The Great Panic of 2015

Has Washington, or the rest of the world, learned anything from the Great Recession?

The World Economic Forum. Click image to expand.
The World Economic Forum in Davos, Switzerland

The Great Recession officially started in December 2007, according to the bean-counters at the National Bureau of Economic Research. Most people on Wall Street or in Washington, however, would probably name Sept. 15, 2008, as the real start date: That was when unprecedented losses in housing-backed securities led to the bankruptcy of Lehman Bros., setting off the banking panic, the credit crunch, and the rest of the horrible aftermath. But the better question is not when the last financial crisis began, but when the next one will.

According to some creative analysts at the management consulting firm Oliver Wyman, that date is April 26, 2015. In a paper presented last week at the World Economic Forum in Davos to much chattering from the fur-and-cashmere class, Wyman analysts imagine an all-too-familiar scenario coming back all too soon. The next time, the authors say, the fat-cat financiers will be in Singapore or Hong Kong, chased away from New York and London by stricter reserve requirements and emboldened regulators. The bubble will appear in developing markets, with easy developed-world money and the promise of ever-spiraling commodity prices funding unnecessary building and silly investments. So there you have it—again: a big pool of money chasing market-beating returns and ultimately inflating asset-price bubbles that burst with awful consequences, from bank failures to sovereign-debt crises.

Do the authors of this report—complete with an imaginary protagonist, “John Banks,” awakened in his air-conditioned Singapore bedroom at 3 a.m. one April day with grim news—really believe another crisis is just around the corner? Well, maybe. “Financial services executives and regulators have worked hard to design a safer and more stable financial system, but we will not know whether they have succeeded until it is tested by the next crisis,” the authors note. “The first aim of our 2015 crisis scenario is to stress test the design of the new financial system, to consider how well it would stand up to this type of adverse scenario. The broader aim of the report is to encourage readers to think about the broader financial system” using many such plausible scenarios, in different markets, in different countries, in different financial institutions.

Now that the recovery has fully taken hold and the global financial regulations overhaul is in the implementation phase, the Wyman analysts are not alone in starting to imagine how the combination of easy money plus risk mispricing and irrational exuberance might again lead to catastrophe. Economist Jayati Ghosh, for instance, also sees hot money flowing into emerging economies, laying the groundwork for troubles. Many economists cite commodities as problematic, given the growing conventional wisdom that increasing demand from countries like China and India means prices will not decline.

Others see troubles starting to brew in the United States’ own finances, with the next crisis perhaps originating in Washington rather than on Wall Street. The documentary Overdose, for instance, argues that the recessionary strategy of shoring up over-indebted private institutions by adding trillions in debt to public ones will result in even greater catastrophe, later if not sooner. Sheila Bair, the chair of the Federal Deposit Insurance Corp., worries about the United States’ crushing debt burden causing financing and dollar problems down the road, as do Allan Meltzer and dozens more economists across the political spectrum.

Other theories focus on continued vulnerabilities in the financial system. Simon Johnson, a professor at the Massachusetts Institute of Technology and former chief economist for the International Monetary Fund, for instance, believes that the policy of “too big to fail,” in which the U.S. government deemed some banks too systemically important to collapse, will make the problems worse down the road. Even though Washington has promised no more bailouts, he believes concentration in the financial sector has made some firms more important, not less—and that the government would step in for the sake of the broader system, again.

All of these narratives of the next big crisis share one very scary assumption: that whatever the United States and its European peers do to try to prevent the next crisis might not be enough. At the heart of the concern is the way Washington approached regulation—an incremental approach based in strengthening existing rules rather than brute force. Some wise men suggested strong leverage caps, or size or activity restrictions to stop financial companies from getting too risky. Others suggested just taxing the whole sector. But politicians in Washington mostly stuck with the rules they had, attempting to bolster them instead. Worries abound, then, as they have for a year, that reform failed to address the core cause of the crisis. Everyone from Forbesto The Nation, from the Hoover Institution to the Roosevelt Institute, has admitted concerns with the Dodd-Frank law.

That leads us back to April 26, 2015. If anything will prevent the next financial crisis, it will be financial firms recognizing bubbles and popping them early, with regulators stepping in to ensure that risk-takers are the ones eating the losses. Vigilance is the word. Of course, bubbles are virtually impossible to see while they’re inflating—who is to say what is a reasonable bull market, and what isn’t, especially when everyone’s making money? For that reason, we all might be left hoping for nothing more than better luck next time.

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