Why This Crisis Differs from the 2008 Version

Why This Crisis Differs from the 2008 Version

Here are four articles analyzing why the current crisis differs from 2008

There are a number of differences, but net, net

1.  Corporations and Businesses and Investors are flush with Cash.  Stimulus isn't needed.  Confidence is needed.

2.  We are dealing with an issue of confidence in Government


Why This Crisis Differs from the 2008 Version

WSJ Money & Investing Editor Francesco Guerrera looks at whether the current market spiral is similar to the situation in September 2008 that resulted in the collapse of Lehman Brothers.
It is a parallel that is seducing Wall Street bankers and investors: 2011 as a repeat of 2008, the history of financial turmoil playing in one endless loop.
As a big fund manager muttered darkly this past weekend while heading into the office to prepare for a tumultuous Monday, "The sense of déjà vu is almost sickening."
Those who think of 2011 as "2008—The Sequel" now have their very own "Lehman moment." Just substitute Friday's historic downgrade of the U.S. credit rating by Standard & Poor's for the collapse of the investment bank in September 2008, et voilà, you have a carbon copy of an event that made the unthinkable happen and spooked markets around the globe.
They got the last part right. Investors looked decidedly spooked on Monday with Asian and European bourses down sharply and the Dow tumbling 643.76 points, or more than 5%.
But market turbulence alone isn't enough to prove that history repeats itself.
To borrow a phrase often used to rationalize investment bubbles, this time is different, and the bankers, investors and corporate executives who look at today's problems through the prism of 2008 risk misjudging the issues confronting the global economy.
There are three fundamental differences between the financial crisis of three years ago and today's events.
Starting from the most obvious: The two crises had completely different origins.
The older one spread from the bottom up. It began among over-optimistic home buyers, rose through the Wall Street securitization machine, with more than a little help from credit-rating firms, and ended up infecting the global economy. It was the financial sector's breakdown that caused the recession.
The current predicament, by contrast, is a top-down affair. Governments around the world, unable to stimulate their economies and get their houses in order, have gradually lost the trust of the business and financial communities.
That, in turn, has caused a sharp reduction in private sector spending and investing, causing a vicious circle that leads to high unemployment and sluggish growth. Markets and banks, in this case, are victims, not perpetrators.
The second difference is perhaps the most important: Financial companies and households had feasted on cheap credit in the run-up to 2007-2008.
When the bubble burst, the resulting crash diet of deleveraging caused a massive recessionary shock.
This time around, the problem is the opposite. The economic doldrums are prompting companies and individuals to stash their cash away and steer clear of debt, resulting in anemic consumption and investment growth.
The final distinction is a direct consequence of the first two. Given its genesis, the 2008 financial catastrophe had a simple, if painful, solution: Governments had to step in to provide liquidity in droves through low interest rates, bank bailouts and injections of cash into the economy.
A Federal Reserve official at the time called it "shock and awe." Another summed it up thus: "We will backstop everything."
The policy didn't come cheap as governments world-wide poured around $1 trillion into the system. Nor was it fair to the tax-paying citizens who had to pick up the tab for other people's sins. But it eventually succeeded in avoiding a global Depression.
Today, such a response isn't on the menu. The present strains aren't caused by a lack of liquidity—U.S. companies, for one, are sitting on record cash piles—or too much leverage. Both corporate and personal balance sheets are no longer bloated with debt.
The real issue is a chronic lack of confidence by financial actors in one another and their governments' ability to kick-start economic growth.
If you need any proof of that, just look at the problems in the "plumbing" of the financial system—from the "repo" market to interbank lending—or ask S&P or buyers of Italian and Spanish bonds, how confident they are that politicians will sort out this mess.
The peculiar nature of this crisis means that reaching for the weapons used in the last one just won't work.
Consider Wall Street's current clamor for intervention by the monetary authorities—be it in the form of more liquidity injections (or "QE3") by the Fed or the European Central Bank.
So 2008.
Even if the central banks were inclined that way, pumping more money into an economy already flush with cash would provide little solace. These days, large companies are frowning all the way to the bank, depositing excess funds in safe-but-idle accounts, as shown by Bank of New York's unprecedented move last week to charge companies to park their cash in its vaults.
As for jittery investors, a few more billions minted by Uncle Sam or his Frankfurt cousin are unlikely to be enough to persuade them to jump back into the market.
In 2011, the financial world can't go cap in hand to the political capitals, hoping for a handout. To get out of the current impasse, markets will have to rely on their inner strength or wait for politicians to take radical measures to spur economic growth.
A market-led solution isn't impossible. At some point prices of assets will become so cheap that they will reawaken the "animal spirits" of both investors and companies.
As Warren Buffett once wrote to his shareholders, "we have usually made our best purchases when apprehensions about some macro event were at a peak".
The alternative is to hope that politicians in the U.S and Europe will introduce the fiscal and labor reforms needed to reawaken demand and investment growth. But that is bound to take time.
As often, the past looks a lot simpler than the present. But the reality is that, unlike 2008, governments' money is no good in today's stressed environment.
—Francesco Guerrera is the editor of the Wall Street Journal's Money & Investing section.


