The Panic of 2008 and the Great Recession it spawned are no longer news; they are history. Recovery will be slow and other hazards threaten our future prosperity, but we got through the crisis in better shape than we might have.
Though it will be some time before economists crunch the numbers and declare the recession officially over, it is pretty clear that the U.S. economy turned the corner in the spring or summer. Unemployment could continue to rise for another three to six months or so, perhaps longer, and may get into the double-digit range not seen since the early 1980s. That will make this recession the longest and arguably the most severe since World War II, but comparisons to the Great Depression of the 1930s, heard frequently during the past year, were vastly overblown.
For a brief period in September 2008, there was a real possibility of another depression. The collapse of Lehman Brothers, the government takeover of Fannie Mae and Freddie Mac, the costly bailout of AIG and the failure of the Reserve Primary Fund money market vehicle came dangerously close to bringing down the global credit system. Perfectly sound companies had hundreds of millions of dollars tied up in unsound institutions and might have been shut off from their own cash, as well as from new credit. The results could have been catastrophic.
But policymakers, who many believed erred by letting Lehman collapse, were quick to realize their mistake. They did the only thing they could: put the financial strength of the world’s major governments, led by the United States, on the line to restore confidence.
It took a little time, and we had to get through an aftershock of panic early in 2009 when the extent of the economic damage started to become clear, but ultimately, the intervention worked. By the time September rolled around, marking the one-year anniversary of Lehman’s collapse, conditions in most corners of the financial markets looked like something approaching normal. Not necessarily good, but normal, especially for a world economy just beginning to emerge from a deep recession.
Enough time has passed to let us identify key events and draw important lessons.
The most significant observation might be that the panic came in two distinct waves. The first, from mid-September through October 2008, was touched off by Lehman’s collapse and the credit market turmoil that followed. It reached its low point when the U.S. House of Representatives, in a fit of ignorant pique, at first declined to enact the $700 billion Troubled Asset Relief Program because it was viewed as a bailout for banks and bankers rather than for the broader economy. The stock market fell so sharply that our firm took out a full-page newspaper advertisement in our headquarters village of Scarsdale, N.Y., counseling neighbors and clients not to succumb to the spreading fear (see sidebar).
The second wave of panic crested in February and early March, when business conditions were at their worst and newly sworn Treasury Secretary Timothy Geithner was slow to articulate his plan to help the financial system recover. This wave of selling drove the Standard & Poor’s 500 stock index down to levels not seen since 1996.
Investors with a long-term focus seemed to handle the initial panic pretty well, but the second installment was more difficult. For a few weeks last winter, my colleagues and I, like many financial advisers, spent hours on the phones each day, urging clients to stick with their long-term investment strategies rather than sell stocks at fire-sale prices. In our case, it worked. Nearly all our clients took our advice, and they benefited from the market recovery that within six months brought the major indexes up by 50 percent from their lows.
As I write this in mid-September, 2009 has turned out to be a pretty good year in the stock markets, with the S&P 500 up about 12 percent since Jan. 1. This is not surprising when you consider just how awful 2008 was. The index dropped more than 38 percent last year, its worst performance since the 1930s. Barring catastrophe, a rebound was likely.
Catastrophe is what some people thought they saw during the early months of 2009. By March 9, the S&P 500 was down around 25 percent since Jan. 1. Nouriel Roubini, a New York University economics professor who became well-known for correctly predicting the end of the housing bubble and a mortgage-linked financial crisis, said that day that the S&P would probably lose 33 percent by the time 2009 is over.
The fact that it never happened is not so much a reflection on Roubini’s skills as it is evidence that nobody can reliably predict short-term stock market movements. This is why stock investments should be made for the long term.
One of the most difficult things for investors to do during the crisis was to buy when everyone else was selling. It was also the most profitable thing to do. With stock prices down, merely rebalancing a portfolio to its normal allocation of stocks would have allowed investors to pick up shares at rock-bottom prices. Most of our clients let us do that for them, to their great benefit when the market rebounded in the spring and summer.
The panic also created great opportunities for transferring wealth to younger generations, bypassing potential gift and estate taxes. In late February, it was possible to lend money to family members at less than 2 percent interest for nine years without having that low-interest loan treated as a taxable gift. If those family members used the borrowed money to buy stocks, which then were near their lows, the result was a quick and substantial profit — again with no gift tax implications. I wrote about this opportunity in January’s Sentinel. It came to pass just as expected.
There are still many economic challenges ahead of us. Huge trade and fiscal deficits, decimated state and local budgets, an aging population and an enormous federal debt all have the potential to hamstring the U.S. economy. Some other major economies have similar problems. The road to prosperity is likely to be neither smooth nor short. But risks can be managed, downturns can be survived, and stampeding herds are best avoided.
These will be the lasting lessons of the Panic of 2008.
