Wall Street tamed

America’s financial firms often acted as engines of instability during past bull markets. Banks unleashed lending binges that fueled economic growth and increased stock prices. But when borrowers defaulted, banks pulled back sharply, making economic slowdowns and stock market crashes all the more severe. The financial excesses of the five-year bull-run that ended in 2007 illustrate the central role banks can play in creating conditions for a bust.

After 2008, the Federal Reserve and Congress required changes — like safer balance sheets and lending practices — that largely stopped banks from acting in such a destabilizing manner. In the years since the financial crisis, banks have continued to lend to individuals and companies as well as raise money in the markets for their clients. And they have remained profitable. In the first quarter of this year, banks’ profits were equivalent to 1.28 percent of their assets, which is significantly higher than the 1.03 percent median return since the mid-1980s, according to data from the Federal Deposit Insurance Corp.

What could go wrong? The banks are lobbying to loosen many of the post-crisis rules. Gradually, regulators and investors could forget the lessons learned in tough times.

The Fed got it right

Many investors feared that stock prices were being artificially supported by the Fed’s extraordinary post-crisis monetary policies, like its enormous bond-buying programs. There were two main concerns: First, the policies might cause inflation to take off; second, once the Fed withdrew support, it could set off chain reactions that would cause the economy to slow and the stock market to fall. Neither has come to pass, at least so far.

The Fed’s policies may not have been as loose as they appeared. On a nominal basis, interest rates were indeed cut to historical lows. But what mattered is whether they were low after adjusting for inflation. It appears corporate borrowers did not get a huge break from the Fed: During the latest bull market, the yield on corporate bonds rated BAA by Moody’s (a good and historical proxy for average corporate borrowers) was 3.7 percent on average, after adjusting for inflation. That compares with an average of 4 percent since 1950.