As part of this month's cover feature looking at the
most influential people, institutions and events in financial
regulation, during a conversation with Congressmen Barney Frank
– co-author of the Dodd-Frank Act – IFLR
asked what he sees as the biggest threat to financial stability
in the US. It wasn't the banking system, or cybersecurity, or
anything like that. It was "risks we don't even know about
"There is no risk from what we know. At some point,
technology is going to produce a new ability to amass a lot of
debt without being able to keep track of it – and we
don't know where it will come from," he said.
Echoing this sentiment was outgoing chairman of the CFTC
Christopher Giancarlo, who in response to the same question
explained the reason behind his insistence on future-proofing
the Commission during his tenure. "The next crisis won't look
like the last crisis. Our markets have been going through very
profound market structure changes. We have to be
better-prepared when the inevitable credit cycle change
These two individuals of course have a cognisant grasp of
the financial sector, but when it comes to speculation, anyone
can be proven right or wrong – especially in this
The US markets have been going through very profound changes
in market structure and participation. During the first 20
years of this century it was banks at the centre of financial
markets. Nowadays things look a little different: there are new
players on the scene, non-bank participants. The markets have
been profoundly digitised, and when the credit cycle does
change it is likely to uncover whatever shortcomings are hidden
in that structure.
One potential disruptor is shadow banking. Non-bank lenders
now have as much as $52 trillion in assets and are in the
process of taking over in certain areas of the economy
entirely. Couple this with the credit cycle, which has moved a
risk-taking appetite firmly back into the foreground, and there
is room for disaster.
In the financial services industry it is leveraged loans
that are ringing alarm bells. Collateralised loan obligations
– or CLOs – are marketed as bitesize pieces
of existing debt and assets that can be digested by companies
with existing debt or low credit ratings. There is little in
the way of protections or restrictions on CLOs, which increases
the risks substantially.
The process is allowing the banking system to offer these
risky businesses loans of significant size, then farm them off
to more risk-loving investors in the industry. These CLOs are
being snapped up in their trillions by hedge funds and the
like, yet US banking regulators like the Office of the
Comptroller of the Currency (OCC) or the Federal Reserve are
doing nothing to step in and mitigate the risk.
These regulators have the tools and the means to step in
before it is too late, but at the orders of a Republican
risk-hungry administration, have not.
Frank and Giancarlo may yet be wrong, and the cause of the
next financial crisis could indeed be right under all of our
noses. But as to whether those in a position to do something
about it will or not? The jury is out.