Perhaps you’ve noticed that the markets have been nosediving the last couple of days and they are actually below where they were when Biden left office. It’s possible that it’s just a correction. The markets have been soaring for a couple of years. However, there is good reason to believe that there could be some major trouble on the horizon.
In a week in which Trump has firmly allied himself with Russian aggression while falsely claiming that millions of dead people receive Social Security, how many people noticed Tuesday’s executive order that appears to be an effort to strip the Federal Reserve of its ability to oversee and regulate Wall Street?
This is, however, important. The Musk/Trump administration has been weakening financial regulation across the board. The Consumer Financial Protection Bureau, which aims to shield Americans from fraud, has been shut down. All of the agencies that try to supervise and regulate financial institutions, other than the Fed, are now being run by people hostile to the very idea of regulation. Cryptocurrency, which is rife with fraud and scams — indeed, the whole thing may be a scam — is now being actively promoted by the executive branch.
And all of this couldn’t be happening at a worse moment. MAGA may well be laying the foundations for the next financial crisis.
Economists have known for a long time — more than 250 years — that financial institutions should be regulated. Libertarians often invoke Adam Smith’s The Wealth of Nations for its advocacy of laissez-faire economic policies. But even Smith, who had witnessed the Panic of 1772 that hit Scotland, London and Amsterdam — arguably the first modern banking crisis — called for significant restrictions on banks,
The 21st-century financial system is, of course, far more complex than that of the 18th century, although there are some echoes. Notably, “stablecoins,” crypto tokens that can supposedly be redeemed at will for actual dollars, are a lot like the privately issued bank notes of the 18th and 19th centuries, which could supposedly be redeemed at will for gold and silver coins. The main difference is that while bank notes were clearly useful for legitimate business, cryptocurrencies still don’t seem to have any real use case other than money-laundering.
Did I mention that Howard Lutnick is now the Commerce Secretary? Lutnick has had close financial ties to Tether, which Bloomberg describes as
the stablecoin used by drug traffickers, terrorists and scammers to move money around the world.
And crypto aside, the complexity of modern finance makes it even harder for both consumers and investors to assess banking risks, so we need effective financial regulation to avoid or at least limit financial crises.
Yet the Musk/Trump administration is moving to loosen if not eviscerate financial regulation. And it’s doing so at an especially dangerous time.
In the aftermath of the 2008 financial crisis I, like many economists, became a fan of Hyman Minsky’s “financial instability hypothesis.” At a time when many economists were arguing that financial markets are generally efficient in the sense that asset prices reflect the best information available, Minsky argued instead that they are driven by cycles of greed and fear. A Minsky cycle looks something like this:
In the aftermath of a financial crisis, investors are well aware that markets can go down as well as up. They are cautious about taking risks, and especially about leveraging up — investing with borrowed money. And as a result of this caution, financial markets are calm with relatively few crises.
Over time, however, memories of past disasters fade, in part because those who remember bad things retire or move on, replaced by younger traders who have never experienced a major crisis. This eventually produces markets in which prices seem to go in only one direction — up — and whoever is most willing to take leveraged risks wins. Even those who intellectually know better get sucked in because of FOMO: fear of missing out.
This manic phase doesn’t just induce many people to take on risks they don’t understand. It also creates what the famed investor James Chanos calls a “golden age of fraud.” (I’ll be posting a long talk with Chanos this weekend.) When it seems as if fortune favors the brave, con men or, sometimes, con women find it especially easy to attract suckers, especially if they can hang their promises on a narrative — say, the wonders of crypto or the limitless potential of AI.
The New York Times recently ran a heartbreaking story about how the president of a community-owned bank in Elkhart, Kansas fell for a crypto scam, destroying the bank and quite a few people’s life savings in the process. You can be sure that we’ll hear many more such stories once we reach the final stage of the cycle — the Minsky moment, when euphoria-driven asset price surges give way to fire sales as highly leveraged investors desperately try to raise cash.
The crypto scam makes this whole thing way more dicey than what we’ve experienced in the past. If Krugman is right, we could be looking at something extremely destructive. But then, when it comes to Trump, what isn’t?
Get yourself a drink and read the whole thing. Let’s hope we get lucky this time. There are more than enough atrocities to defeat Trump and the Republicans without a big banking crisis. We really don’t need that.