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Crashed: How A Decade Of Financial Crises Chang... _HOT_

The road to recovery has been a long one since those white-knuckle days of September 2008. Historically, it has taken an average of eight years to recover from debt crises, a pattern that held true in this case. The world economy has recently returned to robust growth, although the past decade of anemic and uneven growth speaks to the magnitude of the fallout.

Crashed: How a Decade of Financial Crises Chang...


Central banks, regulators, and policy makers were forced to take extraordinary measures after the 2008 crisis. As a result, banks are more highly capitalized today, and less money is sloshing around the global financial system. But some familiar risks are creeping back, and new ones have emerged. In this article, we build on a decade of research on financial markets to look at how the landscape has changed.

An extended period of historically low interest rates has enabled companies around the world to take on cheap debt. Global nonfinancial corporate debt, including bonds and loans, has more than doubled over the past decade to hit $66 trillion in mid-2017. This nearly matches the increase in government debt over the same period.

Even this bleak outlook is subject to great uncertainty and significant downside risks. The forecast assumes that the pandemic recedes in such a way that domestic mitigation measures can be lifted by mid-year in advanced economies and later in developing countries, that adverse global spillovers ease during the second half of 2020, and that widespread financial crises are avoided. This scenario would envision global growth reviving, albeit modestly, to 4.2% in 2021.

However, this view may be optimistic. Should COVID-19 outbreaks persist, should restrictions on movement be extended or reintroduced, or should disruptions to economic activity be prolonged, the recession could be deeper. Businesses might find it hard to service debt, heightened risk aversion could lead to climbing borrowing costs, and bankruptcies and defaults could result in financial crises in many countries. Under this downside scenario, global growth could shrink by almost 8% in 2020.

Congress passes legislation that requires government-sponsored mortgage giants Fannie Mae and Freddie Mac to devote a percentage of their lending to affordable housing. This leads to an increase in the overall number of loans being pooled and securitized or sold as financial instruments to other investors. Two years later, J.P. Morgan introduces the first credit default swap (CDS), a credit derivative that can act as a kind of insurance against defaults for investors. Over the next decade and a half, CDSes become the most widely traded credit derivative product globally. The CDS market proves to be a major source of systemic risk to the U.S. financial system when the crisis hits more than a decade later.

Prompted by the burst of the dot-com bubble and the resulting recession, the U.S. Federal Reserve, led by Alan Greenspan, lowers its benchmark interest rate eleven times. Falling interest rates lead to an easy-credit environment, encouraging lending practices that prove unsustainable later in the decade. The ensuing credit bubble plays a large role in the run-up to the financial crisis.

The past decade has been a roller coaster for oil prices, one that market participants have probably not much enjoyed riding (Figure 1). The period includes much volatility and two sharp crashes. One crash, in 2008, was associated with the financial crisis and the Great Recession. The second may still be going on: Oil prices have fallen from over $100 per barrel in mid-2014 to around $30 per barrel recently.

The Great Depression began in August 1929, when the economic expansion of the Roaring Twenties came to an end. A series of financial crises punctuated the contraction. These crises included a stock market crash in 1929, a series of regional banking panics in 1930 and 1931, and a series of national and international financial crises from 1931 through 1933. The downturn hit bottom in March 1933, when the commercial banking system collapsed and President Roosevelt declared a national banking holiday.1 Sweeping reforms of the financial system accompanied the economic recovery, which was interrupted by a double-dip recession in 1937. Return to full output and employment occurred during the Second World War.

Once the moment of panic had passed, however, unanimity quickly unraveled. In early 2009 there were essentially two working theories about what to do next. One, harking back to Keynes, was that these tempestuous times called for bold measures. With the private sector speedily retrenching, big government stimulus spending was in order, as were unconventional asset purchases and other interventions by central banks. The other theory was that with a financial meltdown averted, things were more or less back to normal. Inflation would soon again be a threat that demanded vigilance from central bankers. Big government deficits would lead to crises of investor confidence. Unemployment insurance and other aid programs would do more macroeconomic harm (by discouraging work) than good. The old rules would still apply.

The two great challenges of the 21st century are the battle against poverty and the management of climate change. On both we must act strongly now and expect to continue that action over the next decades. The current crisis in the financial markets and the economic downturn is new and immediate. All three challenges require urgent and decisive action, and all three can be overcome together through determined and concerted efforts across the world. It is important, however, to understand the depth and severity of the two long-term challenges, and their intimate relationship, before we turn to the shorter term.

The long-term decline in interest rates began just a few years after the advent of risk/return thinking, and I view the combination of the two as having given rise to (a) the rebirth of optimism among investors, (b) the pursuit of profit through aggressive investment vehicles, and (c) an incredible four decades for the stock market. The S&P 500 Index rose from a low of 102 in August 1982 to 4,796 at the beginning of 2022, for a compound annual return of 10.3% per year. What a period! There can be no greater financial and investment career luck than to have participated in it.

