The financial crisis of 2008 was the most important trauma suffered by the global financial system since the breakdown of Bretton Woods in the early 1970s. In between those two events the world witnessed a phase of rapid growth in financial activity, increasingly divorced from the unfolding of the real economy.
The crisis has claimed many victims, especially in terms of reduced growth and unemployment. It has also cast doubt on long-standing claims about the efficiency of financial markets, the quality of regulation, or the role of governments and central banks in economic governance.
Most importantly, the line between risky and safe financial markets has been blurred.
Investors continue to be jittery and fundamentally worried about the self-destructive potential of many aspects of financial markets.
What was once seen as innovative and technologically advanced is now regarded as volatile and prone to failure. Risk management systems are a main source of concern.
Skepticism about the ability of banks to do business safely is rampant. Regulators and customers are reluctant to award banks a high degree of autonomy in decision making.
It seems as if large, complex banks simply do not have the trust needed to operate successfully. This skepticism about banks and financial markets more broadly represents a major departure from the recent past.
A second radical change has to do with taxpayers.
Most people see the benefits of financial development as accruing to just a few while the costs of financial mishaps are distributed among all taxpayers. The increase in income and wealth inequality in both Europe and the United States has added to the misgivings that the public has about the contribution of the financial sector to economic well-being.
As a result, a third key trend has to do with enhanced regulation.
Banks, non-bank financial intermediaries, insurance companies, rating agencies and other types of actors in the financial sector are entering an era of higher capital requirements, greater scrutiny of risk management practices, and prohibition from engaging in a wide array of financial activities, especially if they create moral hazards or conflicts of interest.
These pressures will place a negative premium on the size and complexity of financial firms. Depending on the final regulations adopted on both sides of the Atlantic, and on the zeal of supervisors and regulators when it comes to enforcing them, we may well see in the next few years a rapid unravelling of the financial landscape as we knew it.
Lastly, global coordination of financial regulation and supervision may become a new culprit for avoiding some of the excesses of the so-called Great Moderation. Competition among financial centres led to a regulatory race to the bottom that gave financial companies way too much power and discretion. Closing the loopholes will not be easy, and new opportunities for regulatory arbitrage will likely surface.
It is only during episodes of acute crisis that one realizes how intricately delicate and momentous the financial system actually is.
The credit crunch which continues to affect families and businesses in Europe—and now also China and other emerging economies—threatens the economic recovery, and with it the reduction of unemployment in Europe and the resumption of wealth-creating growth in the emerging world.
Never so few (in the financial sector) did so much to damage the many.
The issue is that the many now need a well-functioning financial system more than ever.