Why a financial crisis like 2008 could happen again

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The Fragile Banking System: A Crisis in the Making?

The global banking system, once thought to be a rock-solid foundation of modern economies, has shown time and again that it is far more fragile than most believed. The 2008 financial crisis exposed this fragility in dramatic fashion, revealing that despite having every regulatory tool at their disposal, authorities failed to supervise the banking sector effectively. More than a decade later, many of these problems remain unresolved, and in some cases, have worsened.

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Regulatory Failures and Political Inaction

Regulators in the U.S. and other developed economies have faced intense criticism for their handling of banks. Despite having the authority to impose stricter oversight, many failed to act decisively. The debate in the U.S. has intensified in recent years, with fierce lobbying efforts pushing for small, almost cosmetic, changes to banking regulations. These lobbying campaigns have been successful in weakening regulatory safeguards—regulators have capitulated to demands from financial institutions, weakening the protections that were put in place after the 2008 crisis.

The situation is not much different in the U.K., where similar regulatory capitulations have occurred. The political systems in both countries appear to be unable, or unwilling, to make meaningful changes that could strengthen the banking system. This failure to act is not just a domestic issue—because of the highly interconnected nature of the global financial system, any major disruption in these economies sends shockwaves across the world.

The Collapse of Lehman Brothers: A Flashpoint

One of the most notorious failures of the 2008 financial crisis was the collapse of Lehman Brothers. When the U.S. government allowed Lehman to file for bankruptcy without providing a bailout, the global economy went into a tailspin. It marked the most significant financial collapse since the Great Depression, as stock markets plummeted, credit markets froze, and financial institutions around the world scrambled to secure liquidity.

While Lehman’s failure was the immediate spark that triggered the crisis, it was not the root cause. The global financial system was already deeply fragile. What began as a relatively modest decline in U.S. housing prices triggered a global meltdown, not because the losses were insurmountable, but because the system was so poorly structured that it couldn't handle any significant disruption. The interconnectedness of the banks, their dependence on short-term funding, and the complex web of derivatives made the entire system highly vulnerable to a domino effect of failures.

The Power of the Financial Lobby and the Weakness of Consequences

In the aftermath of the crisis, one would expect that the individuals and institutions responsible for the disaster would face severe consequences. However, that was not the case. Most of the key players—including top executives at the largest banks and the regulators who were supposed to oversee them—escaped largely unscathed. While banks received massive bailouts, ordinary taxpayers were left to pick up the tab.

In Germany, for instance, it is now estimated that up to €36 billion was lost from the national treasury due to tax schemes tied to the crisis. This is money that should have been used for public services, but was instead funneled into complex financial transactions that benefitted a small, elite group.

This failure to hold individuals accountable has had significant long-term political ramifications. One of the most notable is the rise of populism across Europe, especially in countries like Germany, where many citizens feel that their interests were sacrificed to protect a powerful financial elite. This growing disillusionment has led to the emergence of political movements that challenge the status quo, often capitalizing on the perception that governments and banks are in collusion to serve the wealthy at the expense of the average person.

The Problem of “Too Big to Fail” Remains Unsolved

One of the primary goals of post-crisis regulatory reform in the U.S. was to eliminate the concept of "too big to fail"—the idea that some financial institutions are so large and interconnected that their failure would be catastrophic to the economy, forcing the government to step in with a bailout. The Dodd-Frank Act, passed in 2010, gave the Federal Reserve and other regulators the mandate to ensure that no bank could become so large that it posed a systemic risk to the financial system.

Yet, despite these efforts, the problem has only grown worse. Major institutions like JPMorgan Chase and Bank of America have continued to grow, and the U.S. now has at least six banks that are widely believed to be too big to fail. These institutions hold enormous amounts of assets and operate globally, making their failure unthinkable. The political will to break up or regulate these financial behemoths has largely evaporated.

Stress Tests: A False Sense of Security?

In an attempt to monitor the health of the banking system, regulators have implemented "stress tests" that are designed to simulate how banks would perform in adverse economic conditions. These tests, however, have been widely criticized as inadequate. The way they are conducted often fails to account for real-world market dynamics, such as the cascading effects that occur when banks start to sell assets in a panic, driving down prices and creating a vicious cycle of losses.

Stress tests also do not take into account the interconnectedness of the financial system. For example, if one bank sells off assets in a distressed market, the ripple effect of declining asset prices can spread throughout the entire system, triggering second-round effects that could lead to a broader collapse. This was one of the key factors that worsened the 2008 crisis after Lehman Brothers went bankrupt. Unfortunately, current regulatory frameworks do not fully consider these cascading risks.

Incentives for Risk-Taking and Public Subsidies

At the heart of the banking system’s problems is a misalignment of incentives. Banks have strong incentives to take on risky investments because they stand to gain massive profits if things go well. However, if those risks backfire, the losses are often absorbed by taxpayers rather than the banks themselves. This is due to the existence of implicit and explicit public subsidies, such as government-backed deposit insurance and the likelihood of government bailouts in a crisis.

This system encourages banks to take on excessive leverage—borrowing large amounts of money to magnify their returns on investment. This also magnifies their losses, but they know that in the worst-case scenario, the government is likely to step in to prevent a total collapse. As a result, the downsides of risk-taking are often borne by the public, while the upsides go to bank shareholders and executives.

The Path Forward: Political Will and Regulatory Reform

Despite the massive harm caused by the 2008 financial crisis, meaningful regulatory reform has been limited. There are few signs that the political will exists to tackle the fundamental problems in the banking system. Stronger regulations, higher capital requirements, and better oversight are all essential, but they require policymakers who are willing to stand up to powerful financial interests.

The reluctance to make these changes is partly due to the complex symbiotic relationship between banks and governments. Banks are often major donors to political campaigns, and their executives hold significant influence in shaping policy. This close relationship makes it difficult to push through reforms that could weaken the banks' power or limit their ability to take risks.

Until these systemic issues are addressed, the global banking system will remain vulnerable to future crises. The question is not whether another financial crisis will happen, but when—and whether the next one will be even more damaging than the last.

In conclusion, the lessons of 2008 have not been fully learned. The global banking system remains deeply flawed, with regulators, politicians, and financial institutions all contributing to a dangerous status quo. Without significant reform, the world risks repeating the mistakes of the past, with devastating consequences for ordinary people and the global economy.