Echoes of 2008 crisis met with dull bailout tools

Tue Aug 9, 2011 6:55pm EDT
* Dodd-Frank limits ability to help individual firms
* Still skepticism "too big to fail" is over

By Dave Clarke
WASHINGTON, Aug 9 (Reuters) - Extreme market volatility has sparked comparisons to the 2008 global credit crisis, but Washington's ability to help out weak financial firms is dramatically different.
The 2010 Dodd-Frank financial oversight law purposefully limits regulators' ability to prop up firms caught in the cross-hairs of a market crisis of confidence.
The idea, meanwhile, that Congress would approve any special assistance is remote, with both liberals and conservatives still holding their noses from the public stink raised by bank bailouts during the financial crisis.
"I think it's unimaginable," said Phillip Swagel, who served in the Treasury Department under President George W. Bush.
Markets' fear factor has been sky high recently as worries about the global economy escalate after an embarrassing downgrade of U.S. debt. In addition, fears remain that European efforts to put a safety net under heavily indebted Italy and Spain might not suffice to avert wider credit market disruptions.
U.S. bank shares have fallen by almost 20 percent from an early July peak, as measured by the KBW Bank Index .BKX. Bank of America Corp (BAC.N), in particular, has taken a hit, falling by about 31 percent over that time frame.
Bank stocks did rebound on Tuesday with the KBW index closing up 7 percent, but questions remain about the ability of banks to deal with their mortgage exposures and what might happen if market volatility evolves into a credit crisis.
Dodd-Frank restrains regulators from aiding individual firms, and instead pushes the government to seize and liquidate in an orderly fashion a large, failing financial firm.
For instance, it ends the Fed's ability to extend emergency loans under its so-called "13(3)" powers.
It also prevents the Federal Deposit Insurance Corp from providing "open bank" assistance directly to an individual institution, as it did for Citigroup Inc (C.N) in November 2008, to help keep it in business.
Regardless of the restrictions the law places on banking agencies, several analysts and industry lawyers said the creativity of regulators should not be underestimated if they decide quick action is needed.
"I would bet that regulators would figure out what to do and find a way to do it," said Thomas Vartanian, a bank regulatory attorney with Dechert in Washington.
The law, for instance, does allow both the Fed and the FDIC to create programs intended to deal with liquidity problems that would be considered financial industry-wide.
Several analysts said it is unclear how this would work in practice. But they said regulators might have some wiggle room that could allow them to help one or only a few banks without violating the law.
Despite the troubles facing bank stocks, there is little evidence right now that any large institution is at a stage where the need for a bailout needs to be considered, experts said.
"I think we're very far away from that being an issue, our big banks are in much better shape today," Swagel said.
The issue for banks will be if worries over their health leads to problems raising funds, analysts said.
If this were to occur, banks could fend off troubles for a while by borrowing from the Fed through its discount window.
"If someone needs liquidity in the short run, they go to the Fed," said Ernest Patrikis, a partner at law firm White & Case and a former general counsel at the New York Fed. "I don't know why in this market a bank could not get liquidity." (Editing by Andre Grenon)


