We examined multiple likely causal reasons that in combination exacerbated the 2008 crisis in the United States. Our analysis removed the “least important” variables and left us with four variables with high explanatory power – decline in home prices, a doubling in oil and higher energy prices, wealth destruction in equity markets and large reduction in credit availability. We do not see this combination of factors during 2020.
While governments will stand behind banks as the Coronacrisis unravels, most banks will be left in a weaker position when all this ends. Government will inevitably have to step in and rescue and restructure the financial sector if the crisis drags on and migrates from the real economy to the banking sector. In examining past instances, and the history of financial sector restructuring, I was particularly impressed (and summarize here), with the way France resolved its own crisis. An example was the Credit Lyonnais bailout.
The sub-prime crisis was the catalyst for the broader crisis which followed. It led to a breakdown of confidence in the banking system, and a subsequent lack of liquidity, with bank balance sheets placed under severe stress and deleveraging rapidly while government intervention was uncoordinated. In 2020 the banking system remains intact.
This week’s large banks stress tests by the Federal Reserve project losses in pronounced downturn at $700 billion. This scenario is likely in the event of a widespread and prolonged economic downturn.
Are we headed into one with attendant risks of a financial crisis? Looks unlikely. I examined financial crisis over the last 3 decades and was quite unable to come up with common root causes that trigger these events – necessitating different tools each time . Here is a visual I update that speaks to this.
The Wall Street Journal Fri, June 26, 2020 reports Federal Reserve writedown estimations after it conducts stress tests on leading banks. It orders banks to cap dividends and suspend share buy backs.
We contrast June, 2020 write down estimations with reconstructed numbers from October 2008 estimations. Federal Reserve stress tests June 2020 project large bank losses in pronounced downturn at $700 billion on soured loans and writedowns. In 2008 this loss was estimated at double the amount, suggesting that the global financial crisis was twice as severe as far as the banking sector is concerned.
The New York Times, Tue Jun 2, B3 ” Poor Countries Facing an Unparalleled Debt Crisis”
Once the dust settles, we expect the banks are going to get hit. 77 poor countries scheduled to make $62 billion payments on debts in 2020. While governments will stand behind banks as the Coronacrisis unravels, most banks will be left in a weaker position when this ends. I recommend that banks need to now begin to build capital (and cut balance sheets) from recent levels, take account of an expected increasing level of loan losses, not just from problems emerging to date but from risks of a possible “ credit crunch”, likely over the course of a developing economic down-turn. Here is one scenario how this may play out.
After today’s NextGenerationEU announcement I did a back of envelop calculation to contrast the already announced, and proposed stimulus, with the European outlay during 2008. The data shows that European Union 2020 coronacrisis stimulus is twice that it provided in 2008. Infact, it equals the entire global stimulus during 2008 Global Financial Crisis. Still too early to arrive at implications of this huge outlay.
Pandemic Emergency Purchase Program has envelope of €750 billion to buy government and corporate bonds. Complements big bank stimulus package. Eases collateral standards and removes self imposed restrictions on purchases. Next Generation EU of €750 billion as well as targeted reinforcements to the long-term EU budget for 2021-2027 will bring the total financial firepower of the EU budget to €1.85 trillion.This is near equal to the $2,000 billion stimulus provided across the world during the 2008 global financial crisis.
#ActiveAllocator Research- ‘Today, the European Commission has put forward its proposal for a major recovery plan. To ensure the recovery is sustainable, even, inclusive and fair for all Member States, the European Commission is proposing to create a new recovery instrument, Next Generation EU, embedded within a powerful, modern and revamped long-term EU budget. The Commission has also unveiled its adjusted Work Program for 2020, which will prioritize the actions needed to propel Europe’s recovery and resilience.’
We welcome this initiative and await details.
Lesser educated now most adversely affected and constitute the bulk unemployed. Only 7 percent of top quartile earning urbanites report losing employment, along with 5 percent of upper class, well-to-do people and just 4 percent of those with post-grad schooling. Wage disparity grows during coronacrisis.
Prudent government intervention to support a fragile banking system in 2008, is still vociferously attacked and characterized by many as a sell out to Wall Street greed. The CARES Act now provides US$2 Trillion relief to individuals, businesses, states and other actors. Yet, ostensibly because bulk proceeds go to Main Street participants, I don’t hear a single dissenting voice! As one who had a front row seat on Wall Street and helped shape response to the 2008 financial crisis, I find this rather hypocritical. A bailout by any other name is still a bailout, and I bet Milton Friedman would agree!
The amateur financial historian within me, led me to take inventory of major government interventions then – the major types of action taken, affected companies and governments rationale. I hope this sets the record straight so that we can compare it with the Cares Act. I hope you find this visual useful.
