On March 10th, U.S. regulators swiftly shut down and took over Silicon Valley Bank in the largest bank failure since 2008. Within two days, Signature Bank in New York was also shut down by regulators in order to avoid “systemic risk,” referring to the potential flight of liquidity from our financial markets and a broader catastrophic economic meltdown. Government agencies such as the Federal Deposit Insurance Corporation (FDIC) are currently insuring accounts affected by the liquidity crisis and the Federal Reserve is on standby to prevent other bank runs from happening. Early signs seem to indicate that these collapses were preventable and could’ve been mitigated with stricter regulations and oversight, mirroring past meltdowns seen in 2008 and before. While most Americans may not have been paying close attention to these two bank failures, it’s essential to understand how exactly this happened and the daunting repercussions if more bank runs occur. At their worst, bank runs can become contagious and spread from one bank to another, leading to an onset of an economic depression throughout the country and possibly the world. In order to fully understand this issue, it is important to revisit a brief history of the dramatic rise in banks considered too big to fail and the lack of adequate regulation by the government. 

In the 1980s, commercial banks were nowhere near the size they are today. For the most part, thrift banks, financial institutions that specialize in home mortgages and savings accounts, were dominant at the time. In fact, there were over 4,000 thrifts with over $600 billion in assets at the start of the decade while today there are only 659. However, as interest rates rose to combat inflation, and regulations on how much risk thrifts could take on loosened, many of them started to fail and enter liquidity issues in what was known as The Savings and Loans (S&L) Crisis. The government’s first response was to pass The Depository Institutions Deregulation and Monetary Control Act which deregulated thrifts and other banks by undoing New Deal era reforms, in the hopes that the banks would “grow” out of their own problems. What happened instead was that while thrifts grew by nearly 50%, many failed and relied on the Federal Savings and Loan Insurance Corporation (FSLIC) to carry out a taxpayer-funded bailout. Eventually, after 1,043 thrifts failed and the FSLIC became insolvent, this lead lawmakers to pass the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA). The act abolished the FSLIC and the creation of an agency to oversee thrifts while also raising capital requirements in order to prevent a similar crisis from occurring in the future. By the end of the decade, taxpayers had footed a bill of nearly $124 billion as a result of government deregulation and speculative investments by thrifts. The hope was that this would never happen again; however, history was soon going to repeat itself. 

Commercial banks began to rise shortly after the S&L crisis as FIRREA allowed them to acquire thrifts along with the passage of the Gramm-Leach-Bliely Act in 1999. The law repealed New Deal era bank regulations by allowing commercial banking institutions to consolidate with insurance and investment banks in order to “enhance competition.” Shortly after, two government-sponsored mortgage lenders Fannie Mae and Freddie Mac began excessively lending more than $3 trillion in the subprime market post-1999. The recipients of these loans are considered to have a high default risk but brought great prosperity to those charging higher than usual interest rates. Some banking institutions, like Bear Sterns, became “too big to fail” as a result of the consolidation triggered by deregulation and began investing in these subprime mortgage-backed securities. Analysts like Robert Prechter had already begun to point out issues in the whole banking industry being dependent on property values, but leaders of these institutions and our government ignored any potential warnings and remained aloof from any possible consequences. On top of the mortgage market having shaky fundamentals, credit default swaps (CDS) contracts began to emerge as a popular investment vehicle for hedging against a firm’s credit. It works similarly to a form of insurance, as the investors hedging are mitigating a potential economic downturn. This was a problem however as CDS contracts were completely unregulated, meaning that financial institutions did not need to reserve a portion of that contract in cash. Eventually, Bear Stearns and Lehman Brothers collapsed, and the U.S. entered a long and grueling recession that started in 2008 and affected the entire global economy. All eyes were on the government and what action they would take to potentially regulate and prosecute banks for risky lending, especially in the wake of Barack Obama’s historic victory and the Democratic Party’s sweep in Congress.

In response to the housing bubble crisis of 2007-08, the Bush administration spearheaded a government bailout with the Troubled Asset Relief Program (TARP) and the Obama White House was able to convince Congress and sign into law the Dodd-Franklin Wall Street Reform and Consumer Protection Act. The latter was more noteworthy as it went beyond bailing out banks and enacted strict regulations on CDS contracts, granted the authority to break up banks, and most notably put banks with assets north of $50 billion under more scrutiny. Despite this monumental reform, no Wall Street CEOs were prosecuted for their complicity in enabling the housing bubble. 

Going forward 8 years, President Trump and a Republican Congress partially repealed the law under the belief that the law created a market that was too “illiquid.” The repeal notably weakened key restrictions such as increasing the threshold for heightened scrutiny from $50 to $250 billion in assets. Had this not been changed, banks like Silicon Valley Bank would probably have had the attention of the federal government earlier on for potentially collapsing and causing other bank runs. 

Given all this context, we find ourselves at a crossroads of whether or not we should regulate the banking industry. It’s only in times of imminent economic collapse that the government decides to enact regulations only to undo them years later as if they forgot why they did so in the first place. As the state of the world evolves and more economic uncertainty will brew in the face of climate change, it will be of paramount importance for the government to enact stricter regulations in our financial systems so workers across the world don’t bear the consequences of risky lending practices of a select few firms. Nearly 9 million Americans lost jobs in the Great Recession, and millions more were affected abroad. We need a renewed act of Congress that includes key provisions of the Dodd-Franklin Act and lists a firm commitment of the government to legally reprimand financial institutions for engaging in risky practices. In a political environment increasingly mired by hostile partisanship and divided government, it may be difficult to achieve a consensus and compromise. Nevertheless, the government faces the choice of either acting responsibly or repeating past mistakes and inflicting economic pain on millions of innocent Americans. A failure to act would not be just a mistake but viewed as a direct government-sanctioned expression of indifference towards middle and working-class citizens and a source of national embarrassment on behalf of the world’s largest economy.