Banks Are Put To the Test, Smartphones Measure Movement, and the Poorest Are Hit Hardest

summary
  • Banks Confront A New Kind Of Stress
  • Asking Directions To A Recovery
  • Poorest Hit Hardest

After surviving a crisis, societies frequently take steps to prevent a recurrence. Lessons are learned, root causes are identified, and new safeguards are implemented. “Never again” is often the mantra.

The limitation of that approach is that the next crisis rarely looks like the last one. The pandemic crisis we are currently experiencing has had a very different economic impact than the global financial crisis did 12 years ago. And that may spell trouble for banks. COVID-19, which has presented a significant challenge to public health, may threaten the health of some of the world’s financial institutions.

Banks were at the center of the storm in 2008. Years of aggressive underwriting had created substantial systemic risk. The invention and distribution of exotic financial products added layers of complexity. Risky instruments and operations were often housed outside of bank balance sheets, increasing leverage and stretching reserves.

When the housing market cracked in 2007, banks became agents of contagion. Their troubles threatened to bring the rest of the global economy down, and so they consequently became the focus of rescue and rehabilitation efforts. The optics troubled many (everything for Wall Street, nothing for Main Street), but preventing financial collapse was an effective way of heading off more widespread economic damage.

In the years that followed, financial re-regulation centered on the products and practices that were deemed responsible for the crisis. Most derivative products were moved to transparent exchanges; proprietary trading within banks was limited; underwriting standards were toughened; and firms were required to increase their capital bases, which are considerably stronger than they were 13 years ago.

Weekly Economic Commentary - Chart 1 - 06/19/20