Russia so far has been spared rising Coronavirus infections, but that seems to be changing today with 1,836 cases reported and nine deaths. Which begs the question why have Russia and other Eastern European countries not announced plans for economic stimulus to the imminent fallout? One reason may be that sanctions have insulated Russia from global markets, unlike in 2008 where its banks were deeply entangled with the Western banking system. At that time Russia and Eastern Europe made decisive proactive interventions. This led to banking systems recovery providing the strength to fulfill their role in the economy: that of providing funding to individuals and business.
While recognizing that this crisis is nothing similar, I still think it useful to calibrate the government response at that time to provide a sense of scale – captured in this visual.
Now that the $2 trillion coronavirus relief package has passed 96-0 in the United States Senate I am confident it will soon get through the House. The proposal includes $500 billion in loans for larger industries. I did read somewhere that one out of every five companies now is a zombie company – the walking dead, that earns just enough money to continue operating and service debt, but is unable to pay off their debt. The planned $500 billion Treasury Department fund would be subject to scrutiny via public reporting of transactions, as well as a new dedicated watchdog and accountability committee. The package won’t likely help them and I expect a rise in bankruptcies.
Here are Ten Commandments that responsible CEO/ CFOs and corporate boards may benefit from.
What will happen in 2021? While governments will stand behind banks as the Coronacrisis unravels, most banks will be left in a weaker position when all this ends. Ultimately, only governments will provide the multi-stakeholder leadership, the trust and the huge balance sheet to back banks. I recommend that banks need to now begin to build capital (and cut balance sheets) from recent levels, take account of an expected increasing level of loan losses, not just from problems emerging to date but from risks of a possible “ credit crunch”, likely over the course of a developing economic down-turn.
Historically, governments have used a variety of tools to address financial crisis and recessions with policies of either containment or resolution. For example, in 2008, government intervention moved from the provision of short-term liquidity, through distressed asset funds to medium-term guarantees to full-scale bank capital injections, nationalization and brokered rescues. Whilst the banking system seems secure in the coronacrisis, I think it is inevitable that governments will borrow from previous playbooks.
I surveyed the literature on government response to previous crisis and identified three recurring responses, likely applicable in 2020 too. These being, restoring functioning markets when and if impaired, expansionary monetary policy to catalyze economic and expansion in fiscal policy to support private sector spending slowdown. We present this in a visual, highlighting recent response in 2008 for color.
Pandemic Emergency Purchase Program will have an overall envelope of €750 billion and will buy government and corporate bonds. Complements big bank stimulus package. Eases collateral standards and removes self imposed restrictions on purchases. Details awaited. Measures surpass 2008 crisis response as described below.
That we are very likely in a recession already, awaiting NBER decision, is a given. Whether this will lead to a full blown financial crisis is the real question. Since no two financial crisis are alike I examined the previous 3 recessions to tease leading signals. While not a scientific study, perhaps biased with sampling error and some data mining, I note 4 common characteristics that we should keep an eye out for : (I) poor equity market performance, (II) elevated volatility, (III) a decline in commodity prices and (IV) increased short-term bank funding and long-term capital costs.
Chancellor Rishi Sunak in the #UK is soon going to reveal additional details on a massive corona economic stimulus package – around £350 bn. It will include £330 bn of business loan guarantees. Includes aid to cover a business rates holiday and grants for retailers and pubs. Help for airlines is being considered. Provides increased access to government-backed loan or credit on attractive terms. Mortgage lenders will offer a three-month mortgage holiday. This is taking shape right now (3/18/2020, 10 AM EST). I visited the actions UK government took in 2008 and find those to be very comparable in size and boldness. Here is a visual of actions taken in 2008 by way of quick contrast.
As one who experienced the 2008 crisis first hand on Wall Street, as both front row observer and participant, I been reflecting: It was very different from what’s happening now. It was a banking crisis that unfolded slowly over a year. Interest rates were high and the Fed had a lot of latitude to act, and it did so decisively. The government response too was purposive, proactive and coordinated with policies of either containment or resolution. Government intervention also moved from the provision of short-term liquidity, through distressed asset funds to medium-term guarantees to full-scale bank capital injections, Nationalization and brokered rescues. For those of us who may have forgotten that horrid year, I present the sequence of events as they unfolded, in this visual.
The role of the state has been enhanced by recent events – only governments can provide leadership across multiple stakeholders, and strength of central banks balance sheet to ensure stability. In this crude visual I remind you that this crisis is very different from the one in 2007. Here is how ( I think )the previous crisis came about – spread from financial crisis to the real economy. This time it is the other way around. “History doesn’t repeat itself but it often rhymes”.