Banking and Finance Law Daily Wrap Up, FEDERAL RESERVE SYSTEM—Fed’s Barr warns against weakening regulations and repeating past mistakes, (Jul 17, 2025)

By A. Bryan Gerepka

Weakening regulation often drives risk-taking and increases bank fragility during the boom, making the ensuing bust more painful.

Regulators should approach the financial system with a through the cycle perspective and avoid thinking “this time is different”, resist the pressure to ease regulations during boom times, and ensure that regulations adjust to meet the needs of an evolving financial sector. Those views were expressed by Federal Reserve Board Governor Michael S. Barr, in a July 16, 2025, speech to the Brookings Institution. In his speech—Booms and Busts and the Regulatory Cycle—Barr highlighted the relationship between regulatory weakening and economic and financial cycle of booms and busts, and how regulatory failures contributed to the 1929 Great Depression, the Savings and Loan (S&L) Crisis in the 1980s, and the 2008 Global Financial Crisis.

“In each of the booms I have covered, there was a heady confidence that market discipline would control risk-taking, that downside risks were so implausible as not to merit attention, and that easing regulation was justified,” Barr said. “With such confidence, insufficient thought was given to how regulatory weakening might create new vulnerabilities,” he added. While Barr conceded that regulations cannot remain static, he cautioned that an effective regulatory framework should be balanced between encouraging economic growth while having appropriate protections in place to reduce the risks and costs of the resulting busts. In principle, Barr stated, financial regulation should incentivize banks to engage in responsible risk-taking and “build up resources in good times, so that they can deal with times of financial stress and continue their vital role in the economy in bad times.”

Regulatory Weakening Lessons from the Past. Regulatory weakening can take two forms: regulators fail to keep pace with a rapidly evolving financial system and deliberate actions to lower regulatory burden that ends up miscalculating the risk involved. The 1920s and the resulting Great Depression highlighted regulators’ failure to keep up with the financializaton of the markets. The Roaring 20s were characterized by high levels of risk taking both inside and outside the banking sector. At the same time, many banks were relatively thinly capitalized, leading to a cascading series of bank failures across the country. Notably, banks in states that had more robust regulatory frameworks—for example, those that applied higher capital requirements—had lower rates of failure, Barr observed.

In contrast to the Great Depression, affirmative deregulation led to excessive risk-taking by S&Ls, as well as banks, during a boom period, Barr stated. As circumstances soured, revealing weaknesses, Congress attempted to bolster the S&L sector by further loosening the regulatory framework. This failed to resolve the underlying stress and instead further fueled the buildup in risk-taking, worsening the losses in the subsequent bust, Barr noted. In this case, regulatory weakening propped up failing institutions, allowing “zombie institutions to persist, accumulating much greater losses than they otherwise would have”, he observed. The cost to resolve the S&L crisis totaled nearly $160 billion.

In the decade leading up to the 2008 Global financial crisis, America experienced rapid credit growth and a housing boom, led by optimism about the benefits of financial innovation, such as securitization of home loans, and belief in the power of market discipline as a form of self-regulation. Barr noted that home prices and mortgage debt accelerated in tandem, driven by a mutually reinforcing cycle of optimism, with home prices roughly doubling between 1997 and 2006, and even larger increases in mortgage debt. Amid this boom, lending standards dropped, driven by investor demand for complex high yielding securities, such as mortgage-backed securities and Over-the-Counter (OTC) derivatives.

The regulatory environment failed to keep up with these changes in activity and the increasing complexity of financial institutions and markets, Barr noted. And regulatory weakening heightened vulnerabilities. He cited legislation such as the Gramm-Leach-Bliley Act in 1999 and the Commodities Future Modernization Act of 2000 that allowed banks to invest in diverse financial products and businesses, but failed to envision and implement appropriate regulatory frameworks commensurate with the full range of risks related to those activities.

Weakening regulation often drives risk-taking and increases bank fragility during the boom, making the ensuing bust more painful, he added. “It is well within our ability, and is our duty as regulators, to learn from these episodes to avoid making the same mistakes. In doing so, we can help to ensure that the financial system is prepared to weather downturns and continue to serve households and businesses,” Barr concluded.

RegulatoryActivity: FederalReserveSystem FinancialStability PrudentialRegulation