The coronavirus is pushing the U.S. toward a recession. Economists and financial experts are quick to point out the similarities between the coronavirus triggered downturn and the one seen during the 2008 financial crisis. Though there are a few similarities between the two crises, a major difference between the two is that the latest crisis originated in a real economy.
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Lehman Brothers’ collapse in September 2008 triggered the global financial crisis in the last decade. At the time, the fallout of the collateralized debt obligations (CDOs) markets made it almost impossible for the companies holding these CDOs to continue with operations.
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On the other hand, the coronavirus-led downturn is primarily the result of a slowdown in global economic activity. People staying at home along with the lack of economic activity resulted in a drop in cash flows and household incomes. Or, it can be said that it “originated in the real economy,” said Nomura analyst Richard Koo in a report dated March 17.
To combat the 2008 crisis, the U.S. authorities introduced several recapitalization measures under its TARP program. This allowed the authorities to prevent the complete breakdown of the financial sector, which was the source of the crisis.
Thereafter, the authorities came up with a fiscal stimulus to boost the GDP. In turn, this helped the companies to improve their damaged balance sheets and maintain people’s incomes.
“From a macroeconomic perspective, the government was able to sustain GDP by borrowing and spending the increase in private-sector savings (including debt paydowns) following the bubble’s collapse,” the analyst said. “This surplus of private-sector savings amounted to just over 10% of GDP even at the height of the crisis, just after the bubble collapsed, and this was well within the government’s ability to spend.”
How to address the crisis?
Since the conditions that led to the current coronavirus-led financial crisis are very different from the ones that triggered the 2008 crisis, so the measures needed are also different. Presently, there has already been a drop in growth rate, due to the massive fall in revenue for the affected industries. Moreover, there has also been a sharp drop in the household income for those connected to the affected industries.
Thus, as per Koo, the need of the hour is unsecured, no-interest loans and credit guarantees. Germany has already set aside €550 billion to give as a loan to prevent companies from going bankrupt and save jobs. Moreover, the country has expressed intentions to raise funds if needed.
Talking of Japan, the analyst says that in addition to the “usual economic stimulus,” the country needs to “quickly prepare tens of trillions of yen in unsecured, no-interest loans” to help businesses improve cash flows and also household incomes.
Retained earnings to play crucial role
Along with the support from the government, the analyst says the savings (both households and businesses) will help in the survival as well. Giving an example, the analyst said that when Greece witnessed a fiscal crisis in 2010 and its GDP dropped 27% from its peak, households were forced to use their savings.
This, according to Koo, helped in maintaining financial conditions in the country “fairly restrictive despite aggressive monetary accommodation by the ECB.” Further, the analyst says that even though the reason for the drop in GDP is different now (coronavirus) compared to the 2008 crisis, whether or not households and businesses would be able to weather the crisis would depend significantly on the financial assets they have.
Thus, in such a scenario, the survival of the Japanese companies is more likely as they, over the past decade or so, have built their retained earnings. “When sales are plunging, the amount of savings a company has will greatly influence its probability of survival,” the analyst said.
It is possible that not all companies have retained earnings in the form of cash. Even then, the companies with any kind of assets would be in a stronger position to survive the crisis when compared to those who have returned the money back to the shareholders in the form of dividends and share buybacks.
Talking about what is needed now, the analyst suggests a policy of forbearance, such as the temporary deferment of debt repayments. China did something similar recently. Under this, the companies that are witnessing a drop in revenue would be categorized only as non-performing even if they fall behind on their payments.
In fact, financial institutions should be encouraged to give more loans to such companies. As per the analyst, such a policy was used during the Latin American debt crisis in August 1982 and the U.S. debt crisis in October 2009.
“I think the People’s Bank of China was the first central bank to announce such a policy this time not only because COVID-19 first emerged in China but also because local companies were facing funding difficulties even before the virus outbreak,” Koo said.