
Here at The D&O Diary we try to follow the latest events. And while we think it is important to keep track of what is happening now, we also think it is important to keep things in perspective. It is particularly important to maintain a historical perspective. It is for that reason that we read with interest a recent speech by outgoing FDIC Chair Martin Gruenberg, in which he gave a retrospective overview of the three banking crises of the last four decades, as well as a reflection of the lessons to be learned. Gruenberg’s speech is must reading for anyone that wants to understand the prior banking crises, as well as to appreciate the risks that may lie ahead. The text of Gruenberg’s January 14, 2025 speech can be found here.
The three banking crises to which Gruenberg refers are the Thrift and Banking Crisis of the 1980s; the Global Financial Crisis of 2008-2010; and the Bank Failures of 2023. By way of explanation of why he chose to review these crises and consider their lessons, Gruenberg notes that he is “concerned that memories are short.” He notes that while we are now in a period of “current relative stability,” these very conditions could “lull us into a false sense of complacency.”
He notes, with significant accuracy in my view, that “not only are many people not familiar with the thrift and banking crisis of thirty years ago, some seem to have lost sight of the experience of the Global Financial Crisis of 2008 and even the regional bank failures of the spring of 2023.”
The three banking crises Gruenberg considers are indeed interesting and do indeed suggest some lessons as we are going forward. He starts his speech by noting that for most of the early years of the FDIC’s existence (from 1933 to 1978), the banking industry was characterized by stability and was “perhaps even boring.”
However, a rise of new kinds of financial products outside the banking sector in the 1970s led to competition for banks and savings and loan institutions. Regulatory and legislative changes in the late 70s and early 80s allowed thrifts to begin to offer higher interest rates and to diversity into new lending areas, including in particular, in commercial real estate. At the same time, banking institutions became overinvested in real estate and the energy sector, which made many banks vulnerable to regional recessions. Changing economic and market conditions caused a host of institutions to fail. Between 1980 and 1994, 1,300 thrifts (nearly one third of the industry), and more than 1,600 banks failed. A host of new regulatory measures were put in place and after the mid-1990s the industry recovered and expanded.
The rise of new financial products, the enormous growth and expansion of some financial institutions, and a surging bubble in residential real estate values all came together in the Global Financial Crisis of 2008-2010. The regulatory system was not able to track the extent of either industry-wide or market-wide financial risk exposures. The “interconnectedness” of the system, was “significant and underappreciated.” When over-inflated residential real estate prices began to soften it triggered a series of reactions across the financial system that ultimately caused the most significant financial crisis since the Great Depression. Between 2008 and 2013, nearly 500 banks failed. In response to these developments, a host of regulatory and legislative measures were put in place.
Among other measures, the post-Financial Crisis regulatory framework stressed oversight of systemically important financial institutions. It may have been that this framework insufficiently considered the importance of smaller, regional banking institutions. And so it was that the failure of Silicon Valley Bank nearly triggered another systemic financial crisis. Three of the five largest U.S. bank failures did take place in 2023. While a full blown crisis was averted, the significance of the failures and the threat to the overall system to have their important implications.
Having walked through the history of the three crises, as well as the history of the regulatory response to the crises, Gruenberg notes that while “the specific context and details” of the three crises differ, “many common threads run through them”:
Interest rate and liquidity risk, reliance on uninsured deposits and wholesale funding, inadequate capital, leverage, rapid growth, poorly understood new financial products and companies, sheer size, inadequate risk management by the banks, and accommodating supervision and regulation have repeatedly forced the hand of the U.S. government to intervene and protect different types of creditors, and the firms themselves.
While, Gruenberg notes, the financial system has been improved with heightened capital and liquidity requirements for banking institutions, “the largest banks are bigger, more complex, and deeply interconnected domestically and internationally.” Gruenberg is worried that too many may not recall the problems of the past, nor understand the lessons. As it is, “new technologies, new financial products, and new kinds of financial companies are part and parcel of the evolution of the financial system,” that we “have experienced before.” But we “should not kid ourselves into believing that they do not present risks that need to be carefully supervised and, if necessary, regulated.” That, says Gruenberg, “is the core lesson of these three financial crises to which I hope we pay close attention.”
Discussion
Readers may be aware that Gruenberg resigned earlier this month, shortly after he delivered this speech, before the onset of the new Presidential administration. So this speech represents not only a retrospective overview but something of a valedictory presentation as well. While in the end Gruenberg’s presentation is a plea for the important of continued regulatory vigilance and perspective, it is also a forceful reminder of the recurrent systemic breakdowns to which our banking system is prey, as well as of the recurring problems that trigger these periodic crises.
In my view, Gruenberg’s review of the three past crises is a sharp reminder of the kind of complex problems that might arise in the future as well. As he put it, the current relatively stable conditions should not allow us into a complacent sense that these kinds of problems aren’t possible in the future.
A particular recurrent theme in his review is worth emphasizing. It is clear that there is a pattern in the history of regulatory oversight, by which problems provoke a strong regulatory response, followed by a recovery period and then stability, which then encourages a loosening of regulatory standards, which enable new problems to emerge. This aspect of Gruenberg’s overview may be particularly instructive at a time when we appear to be heading toward a period of regulatory loosening.
While I have summarized Gruenberg’s speech above, I have not done sufficient justice to the significant interesting detail in his presentation. I recommend reading the report in full. It is interesting and thought-provoking, particularly for anyone who is active in the financial institutions space. For anyone now in the financial institutions space who wasn’t involved in the space at the time of the S&L Crisis or the global financial crisis, the speech ought to be mandatory reading.