Analysis: 10 years after global financial meltdown, big banks still play with fire

It’s been a decade since the global financial crisis rocked the world. In the years since 2008, the U.S. and other countries mended their broken economies, assessing what went wrong and trying to curb the abuses that could lead to another crisis. But today many factors that contributed to the implosion still pose a threat.

Although Wall Street may not go gaga over home loans as it did leading up to the last panic, it's only a question of time before the next speculative frenzy. Even with regulations in place, competition and greed push Wall Street to find a new way to get rich quick. These four factors will make the ensuing financial crisis all the worse.

1. Big banks hold even more assets than before the crisis

One of the contributing factors to the 2008 global financial crisis was that so few banks owned so many assets. The top five banks owned nearly 45% of financial assets before the crisis, and they own slightly more today (more than 46%). The top 10 banks control more than 55% of total assets. America’s approximately 5,700 other banks control the remaining 45%.

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Concentration in itself is not worrisome. There’s no reason big banks can’t keep making smart decisions. But concentration becomes catastrophic when those banks are all doing the same (dumb) thing, such as writing poor loans or gambling against the value of homes via sophisticated insurance contracts (credit default swaps). Then other smart financial institutions are not large enough to step in and bail out the failing ones. So the government has to intervene.

And whereas the banks may avoid speculative excess today, competition virtually ensures that, eventually, Wall Street will do dumb things again.

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2. Banks retain high leverage

The banking sector is prone to blowups because it uses a lot of debt (i.e., leverage), writing large loans against a small down payment. This is normal for the industry and not especially worrisome, if banks operate prudently. Banks are using a bit less leverage today than in 2008.

During good times leverage rapidly increases a bank’s profitability. That’s why banks would like to use more. But leverage does the opposite in bad times. When house values plummet, banks are required to write off that value, making the bank even more leveraged. If leverage keeps rising, the bank effectively becomes bankrupt. That’s why stringent regulations limit how much leverage a bank can assume, and why further regulations were developed after the crisis.

The proverbial run on the bank can happen a lot faster than in industries without leverage.

3. Limited prosecutions lead to moral hazard

No executives from "too big to fail" banks were prosecuted for issues related to the financial crisis, which many argue was due to banks’ criminal activities. The lack of widespread punishment creates "moral hazard." In other words, if executives feel they are personally exempt from repercussions, they’re more likely to engage in bad behavior, especially if they benefit financially.

Rather than pursue executives individually, prosecutors have tended to go after the companies. They’ll fine the bank, and no one gets jail time. According to The Wall Street Journal, the six largest banks paid $110 billion in penalties for issues related to the crisis. So it’s the shareholders who suffer, rather than executives.

4. Politicians, banks aim to peel back regulations

Following the crisis, Congress passed the Dodd-Frank Act, which regulated banks. The law created the Volcker Rule preventing government-insured banks from engaging in certain speculative, typically highly leveraged activities. The law also created the Consumer Financial Protection Bureau, which regulates the banking industry.

Following a few years of economic normalcy, the financial lobby and many politicians are pushing back, saying that regulation harms the industry. There’s at least some truth to that, because the legislation is more costly for medium and small community banks. But larger banks are also pushing this line because they want to take more risks; for example, in speculative trading that is currently prohibited by the Volcker Rule. Those riskier activities could blow up a bank.

So a repeal of those regulations, or even parts of them, could pose more danger to the economic system, setting the stage for more "casino capitalism" and another crisis.

What can you do now?

It's not surprising that the global financial crisis happened within a decade of the 1999 repeal of the 1933 Glass-Steagall Act limiting banks' risk-taking. Regulation effectively prevented full-on bank crises since the Great Depression, and it's a step that could work today.

Consumers can contact their representatives in government to voice their concerns, or support candidates who favor stronger financial regulation. As things stand now, though, it’s only a matter of time until we're asking these questions again.

More from NerdWallet:

Panic-proof your portfolio for the next bank crisis

Learn to grow your savings in good times and bad

How Dodd-Frank rollbacks could affect your bank account

Jim Royal is a staff writer at NerdWallet, a personal finance website. Email: jroyal@nerdwallet.com. 

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