As threats of the coronavirus continue to rise and the financial markets plunge, it would only be a matter of time before the global economic downturns. Despite the actions by the World Bank Group, IMF, and the US fiscal monetary stimulus, the global economy might still suffer a few blows from the coronavirus impact on different nations’ economies. Like the US stock market, Asian and European stock markets have been trapped in a rollercoaster of price falls and rise. For developing countries and poor countries, their stock markets would be the least of their problems as containing the coronavirus and preventing it from spreading is more important—stabilizing societal health.
Many experts and analysts are pessimistic that unless a cure is found for the virus, no amount of money pumped into the economy would be enough. Hence, threats of a financial crisis continue to lurk around the corner of uncertainty. The last financial crisis, over a decade ago, was one that was caused by government and institutional “mistakes”—the subprime mortgage.
What Triggered the 2008 Financial Crisis?
What started out as a subprime mortgage “fail” eventually developed into a full-blown financial crisis, following the collapse of the Lehman Brothers on September 15, 2008. It wasn’t enough that subprime mortgages were granted to people who didn’t meet the requirement but banks also participated in this wild-goose-chase by further escalating this high-risk mortgage. The result of this led to the adoption of fiscal stimulus by the government to bailout big banks and financial institutions. It was, however, “too late” as the global economy began to react to the financial crisis in the US. The Asian markets were soon affected and volatile following the US subprime crisis while the crisis in the European banking system arose, especially among the European countries that use the euro—the European sovereign-debt crisis.
A report from the US Senate (the Levin-Coburn Report), indicated that the financial crisis was caused by “high risk, complex financial products; undisclosed conflicts of interest; the failure of regulators, the credit rating agencies, and the market itself to rein in the excesses of Wall Street.”
At the collapse of the crisis the Financial Crisis Inquiry Commission set up a committee to look into the matter to identify the major causes of the crisis and we learned that the financial crisis was totally avoidable and was triggered by “widespread failures in financial regulation and supervision … dramatic failures of corporate governance and risk management at many systemically important financial institutions… a combination of excessive borrowing, risky investments, and lack of transparency by financial institutions,” a “systemic breakdown in accountability and ethics… collapsing mortgage-lending standards and the mortgage securitization pipeline.” There was also the issue of “the failures of credit rating agencies” to accurately price risk.
A lot of blames were heaped on the government for not adjusting its financial regulatory practices to fit the 21st century, while credit rating agencies were accused of failing to properly price risk in mortgage-backed securities.
It so happened that many causes can be pointed out to be a cause of the financial crisis. It is, however, an undeniable fact that the subprime mortgage crisis was the starting point of every other cause. Prior to that, there was a large inflow of foreign funds into the US after aiding the Asian financial crisis and the Russian debt crisis (1997-1998). This inflow of foreign funds led to the easy availability of credit in the US and banks began to give out loans of all kinds including mortgage and credit card loans.
A housing and credit boom soon began in the early 2000s, and quite a few financial agreements categorized as collateralized debt obligations (CDO) and mortgage-backed securities (MBS) were on the increase, deriving their profits from housing prices and mortgage payments. This seemed like a really good investment opportunity and many investors in the US and around the world took advantage of it—only a little “too much” advantage. All seemed to go well and only a few people ever suspected the result to be a financial crisis.
It was only a matter of years before prices began to fall and homes decreased in values lower than the mortgage loans, thereby, providing borrowers with the financial incentive for foreclosure; continue to pay a loan with a negative net value home as collateral. Other loan types were soon impacted causing the crisis to expand beyond the housing market to other financial markets. The financial markets soon became increasingly fragile (financialization).
The Effects of the Financial Crisis
Since the 1930s, the 2008 financial crisis was the worst recession the US had experienced. The Lehman Brothers had to file for bankruptcy, JP Morgan Chase (NYSE: JPM) acquired Bear Stearns, Bank of America bought Merrill Lynch, and Freddie Mac and Fannie Mae were placed under the regulation of the US government. Following the collapse of the Lehman brothers, there was a wave of panic in the financial markets that many other big banks and large institutions may collapse. As a result of this, the government stepped in with a bailout solution, to support major institutions they considered “too big to fail”. Basically, because the collapse of certain institutions would create a ripple in the US economy and the global economy at large. The decision was taken after Hank Paulson, the secretary of the Treasury, together with Ben Bernanke, the chairman of the Federal Reserve, appealed to the lawmakers to mobilize a $700 billion bailout otherwise the financial system would completely collapse.
The bubble in the housing market which developed as a result of the subprime mortgage crisis. While the housing and mortgage policies in effect during that period encouraged a lot of homeownership by allowing people to take up subprime loans and making the process unrestricted and easier, housing prices quickly escalated. Thereby, overvaluing the worth of subprime mortgages as a result of investors and institutions thinking the prices of houses will continue to increase. Financial institutions, as well as banks, were not left out in this as they encouraged unregulated mass borrowing for subprime mortgage purposes.
