With bank failures, government bailouts and a wild ride on Wall Street, 2008’s financial crisis is huge. But just how big is it? The Business Journal’s Dan Beighley asked some local experts how this financial meltdown ranks against the savings and loan crisis, the 1987 stock market crash and even the Great Depression. Here are their edited comments.
Esmael Adibi
Chapman University economist
This financial crisis is the worst crisis since the Great Depression. So far, the government committed $900 billion to rescue financial institutions, and the proposed purchase of underperforming assets will definitely cost more than the estimated $700 billion. In comparison, the savings and loan crisis cost the taxpayers about $250 billion in current dollars ($142 billion then). A big difference is the financial system is operating more efficiently than it was at the onset of the 1930s Depression. We have a better understanding now. There was no FDIC to protect the public back then. We had control of the central bank, but they reduced the money supply to fight inflation. Now we are taking better steps, we’ve opened the discount window. And interest rates are already low and can be set lower. But what makes this troubling is that the rest of the world is facing it as well. We’re so interconnected that our troubles put pressures on foreign economies. But as far as the magnitude of the 1930s Depression, we’re not there. The S & L; crisis wasn’t as bad because we didn’t lose the money center banks. Then, the Resolution Trust Corp. was set up by the government to take over failed thrifts to isolate the problem. This time the problem is with large commercial banks that have a bigger function in the economy. They remain vulnerable to runs on deposits from nervous customers. They’re hoarding money as a reserve to protect against bad debt. Smaller regional banks will also be impacted in this crisis.
JP Gough
Chief Executive, Orange County Business Bank
When you are living in the midst of a crisis, it always seems worse than any other. This one is big, no doubt about it. But our country has these gigantic crises periodically. When the government stays out of them, the crises recover faster. The banking crises and depressions of 1907 and 1921 were just as bad as that of 1928, but the government’s actions exacerbated the problem on the first two. This crisis is not really “systemic” because the whole banking industry is not sharing in the problems of subprime mortgages and derivatives. The 8,000 or so community and regional banks are largely not involved in this one as they had been in the downturn of 1990 to 1994. But because this crisis is badly affecting the top 20 banks in America, with only a few exceptions, it is getting a lot of play in the media. With the biggest banks and Wall Street taking it on the chin, people have been missing the fact that the world has been in a fast deceleration of trade since earlier this year-which is more important and totally unrelated to the 2008 derivatives meltdown. The crisis of 2008 really started on Wall Street with the stock brokerage and bond trading firms (what are called “investment banks”-not to be confused with “commercial and community banks”). These Wall Street guys thought they could use statistics to calculate risk without ever meeting any of the borrowers on the underlying loans. What’s more, they felt that because of their superior use of computer modeling, they could offer marginal borrowers credit at rates that banks only give to people with the best of credits. There was a lot of hubris and delusion as they tried to make all lending to everyone a “wholesale” business. But the key to lending and banking generally is that the banker and the borrower know each other. In the last 15 to 20 years, we have been witnessing the dismantling of the Glass-Stiegel Act, which kept investment banking and trading separate from commercial banking. There was a lot of wisdom in that post-Depression separation of financial activities and we are now paying the price for ignoring that 80-year-old lesson. Because of that breakdown of Glass-Stiegel, the top 10 banks in America today are dependent on “trading income” (legalized gambling in securities) for about half or more of their profits. So the biggest banks have been sucked into Wall Street’s paradigm of easy money by passing things around to ever-bigger fools. But in finance, everything still comes down to cash flow; prices in excess of proven cash flows are fool’s gold. The $700 billion bailout is really unnecessary. There are other ways to fix this problem that do not involve throwing government money around to bail out bad bets. We should approach this problem the same way we did the Latin American debt crisis in the early 1980s. In that crisis (which could have sunk more banks than today’s crisis) that balloon was slowly deflated in a way that Wall Street brokerage firms, banks and the government could digest it all over time, without increasing the national debt to surreal levels.
