When South Koreans began to worry that online video games were addling the minds of a generation of teenagers, politicians came up with a plan to tame a powerful industry and reform a generation of morose and twitchy youths. They called it the Cinderella law.
Instead of banning video games — the approach the military government of the 1970s took towards mullets, miniskirts and other supposed social ills — legislators settled on a selective cyber-curfew. Every night at 10pm, gaming platforms must switch off the accounts of under-16s, so they can sleep for a full eight hours.
If the US banking laws of the 1930s felt to Wall Street like a form of a financial dictatorship, the past decade of regulation has been more like helicopter parenting now practised by South Korean lawmakers. In the depths of the Great Depression, the US introduced sweeping securities laws that banned whole classes of activity outright. This time, regulators have generally allowed risky lending to continue, so long as it happens outside banking institutions deemed so important to the rest of the economy that they cannot be allowed to go bust.
People with dodgy credit scores can still find car loans, although no longer from Wells Fargo. A private equity fund can still buy a company earning $100m a year of profit, and load it with $700m of no-strings debt. As the Financial Times reported this week, three of the four biggest US private equity firms now manage more money in credit funds than in their private equity arms. Along with other lightly regulated asset managers they have amassed $160bn of capital that is now waiting to be lent out, twice what they had a decade ago and enough to support perhaps $360bn of business lending once bank debt is added on top.
Asset managers have been the winners from the capitulation of the banks. Top private equity firms, long notorious for forcing risky borrowing practices on to the companies they buy, have become leading lenders to companies owned by their rivals. Bond managers, too, have struck pay dirt. Globally, annual issuance by companies other than banks has more than doubled in the past decade, accounting for one-fifth of their borrowings. Most of the growth involves either the lowest rung of investment grade companies, or those whose debt is already classified as junk.
Some of these funds will lose money, as the people who manage them cheerfully agree. (They earn a fixed annual fee as well as a share of the uncertain profits, and as a rule expect the losses to fall on rivals). The reasons are obvious. The Fed has finally raised interest rates, with more hikes to come. America is widely believed to be closer to the end than the beginning of its current streak of economic expansion. Lenders, falling over each other to sign deals after a decade of loose monetary policy, overlook the elastic arithmetic behind many companies’ profit calculations, and waive customary protections intended to keep executives accountable.
Asset managers say risk has shifted to less important institutions. Unlike banks, which are funded by short-term deposits, private credit funds lock up their clients’ cash for the entire duration of each loan, so they cannot become forced sellers. (The same cannot be said for bond mutual funds, which allow investors to redeem their money before the bonds are paid off.)
Still, non-bank finance does not eliminate the risk of bailouts. It is true that most of the big rescues mounted during the crisis were ultimately aimed at saving banks, even when the immediate recipients were insurers (AIG) or reckless sovereign borrowers (Greece). But as US support for its stricken auto industry proved in 2008, public funds can be summoned to the aid of other important constituencies. Sovereign wealth funds can probably be allowed to suffer huge losses without political repercussions, but public pension funds, which provide retirement incomes and health benefits to millions of elderly Americans, surely cannot.
As important are the businesses and households that increasingly rely on funds borrowed from outside the banking system. That puts them in a precarious position if the cash dries up. Lenders who held on to their assets through the last credit crunch mostly emerged with modest losses, but borrowers were not so lucky. When financing evaporates so does trust, hampering commerce, pushing borrowers towards bankruptcy and turning financial glitches into real recessions.
Perhaps the most unsettling day of the last financial crisis was September 16 2008 when the Reserve Primary Fund — which was not a bank, and had no deposit insurance, but promised to pay investors on demand — announced it could only pay out 97 cents for every dollar invested. Americans raced to pull their money out of similar funds, shutting down a key part of the credit system.
For today’s non-bank lenders, avoiding an exact repeat of that episode should not obscure a larger lesson. The distinction between banks and other financial actors matters deeply to regulators, yet it has frequently been mocked by history.