What You Wish You Knew About Recessions​ (you know, like the big ones)

It’s kind of ironic that I’m writing this post today, since when I went to do some more research on it the results showed that other people are already thinking about it too. The word recession is already flying around in Europe in places like Germany and with the recent government shutdown in the U.S., fears are rising that it may happen here. But even before the shutdown happened, we were talking about it in my classes at university, but that was for 2020. Right now, speculators are wondering if we could enter a recession this year. 

Of course, the most recent recession is still fresh in everyone’s mind, even if last September made a decade since the bank failure. The fallout from the Great Recession has made a lasting impact on our economic psyche and it’s been a factor in deep political and generational divides in the U.S. especially. Every well-meaning adult think that they know exactly what happened and who to blame. Precisely because it’s illogical to blame an entire global recession on just the government, corporations, or ill-advised home buyers, it’s hard to say whether the public or politics would be prepared for another recession. As divided as we are right now all around the globe, it’s difficult to imagine how things would workout should another recession happen.

The Great Recession Recap (condensed version)

The Great Recession of 2008 to 2009 was preceded by a financial crisis, brought on by banks who packaged mortgage backed securities like they were assets to sell to other banks. The banks were highly leveraged, or in other words, if crap hit the fan most banks did not have enough money to pay off even a portion of their debt. Some were even leveraged 75 to 1. When word started to spread that there were banks like this, banks like Bear Stearns, it made investors and fellow banks nervous about trading with them, so money began to flow out, and Bear Stearns no longer had the money available (or liquid assets) to pay its debts. It was highly leveraged and the remaining money it did have was in faulty mortgage loans about to go bad. Because, in the housing boom from the prior five years, seven out of ten mortgages were cut up and sold as mortgage-backed securities to investors. People like looking rich on paper, even if the money isn’t really there. Those mortgages were faulty home loans given to people who really couldn’t afford it, and so they started defaulting on home loans just a few years later.

Bear Stearns was one of the smaller players on Wall Street, but it played a backend role for many of the larger banks and if it failed it would leave a not so easy to fill gap in the sector. In order to avoid this the Fed “bailed out” Bear Stearns by having JPMorgan and Chase buy it and providing $30 billion to cover the mortgage securities that Bear still had. That action set a bad precedent in the minds of investors as well as the American people. Many felt that the bail out set a dangerous precedent for other banks to expect a bail out should the same scenario happen to them. 

Then there’s Lehman Brothers, larger than Bear Stearns in almost every way, they filed for bankruptcy September 15, 2008. They did not get a bail out, and the financial crisis turned into a recession, which spurred a global recession. Ten years later we’re still questioning if we did things right. 

On September 18, 2008 Frank Paulson and Ben Bernanke urged the government to create a spending package worth billions of dollars in order to secure the financial system and protect the economy. In the following years more measures would be taken in the form of stimulus bills and quantitative easing in an effort to stave off a deeper and longer recession and to recover from it. Many people don’t agree with the actions that were taken, even though by most accounts, the policies and actions taken accomplished the task at hand – to preserve the financial system and avoid a repeat of the Great Depression of the 1930’s. We still had a recession, the largest since the Great Depression, and it was probably avoidable.

It was probably avoidable. 

There’s not an accurate way yet to predict what will precede the next recession, whether it is a government shutdown or caused by credit, nobody can really say yet. We can try to build models and prepare, but most likely there will variables thrown our way and we have to act as best we know how at that moment. Knowledge is indeed power, I believe. 

What You Wish You Knew About Recessions

  • Banks: our current economic system is based on capitalism which, “Is the worst one yet, except for all the other systems that came before it.” It’s bad, admittedly, but it’s what we’ve got for now. Capitalism relies on money. Banks, the government, and investors are responsible for taking care of that money. When you deposit a check into the bank, it doesn’t stay there, it gets circulated through the system. The bank ensures that they have enough money on hand for you to make a withdrawal from your account, but money put into a bank is circulated in the economy through other banks and investment firms, both foreign and domestic. Which is why when there’s unease in the market one of the worst things that can happen is everybody pulling their money out because money gets taken out of circulation. It’s like taking the radiator fluid out of a car, things start to get noisy and it’s the signal of a breakdown. This happened in 1929, and a similar thing happened with Bear Stearns and Lehman Brothers. The market grew uneasy and started to pull their money out which left the firms empty and you and I vulnerable. 
  • Globalization: banks and investment firms are not required to only circulate money domestically. More often than not they’re buying assets from foreign markets in dollars. In fact, most transactions done outside the U.S. are done in dollars. If Kenya were to trade with France, they wouldn’t trade euros for Kenyan shillings; each currency would first convert to the U.S. dollar and then trade. So, if a crisis happens domestically in the U.S. that shakes the confidence in the dollar, many other foreign markets could be affected because they trade in dollars. 
  • Technocrats: this is not a very common word but it’s very useful to discussing recessions. Technocrats are people who are experts in their field, they are the people most knowledgeable about a given subject and who are able to give the most logical advice when it comes to crises like recessions. Ben Bernanke is one such technocrat, he is an expert on the Great Depression. Many people dislike the way that he handled the recession, and even argue that since his expertise focused on the Great Depression that he was dispositioned to look at the unfolding Great Recession in a certain way and treat it like the Great Depression. That point probably can be soundly argued by many people, but we also all know the condensed version of the Great Depression and not all the details. The Great Depression was also preceded by a financial crisis, stock markets fell, and people withdrew all their money from banks, hid it in mattresses and took it out of circulation. The government at the time also allowed thousands of banks to fail: 744 during the first 10 months of 1930, and all in all 9,000 banks failed during the decade of the 1930’s. This was when banks were less interconnected, when the world was not as globalized, before we stopped using the gold standard and switched to the dollar. So yes, Ben Bernanke’s expertise in the Great Depression effected his policy decisions for the Great Recession. It’s not right or smart probably that the top 10 investment firms on Wall Street held 55% of the nation’s asset by 2005. But given these facts, the actions taken to avoid an economic meltdown saved the nation from a whole lot worse. 
  • Politics: definitely not my favorite word, but people seem to use politics to justify a lot of things. The thing to remember about politicians is, they’re notexperts. Most of them probably have law degrees, so they may be experts at arguing their case, but they’re not scientists, or thinkers, or even doers really because they get so bogged down in arguing that they fail to pass anything really meaningful. Yet we listen to them like they’re experts even though they’re not required to adhere to expert’s advice. Politicians however are important when it comes to running a country. The can often influence market behavior with their decisions or even indecisions, and ultimately it’s the people in office that the public rely on to approve of programs that will help avoid the worst of a recession.

Wrap-Up

I hope you enjoyed today’s post and that you could learn something new from it. The section below has the links to the articles that inspired this post. Personally, I think recessions are a bit too heavy to cover in just one post, so I’ll work on creating content better suited for it. The goal is that each of these posts will inspire some sort of discussion or thought, so please, if this made you think about anything or if you learned something new, leave a comment down below. I only ask that we reserve ourselves and not take democratic or republican sides, and leave the bipartisan bickering where it belongs, in D.C.. Also I want to get to know my audience, so even if you don’t want to leave a comment about the post then tell me, what is your favorite national park in the U.S.? And if you don’t want to tell me that, then just say what you’d like for me to write about. 

Have a great Thursday!

Reference Articles

The Atlantic, When America Stared Into the Abyss

The New York Times, The Policymakers Saved the Financial System. And America Never Forgave them.

The New Yorker, The Real Cost of the 2008 Financial Crisish

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s