Up until the COVID-19 recession came up, the 2008 crisis was the greatest economic disaster the world economy had ever faced after the Great Depression of 1929. But now it has been dethroned by the latest recession, which has been christened the Great Lockdown by economists. In this context, it is essential that we learn from the mistakes that we committed the last time, to ensure that we don’t repeat those mistakes again.
So, what are some of the lessons that we can learn from the 2008 recession that will put us in a better position to deal with this depression? What are some of the similarities and differences between the two phenomena? In this article, we shall analyse both the events.
While the 2008 recession is such a major historical event, not many people know how it came to be, and what the causes were for the recession. The 2008 recession was caused mainly by human error and greed. Because interest rates fell to around 1% in the US in the early years of the 21st century, bankers started lending money to people to buy houses. Several of these loans were given to subprime borrowers, who were people who had a higher risk of defaulting because they did not have much assets, incomes, or any other means to repay them. In addition to that, bankers also started collecting these mortgage loans in piles called Collateralized Debt Obligations (CDOs) and started trading them. They were given a very high credit rating because it was assumed that no one would default on their mortgages.
However, when interest rates went back up again, most people couldn’t afford to pay their mortgages, and so they defaulted. And the market failed and crashed. Several investment banks went out of business, and huge fiscal policies were enacted by most countries around the world to prevent the world economic system from collapsing. Real estate prices plummeted, and they haven’t come back to old levels ever since.
However, while the 2008 recession was caused by human greed and error, the COVID-19 recession is not. As the name suggests, the recession is caused by the global pandemic that has claimed around 4 hundred thousand lives till date. The economic recession was brought on by the panic selling induced by the imposition of lockdowns in several countries around the world. As several countries banned business activities in their domiciles to enforce social distancing and keep people safe from the virus, people panicked and became fearful for the safety of these companies, thereby triggering a huge fall in stock prices.
Using Stock Options
One of the major differences that many people fail to notice between the 2008 recession and 2020 recession is the prevalence of stock options. For those who may not be aware of what stock options are, they function in more or less the same way as futures, except they’re optional. For example, if I think that a particular stock price will go up in the future, I can buy a call option. Suppose the stock price is $40 right now. I can buy a call option for $40 with an expiration date of a month. After two weeks, if the stock price goes up to $50, I can then call in my option and buy the stock for $40. Then, I sell it for $50 in the market and make a $10 profit. Like any other derivative, the value of a call option depends on the underlying stock or security that it depends on. Therefore, they’re a very good way to be able to hedge your bets in the market.
While options trading was not very common in 2008, with the advent of technology in 2020 it has become a very preferable means of protecting oneself from the volatility that is a major part of the stock market in these troubled times. Therefore, such options can be used instead of outright selling the stocks, and this would definitely help reduce the sudden changes in the market, thereby stabilising the market to some extent and avoiding a recession.
The Boon and Bane of Technology
Technology has changed exponentially since 2008. While we only had the first iPhone prototype in the last recession, today almost anything can be done through technology, and this applies to finance as well. Gone are the day where you needed to call your broker to make transactions, now you can trade stocks on your phone with just a click of your fingers. While this has certainly improved the efficiency of the stock market, it can also lead to several problems and issues, especially during recession.
Higher accessibility means that people are much more likely to panic and hit the sell button at the slightest signs of problems, and that they are less likely to consult their brokers before making such a decision. Another major factor to be considered in this regard is FOMO: Fear Of Missing Out. Most people are so fearful of missing out on trends in the market that they tend to make decisions impulsively, and do not think their trades through.
The FOMO has also been compounded due to the prevalence of rumors and fake news in the market, that is waiting as a trap to lull unsuspecting investors. Sometimes, even prominent financial personalities indulge in such rumor-mongering. A notable example of this is Bill Ackman, a hedge fund owner who gave an interview to CNBC in March about the pandemic where he said, “Hell is coming.” This led to a huge panic in the market and people scrambled to sell their shares, until it turned out that Bill was actually shorting most of the stocks in the market, and that he made a fortune when the share prices fell. Incidents like these prove how rumors and news are sometimes manufactured by financial analysts for their own personal gain, and hence one must be wary of such information.
While the 2008 Great Recession and the 2020 Great Lockdown might not have much in common, there are definitely a few things that we can learn from our past mistakes in order to be able to efficiently get through this recession without much of a loss.