Lessons learned from the 2008 financial crisis

David Joy, Chief Market Strategist, Ameriprise Financial

Pathway - Lessons from financial crisis

October 2018

Key Points

  • A decade has passed since the start of the 2008 financial crisis
  • The Fed’s actions and U.S. policy changes have contributed to more economic stability today
  • Both U.S. and global debt levels have escalated stimulating economic growth, but long-term risks exist

Ten years ago, the investment bank Lehman Brothers filed for bankruptcy protection, setting in motion the most severe financial crisis among developed market economies since the Great Depression. An overheated U.S. housing market, fueled by sub-prime mortgages, made evident the capital inadequacy of the financial system. By 2009, half of the world’s economies were in recession and roughly three-quarters of global gross domestic product (GDP) was in economies that were contracting.1

Today, the U.S. is in the 10th year of an economic expansion, the second longest on record,2 and experiencing the longest bull run in stock market history.3 According to the International Monetary Fund (IMF), the global economy, which contracted by 1.7% in 2009, has been expanding ever since.4

Have we simply moved on and relegated the crisis from 10 years ago to the history books? If not, what is the legacy of the financial crisis?

By 2009, half the world’s economies were in a recession. Today, the U.S. is in its 10th year of economic expansion, the second longest on record.

The role of Federal intervention in the recovery

The emergency response at the federal level that provided liquidity to the financial system was a critical factor in preventing the crisis from spiraling into an economic depression. Although such emergency measures may have been necessary, they came at a significant cost. In providing support to the private sector, the public sector assumed an unprecedented amount of debt.

The Federal Reserve’s balance sheet (primarily its holdings in government debt securities) has grown exponentially since. The week before Lehman failed, the Fed’s balance sheet totaled less than $1 trillion. Just three months later, at the end of 2008, it was $2.2 trillion, and today it totals $4.2 trillion.5 As a percentage of GDP, federal debt held by the public was just 36% midway through 2008 but has ballooned to 77% today.6 And that debt burden continues to grow.

Persistent legacies of the crisis in U.S. policy

Another legacy of the crisis has been the normalization of the Fed’s use of extraordinary monetary policies to influence the economy. What was once considered a “last resort” response, has now become commonplace. These tactics include actions such as:

  • Adjusting rates to zero percent
  • Implementing quantitative easing bond buying programs; and
  • Manipulating the yield curve

The primary regulatory response to the crisis came in the voluminous and far-reaching Dodd-Frank Wall Street Reform and Consumer Protection Act passed in 2010. This created new government agencies, including the Financial Stability Oversight Council and the Bureau of Consumer Financial Protection.

The Act’s primary objective is stricter oversight of so-called systemically important financial institutions. Provisions include restrictions on certain business activities and regular testing of capital adequacy – a measure that indicates a bank’s ability to absorb losses – during economically stressful periods.  

Once considered a last resort emergency response, the Fed’s use of extraordinary monetary policies to influence the economy has become commonplace.

The global response

The financial crisis may have originated in the U.S., but its impact was by no means confined to the United States. Through the interconnectedness of the global financial system, investors and financial institutions elsewhere were also negatively affected.

This was particularly true in Europe and Japan, where emergency monetary policy measures remain in place today. To keep its own robust economic recovery from derailing, China also undertook a massive stimulus program that greatly expanded its indebtedness with which it continues to struggle.

Progress, but with some caveats

In his keynote address at the recent central bank retreat in Wyoming, Federal Reserve Chair Jerome Powell noted, “A decade of regulatory reforms and private-sector advances have greatly increased the strength and resilience of the financial system, with the aim of reducing the likelihood that the inevitable financial shocks will become crises.”7 But there is still work to do.

As the IMF warns, “global debt is at historic highs, reaching the record peak of $164 trillion U.S. dollars in 2016, equivalent to 225% of global GDP. The world is now 12% of GDP deeper in debt than the previous peak in 2009.”8

As investors, it’s important to appreciate how far we’ve come since 2008. At the same time, we caution against complacency. Heightened global debt may spur growth in the near term but presents substantial risks for the long term. Speak to your financial advisor about how your portfolio aligns with both your near-term and long-term goals in the context of today’s market and economic realities.

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