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 percent 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 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 U.S. 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, Conn. “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 A.I.G.,
institutions whose downfalls threatened the stability of the entire system.
In an ominous echo of 2008, European bank
stocks on Wednesday fell 10 percent 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 percent 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 Sept.
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 policy makers 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
Mr. 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 policy makers 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.”
By: Nelson D. Schwartz
This story originally appeared in The New York Times
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