Doubling Down on Failure: Subsidizing One-Way Bets and the Re-Emergence of Financial Instability

This podcast episode, titled "Doubling Down on Failure Subsidizing More One Way Bets," delves into the persistent vulnerabilities within the global financial system, arguing that deregulation and inherent cultural issues among regulators are sowing the seeds for another catastrophic financial crash. Dennis Kelleher introduces the panel, highlighting his paper on how financial reform is being undermined by deregulation that incentivizes 'one-way bets.' The discussion shifts from a 'reawakening' to a 'rude awakening,' emphasizing the continued risks posed by 'too big to fail' institutions and the mechanisms that allow them to externalize risk onto taxpayers.

The first speaker, Ed, focuses on 'zombie banks,' particularly in Europe, and the 'chicken game' played by mega-bankers who risk firm ruin to hold the macroeconomy hostage, thereby extracting implicit guarantees from regulators. He introduces a new statistical method to measure taxpayer subsidies and critiques the regulatory culture, which he argues prioritizes concealing losses and extends 'mercy' and 'benefit of the doubt' to troubled firms, while individual career incentives discourage challenging the status quo. This 'culture-driven mega bank bailout model' perpetuates the 'too big to fail' problem, evidenced by high default probabilities in major European banks despite post-crisis reforms.

Anastasia then analyzes the asset-backed securities (ABS) market, recalling its role in the 2007-2009 crisis and the re-emergence of similar instruments like collateralized loan obligations (CLOs). She argues that while securitization was blamed, its nuances and the underlying investor demand for yield are often overlooked by regulators. The discussion highlights 'financialization' – the increasing role of financial markets and bonds – and the structural mismatch between the fluctuating supply of traditional bonds and the monotonically increasing demand from institutional investors (pension funds, insurance companies) seeking stable stores of value. This demand, driven by demographic shifts and neoliberal policies, creates a need for instruments like ABS to equilibrate the market.

Ultimately, the episode concludes that post-2009 regulatory policies suffer from an incomplete diagnosis, focusing too heavily on banks and underestimating the systemic risks posed by the broader financial system and the demand-side pressures from institutional investors. The speakers warn that the current environment, characterized by regulatory blind spots, cultural inertia, and the re-emergence of complex, potentially mispriced financial products, mirrors conditions that led to previous crises, suggesting that the lessons of 2008 have not been fully learned and that taxpayers remain on the hook for future bailouts.

"financial reform is working but deregulation that incentivizes one-way bets are sowing the seed of another catastrophic financial crash."

"it might be better titled from reawakening to rude awakening."

"most of the mega banks in Europe are either actually zombies who are on the edge of zombie Ness and that the regulatory arrangements are very deferential to their interests."

"bankers now or certainly ought to know that they can benefit personally from aggressively risking the ruin of their firm and then holding the the macro economy hostage and basically scaring the regulator's into into letting them stay stay in business in an uninterrupted way."

"the US taxpayer is the sturdiest element of the safety net as the size of these hidden losses in european sami banks keeps expanding."

"post-crisis arrangements for resolving crisis resolving banks and future crises sounds very good but these are largely a bluff."

"the culture of regulation thinks it's not only alright but a good thing for for big banks to hide losses that's just fine and that's because it makes sure that we won't have a run."

"derivatives were weapons of mass destruction."

"there is a reason why investors are choosing these complex securities there are risks of artificially inflating them of mispricing them and again ignoring all the stuff that already had happened to the system."

"regulators don't really appear to understand the nuances of securitization they don't really appear to be paying too much attention to the problem of demand of investor demand and the political economy of that demand for yield."

"financialization is about the increasing role of financial markets interests motives and prices in our everyday life."

"our knowledge about bonds as debt is dominated by the first function... We know very little about the second function."