But will future generations have homes and the equity socked away in them to draw upon in retirement? The financial crisis of a decade ago resulted in tightened credit standards relative to historic norms, which has made it harder to get a mortgage, says Susan Wachter, Wharton professor of real estate and co-director of the Penn Institute for Urban Research at the University of Pennsylvania.

The volume of accounts for the various credit products has also experienced major shifts during the course of the last 10 years. Credit cards remain the most ubiquitous credit vehicle, and while originations were noticeably lower soon after the financial crisis, they have recovered in recent years to around 2008 levels as lenders have provided more access to credit over this time period. Mortgage originations dropped dramatically during the last decade, whereas both auto loans and unsecured personal loans have grown significantly. A combination of lenders expanding access to credit following initial tightening after the crisis, as well as changes in technology driving continued innovation, have provided consumers with more options for their borrowing needs.

  • To Create Trade Opportunities and Expand the Benefits of Globalization, President Clinton: Won Ratification of the North America Free Trade Agreement (NAFTA) in 1993, creating the world's largestfreetrade zone of the U.S., Canada, and Mexico. U.S. exports to Mexico grew 109 percent from 1993 to 1999, while exports to the rest of the world grew by 49 percent.

  • Won Approval of Permanent Normal Trade Relations with China. In 2000, Congress ratified permanent normal trade relations with China. The agreement will integrate China into the world economy through entry into the World Trade Organization (WTO), open Chinese market to U.S. exports, slash Chinese tariffs, and protect American workers and companies against dumping.

  • Successfully Completed the Uruguay Round. The 1994 Uruguay Round transformed the world trading system, opening markets in a wide range of industries, enabling the U.S. to enforce agreements more effectively, and applying the rules for the first time to all WTO members (now 138 in total).

  • Fought for the First-Ever African and the Caribbean Basin Trade Bills. The African Growth and Opportunity Act of 2000 will support increased trade and investment between the United States and Africa, strengthen African economies and democratic governments, and increase partnerships to counter terrorism, crime, environmental degradation and disease. The legislation will also create incentives for the countries of sub-Saharan Africa and the Caribbean Basin to continue reforming their economies.

  • Promoted Trade Opportunities for High Technology. The Clinton Administration completed series of trade agreements on technology, including the WTO's commitment to duty-free cyberspace, keeping the Internet free of trade barriers, in 1998; the global WTO agreements on Financial Services and Basic Telecommunications in 1997; the global WTO agreement on Information Technology in 1996; and a series of bilateral agreements on intellectual property, high-tech products, services and other sectors. These efforts are the building blocks of the New Economy.

  • Secured Historic Debt Relief. In March 1999, President Clinton presented a plan to a U.S.-Africa Summit in Washington that became the basis for the G-7 agreement in Cologne, Germany (known as the Cologne Debt Initiative). The plan would triple the amount of debt relief available for poor countries, reducing their debt by about 70 percent ($90 billion), in return for firm commitments to channel the benefits into improving the lives of all their people. In September 1999, the President announced that the U.S. would unilaterally exceed the terms of the G-7 initiative and entirely cancel the $5.7 billion in U.S. government debt owed by qualifying countries. In November 2000, President Clinton won $435 million from Congress for U.S. participation in the Cologne Initiative.

  • Dramatically Expanded U.S. Efforts to Fight Child Labor and Expand Basic Education. In June 1999, the President traveled to the International Labor Organization (ILO) conference in Geneva, Switzerland, to urge adoption of an historic international convention banning the worst forms of child labor. He won $30 million for ILO enforcement of child labor laws and is fighting for a new initiative to promote basic education in areas of the world where child labor is widespread. In 2000, at U.S. urging, the G-8 countries endorsed the goal of universal basic education. President Clinton brought other issues to the forefront of the international economic agenda, including incorporating labor and environmental considerations in the work of major international economic institutions, increasing U.S. support for global efforts to fight HIV-AIDS and infectious diseases, and closing the digital divide.

  • Defused International Economic Crises. In 1995, after Congress refused to act, President Clinton made $20 billion in emergency loans to Mexico to stabilize the country's financial markets. Mexico repaid the loans in full, with interest, three years ahead of schedule. Following the Asian and Russian financial crises in 1997 and 1998, the Clinton-Gore Administration led a global effort to re-capitalize the International Monetary Fund to allow it to more effectively deal with these problems. President Clinton also insisted that the G-7 develop a set of measures to restore confidence in the world financial system.

  • Promoted U.S. Competitiveness. The Clinton-Gore Administration has made key investments in education and training for American workers and research and development. It has also maintained federal fiscal discipline, helping to reduce interest rates, encourage private-sector investment, and keep productivity high.



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