Combine a more resilient financial sector with a more robust regulatory regime, and we think there’s a much lower probability that banks will cause or accelerate a wider crisis. Banks aren’t the only ones who’ve tightened their belts: other sectors have made strides in reducing their debt burdens, most notably households—primarily in the form of mortgage borrowing.
The federal government is the obvious exception—federal debt is up by a whopping 80%. But federal borrowing has a vastly different risk profile than other borrowers in the US economy. Unlike any other borrowers, the US Treasury can’t go bankrupt and, barring a debt-ceiling accident, can’t default. That makes government borrowing far less likely to trigger a broader crisis than private sector borrowing.
15 Years of Deleveraging Has Improved Resilience
Past history suggests that markets should always be on the lookout for pockets of excess leverage that may be revealed by interest-rate hikes, but we think the odds of that sort of crisis are much lower now than in past episodes. Prior rate hikes have come on the heels of significant run-ups in debt/GDP across sectors; the current cycle comes on the heels of nearly 15 years of deleveraging.
None of this means a crisis is out of the question, but in our view, a less vulnerable system means that there’s less likelihood of the system breaking. We’ve seen one stress test play out favorably already: the collapse of crypto assets might have had much wider consequences if other economic actors were exposed to crypto in a levered way. That the damage didn’t spread further is a real-time example that today’s financial system is better fortified.