03 June 2022

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Have financial crises taught us anything?

Author: Luigi Campopiano

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History is full of economic and financial crises that have helped economies to move more carefully. According to Capital Group, market crises are part of the life of investors and we have one every 18 months or so (since 1987 alone we can count more than twenty, and all of which have had a negative impact on an economic level). Among the most important crises in history, there are about ten that have changed the course of events, from which it is possible to draw valuable lessons:

1. Crisis of '29. It led the US to the Great Depression. The economic boom that emerged from the First World War favored speculative stock activity, creating a bubble that burst in 1929, then spilling over to world markets. The theory of "improving your internal situation at the expense of other countries", applied between '29 and '33 by some of the major economies, worsened the recovery phase. This led to the creation of monetary and economic organizations of an international nature (signing of the Bretton Woods agreements and birth of the United Nations "UN").

2. Inflationary crisis of 1974. During the 1970s, the political crisis between the US, Israel and the Arab world led the latter to gradually reduce oil exports to the West. The result was a progressive increase in the price of crude oil, followed by that of commodities. Inflation reached double digits, with subsequent increases in interest rates;

3. Financial crisis of 1987 “Black Monday”. The black Monday of the markets, because in just one day the world markets suffered a sudden drop in the value of listed securities. The epicenter was Hong Kong, where the capitalization of its indices was halved. The crisis spread throughout the rest of the world, sparking panic among traders;

4. Japanese speculative bubble (1991). It all started with the initiation of accommodative measures by the banks, thanks to high levels of savings and high liquidity deposited, in support of an economy in which demand grew more than supply. The rapid economic growth allowed companies to invest in speculative activities, where a financial bubble developed from real estate. The sudden move by the Bank of Japan worried about excessive credit granting (it sharply raised interest rates to adopt a more restrictive fiscal policy) burst the bubble, leading Japan towards the so-called "lost decade" (deflation, recession and economic stagnation);

5. South East Asia (1997). It began when the Thai government decided to devalue its currency with the aim of returning to the markets, following a series of speculative attacks by international investment funds. Under the IMF and the USA, Thailand had recently experienced the effects of the liberalization of the capital market, which led to an increase in capital flows and exchanges of up to one sixth of GDP. The IMF tried to counter currency and capital losses with government funding, but it worsened the confidence picture. The collapse of the Thai currency triggered contagion phenomena that quickly involved the neighboring economies, known as "Asian Tigers". Upstream of financial speculation was the significant level of private sector debt which caused the outflow of foreign capital. The international institutions let the crisis pass because they did not look favorably on the interference of the Eastern governments (between 1985 and 1996 they had initiated flourishing developments in contrast with Western liberal policies);

6. Bulletin of the "dot.com". Between the late 90s and early 1900s, general euphoria resulting from the concepts of development and technological progress, associated with the cutting-edge sector of the new economy it fueled investors' expectations that tech stocks could continue to post increases in value, regardless of the strength of the profitability indicators. The lesson of this crisis was seen with the technological development of the late '10s, with a significant rise in prices associated with the consistency of company profits and revenues;

7. US financial crisis 2007-2008. It should be divided into two stages: the first, caused by the bursting of the bubble on subprime mortgages; the second, combined with the first and culminating in the failure of Lehman Brothers, originating from a liquidity crisis in the banking sector. With the growth of the real estate sector, banks began to grant loans for the purchase of the house to people with increasingly lower creditworthiness, having as a guarantee the high value of the housing market. Subprime mortgages were securitized and sold to special purpose vehicles, thus shifting the risk from the banks to the buyers. In 2006, with the increase in average mortgage rates, insolvencies began, the value of homes began to fall rapidly and with it the value of financial instruments. The most exposed recorded heavy losses and the securitized securities lost much of their value; SPVs began asking banks for funds, but they were unable to find them. In a short time, a liquidity crisis developed, which was transmitted to the real economy;

8. Eurozone sovereign debt crisis (2010). It originated from countries that were experiencing serious economic difficulties and unsustainable levels of public debt, due to the accumulated debt since the 1990s. Upstream of the crisis, the difficulty of some countries ("PIIGS" Portugal, Ireland, Italy, Greece and Spain) to finance further levels of deficit in the face of their budget in the red. Growing budget deficits and sovereign debt widened the spreads between government bonds and increased risk. With the wave of downgrades by the main international agencies, we came to a phase of recapitalization of the banking system, the skeleton and support tool for the economy;

9. Dragon Crisis (2015). In 2014, the Chinese real estate market began to weaken and domestic capital began to converge towards the stock markets, even in the face of the government's stringent anti-corruption policy that prevented large capital of dubious origin from leaving the country. The rise in the market fueled new growth and the influx of private savings of young people and families. On June 12, 2015, profit taking began and then a wave of sales. Immediately afterwards, but belatedly, the action of the authorities arrived, which lowered interest rates and issued an appeal to state-owned companies not to sell their shares. The crisis has accelerated the development of Chinese regulation and the opening up to international markets;

10. Pandemic crisis from Covid-19 (2020). Union, through the virus, of the concept of economic crisis and health crisis, with an alignment of monetary and fiscal policies with monstrous figures in an attempt to stem the spread of the epidemic. Countries around the world had to close their economies to safeguard public health, while new liquidity continued to enter the market in an attempt to offer market support.