Lessons for next U.S. financial crisis from 3 key ex-officials

Three officials who played vital roles in combating the 2008 financial crisis say they worry that the painful lessons from the banking system's near-collapse a decade ago may be forgotten.

"It is important that people focus on the lessons," said former Treasury Secretary Henry Paulson. "We are not sure people remember everything they need to remember."

Paulson, who was at the Treasury's helm when the crisis erupted in the fall of 2008, and Timothy Geithner, who succeeded him in 2009, joined Ben Bernanke, the former Federal Reserve chairman, at a round-table discussion last week in advance of the 10th anniversary of the crisis.

The turbulent period, in which key financial institutions, including Lehman Brothers, Bear Stearns, Fannie Mae, Freddie Mac and American International Group either failed or nearly did, marked America's worst financial crisis since the Great Depression.

On Sept. 11, former officials from the Fed, the Treasury and other agencies will meet at the Brookings Institution in Washington to discuss what worked and what didn't and what should be done to prepare for the next crisis.

"We hope to provide some useful guidance — perhaps more than the three of us had," Bernanke said.

Since President Donald Trump took office, momentum has grown within the administration and among Congress' Republican leaders to reverse parts of the Dodd-Frank financial overhaul law, which Congress passed in 2010 to tighten regulatory loopholes revealed by the crisis. Legislation enacted this year makes modest changes to Dodd-Frank, mainly in exempting smaller banks from the stricter requirements.

Bernanke, Geithner and Paulson said that so far, the easing of parts of Dodd-Frank represented sensible changes. But they cautioned that deregulatory zeal could go too far and again leave the financial system vulnerable to excessive risk-taking.

"We let the financial system outgrow the protections we put in place in the Great Depressions and ... made the system very fragile and vulnerable to panic," Geithner said. "One of the most powerful lessons from this crisis should be that you want to work very hard to make sure that your defenses are robust."

The 2008 crisis deepened a recession that had begun in late 2007 and turned it into the worst downturn since the 1930s, with 8.7 million people thrown out of work. Though the economy has created 19 million jobs since the depths of the downturn and the economy has expanded since 2009, the recovery has been the slowest in the post-World War II period and wage growth has languished.

The resulting economic discontent, fed by widening financial inequality, contributed to Trump's presidential victory. Similarly weak recoveries fueled populist backlashes in other nations, too.

"Financial crises, particularly big ones, do tend to get followed by a population reaction; that was certainly the case in the 1930s," Bernanke said, alluding to the rise of Hitler in Germany and other fascist movements.

But Bernanke suggested that some disturbing trends — from worsening income inequality to a lack of upward mobility to the opioid epidemic — go back much further than 2008.

"The changes brought about by technology and globalization displaced many people in many communities, and there was not an adequate effort to deal with these displacements," he said.

The three agreed that one of their mistakes during the crisis was failing to adequately explain publicly why billions in bailout dollars were being provided to the big banks, whose executives were able to keep their huge bonuses even though they ran the institutions that caused the crisis.

The three asserted that they had no choice but to use taxpayer money to stabilize the financial institutions — money that was eventually repaid — because the only alternative would have been to allow the entire banking system to collapse, with far graver consequences for the country.

"The public was angry; they wanted to see us, if not punish the banks, (then) put limits on bonuses," Paulson said. "I was totally ineffective at having the American people understand that what we were doing was for them and not for Wall Street."

Paulson and the others expressed concerns about the huge budget deficits now being projected over the next decade as well as about restrictions imposed on the Fed, the Treasury and the Federal Deposit Insurance Corp. in managing any future crises. The Dodd-Frank law restricted the ability of the Fed, the Treasury and other federal agencies to make the types of emergency loans to troubled banks that they did in 2008.

But they also noted that government officials confronted tough obstacles in 2008: They had to address the crisis with outdated laws ill-suited to managing the giant banks that needed bailouts. Government officials also faced a lame-duck President George W. Bush and a politically polarized Congress.

At the same time, Geithner said, "We had the benefit of two presidents of two different parties at a very dangerous moment working together and a set of institutions willing to work very cooperatively," Geithner said.

Such collaboration, he said, is necessary to manage any significant economic threats.

"We need to find a way politically to bring the same level of overwhelming force and creativity to the range of other daunting challenges facing the American economy," Geithner said.