Hector Cuellar
President, McGladrey Capital Markets
Charlene Davidson
Senior Managing Director,
McGladrey Capital Markets
This crisis is unmatched and while its visible implications are often compared to that of the Great Depression, this touches far more aspects of the economy and with deeper global implications at stake. It’s so complex that the consumer, commercial, corporate and global markets are all simultaneously affected. The interconnectivity of these capital markets is negatively affecting personal stock accounts, corporate balance sheets and the real estate we live on, work in and drive by. In other words, this touches everybody. One move by the government won’t fix it. The root of the problem began with loss of control and oversight, eventually spreading to potentially intentional fraudulent prac-tices. And despite the evidence of a fractured system years ago, the immediate opportunities outweighed the complexities of meaningful discovery and conscientious objection to the enormous wealth being created. We’re nervous, yet prepared to weather the storm. We think it could be another six to nine months for the undercurrents to stabilize and expect upward trends 12 to 18 months out. Credit markets have shut down for many types of deals. In the investment banking world there’s considerable market confusion and a realignment of investor strategies. Fundamentally speaking, a lack of financing makes deals harder to close. And with less cash flow from companies, deals become less attractive and even less likely to be financeable. Larger deals are generally hit the worst. There were signs of their distress in 2007 and by the beginning of 2008, things got progressively worse and have since been trickling into the middle-market deal flow. The larger appetites for risk and the sheer magnitude of their exposures have sidelined many of the major Wall Street firms. The next tier of investment banks doesn’t carry the same risk but do remain subjected to significant downsizing. And while we are all vulnerable to a shrinking economy with less access to credit, we believe that boutique firms actually have the greatest opportunity ahead.
David Maxwell
Associate Director, Merrill Lynch & Co.’s Southern California Region in Newport Beach
We are witnessing the greatest government intervention in the financial sector since the 1930s, but according to our Merrill Lynch Economist David Rosenberg, it’s far from clear that this is the cathartic market-bottoming event everyone is hoping for. Recalling the 1989 to 1993 experience with Resolution Trust Corp., the 10-year Treasury note yield during that prolonged debt deflation period plunged 400 basis points as the inflation rate was cut in half from more than 5% to around 2.75%. Let’s also remember that even as we look back to the original RTC, and that too was a major intervention at the time, it took a full year for the equity market to bottom, two years for the economy to bottom and three years for the housing market to find a bottom. All the actions the government has taken remove the tail risk of a meltdown, in our opinion. However, that does not change the fact that the U.S. economy is about to embark on the first consumer recession in 17 years nor does it change the fact that what we’re facing is a secular decline in the supply of private sector credit. Despite corrections in the marketplace, there are still smart places for your money. A number of investments seem suited to the present volatility and are poised to do comparatively well in the months and years ahead, even if the economy continues to struggle. Our chief investment strategist, Richard Bernstein, recommends investors increase the overall duration of their fixed-income portfolios, either as a part of an overall rebalancing or the investment of available cash in bonds of a similar maturity. Understanding the market’s underlying patterns can help shape one’s investment strategy during these challenging times.
Richard Gadbois
Managing Member, Argyle Street
Management Americas LLC
This crisis is far worse than other recent ones. It’s a threat to the stability of banks and will likely to lead to a financial slowdown. It’s not hard to imagine what the death spiral could look like. Falling home prices and more foreclosures would hit consumer spending and jobs would be lost. The silver lining so far is that job losses haven’t been as bad as you would think. In the past, markets have rebounded after market stock crashes, but it feels different this time. Clearly we’re in new territory with financial institutions going under. There are few places to hide. A lot of hedge funds are closing. Big investment banks haven’t been realistic about what they think their assets are worth. But there are bright spots with Asian countries like China that have macro growth stories. The crash in 1987 was a lot different than what we recently had. The panic selling then included the demise of financial gimmicks like portfolio insurance that added to the selling. But the market ended up at the end of that year, just like it did in 1998 after the Asian crisis. Very often when things look their worst it will turn around. In 2002 the market bottomed after a two-year bear market when tanks were rolling into Baghdad and it seemed like the end of the world. But when you’re going through it it’s hard to stomach it and buy. The point I would make about comparing now to the Depression is that the U.S. financial structure was much simpler then.
