In their co-authored new book Firefighting: The Financial Crisis and Its Lessons, Ben Bernanke, Henry Paulson and Timothy Geithner revisited the experience of dealing with the 2008 financial crisis as three of its first responders. The authors concluded that much has been done, as coping measures, in micro-level financial regulation, macro prudential policies and cross-country regulatory cooperation to expand the monetary policy and financial regulation toolkit, and with more robust regulation and gradual improvement in economic fundamentals, the financial system had better capitalized, less leveraged, and maturity mismatch in balance sheets had somewhat corrected with more solid risk buffers.

Ten years on, many of the lessons on the outbreak of the crisis are passing into oblivion. And with reforms deemed necessary in times of crisis distorted and effective policy tools restricted, the United States might not have prepared for the next crisis or the next round of financial turbulence yet.

The first reason for this is the vanishing bipartisan consensus, which makes it harder to come up with responses in a timely manner. A crisis can be highly uncertain in terms of the time of occurrence and how it evolves. And sometimes it will not happen for decades. But when it does, it could change the course of decades to come in a matter of weeks. How a crisis spreads and the effectiveness of response measures depend, to a large extent, on whether the right decisions can be made in the nick of time, whether conventional strategies and preconceived notions can be turned around in time, and whether the decision-makers can tolerate uncertain consequences and even a public relations fiasco.

Despite having vastly different ideas about what should be done, in 2008, the Democrat-majority Congress approved the bailout of Fannie Mae and Freddie Mac and passed the Troubled Asset Relief Program Act, both of which were proposed by a Republican president, preventing the further spread of the crisis.

However, politics in the United States has only seen more polarization with the Trump presidency. So, not only did TARP expire, but the Federal Deposit Insurance Corporation coverage and the Federal Reserve’s capacity to bail out non-bank financial institutions are now constrained. So, future bailouts will require TARP-style authorization, making it harder to deliver tide-turning assistance.

Second, the financial regulatory reform has been advancing slower than expected. Passed after the crisis, the Dodd-Frank Act formed the basis of the regulatory framework with the Fed overseeing systemic risks and other regulators overseeing their respective sectors. The act also led to the creation of the Financial Stability Oversight Council and the Consumer Financial Protection Bureau. However, regulatory authority is still spread out among different bodies and no consolidation has taken place, albeit necessary.

For example, the regulatory gap between the Security and Exchange Commission and the Commodity Futures Trading Commission had resulted in the aggressive growth of credit default swaps leading up to 2008. However, merging of the regulatory authorities of SEC and CFTC did not happen like Geithner had expected, with one of the main reasons being that the two have different lines of reporting: SEC to the Senate Committee on Finance and CFTC to the Senate Committee on Agriculture, and neither committee wanted the other on its turf. This issue is brought into relief with the recent dilemma of the supervision of digital currencies, as it goes to the heart of where SEC’s authority (dealing with securities) ends and where CFTC’s authority (dealing with commodities) begins and vice versa.

Third, there is growing public discontent over the government financial bailout scheme. The three authors reject the possibility of a sustainable recovery in the absence of a stable financial system and that of excluding the troublemakers in a crisis bailout. Having said that, they are also aware of the growing income distribution gap within the US and the rise of nationalist sentiment at home since the outbreak of the crisis. So, with fierce partisan rivalry, it is less and less likely that policy-makers will delegate their authority to highly specialized and depoliticized technocrats.

Additionally, financial regulators could come under even more populist pressures as decision-makers pander to certain interest groups or focus on short-term growth. A case in point is US President Donald Trump’s barrage of criticism of the Fed’s rate rising policy and his attempt at nominating two candidates who toe the line for Fed’s Board of Governors.

Fourth, there is narrowing macro policy space for crisis response. While the effectiveness of crisis response hinges on coordination between financial regulation and macro policy, the US is now seeing shrinking room for maneuver in the latter compared to the eve of the global financial crisis. With the Fed Funds Rate at 2.5 percent compared to 4.25 percent at the end of 2007, it will be much easier to hit the Zero Lower Bound in the future. With fiscal deficit and publicly held federal debt ballooning to close to 4 percent and 80 percent of GDP from 1 percent and 35 percent, respectively, they may hover around 3 percent and 90 percent for the next decade as a result of tax cuts and difficulties in reducing inelastic expenditures even in the absence of a crisis.

There is yet another reason that the book neglected to mention: The efforts of other economies, especially those of major emerging economies, which to a large extent explain why the 2008 crisis did not devolve into another Great Recession.

Most major economies implemented reforms of varying degrees to their own financial systems and stepped up international coordination in financial regulation and crisis prevention, with some setting up financial stability boards or adopting Basel III, an international regulatory accord. The US, on the other hand, has frequently resorted to trade, technology and financial sanctions, effectively making itself a source of turbulence in the global economy and financial markets, eroding mutual trust between other economies and sending shockwaves through the global governance system. If a recession were to come back, major economies would struggle to coordinate if not resort to trade protectionism or beggar-thy-neighbor policies, creating further drag on the economy.

“History does not repeat itself but it often rhymes,” thus spake Mark Twain. Even though crises cannot be predicted nor do they follow a predetermined script, macro control authorities and financial regulators can and should stay alert, increase the resilience of the regulatory framework, build up buffers, close regulatory gaps or eliminate overlaps in institutional functions to prevent regulatory competition, and be mindful of policy spillovers and feedback. These will help keep problems at bay in times of peace and build a fully-equipped toolbox and expand room for maneuver if crisis strikes again. At the same time, adapting to changes in technology and ways of communication can help to enhance policy transparency and accountability as well as to garner public support and feedback, which in turn can expand the space for decision-making for crisis prevention and response.

The author is Director and Research Fellow at the Department of Macroeconomic Research, Development Research Center of the State Council of China.

The author contributed this article to China Watch exclusively. The views expressed do not necessarily reflect those of China Watch.

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