The housing bubble reached its peak in late 2006 which led to the plunging of mortgage-backed securities and triggered a global financial crisis. Though the US economy rebounded, thanks to the fiscal stimulus the Obama administration and the purchase of numerous quantities of bonds—quantitative easing—by the government, stock markets still plunged globally. The housing market continued to suffer and eventually resulted in foreclosures, evictions, and unemployment.
The financial crisis also contributed greatly to the collapse of many potential businesses. There was also a great decline in consumer wealth which was estimated in trillions of US dollars.
Curbing the Crisis
In a bid to end the crisis and stabilize the economy, the government and central banks of many nations decided to support financial institutions with liquidity by setting the interbank market back on its feet. With this, the Federal Reserve slashed rates including the funds rate and discount rate. By late 2008, the feds slashed rates were between the range of 1% and 1.75%. Central banks of other major economies like China, Sweden, England, Switzerland, Canada, and the European Central Bank (ECB) all adopted the rate cut technique as a way of helping the global economy. Though rate cuts were insufficient in themselves to prevent a global financial meltdown.
Due to the limiting nature of the feds rate cut, the US government introduced the National Economic Stabilization Act of 2008, by which a large sum of $700 billion was set aside for the purchase of mortgage-backed securities and other “distressed assets.” This move was also adopted by different nations, and different bailout packages were created to fit the specifications of each country.
The aftermath of the 2008 financial crisis
However, not all the $700 billion was used to bailout businesses as the rest was diverted to a stimulus package. President Obama, in February 2009, authorized the American Recovery and Reinvestment Act which consisted of stimulus checks, public works spending, and tax cuts. When the stimulus package began to water down, the Fed boosted the economy again by buying large quantities of bonds; this they called the quantitative easing policy. This move brought the financial crisis to an end in July 2009, and by 2011, about $830 billion was put in the care of consumers and small businesses.
This, nonetheless, came with a price—a price US citizens had to pay dearly for. There were a lot of hardships as thousands of Americans lost their homes to mortgage foreclosures, and the unemployment rate increased to nearly 10%; though, nothing compared to the 1930s great depression. Adam Tooze, a Columbian economic historian is of the opinion that the consequences of the 2008 financial crisis still lingers to date, especially the political consequences. He states that the move to use taxpayers’ money to bailout “greedy and incompetent” financial institutions was strictly political, as well as the quantitative easing which worked in favor of boosting the prices of financial assets owned by the rich.
Tooze further writes in his narrative, Crashed: How a Decade of Financial Crises Changed the World, that in the years leading up to the 2008 financial crisis, the US lawmakers and experts were more concerned with the wrong global danger, that is, the value of the dollar would crash as a result of China reducing its huge holdings in the US Treasury bills; rather than focusing on the subprime mortgage crisis that was rocking the housing market and Wall Street. Bankers literally easily handed out millions of housing loans to borrowers and sold them off to investors in the form of mortgage-backed securities, thereby making overvaluing the housing market.
There are a lot of lessons to learn from the 2008 financial crisis especially that overlooked governmental and economic mistakes can spark a fire of in the “forest” of financial markets; creating a ripple in the global economy if not contained on time. All financial markets are interconnected and failure in a major market can lead to failure in so many other markets, and the restoration may last a long time.
The answer to this is not fully known as there are a lot of uncertainties surrounding the full implications the outbreak might have on the US economy and the global economy at large. Already, similar measures that were implemented to curb the 2008 financial crisis have been put in place such as feds rate cuts (which is now at zero), fiscal stimulus, and financial aids/supports from both the IMF and World Bank Group.
The Trump administration has also pledged to get money to American within the next two weeks by sending direct payments to US citizens. This move would not only encourage consumer spending but mitigate any possible financial impact of the virus. Stock markets would also remain open. In addition to that, the White House is also considering an economic stimulus ranging from $1 trillion to $1.2 trillion to fight further impact of the coronavirus on the economy. Though conscious efforts are being made towards stabilizing the economy amid the outbreak, many are still skeptical as no amount of pumping money into the economy will address the main issue.
The US government are trying at all cost to mitigate all economic threats while the major national and global threat is still on the increase. As regards financial and economic measures the government is putting into combating the outbreak, Peter Boockvar, chief investment officer at Bleakley Advisory Group in a comment said “this better work because I don’t know what they have left and no amount of money raining from the sky will cure this virus. Only time and medicine will.” He precisely captures the fact that “no amount of money… will cure the virus.”
There are chances of the global economy going into a financial crisis sooner or later, the uncertainty of when the pandemic would end only further intensifies the fear of the budding financial crisis. Also, citing the 2008 financial crisis the successes and failures of different economies are interconnected, yet dependent on the individual economies; their government’s ability to properly stabilize the economy in the aftermath of the pandemic. Developed economies like the US are more likely to bounce back shortly after the virus has been contained.