Here is how you can prepare to protect your assets in the next big crash and come out ahead. How is this financial crisis different from the past?
Throughout the progression of the world economy, there has been a multitude of times in which the economy has undergone crises that have come close to crippling the foundations of business in the world, especially in North America. One of the most noteworthy financial crises was at the start of the 19th century with the 1907 bank failure. During a “six-week stretch, starting in October 1907” (James), the New York Stock exchange had fallen almost 50% from its all-time high. Consequently, there was an ongoing run on banks, where depositors withdrew their capital due to the fear of failing to function appropriately.
The panic had ensued due to shrinking market liquidity and dwindling depositor confidence. One reason for this result was the failed attempt of two businessmen to “buy up shares of a copper mining firm resulted in a run on banks” (James). Banks who leveraged the cornering scheme then suffered a run on banks leading to a compounding fear effect. This failed bid led to the downfall of the Knickerbocker Trust Company, a massive institution at the time. This caused panic amongst the country as vast numbers of people withdrew their money from their affiliated banks.
The solution to the crisis came in the form of J.P Morgan, who pledged a large quantity of his wealth along with other financiers such as John D. Rockefeller, who “continued orchestrating deals to bring confidence and liquidity back to the financial markets” (James).
Like the 2008 credit financial crisis, another recession that occurred was the 1980s bank crisis. It was the 1979 energy crisis that was caused due to the Iranian revolution resulting in massive increases in the price of crude oil and its scarcity globally. One significant cause of the downturn was the Federal Reserve’s contractionary monetary policy, which was enacted to help mitigate high levels of inflation at the time.
Stagflation had grasped the economy at the time with very little economic growth and the high steady levels of unemployment. Under the administration of Ronald Regan, there was tax reform legislation that was passed which allowed the United States Congress to simplify the income tax code. This resulted in a reduced maximum rate on ordinary (income) and raised it on long-term capital gains. Likewise, the institutional changes in regulatory and economic environments allowed for free real estate lending, resulting in fraud, misconduct, and other forms of corruption.
Government intervention eventually created a solution to the problem it had caused. One solution was “The Office of Thrift Supervision (OTS) [which] was established, with the authority to charter and regulate S&Ls” (Summa) which was instituted to eliminate failed thrifts which were acquired by regulatory bodies. Congress also enacted “Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) — in which taxpayers began to foot the bill — in response to the deepening crisis.” (Summa). This substituted the Federal Savings & Loan Insurance Corporation (FSLIC) and allowed for the transfer of the failed FSLIC’s assets, liabilities, and operations to the newly created FSLIC Resolution Fund, overlooked by the government’s Federal Deposit Insurance Corporation (FDIC).
The 2008 financial crisis is one of the most devastating financial crises that has affected modern America and the global economy at large. As “2007 got underway, one subprime lender or another was filing for bankruptcy. During February and March, more than 25 subprime lenders did so”(Singh), it became very apparent that the market was not producing any sort of solution to the subprime crisis, and the Federal Reserve and other major institutional banks began to leverage billions of dollars in loans to global credit markets. A freeze was implemented as global asset prices plummeted.
One of the factors that had internally corrupted the economy was the housing market. Mortgages issued by major banks were being distributed through the method of mortgage-backed securities usually referred to as securitization. These “packages” were issued out as low-risk securities.
However, it was through the backing of credit default swaps. Housing became incentivized as legislation such as the community reinvestment act (CRA) was implemented. It was federal legislation to provide mortgages for low to moderate earning Americans issued by banks to higher-risk families. This created a bubble that eventually had burst with the multitude of defaulting payments and credit fraud in a short period of time. Likewise, the two biggest home lenders, the Lehman Brothers, had been indulging in large amounts of secularization in the effort to capitalize on their investment with the financial instruments, only to be seized and deemed as a hazard to the economy by the United States government.
The 1980s and the 1907 financial crisis were similar as they were both influenced through a commodity at the time one being copper and the other being oil. However, the 1980s crisis had a significant impact as there was a sudden spike in oil prices, along with a regime change as the Shah of Iran was overthrown. The 1980s financial crisis, in addition to the Regan tax cuts and legislation, was one of the few financial crises that were influenced by foreign policy or political turmoil.
The 1907 and the 2008 crises were more internally based as the massive run on banks and the mortgage-backed securities were inflicted by Americans upon Americans. Likewise, in all three cases, it was the major banks that were the hardest hit, but in the financial crisis of 2008, it was a whole industry (housing) that caused the large amounts of risk and debt put upon the mid to lower-income Americans and was at risk of falling apart. All institutions such as the “Fed, Treasury Department, White House, and Congress struggled to put forward a comprehensive plan to stop the bleeding and restore confidence in the economy” (Singh).
The economic sphere that existed in 1907 is nowhere near the complex system that exists today. In 1907, JP Morgan himself started an investment bank that had only just begun to cement himself as a major financier while also bailing out the banks and markets. In comparison to the investment banks today such as Goldman Sachs, Wells Fargo, and Bank of America, and JP Morgan that are significantly more equipped to handle a financial crisis or are ready to provide liquidity in markets to ease the tension that might arise. In all cases, the government played a significant role to aid the fear in the markets and come to the aid of the American people. However, the 1980s financial crisis was largely affected by legislation passed under the Regan administration, while he later provided the solution.
The government over the three economic downturns has become better at handling such crises. Although they have not become quintessential in assessing major downturns, as they usually occur in places which may never be looked at until the effects follow through (such as the mortgage-backed securities bubble).
Chen, James. “Bank Panic of 1907 Definition.” Investopedia, Investopedia, 28 Aug. 2020, www.investopedia.com/terms/b/bank-panic-of-1907.asp.
Edey, Malcolm. The Global Financial Crisis and Its Effects*. 16 Dec. 2009, onlinelibrary.wiley.com/doi/full/10.1111/j.1759–3441.2009.00032.x.
Feldstein, Martin. 1980–82 Early 1980s Recession. 0AD, bancroft.berkeley.edu/ROHO/projects/debt/1980srecession.html.
Moen, Jon R., and Ellis W. Tallman. The Panic of 1907. www.federalreservehistory.org/essays/panic_of_1907.
Singh, Manoj. “The 2007–08 Financial Crisis in Review.” Investopedia, Investopedia, 23 Aug. 2020, www.investopedia.com/articles/economics/09/financial-crisis-review.asp.
Summa, John. “From Booms To Bailouts: The Banking Crisis Of The 1980s.” Investopedia, Investopedia, 2 Mar. 2020, www.investopedia.com/articles/financial-theory/banking-crisis-1980s.asp.