ARCHIVE: INSIDE OUTLOOK
Crisis and Intervention: Lessons From the Financial Meltdown
December 6, 2010
Extraordinary times demand extraordinary measures. In the fall of 2008, governments around the world responded to a once-in-a-lifetime global financial crisis and to the resulting recession by taking exceptional action on numerous fronts. They needed to act swiftly and almost simultaneously.
If there was a major error, it came in the very early days of the crisis, with the failure of investment banking giant Lehman Brothers. Rather than intervening to keep Lehman Brothers intact—as Washington had already done with Bear Stearns in the spring of 2008 and Merrill Lynch earlier in September 2008, when they were in deep financial trouble—the U.S. government allowed Lehman Brothers to fail. The bankruptcy unleashed waves of fear and financial loss that rippled through the entire global financial system.
The anxiety sparked by the failure of Lehman Brothers created a severe systemic shock. Governments managed to contain the systemic risk in the financial sector by building a floor under the global financial system. They did so with coordinated intervention by nationalizing companies (in whole or in part), injecting equity, and providing guarantees, as required.
Governments managed to contain the systemic risk in the financial sector by building a floor under the global financial system.
Governments eventually undertook similar intervention in the U.S. auto sector, bringing order to a chaotic situation. Central banks used monetary policy aggressively to provide exceptional levels of liquidity and stave off deflation. Governments injected massive amounts of fiscal stimulus to help restore confidence and to kick-start economic growth.
Investor Confidence Rebuilt
For the most part, the plan worked. Specific measures were implemented in a coordinated, orderly, and pragmatic way. When something didn’t work, such as the efforts to strip bad mortgage assets out of U.S. banks, the strategy was quickly adjusted to find some other form of intervention that would.
Thanks to the massive concerted action, confidence in the international financial system has been rebuilt—unevenly, but steadily—and the global economy has sputtered back to life. The global economic and financial system remains fraught with risk and uncertainty, as demonstrated by the shock to investor confidence caused by the Greek financial tragedy in the spring of 2010. But growth has returned, and step-by-step healing is under way.
In Crisis and Intervention: Lessons From the Financial Meltdown and Recession, members of The Conference Board of Canada’s Forecasting and Analysis team outline 10 key lessons for business leaders and policy-makers:
- Canada’s fiscal stimulus spending, along with record-low interest rates, helped the country overcome the worst of the recession and kick-start the economy.
- The recession only delayed the inevitable workforce shortages. A mass exodus of baby boomers will force employers to compete even more fiercely for skilled workers. It will also put pressure on policy-makers to reform labour market and immigration policies.
- Because it interacts with all other players in the economy, the financial sector is unique and must be treated differently than other sectors via regulation and greater transparency.
- Public sector financial institutions are a critical backstop to provide credit when private lending dries up, but they must exist before a crisis hits; it is too late for governments to create them in an emergency. Canada had these public sector financial institutions—specifically, Export Development Canada and the Business Development Bank of Canada—in place, and they provided exceptional support during the crisis.
- Policy coordination among global bodies—such as the International Monetary Fund, the World Bank, and the G20—helped bring the world economy out of the crisis. As the global economy returns to growth, there is a risk that this coordination will weaken.
- Firms can be “too big to fail,” with catastrophic costs to an economy. As a consequence, it is in the public interest to limit the systemic risk posed by very large firms in advance of any crisis.
- International trade links pulled countries into a wider and deeper recession than would have otherwise been the case, but these same connections may have blunted governments’ impulses to enact protectionist measures. These links can help revive the Canadian and global economies as they come out of the recession.
- Local governments do not have the fiscal powers and muscle to help pull their regions out of the recession.
- Policy-makers must change fiscal and monetary policies early in a recession, because consumer and investor psychology was a crucial factor in speeding the downturn.
- Governments must begin implementing the tough but necessary measures to get their deficits and debt under control.
The worst of the recession and financial crisis is over. The need to adapt—in the way we act and organize ourselves to avoid the worst impacts of the next financial crisis—is not.
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The Financial Crisis, Regulatory Reform, and International Coordination: What Remains to Be Done
World Outlook—Autumn 2010
U.S. Outlook—Autumn 2010
Index of Consumer Confidence: November 2010
The International Trade and Investment Centre