, too, as it became too easy to get a mortgage.”

A side effect of this state of affairs was the creation of financial institutions that were “too big too fail,” that posed a systemic risk to the entire financial system.

But how has the situation changed? Have the necessary safeguards been implemented to forestall a repeat of the Great Recession?

Bair believes that regulators have better mechanisms in place now to resolve a repeat of the “too big too fail” conundrum that dragged down the global economy in 2007–2008. “I think the tools are there. The FDIC’s put out some good analysis and work explaining how . . . they would take down a large financial organization if it gets into trouble,” she says. “The best way to take control of these institutions now if they get into trouble is through the holding company, to continue to fund the operating subsidiaries, which is the near-term plan.”

As for the future, Bair believes that whatever happens, the market should be the main catalyst of how financial institutions operate. “I would like to see the market drive the optimal size, efficiency, and complexity of large financial institutions. But as long as we have ‘too big to fail,’ we’re not going to see that dynamic.”

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