Why this debt crisis is different

This recovery is unfolding like no other in recent memory.
Government debt has brought the world to the edge of a brand new financial crisis, in a stark reminder that the biggest economies of the world are only three years past a major financial system failure. The financial crisis and ensuing recession saddled many governments with an unprecedented level of debt, as they spend money to fix insolvent banks, soften the blow for millions of unemployed and try to stimulate growth.
Other debt crises over the past three decades have typically involved smaller countries, including Canada in the early-to-mid-1990s, that were able to lean on the larger economies of the world to drive growth while they took steps to clean up their own books.
But unlike earlier predicaments, this one is not borne of a normal, cyclical recession, where the economy expands and then contracts when supply exceeds demand and business inventories get too high.
Rather, the U.S. and Europe – still by far the world’s two most important economic blocs – are mired in a so-called balance-sheet recession, where the combination of too much debt and too little confidence suppresses demand for a long period of time. These kinds of recessions are much harder to pull out of, as Japan has discovered since its real-estate crash two decades ago.
That has left policy makers in the United States and Europe trying to dig themselves out of debt while stimulating their economies with a dearth of tools.
Now, investors are waking up to just how intractable this type of economic crisis can be.
“The pity of it is that there’s no easy fix,” said Robert Kessler of Kessler & Associates. “They could say everyone will have to tighten their belts and change their lifestyle; and once [public] debts are paid down, you’re going to have a better country. Okay, so call me in 10 years.”
The description of the balance-sheet recession was popularized by influential Japanese economist Richard Koo when Japan ran into a similar situation. Corporations and consumers follow a credit binge by focusing on reducing their debt, which can take a decade or more to work out.
Banks sit on their money, borrowing dries up and demand shrinks, leaving public-sector spending as the only alternative. In Japan, heavy deficit-spending in the 1990s prevented a full-blown depression that could have seen the Japanese economy shrink by as much as 50 per cent. But Mr. Koo has argued the government made a critical error by attacking its deficit in 1997 and again in 2001, prolonging the slump.
The whole concept of a credit recession is deleveraging. When governments withdraw stimulus, as is now occurring in the U.S., Europe and elsewhere, it makes the problem worse, as Mr. Koo notes. Coming out of an ordinary recession, consumer spending picks up, as does corporate investment. Production expands to meet growing or prospective increases in demand and job growth occurs. Governments can withdraw stimulus in the knowledge that business will take over the reins of economic expansion.
But in a balance-sheet or credit recession, businesses continue to retrench, even when capital is plentiful and cheap.
Canadian investor Stephen Jarislowsky has described a balance-sheet recession as fundamentally different than a cyclical recession. “A balance-sheet recession is where you have a big bubble, and everybody and his brother has to de-lever in order to become really solvent again. By that, I mean they have to get debt off their balance sheet.
“The more everybody [reduces debt], the deeper the recession becomes, unless it’s counteracted by fiscal spending.”
When Canada and Sweden faced significant debt worries in the early 1990s, both countries were able to count on the growing world economy – fuelled by U.S. expansion and a rapidly growing technology sector – to give themselves momentum. In Canada’s case, deep spending cuts undertaken by Ottawa, along with the introduction of the Goods and Services Tax in 1991, helped pay down debt and return the government to surplus much faster than had been anticipated.
“Canada was definitely better positioned to deal with its deficit situation in the ’90s, [for] three reasons: We did have a strong U.S. growth performance to lean on, our deficit was significantly smaller as a share of GDP, and much of the deficit was due to outsized interest costs,” said Douglas Porter, deputy chief economist at the Bank of Montreal.
“There’s next to no room for that now in the U.S. – it will require very real restraint for and extended period of time. Given the political climate, not to mention the high starting point for U.S. unemployment, that looks like a very tall order indeed.”


Why 2011 Is Different From 2007

On August 9, 2007, BNP Paribas suspended redemptions on three money-market funds, triggering a chain of events that led just over a year later to the collapse of Lehman Brothers. On the fourth anniversary of that event, markets are once again highly volatile. But this time, there is far less leverage and complexity in the financial system, making a full-blown repeat of the forced selling that made the 2007-2008 crisis so toxic less likely.
Many of the highly leveraged vehicles that caused such havoc last time have disappeared. Structured investment vehicles, which peaked at $400 billion in mid-2007, had disposed of 95% of their assets by mid-2009, according to Fitch Ratings. Average leverage in the $2 trillion hedge-fund industry is now just 1.1 times, according to Hedge Fund Research. Banks are better capitalized; average leverage ratios have halved from around 30 to below 15.
There are also fewer complex and illiquid securities stuffed into hedge-fund portfolios. In 2007 many funds were dabbling in structured credit and bank loans that proved hard to value when they were forced to simultaneously sell assets to meet redemption requests. Now, an estimated 60% of portfolios could be liquidated within five days, according to a Financial Services Authority market survey of roughly one fifth of the industry by assets.
Nor is the hedge-fund industry yet suffering the same widespread margin calls that hit during the last crisis, according to a London-based prime broker. The average fund was up 1.55% in the year to July, according to Hedge Fund Research. Even after the past two days of turmoil, the average long/short fund is likely down by no more than 6% to 10% for the year, while many global macro funds have turned positive, said the broker.
Less liquidity risk doesn't detract from the severity of the current correction, with many stock markets now down at least 20% corrections from 2011 peaks. Nor does it make light of the fears over the credit risk now embedded in sovereign debt. But it should mean more investors can hold on for longer if they choose.

Brophy Tuesday 09 August 2011 - 8:27 pm | | Brophy Blog

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