The Flinchum File

Thoughtful Economic Analysis and Existential Opinions
Subscribe to the Flinchum File
View Archives

Comparing Recessions

There are many similarities and many differences between the Great Recession of 2008/9 and the current banking “crisis”. In no particular order, here are some initial thoughts:

1. Social Media: One cause of the current “crisis” is that it is the first downturn since social media overwhelmed America. I’ve seen many banks experience a “run-on-the-bank” and go under, but I have never seen banks collapse so suddenly. Between Twitter & Facebook stoking fears over a weekend, those banks were walking-wounded by Monday morning. Fortunately, the Fed and FDIC took action very quickly, but they are no match for social media!

2. Weak Investments/Collateral: The business model of banks is that they take deposits and pay low interest rates, before investing the money at higher interest rates, netting the difference as their profit. That has worked well for generations . . . as long as the invested money gets repaid.

Before the Great Recession, the banks invested/bought bonds that were secured by mortgages, often flaky mortgages with no equity. Both depositors and investors smelled the problem and started pulling their money out.

After the Great Recession, banks were required to show the real value (“mark-to-market) of those investments, so the banks started to invest/buy Treasury bonds, which are commonly thought to be “risk-free.” Remember: the value of bonds decrease as interest rates increase – all bonds go down when interest rates go up – even Treasury bonds (unless held to the maturity date). Everything was fine, until last year when the Fed started increasing rates at the fastest speed in history. Accounting rules require that “write-downs” in asset values be reflected in reported income. This made investors nervous. How do you lose money on U.S. Treasuries? By owning them when interest rates are rising!

This run-on-the-bank is a direct result of the Fed raising interest rates so much and so fast.

3. Scapegoating: Another cause would be bad management and lazy regulators. There is always a need to find a “bad guy” to blame things on! In this case, SVB’s business model was to concentrate on making loans to technology firms, whose shares plummeted early last year, when interest rates starting rising quickly. The management further sullied their reputation by paying bonuses just before their collapse. Incredibly, the bank did not even have a Chief Risk Officer, which the regulators should have strongly demanded.

4. Recovery: This banking “crisis” is less severe than the Great Recession and not likely to last as long. Stock markets tend to rebound sharply after sharp drops, although economies usually take longer to rebound after sharp drops.

5. Prediction: If you survived the Great Recession, I suspect you’ll survive this relatively weak recession just fine. However, are you happy with your reaction to this “crisis”? With 100% confidence, I predict there is another recession out there – there always is! Will you react differently next time?