The several stages of the crisis (2)
The combination of falling house prices, reduced mortgage lending and a higher cost of living put household budgets under strain. There was a sharp slowdown in US consumption growth – not just housing-related expenditure but other categories of consumer spending as well. Stock prices, especially those of financial stocks, weakened, the Dow Jones industrial average falling to around 11,500 in the summer of 2008. Charles Bean’s remarks reflected a growing realization that the financial and economic crisis would be long-lasting.
But still no one realized quite how severe it would yet become. Less than a month after Charles Bean’s interview, the global credit crisis took a new, unexpected, and even more serious, turn for the worse. The failure of Lehman Brothers on 15 September 2008, and the bailout of the giant US insurer AIG the following day, marked the start of a four-week-long worldwide financial panic, with a dramatic loss of confidence in bank liabilities, a virtual free fall in bank share prices and massive withdrawals of money by professional investors from both banks and money market mutual funds.
This was nothing less than a run on the entire global banking system. Only an unprecedentedly large expansion of central bank lending to commercial banks, making up the shortfall created by this withdrawal of short-term investor funding, prevented widespread bank failure. The Federal Reserve, the European Central Bank and the Bank of England increased their loans to banks by more than $2 trillion in just four weeks, an astonishing increase that roughly doubled the size of their balance sheets. Even then, the panic only finally abated after the announcement of massive packages of government support, with first the UK and then other governments stating their intention to purchase large amounts of newly issued bank shares and to provide widespread guarantees of bank borrowing.
In early 2009 it appears that even these substantial commitments of funds in support of the world’s banks will not prevent a global economic contraction deeper than any in the past seventy-five years. Share prices remain weak. By 20 November 2008 the Dow Jones industrial average had fallen to an intra-day low of below 7,200, nearly 50 per cent below its all-time peak just over a year earlier, and had fallen even further by early March 2009. The spectre we now face is of a return to the worldwide slump of the 1930s, with all the accompanying problems of long-term unemployment, social deprivation and political instability of that time. So what, then, lay behind these dramatic events, and what can be done about them?