This post will address the ways in which the coronavirus crash is different from the 2008 financial crisis and why these differences matter. The most apparent difference is that the coronavirus crash has been largely self-inflicted while the 2008 crisis was characterized by a downturn in real estate markets. Moreover, the 2008 crisis was particular to the U.S. (though the cascading effects were felt globally). This is the first time in history that we’ve witnessed a global shutdown of the economy at scale and all countries have essentially opted in to this shutdown of the economy via public health policy decisions. To put it simply – the economic crisis has been subordinate to the public health crisis and this is unprecedented.
2008 In Perspective
As mentioned above, in 2008 we witnessed the impact of financial uncertainty resulting from a downturn in real estate markets. The primary cause of this downturn can be attributed to the subprime mortgage funding markets. When borrowers were no longer able to afford their subprime mortgages, the balance sheets of major banks collapsed. This was compounded by the excessive use of leverage, which resulted in a chain of defaults throughout the financial sector. This was an unprecedented financial shock at the time and it resulted in the contraction of economic activity. Between 2008 and 2009 we saw more than 750,000 job losses per month. This is resulted in a total of 8.7 million job losses over the course of the entire recession.
Major American companies ran the risk of going bankrupt and the ramifications in the global economy were profound, leading to the largest contraction in international trade recorded at the time. The crisis required significant government intervention in terms of monetary and fiscal policy to avert a prolonged recession. Interest rates were slashed, we witnessed the introduction of quantitative easing, and the Troubled Asset Relief Program (TARP) was implemented to remove toxic asset from bank balance sheets. As a result of this unprecedented effort, an economic recovery began in the back half of 2009. Ultimately, the 2008 financial crisis is a story about, as Steve Eisman puts it, “leverage being mistaken for genius.”
The Coronavirus Crash Thus Far
It’s still too early in the game to predict with any level of certainty what the ramifications of this economic downturn will be, but a recession certainly feels inevitable. The prior crisis was particular to banking institutions and decisions they had made; the current crisis is embedded in the real economy as we are deliberately shutting down the world’s major economies for a period of at least several months – perhaps longer. This deliberate action has, in my opinion, exposed a significant flaw in our financial system. Similar to 2008, it is apparent that leverage has once again been mistaken for genius. This time, however, it isn’t the banks that are over leveraged – it’s the corporate sector. The decision to shut down the U.S. economy has resulted in a liquidity crisis for several large firms, most notably in the airline industry. Moreover, the reason many of these firms lack the liquidity to weather the shutdown is because they have spent significant amounts of their earnings on stock buybacks and the results have been catastrophic.
As of March 24, 2020 there has been ~6.6 million unemployment claims filed. This is rapidly approaching the total amount of job losses we saw in 2017. This has again lead to unprecedented actions taken in the spheres of monetary and fiscal policy. The Fed, in addition to cutting interest rates down to zero, have an enacted a policy many are referring to as “QE infinity” as there appears to be no end in sight to the amount of money they will deploy in the economy during this crisis. As it relates to fiscal policy, last week we saw the passage of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. This is a truly historic stimulus package totaling $2TN that includes economic stimulus for individuals, small business owners, non-profit organizations, and large corporate employers. Additionally, the act prohibits the use of stock buybacks for any publicly traded company that accepts proceeds from the stimulus package.
The market’s reaction to the radical new monetary and fiscal policies has been relatively stable (i.e. sell offs slow down and individuals begin purchasing stocks again), but the market is still highly volatile and susceptible to shocks. Until a solution is provided to the public health concern the market will remain unpredictable, and it is still unclear how the economy will recover once the shutdown comes to an end. However, one thing is for certain – this crisis has fundamentally altered the way we conceive of markets and the use of leverage. It will be interesting to see what comes into play after the dust settles.
As always, thank you for taking the time to consider my perspective. If you found this content valuable, please remember to like, subscribe, and share it with others.