In this way, you can prepare yourself to protect your assets in the next big crash and to stay one step ahead. How is this financial crisis different from before?
In the course of the development of the world economy, there have been a myriad of times when the economy has gone through crises that have nearly paralyzed the very foundations of doing business in the world, particularly North America. One of the most notable financial crises in the early 19th century was the bankruptcy of 1907. During a “six week period beginning in October 1907” (James), the New York Stock Exchange had fallen nearly 50% from its all-time high. As a result, there has been a sustained run on the banks with depositors withdrawing their capital for fear of not functioning properly.
The panic arose because of shrinking market liquidity and the dwindling confidence of depositors. One reason for this result was the failed attempt by two businessmen to “buy up shares in a copper mining company, which led to a run on the banks” (James). Banks that used the cornering program then suffered a run on the banks, creating a heightened fear effect. This failed offer led to the demise of the then huge Knickerbocker Trust Company. This caused panic in the country as large numbers of people withdrew their money from their affiliated banks.
The solution to the crisis came in the form of JP Morgan, who pledged much of his fortune along with other financiers like John D. Rockefeller, who “continued to orchestrate deals to restore confidence and liquidity to financial markets” (James).
Like the credit financial crisis of 2008, the banking crisis of the 1980s was another recession. It was the 1979 energy crisis caused by the Iranian revolution that resulted in a massive spike in the price of crude oil and its global scarcity. A major reason for the downturn was the contractionary monetary policy of the Federal Reserve, which was enacted to moderate the then high inflation rate.
Stagflation had hit the economy at that time with very low economic growth and constantly high unemployment. Under the Ronald Regan administration, a tax reform bill was passed that allowed the United States Congress to simplify the income tax bill. This resulted in a reduced maximum rate for ordinary (income) and increased it for long-term capital gains. Likewise, the institutional changes in the regulatory and economic environment made it possible to allocate real estate free of charge, which led to fraud, misconduct and other forms of corruption.
Government intervention eventually provided a solution to the problem that had caused it. One solution was “The Office of Thrift Supervision (OTS) [which] was established with the power to charter and regulate “S & Ls” (Summa), which was set up to eliminate failed frugality acquired by regulators. Congress also passed the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) – in which taxpayers began paying the bill – in response to the deepening crisis. (Summa). This replaced the Federal Savings & Loan Insurance Corporation (FSLIC) and enabled the assets, liabilities, and operations of the failed FSLIC to be transferred to the newly created FSLIC Resolution Fund, overseen by the government’s Federal Deposit Insurance Corporation (FDIC).
The 2008 financial crisis is one of the most devastating financial crises to hit modern America and the world economy at large. At the beginning of 2007, one or the other subprime lender filed for bankruptcy. In February and March, more than 25 sub-prime lenders did so ”(Singh). Dollars in credit to the global credit markets. A freeze was introduced when global asset prices collapsed.
One of the factors that internally corrupted the economy was the housing market. Major bank mortgages have been marketed through the mortgage-backed security method commonly known as securitization. These “packages” were issued as low risk securities.
However, this was done by hedging credit default swaps. Incentives for housing have been created through the implementation of laws such as the Community Reinvestment Act (CRA). It was federal law to provide mortgages for low- to middle-income Americans that banks issued to higher-risk families. This created a bubble that, with the large number of defaults and credit fraud, burst in a short space of time. Likewise, the two largest home lenders, the Lehman Brothers, had gone through a major secularization to capitalize on their investments in the financial instruments only to be seized by the US government and viewed as a threat to the economy.
The 1980s and 1907 financial crisis were similar in that they were both influenced by one commodity, one was copper and the other was oil. However, the crisis of the 1980s had a significant impact as there was a sudden surge in oil prices and regime change when the Shah was overthrown by Iran. The financial crisis of the 1980s, along with Regan’s tax cuts and laws, was one of the few financial crises influenced by foreign policy or political turmoil.
The crises of 1907 and 2008 were more internal, as the massive run on banks and mortgage-backed securities was inflicted on Americans by the Americans. Likewise, in all three cases, it was the big banks that were hardest hit, but in the 2008 financial crisis it was an entire industry (housing) that created the high levels of risk and debt that middle to high-income Americans were facing and threatened to fall apart. All institutions like the “Fed, Treasury, White House and Congress struggled to come up with a comprehensive plan to stop the bleeding and restore confidence in the economy” (Singh).
The economic sphere that existed in 1907 is nowhere near the complex system that exists today. In 1907, JP Morgan itself founded an investment bank that had only just begun to consolidate itself as a major financier while saving banks and markets. Compared to today’s investment banks like Goldman Sachs, Wells Fargo and Bank of America as well as JP Morgan, which are much better equipped to deal with a financial crisis or are ready to provide liquidity in the markets in order to relieve any tensions that may arise. In all cases, the government played an important role in allaying market fear and helping the American people. However, the 1980s financial crisis was largely influenced by the laws passed under the Regan administration, while he later provided the solution.
The government across the three economic crises has gotten better at handling such crises. While not strictly necessary for assessing major downturns, they usually occur in places that may never be investigated until the impact occurs (e.g., the bubble of mortgage-backed securities).
Chen, James. “1907 Bank Panic Definition.” Investopedia, Investopedia, August 28, 2020, www.investopedia.com/terms/b/bank-panic-of-1907.asp.
Edey, Malcolm. The global financial crisis and its effects *. Dec. 16, 2009, onlinelibrary.wiley.com/doi/full/10.1111/j.1759-3441.2009.00032.x.
Feldstein, Martin. 1980–82 recession in the early 1980s. 0AD, bancroft.berkeley.edu/ROHO/projects/debt/1980srecession.html.
Moen, Jon R., and Ellis W. Tallman. The panic of 1907. www.federalreservehistory.org/essays/panic_of_1907.
Singh, Manoj. “The 2007-08 financial crisis in retrospect.” Investopedia, Investopedia, August 23, 2020, www.investopedia.com/articles/economics/09/financial-crisis-review.asp.
Summa, Johannes. “From Boom to Bailout: The Banking Crisis of the 1980s.” Investopedia, Investopedia, March 2, 2020, www.investopedia.com/articles/financial-theory/banking-crisis-1980s.asp.