The US economy has no brakes

Without macroprudential enforcement like CCyB, debt-fueled booms magnify busts, and crises remain an inevitable feature of a lightly constrained, market-based financial system.

To prevent excessive leveraging, regulators impose capital and liquidity requirements, forcing banks to reserve equity for each new loan. By constraining bank leverage, regulators also indirectly constrain the leverage of households and businesses, mitigating the risk of credit-fueled booms and collapses.

Countercyclical Capital Buffers (CCyB), designed to curb credit booms, were never activated in the U.S. during the 2010s, despite rapid household and corporate debt growth.

Many European countries also delayed CCyB activation, whereas Sweden, Norway, and the UK actively used buffers to prepare for downturns. This inaction left the U.S. economy without preventive capital cushions, forcing reliance on emergency Federal Reserve liquidity during COVID‑19.

1. The Challenge of Leveraging in Market-Based Financial Systems

While banking regulation can limit traditional credit expansion, constraining leverage is much harder in market-based financial systems like that of the United States:

1. Rise of non-bank financial intermediaries (NBFIs)

   • Nonbanks, such as money market funds, hedge funds, and mortgage companies, facilitate credit through securitization rather than deposits.

   • Banks transform short-term deposits into long-term loans, while nonbanks transform short-term securities into long-term securities—a form of maturity transformation that mimics bank risks but faces looser oversight (Pozsar et al., 2013).

2. Securitization without balance sheet risk

   • Financial agencies can originate and distribute loans without holding them.

   • For instance, U.S. mortgage originators can package and sell loans as mortgage-backed securities (MBS) without reserving significant capital.

   • This allows virtually unlimited credit creation without triggering regulatory brakes, amplifying systemic leverage.

     
     

2. Post-2008 Regulation and Its Gaps

After the Global Financial Crisis of 2008, Basel III introduced:

• Higher capital ratios and leverage limits

• Liquidity Coverage Ratios (LCR) and Net Stable Funding Ratios (NSFR) for banks

• Countercyclical Capital Buffers (CCyB) to curb procyclical credit growth

However, nonbanks remained largely outside Basel’s direct scope, unless designated as Systemically Important Financial Institutions (SIFIs).

• The Financial Stability Oversight Council (FSOC) initially designated several large insurers and finance companies as SIFIs.

• Yet by October 2017, all three nonbank SIFI designations were rescinded, reflecting political and industry pushback (FSOC, 2017).

• Consequently, nonbank credit creation has grown faster than traditional banking, accounting for nearly 50% of global financial assets by 2021 (Financial Stability Board, 2022).

  
  

3. The Missing Brake: CCyB Inaction in the U.S. and Beyond

The Countercyclical Capital Buffer (CCyB) is designed to force banks to build extra capital during credit booms, releasing it during downturns. Yet many economies have failed to activate this critical brake, leaving systems exposed:

• United States:

  • CCyB remained at 0% throughout 2013–2019, despite rapid credit expansion and record household debt.

  • No capital cushion was built to absorb shocks, leaving banks reliant solely on emergency liquidity during COVID‑19 (MyRepublica).

• Euro Area Examples:

  • Germany, Spain, and Italy delayed CCyB activation until 2019, and buffers were minimal (0.25–0.5%) before being rescinded as COVID‑19 struck (ECB Macroprudential Bulletin).

• In contrast, proactive countries like Sweden (2.5%), Norway (2.5%), and the UK (~1%) used CCyB to cool housing booms and build resilience, leaving them better prepared for shocks (Norges Bank).

Implications of CCyB Inaction

Consequence	Implication
Credit booms with no CCyB	Higher systemic vulnerability during downturns
No buffer to release in crisis	Banks tighten lending sharply to protect equity
Prolonged procyclical cycles	Debt-fueled expansions magnify future recessions
Political reluctance to act	Tools exist but remain unused in good times

By not raising CCyB, the U.S. and many peers entered COVID‑19 with no prebuilt capital cushion, leaving the system dependent on emergency Fed interventions rather than preventive measures.

4. COVID‑19: A System Without Brakes Meets a Shock

The COVID‑19 pandemic exposed the fragility of this unbuffered financial system:

1. Liquidity Crisis

   • March 2020 saw a dash for cash, with fire sales of Treasuries, corporate bonds, and MBS.

   • The Federal Reserve intervened aggressively, backstopping Treasury, corporate, municipal, and even ETF markets to prevent systemic collapse (Federal Reserve, 2020).

2. Solvency Crisis Lag

   • While liquidity crises can be papered over, solvency crises emerge when borrowers’ incomes collapse.

   • In 2020, U.S. GDP contracted 3.4%, and unemployment peaked at 14.8%, the highest since the Great Depression (BLS, 2020; BEA, 2021).

   • High leverage meant that even modest income drops could trigger waves of defaults.

3. Credit Contraction Feedback Loop

   • Rising delinquencies prompt banks to tighten credit, which reduces consumption and investment, amplifying the downturn—classic debt-deflation dynamics (Fisher, 1933).

     
     

5. Conclusion: A System Primed for Procyclical Crises

The U.S. economy “has no brakes” because its credit system is faster than its regulatory response:

• Banking regulation slows traditional leverage, but nonbank markets remain largely unrestrained.

• CCyB inaction during the 2010s left the system without preventive buffers, forcing reactive bailouts in 2020.

• Liquidity interventions can delay crises but cannot resolve solvency risks in over-leveraged economies.

Without consistent macroprudential enforcement, the cycle of booms and busts remains an embedded feature of the U.S. and other lightly buffered economies.

References

McLeay, M., Radia, A., & Thomas, R. (2014). Money creation in the modern economy.Bank of England Quarterly Bulletin, Q1 2014.https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/money-creation-in-the-modern-economy

Pozsar, Z., Adrian, T., Ashcraft, A., & Boesky, H. (2013). Shadow Banking.Federal Reserve Bank of New York Staff Report No. 458.https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr458.pdf

FSOC (2017). Rescission of Nonbank SIFI Designations.https://home.treasury.gov/policy-issues/financial-markets-financial-institutions-and-fiscal-service/fsoc

Financial Stability Board (2022). Global Monitoring Report on Non-Bank Financial Intermediation 2022.https://www.fsb.org/2022/12/global-monitoring-report-on-non-bank-financial-intermediation-2022/

Federal Reserve (2020). Federal Reserve announces extensive new measures to support the economy.https://www.federalreserve.gov/newsevents/pressreleases/monetary20200323b.htm

Bureau of Labor Statistics (2020). Unemployment rate rises to 14.8% in April 2020.https://www.bls.gov/opub/ted/2020/unemployment-rate-rises-to-record-high-14-point-8-percent-in-april-2020.htm

Bureau of Economic Analysis (2021). U.S. GDP decreased 3.4 percent in 2020.https://www.bea.gov/news/2021/gross-domestic-product-2020

ECB (2018). Macroprudential Bulletin – Annex on CCyB implementation.https://www.ecb.europa.eu/press/financial-stability-publications/macroprudential-bulletin/html/ecb.mpbu_annex201810.en.html

Norges Bank (2023). Countercyclical capital buffer.https://www.norges-bank.no/en/topics/financial-stability/macroprudential-supervision/Countercyclical-capital-buffer/

Fisher, I. (1933). The Debt-Deflation Theory of Great Depressions. Econometrica, 1(4), 337–357.