It’s been one year since the economic crisis hit hard with the failure of Lehman Brothers, which reverberated throughout the financial sector and the world. President Obama gave a speech on Wall Street pressing for financial system reforms to prevent a future similar crisis. Vice President and Economic Studies co-director Karen Dynan evaluates the impact of the government’s intervention over the past year and where we go from here.
“President Obama is, reportedly, speaking about efforts to unwind the government involvement in the financial system as well as the need to take immediate action to make regulatory changes to prevent this sort of crisis in the future. This seems appropriate to me. Over the past year policymakers have focused their attention on addressing the immediate needs of the crisis. But with the recovery that we’re seeing in the world economy and the improved conditions, albeit not normal conditions, in the financial markets it’s time now to turn our attention to redesigning the regulatory system so as to prevent this sort of crisis in the future…”
“…We did see excessive borrowing. We saw people taking on loans that were used to spend or to invest on the basis of unrealistic expectations about income and asset price growth. But in thinking about whether this means that it would be a good thing for lenders and the government to try to restrict access to credit I think we need to remember that there are many benefits to greater access to credit. My own research, I have shown that financial innovation in the 1980s & the 1990s that enhanced access to credit brought in important benefits to households. It helped households better smooth their spending in the face of temporary disruptions to their income or to their cash flow. In other research we’ve seen that greater access to credit has allowed younger households to sustain a higher standard of living – one that’s consistent with reasonable expectations of their income five or ten years out. I think what we need is to reach a happy medium. I think, clearly, we saw too much borrowing in the middle part of this decade but I wouldn’t want to see some of the important financial innovations that provided benefits in terms of access to credit in the 1980s and 1990s to be reversed…”
“…In order to address systemic risk to the economy the government did promote some so-called “shotgun marriages” to the financial institution with a prominent example being the agreement with Bank of America to acquire Merrill Lynch last September. At the time these events were needed, or most-likely needed, to prevent a collapse of the global financial system which would have had far-reaching consequences for the world economy. But going forward these arrangements do accentuate the challenge of preventing firms from becoming “too big to fail” which, in turn, could lead them to engage in excessively risky activities.”