No Financial Crisis in Our Lifetime? Think Again
Not too long ago, the U.S. Federal Reserve Chair Janet Yellen made a remark about financial crises that shouldn’t be ignored.
At an event in London, Yellen said, “Would I say there will never, ever be another financial crisis?” She added, “You know probably that would be going too far but I do think we’re much safer and I hope that it will not be in our lifetimes and I don’t believe it will be.” (Source: “Fed’s Yellen expects no new financial crisis in ‘our lifetimes’,” Reuters, June 27, 2017.)
Advertisement
In short, Yellen believes there will not be another financial crisis in our lifetime.
Also Read:
“Economic Crash 2017” and How Next Financial Crisis Could Be Worse than 2008
If that’s how the Fed is thinking, what happens when there’s actually a financial crisis? Remember, the Federal Reserve denied several times that we had any financial crisis during the crisis of 2007–2009.
Four Phenomena That Could Lead to a Financial Crisis
With this said, there are a few events that could actually cause a financial crisis.
Pay attention to the derivatives market. It’s immense. At the end of the fourth quarter of 2016, the top 25 U.S. banks had derivatives with a notional value of $165.2 trillion. Mind you, a lot of these derivatives are based on interest rates. (Source: “Quarterly Report on Bank Trading and Derivatives Activities,” Office of the Comptroller of the Currency, last accessed June 30, 2017.)
As the Federal Reserve is raising rates, if just a small portion of these derivatives go bad, it could really have dire consequences. We could see bank failures. We could see a crisis as a result. To put things into perspective, the current U.S. gross domestic product (GDP) is roughly about $19.0 trillion. The top 25 U.S. banks collectively have about 8.6 times the U.S. GDP’s worth of notional derivatives.
Is the Federal Reserve watching this?
But derivatives are just one thing. The U.S. has a huge national debt, and it’s only expected to grow. Could this be a catalyst to a financial crisis? It is certainly possible.
What about a banking crisis outside of the United States? Not too long ago, two Italian banks had to to be bailed out. Over the past few years, we were told that the European debt crisis was under control. Could this spread into something big?
What if there’s a stock market crash? Could this cause a financial crisis? You see, valuations on the stock markets are very high relative to historical averages, and complacency among investors is extremely prevalent. Prior to almost every stock market crash, we have seen this happen.
What Could an Investor Do?
Dear reader, buying into the idea that there wouldn’t be a financial crisis anytime soon would be a deadly mistake. As it stands, there are already are few things that have the potential to cause havoc.
When I look at the comments like the one made by the Federal Reserve, I see it as nothing but a sign of complacency. Be very, very careful.
Remember, in good or bad times, capital preservation isn’t a bad idea. Always have stops in place and cash at hand. Know this: in the case of a financial crisis, capital preservation protects a portfolio from deep losses, and cash on hand helps.
