Five years ago, I spent the weekend in the office with a group of very anxious people. I recall the Chicago Bears football game playing on a TV in the conference room, but no one was paying attention to it. It was a different bears game that worried us.
The first cracks in the new paradigm of prosperity had appeared more than a year earlier when two subprime mortgage funds sponsored by Bear Stearns collapsed. Bear Stearns itself fell in the spring of 2008, and IndyMac followed in July. The financial markets had been unsteady throughout the summer, and the solvency of key institutions became the subject of intense speculation.
We had tried for months to anticipate what might transpire, playing out a series of scenarios and trying to plan strategy for each of them. But when Lehman Brothers failed the following Monday morning, reality outstripped even the most pessimistic projections.
No matter where you were or what you were doing at the time, that fateful fall was a defining interval. We all endured a roller coaster of disbelief, panic, anger and exhaustion. We ultimately weathered that terrible storm and set the groundwork for recovery. And we vowed to learn from the experience so it would be much less likely to recur.
One would hope that wed be back to normal by now, but all evidence suggests that the remnants of the global financial crisis are still very much with us. Economic conditions seem stuck at a new, more modest normal, and efforts to reform the financial system have shown mixed results at best. Perhaps its a good time to revisit that fateful time, see how far weve come and determine how far we have yet to go.
Weve almost forgotten, but the years leading up to the crisis were enormously successful. Economic and market performance through 2007 was stellar.
Unemployment had been driven to very low levels. The eurozone was a great success, and emerging markets were emerging. We dared to think that management innovations and enlightened policy-makers had made the global business cycle obsolete.
As it became apparent that this assumption was untrue, the market corrected swiftly. People and financial statements which had been highly trusted could no longer be counted on. Rumor traveled faster than fact.
The demand for liquidity went well beyond what could have been anticipated. With short-term credit constricting, players resorted to selling assets into already-distressed markets to raise money. A negative cycle reinforced itself through collateral calls and cash shortages. Trust was a scarce commodity, and the pricing of credit-sensitive products reflected that.
Policy-makers raced to gain understanding and forge the tools needed to contain the damage. And that they did, throwing almost everything against the wall and hoping at least some of it would stick. Federal Reserve Chairman Ben Bernanke said at the time, There are no atheists in foxholes and no ideologues in financial crises. Governments that had tried to draw a dark line between the private sector and the public sector nonetheless used taxpayer funds to support faltering financial institutions. Stabilize first; philosophize later.
There are certainly those who look back and question some key decisions made in the heat of the moment. Among the benefits of having avoided the worst is the luxury of reflecting critically on that period. But it is an imperfect exercise. Choices made in the autumn of 2008 were based on incomplete information and under the worst pressure.
Economic performance in recent years has left a lot to be desired, but it certainly could have been far worse. The success of crisis policy is the distance between the depth of the abyss we were gazing into and the modest elevations weve reached since not the gap between where we are and normal economic peaks. And in the United States, almost all special crisis programs have made money without even accounting for broader economic benefit.
In their widely noted book, This Time Is Different, Carmen Reinhart and Kenneth Rogoff find that it takes a long time to recover from economic downturns associated with financial trauma. The current cycle seems to be proving them right.
Growth in the major economies has struggled to reach long-run norms, leaving millions of people unemployed. Slack demand from American and European consumers has, in turn, taken a steep toll on developing economies, which rely on exports for growth. In both cases, economic retreat revealed fiscal stress that led some to cry out for rectitude at a time when countercyclical government spending may have been more appropriate.
There is little doubt that restrictive fiscal policies have hindered global recovery. Encouragingly, though, growth seems to have taken the upper hand from austerity in many national budget battles. Well-structured fiscal investments have the potential to pay off handsomely and are to be encouraged.
By contrast, central banks have pursued a more supportive course. Novel approaches like quantitative easing and forward guidance about policy are now conventional. The zero lower bound for interest rates has not constrained monetary expansion.
The creativity and courage that characterized central bank strategy over the past five years has been hailed by many but it may have reached its limits. The incremental benefits of quantitative easing seem to be shrinking, and fears of bubbles down the road are rising. The market tumult which greeted the Federal Reserves hints at tapering suggests that exit from all the accommodation may be a very messy process.
When it set out on the course of quantitative easing, the Fed was certainly aware that unwinding the program ultimately might be very challenging. This is a better problem to have than the one that stared us in the face five years ago. But monetary recovery wont be fully complete until central bank balance sheets have receded to pre-crisis levels. That could take a number of years.
On the bright side, equity markets in many parts of the world have performed exceptionally well since hitting bottom in the spring of 2009. Household wealth in the United States hit a new peak in the most recent quarter; while many rightfully worry about the distribution of this bounty, aggregate spending power provides a good platform for growth.
Some wonder, however, how much longer equity markets can improve at rates that are multiples of economic growth. If top-line revenue remains constrained, asset returns may be, too. Further, the mantle of risk aversion that has its roots in the financial crisis remains in place. All this time after the crisis, banks and investors are keeping vast sums in liquid investments which are earning negative real returns.
As soon as the worst had passed, legislatures took steps to ensure that we never, ever have another crisis. Thousands of pages of new financial regulation were drafted, with many thousands more to come. Among the key goals of the effort are:
As regulatory efforts progress, rule-writers should keep in mind that the next crisis is unlikely to resemble the last one. Closing one trap door may open others down the road. Further, the banking industry is not a public utility and shouldnt be turned into one by overly invasive reforms.
In sum, a grade of incomplete might be appropriate for efforts aimed at recovering from the crisis of five years ago. The world economy has moved ahead but continues to underperform its potential. Unemployment has fallen but remains far higher than desired; millions of experienced and young workers have been searching for far too long. There are no large banks in imminent danger of failure, but many are struggling to regain a clean bill of health. Reform efforts are incomplete and their impact unclear.
Weve learned a lot from the experience, but there are certainly lessons weve yet to master. As tempting as it might be to dismiss the experience of 2008 as a bad dream, we must seek to hold it in our consciousness long enough to appreciate all it has to teach us. For those of us who lived through that interval, it wont soon be forgotten.