the 2008 global financial crisis and today's economy

 

The 2008 Global financial crisis and Today’s economy

In the minds of many, economics came to be thought of as a science. Removed from its rough prediction roots, it became a discipline of watertight theory, with a methodology capable of unearthing indisputable truths. Economists, so the story goes, had successfully grasped the essence of human behavior: rational, and, therefore, highly predictable. With this discovery, an age-old question whose answer for millennia had eluded humanity was finally laid to rest. Where philosophers, psychologists, and sociologists had failed, economists had struck gold. They had cracked it. As a result, imperfect theories - as economic theories inherently are - started to be treated as laws of nature, like facts, and confidence among economists erred towards hubris. A sense of exclusivity pervaded the field, an unspoken agreement that outsiders were unwelcome, and their contributions unneeded. In the last 10 years, however, things have changed, and in this era defined by populist, anti-establishment politics, economists’ time in the sun looks to be drawing to a close - for the time being at least.

Much can be traced back to the global financial crisis, which left the profession reeling, dealing its reputation an almighty blow. As professor Franklin Allen recalls of economists of the time, ‘it’s not just that they missed it, they positively denied it would happen’ - the banks, consensus dictated, were simply ‘too big to fail’. Following the crash, economists were expected to take center stage and steer the global economy towards recovery - that was their job. On that front, though, they also failed. The recovery - itself a generous term given the context - has been sluggish and uneven, the Economic Policy Institute calling it ‘the slowest in recent history’. And meanwhile, poverty levels across much of the Western world have been rising. Orthodoxy had long dictated that job creation solves poverty, the dictum to this day forming the basis of many an economist’s outlooks. If jobs can be made, things will be okay. Post-recession developments on both sides of the Atlantic, however, have seen this one-time pillar of economic thought gutted of its credibility.

 

The 2008 financial crisis was the worst economic disaster since the Great Depression of 1929. It occurred despite the efforts of the Federal Reserve and U.S. Department of the Treasury. The crisis led to the Great Recession, where housing prices dropped more than the price plunge during the Great Depression. Two years after the recession ended, unemployment was still above 9%. That doesn't count those discouraged workers who had given up looking for a job. In 2006, housing prices started to fall for the first time in decades.

 At first, realtors applauded. They thought the overheated real estate market would return to a more sustainable level. They didn't realize there were too many homeowners with questionable credit. In addition, banks had approved loans for 100% or more of the home's value. Many blamed the Community Reinvestment Act, which pushed banks to make investments in subprime areas. Several studies by the Federal Reserve found it did not increase risky lending.

 

To quote from a Working Paper written in August 2008:

“The ‘perfect calm’ from 2003 to mid – 2007 – low-interest rates, loan default rates, risk spreads, and security price volatility, along with high profits and rising stock prices – combined with the structures and practices of the NFA ( New Financial Architecture) to encourage the excesses that caused the current crisis.”

 

 

 

If we were to do the very best one could imagine, the recession globally would still be worse than the Great Recession, not necessarily worse in the developed countries which were most directly hit by the 2007 or 2008 crisis. But it's very important to remember the 2007 and 2008 crisis wasn't really a global crisis. While the developed countries were badly hit and that affected the whole world, China did incredibly well, came out very, very quickly with incredibly strong growth in 2009.

That supported commodities and that meant a lot of emerging and developing countries did pretty well. Today, this is a global crisis. It's affecting every economy in the world, including China, of course, and all the emerging and developing countries, as well as the developed countries. If you think we are now in 1930, as it were, we're going over a cliff faster than in 1930.

It's more global than in 1930. And if it goes like this for two or three years, then I think political consequences which, ultimately, will feedback into the economy are just wildly unpredictable and could be devastating. Without the Great Depression, Adolf Hitler would never have been elected to power in Germany.

It is possible, if we get the disease under control, that the recovery will be quicker. We're going to have to have higher taxation to strengthen our health systems, and I think we'll have to strengthen our social safety nets. And those costs will have to be borne by the relatively well-off.

We will have to consider whether we can continue with gig working, precarious working. We will have to rethink how we relate the winners to the losers in our economic system. Otherwise, I don't believe our democratic systems will survive.

The financial crisis was still not out of woods in 2012. It took a series of measures and economic reforms from both Europe and the US fed to put up the world’s banking system back into order. The received wisdom today is that first you want to make sure that the banks and financial institutions run with less leverage, more capital, and less funding risk.    A culture of overconfidence led to the 2008 crash, and since then the profession’s reputation, like many economies around the world, has been in tatters. Sidelined by politicians and mistrusted by the masses, economists' stock is somewhere close to an all-time low. However, in response to many of the biggest challenges (inequality, stagnant wages, etc.) the discipline remains wanting. Its orthodoxies have been undermined, but are yet to be replaced, and it’s crying out for fresh ideas. Perhaps the saddest thing, though, is that this has been the case for some time.