The panic of 2008
|Mar 30, 2009|
The following is taken from a chapter of Market Panic: Wild Gyrations, Risks and Opportunities in Stock Markets 0470824727, by Stephen Vines, who updated it in the wake of the 2008 economic crisis. e second edition by Stephen Vines. Reprinted with the gracious permission of John Wiley & Sons (Asia) Pte Ltd. The book is available through all major bookstores, US$19.95. First of three parts
It is almost certainly of little comfort to investors, who saw their portfolios slashed to shreds by the market panic of 2008, and of even less comfort to those who lost their jobs and homes during the carnage, but the plain fact remains that this crash was predictable and barely differed, in essence, from any of the major crashes seen in the past century or before.
It may be argued that this crash spread faster and wider than past crashes and a case could be made that the proliferation of financial derivative instruments accelerated the pace of the crash and made the whole mess even more complex.
Moreover, in some ways, the panic of 2008 had a greater ability to shock because it came after a period of sustained economic growth, engendering a false sense of security fortified by the growing acceptance of an ideology asserting the supremacy of free markets and their ability to be sufficiently resilient to cope with any shocks to the system.
However, as the crisis developed, the ideologues were cowed into an awkward silence as it became clear that markets alone could not solve their own problems and that even the most fervent free marketers were seeking state intervention at levels rarely seen in history.
So, there is some validity in attempts to seek exceptional circumstances for the crash of 2008 but the differences are not to be exaggerated.
The effect of this bout of market panic is undoubtedly larger in cash terms than the losses incurred in any previous panic but that is simply because financial markets have got much bigger. Also, nations, notably Asian nations, have developed large stock markets which have joined the global financial system and become subject to the contagion that is part and parcel of globalization.
However, in percentage terms, markets fell more sharply during the crash of 1987 and the contagion from market to market spread with equal speed back then. That said, it is true that there are far more derivative financial products around today and that they have become increasingly removed from the underlying assets they are supposed to represent. In the 1920s, banks were busy repackaging loans they had made for highly speculative purposes, in a manner similar to what we now describe as the securitization of credit, and their activities did much to contribute to the crash of 1929. So, it would be a mistake to believe that there is something fundamentally different about the crash of 2008.
And, because memories are incredibly short, there has been much ill-informed talk of unprecedented government bailouts in the wake of the 2008 crash. Here too, there has been little fundamental departure from ground covered in the past. There was considerable state intervention in the immediate aftermath of the 1929 crash but most of it turned out to be counterproductive.
In 2008, the impressively rapid response by governments does not look as though it will be similarly counterproductive, indeed the emphasis on infusing liquidity into financial systems and preventing the collapse of key financial institutions has a fair chance of ameliorating the worst consequences of the crash. In cash terms, more money is being poured into corporate rescues, loan guarantees and bank deposit guarantees than at any time in the past and it is more than interesting to see the return of nationalization as a means of supporting the economy. Additionally, it is also almost certainly true that the global spread of rescue plans from the United States, to China, to Iceland and so on, occurred at a speed and a level of geographic diversity never seen before.
However, who can pretend that, in terms of scale, what happened in 2008 was smaller than, say, Franklin D. Roosevelt's New Deal program that followed the 1929 crash. Or even the $293.3 billion rescue of the failed saving and loans companies that was launched as one of the first acts of George HW. Bush's presidency and related to just one set of financial institutions, as opposed to a rescue of the entire sector.
In the last big regional crash which preceded the events of 2008, the Asian financial crisis of the mid-to-late 1990s, Hong Kong's acutely self-conscious free market government plunged into the stock market spending $15 billion to buy blue-chip shares in a scheme designed to prevent further market falls. The South Korean government, which espouses capitalism as its reason for being in contrast to the communist government that rules North Korea, spent even more on rescue packages.
In 2008, there were indeed new forms of rescue, initiated by the administration of Prime Minister Gordon Brown in Britain and widely emulated in other countries, including the United States, that involved the partial nationalization of banks. However, these were not novel methods of rescue – on the contrary, they hark back to the period following the end of World War II.
So, in essence, what happened in 2008 fitted neatly into the cycle of past panics rather than breaking new ground. This is not to suggest that the panic of 2008 was somehow trivial and lacked distinctive features but it is to say that its overwhelming characteristic was recognizability. In Chapter 4 we shall see how panics occur in cycles. Although the chapter was written in 2003, there is nothing in its general description of cycles that does not fit the circumstances of 2008. To emphasize this point it is worth going through the stages of the cycle that brought about the crash of 2008.