Are We Heading Towards a Financial Crisis?

As rich nations spend trillions trying to keep businesses afloat they're relying on banks to maintain the flow of cash to industries, offering loan repayments and introducing mortgage forbearance programs. 

In the US, President Trump's administration has been rolling back safeguards to prevent another crisis, relaxing rules on how much money banks should have on hand to cover losses, weakening stress tests and allowing more proprietary trade.  A decade ago, banks would use their own money to bet against their own clients, a practice that has since been terminated.   Today, banks lend money heavily to hedge funds to essentially do the same thing.

The 2008 financial crisis has cost US taxpayers an estimated 23 trillion dollars or $70,000 per American.  Financial institutions, the bloodline of an economy, are in much better shape today than in 2008, but we expect no bank to be prepared for a pandemic of such scale.            

 One of the biggest problems facing corporations today is their exposure to loans held off their balance sheets.  Off balance sheet loans between corporations make them look more desirable to investors and lenders.  This is a form of shadow banking activity that was not regulated post 2008 and it has created serious fragility to the global financial system.  If or when corporations default on their short-term loans to one another, banks will have to step in, which in turn will create additional stress on the banking sector.

 Another problem is the elimination of economic output and the loss in GDP.  More than 100,000 small businesses have permanently closed so far.  Borrowers will default on their loans (non-performing loans) and bank capital reserves may not be sufficient to deal with this kind of crises.  If the pandemic lasts for an extended period of time, banks might face solvency issues and will need the help of central banks.

Tens of millions of jobs have been lost so far despite trillions of dollars spent on saving businesses and industries.  The hardest hit sectors are the airline, hotel and tourism industries.  Goldman Sachs warned last week that unemployment will reach 25%, matching the Great Depression levels.  They also expect unemployment to settle at around 10% by the end of the year and 8% by the end of 2021.

 For context, unemployment was 10% during the 2008 recession. Financial markets are complex and hard to navigate during downturns.  If you need financial advice during these difficult times, we are here to help.

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