It feels eerily familiar: Stocks are plummeting. The economy is slowing. Politicians are scrambling to find solutions but are mired in disagreement.
Many Americans are wondering whether they are in for a repeat of the financial crisis of 2008.
The answer is a matter of fierce debate among economists and market experts. Many say the risks are lower today — at least in terms of an immediate crisis — because the financial system over all is healthier and there are fewer hidden problems. But the experts add that there are reasons to worry, and they do not rule out a quick downward spiral if politicians in the United States and in Europe cannot calm investors by addressing fundamental financial threats.
The core problem, as it was three years ago, is too much debt that borrowers are having a hard time repaying — but this time it is government debt rather than consumer debt.
“So far it’s not as bad as 2008, but it could get much worse because the sovereign debt concerns are much more global than the subprime mortgage risk of 2008,” said Darrell Duffie, a professor of finance at Stanford and an expert on the banking system.
A growing lack of confidence is perhaps the most troubling similarity to 2008 and the biggest worry. “There’s a level of fear out there that is a little similar,” said Michael Hanson, a senior economist with Bank of America Merrill Lynch. “It’s not just the fundamentals. It’s the fear of the unknown.”
Most of the attention so far has been focused on volatility in stocks, with investors spooked by three heart-stopping declines in the last five trading days — including Wednesday’s 4.6 per cent drop in the Dow Jones industrial average.
But the bigger concern of many financiers and government officials was signs of stress on Wednesday in European credit markets, which are essential to financing the day-to-day operations of banks and companies there.
Unlike the 2008 crisis, which began in the United States and spread worldwide after the bankruptcy of Lehman Brothers and the near collapse of the giant insurer American International Group (AIG) as subprime mortgage defaults surged, today’s situation began overseas. The mounting fear about European banks’ exposure to sovereign debt is now fraying nerves here.
Financial institutions across Europe have huge holdings of government and corporate bonds from Greece, Ireland, Portugal, Italy and Spain. Concerns about defaults are growing.
Some insist that the comparisons are overblown. “It feels completely different,” said Larry Kantor, the head of research at Barclays Capital. “I don’t think there is a US debt crisis right now, and European debt is not held as broadly as mortgage debt or derivative debt was back in 2008. The prospect of a 2008-like drop in the market is remote.”
Experts add it is important not to confuse a stock market rout with an all-out panic.
“I think it’s quite different than 2008,” said John Richards, head of strategy at RBS in Stamford, Connecticut. “This is a stock market correction based on slower growth and the increased probability of a recession. In 2008 we had a genuine funding crisis, where banks were reluctant to lend to one another.”
Others on Wall Street maintain that the turmoil is playing out in similar fashion. Traders compare the threat from Greece that prompted the sovereign debt crisis a year ago to Bear Stearns, whose fall in March 2008 was a dress rehearsal for the broader crisis that followed six months later.
For these would-be Cassandras, the huge debt loads of Italy and Spain are now equivalent to Lehman and AIG, institutions whose downfalls threatened the stability of the entire system.
In an ominous echo of 2008, European bank stocks on Wednesday fell 10 per cent or more — and banks in Europe are beginning to hoard cash, crimping the interbank loans that keep the global financial system operating smoothly. While borrowing costs for banks in the United States and Britain have crept up only slightly recently, borrowing costs for Continental banks that lend to one another have doubled since the end of July.
More optimistic market watchers point out that these rates are still well below those at the height of the financial crisis. But they nonetheless are the highest since the spring of 2009.
Because European banks trade billions of dollars daily with their American counterparts, fears of contagion have spread.
Along with the fear is a measure of denial in the period leading up to now, one more echo from 2008. Even as evidence of the subprime threat mounted through 2007 and into 2008, stocks continued to levitate, with the Dow industrials touching 13,000 not long after Bear Stearns had to be rescued. And even as the economy weakens, Wall Street is still predicting earnings in the fourth quarter to be 23 per cent above last year’s level, a target that is looking more out of reach by the day.
Then, as now, there were huge stock market swings, up as well as down. For example, the Dow plunged 777 points on September 29, 2008, after Congress initially rejected the proposed Troubled Asset Relief Program bank bailout, only to rise 485 points the next day. But over all they kept plunging, with the Dow bottoming out at 6,547 in March 2009.
There are, however, some very important differences between now and then that could make the banks more resilient.
Financial institutions in the United States have one-third more capital than they did in 2007, and they are better positioned to weather the current storm. And they have reduced their risk-taking. Instead of lending $25 for every $1 dollar worth of capital they hold, they are now lending a more reasonable $16, according to an analysis by Chris Kotowski, a bank analyst with Oppenheimer.
There are other ways the financial system has reduced the amount of debt.
The size of the market for repurchase agreements, or repos, where financial institutions borrow overnight to finance their operations, has shrunk from a peak of $4.57 trillion in March 2008, the month Bear nearly collapsed, to $2.6 trillion in July 2011.
What is more, consumers and companies alike have scaled back their debts — albeit modestly — even if governments have not. After increasing their borrowing for more than three straight decades, consumers reversed course and actually owe slightly less now than they did in 2008. Similarly, the number of companies whose short-term debt exceeds their assets is at a 25-year low, lessening the chance of the kind of credit squeeze that hit in the fall of 2008.
Moreover, the scope of the problems today is better understood than in 2008, when policy makers were repeatedly surprised at the amount of subprime mortgage debt and how it had coursed through so many corners of the world’s financial system.
Not all the differences are benign, however. Unlike in 2008, when policymakers in the United States moved swiftly to bail out banks and provided guarantees to keep the financial system from seizing up, political divisions in Washington make bold action like another stimulus package much more difficult.
The Federal Reserve also has fewer tools to employ. It has already cut short-term interest rates to nearly zero, and two rounds of injections totaling more than $2 trillion to stimulate the economy have yet to fully restore growth.
“There’s only so much the Fed can do,” added Hanson, of Bank of America. “It’s a different kind of war now, but we’re out of conventional bullets.”
In Europe, where the current crisis originated, political leaders are at least as divided on a course of action as their counterparts in the United States, because different countries there are having a hard time reconciling their different interests.
“We haven’t seen policymakers come out with a plan that is viewed as comprehensive, coordinated and credible,” said Philip Finch, a global bank strategist for UBS. “We need confidence restored and there’s a lot of infighting.”
©2011 The New York Times News Service
