The Old New Financial Risk

WASHINGTON, DC – The main financial risk facing the United States today looks very similar to what caused so much trouble in 2007-2008: big banks with too much debt and too little equity capital on their balance sheets. Uneven global regulations, not to mention regulators who fall asleep at the wheel, compound this structural vulnerability.

We already saw this movie, and it ended badly. Next time could be an even worse horror show.

All booms are different, but every major financial crisis has at its heart the same issue: major banks get into trouble and teeter on the brink of collapse. Disruption at the core of any banking system leads to tight credit, with major negative effects on the real economy. In our modern world, in which finance is interwoven throughout the economy, the consequences can be particularly severe – as we saw in 2008 and 2009.

The most important question to ask of any financial system is how much loss-absorbing equity major banks have on their balance sheets. When a company suffers losses, its shareholder equity falls in value, and less equity means that the company is more likely to default on its debts.