Episode 20: Recession and why this isn't like 2008

This is Before and After from Refinitiv. I'm your host, Johanna Botta. Due to the Coronavirus pandemic we're filming all episodes for the time being in unique circumstances. So the look and feel will be slightly different, but the content itself will remain of the highest quality using the very latest Refinitiv data. Now, as I've said before, we know that this information is more important than ever, so please bear with us while we continue to bring you the show twice a week. 

What we saw in the markets and the economy in 2008 was more than anyone had previously seen in their market experience. Until now. In 2008, when the financial crisis was well underway, we overheard many things like moral hazard, as the Federal Reserve in a joint initiative with the U.S Treasury went very far outside the box of precedent and created TARP. The Troubled Asset Relief Program, which enabled the United States government to purchase toxic assets and equity from financial institutions to strengthen its financial sector. It was passed by Congress and signed into law by President George W. Bush on October 3rd, 2008. Basically, it was a component of the government's measures to address the sub-prime mortgage crisis. Now, the TARP program originally authorized expenditures of $700 billion dollars. At the time, it was revolutionary, and many were up in arms as money was being created out of thin air (or new debt) to bail out the banks and quarantine the worst assets. It worked and created a precedent for Fed saviors. Now everyone expects the Fed to save the day. But this time it actually is different. The only thing in quarantine is the world's workforce. In '08 it was specific mortgage related securities that spilled over to the banks, which took the world to the brink. In this situation, we're already on the brink, and no corner of the world is spared. So now we're trying to bail out everyone, but who will bail out the governments if it doesn't work? How do you save the tens of millions of business owners who will lose everything in this? Some say they need economic activity, not a loan or a basic monthly income. So how do you replace the lifetime of savings gone when those mom and pop shops close? Now, this feels much deeper than 2008, and because of that, a monetary response is not enough. We saw the market crash after the Fed's 100 basis point cut, because it's like putting some rubbing alcohol on a gunshot wound. When it's all said and done, '08 will look like practice while Coronavirus 2020 is the World Cup finals. In 2008 it was the banks who had too much leverage. They've since strengthened balance sheets, especially in the US. Now it's every public company in the world addicted to leverage. The leverage they used not to expand or strengthen reserves, but the buyback stocks. In '08 we had philosophical debates about the role of central banks. Now we will question what is money? The entire system of social contract, government and everything else will be and should be up for review. 

One sector in global finance that has been under stress way before March 2020 is the European banking sector. Let's look at Italy, whose death toll from Coronavirus is the highest in the world and is in total national lockdown. Italian government debt exceeds one hundred and thirty one percent of its annual economic output, according to the International Monetary Fund. That is the second highest level in Europe, trailing only Greece. When investors grow anxious about the public debt burden, they demand higher rates of interest for government bonds. A blow up in rates in Italy would lead the banks to take a hit on their holdings of Italian sovereign bonds - the 'doom loop'. Since the beginning of the year, the yield on 10 year Italian government bonds has more than doubled from 0.9 percent to 2.2 percent. Take Intesa Sanpaolo, Italy's second biggest bank, the stock is down 57 percent from 2018 highs, trading at half their book value of 2.98 Euros per share. And offering a div of 13% at this level. The stress-test knock on effect of Coronavirus will be the strength of the EU. Legarde ruled out specifically buying Italian bonds in a rescue effort. So then where will the line be drawn for rescue? So far, the Germans seem unexcited about sharing the onus of playing savior. This is setting up for a Greek debt crisis on steroids with a calamity in Italy and another potential one in Spain. It's like all of the worst stories of the last decade have all come back as extra symptoms on top of the complete economic shutdown. Now we're staring at zombie banks with broke customers and bad books, out of any possible bailouts that aren't full nationalizations wiping out shareholders. It's in times of crisis one finds out who truly has their back. And that moment is now for Europe. The banks will be the litmus test, and the Eurozone hangs in the balance. 

The helicopters are on the horizon. But at the time of filming, we were still waiting for the House to sign off on the US deal that has passed through the Senate. At that point, the US will have the weaponry of QE infinity combined with the firepower of a fully charged fiscal response aimed squarely at the US economy. Whilst the equity market has attempted to raise itself off its oversold lows in recent sessions, the funding markets are still showing signs of distress. Although the authorities dithered in 2008, once they worked out where the stresses were within the banking system, they were able to channel the support accordingly. Today, the stresses are in the shadow banking system, the real economy, from big businesses down to self-employed individuals and the wider global economy that is desperate for dollar denominated cash flow. Targeting the transmission mechanism will be much harder in this environment where the issues are pervading in all parts of the U.S. and global framework. And yet there could be a sting in the tail. Although the deflationary shock is huge, governments have forced a real economy to mothball huge segments of their productive capacity and supply chains. But if trillions of dollars are now poured in to support demand, whilst the supply of vital goods remains under complete lockdown, then there is a risk of an inflationary surge in the essential items that most people will need. It's not just the size of the bazooka that matters. The timing and aim are of crucial importance as well. 

So there it is. TARP bailouts and the European banks in the Before. QE in the After. Refinitiv data throughout. This has been the Friday episode of Before and After. Please subscribe and hit the notification bell to ensure you're alerted to all of Refinitiv's future market updates. 

We look forward to seeing you again next week.