Will There Be Another Financial Crisis? Yes

Note: I posted this, but it was written by Axel Pierron, Senior Vice President, Securities & Investments. - JC On the occasion of the fifth anniversary of the collapse of Lehman Brothers, people are asking whether there will be another financial crisis. The answer is: yes. Therefore the question is: Are we ready for the next crisis? The major regulatory push has been to address the issue of OTC derivatives trading, which was perceived as the source of the Lehman default, and the AIG bailout. However, with OTC derivatives being centrally cleared, we are raising the level of systemic risk by implementing a common process/infrastructure across the various asset classes. The first rule I learned in grad school was: to minimize your risk, you need diversification. If you take the analogy of Darwin’s theory of the origin of species, the most adaptive species are the ones that survive. Mother Nature does not put all her eggs in one basket. Today, regulators are doing the opposite; hence the next crisis could be much more dramatic. My overall concern is that the regulations will ensure that a minor crisis does not spread across the industry. However, we are ill prepared for a “black swan,” and as we have known since 2007, black swans do exist. It’s a balancing act for regulators between leveling the playing field (for example, by syncing effort between the US and the EU to avoid regulatory arbitrage) and allowing some level of diversification and customization. Nevertheless, some fundamental questions have not been addressed, and we are not questioning how the crisis was handled. Maybe Lehman should have been bailed out as well? Or perhaps there should not have been any bailout? Capital markets are based on risk and reward; one could argue that the bailout program has removed the risk element and sent the wrong signal to the industry and the public. In summary, regulators are working to create a framework to avoid a 2007-like crisis. However, while crises are integral to the functioning of financial markets (we call it a crisis, but in fact it’s a readjustment), their detonators are always a surprise to most people. It would be better to learn from our experience to develop a framework to respond (e.g., chain of command, bailout or not, synchronization of central bank policy, etc.), because crises are inevitable. The current regulatory approach reminds me of the French army in the 1930s leveraging their experience of World War I and building the Maginot line, when in fact World War II would be fought with tanks and airplanes. The last battle is over, and we need to prepare for the next one.