It’s a contraction, not another Great Recession

Mitchell Hartman Aug 25, 2015
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It’s a contraction, not another Great Recession

Mitchell Hartman Aug 25, 2015
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U.S. financial markets rallied through most of the Tuesday, then fell back in the final hour of trading to close with another day of solid losses.

The Dow Jones industrial average fell 204 points, 1.3 percent, to close at 15,666. The Standard & Poor’s 500 index dropped 25 points, 1.3 percent, to close at 1867. The Nasdaq fell 19 points, 0.44 percent, to close at 4506. The yield on the benchmark 10-year Treasury bond rose to 2.07 percent.

The Tuesday morning rally in the market (after steep losses on the two previous trading days) came after China’s central bank lowered interest rates to stimulate the country’s economy and try to reverse recent stock market declines, and the Conference Board reported an improvement in U.S. consumer sentiment.

While investors may be experiencing a high degree of fear and uncertainty, the overall financial picture does not resemble the financial crisis of 2008. From August to October 2008, the stock market was also tanking. Plus, Lehman Brothers and Washington Mutual had failed; Fannie Mae and Freddie Mac were seized by the government as subprime borrowers defaulted, mortgage bonds went bad and home prices crashed; the Big 3 automakers and the nation’s biggest banks were on their way to receiving massive government bailouts to stay afloat.

The global financial system was seizing up, says economist Paul Ashworth at Capital Economics in Toronto. “What we’ve had over the last few days is a drop-back in equity prices,” he says. “But we haven’t seen any sign of a credit crunch. Banks are still freely lending to other banks, which was a big problem in the financial crisis. And banks are pretty much willing to lend freely to most businesses and individuals.”

Ashworth says this time around, the underlying economy remains strong, and growth prospects so far haven’t suffered from the recent market turmoil. “The unemployment rate has come down substantially, a lot more people are employed,” Ashworth says. “Domestic sectors of the economy, including housing, look like they’re finally coming back.”

Boston University finance and law professor Cornelius Hurley points out that a key aspect of the 2008 crisis was the bursting of the housing bubble. That left homeowners, institutions, banks and investors holding assets — homes and mortgages and mortgage-backed securities — that couldn’t be valued because there were no buyers for them.

Hurley points out that was also a homegrown crisis that spread globally. “This crisis is generated through China and Greece, and other foreign venues, so it seems somewhat remote,” he says.

The U.S. economy is connected to Europe and China and other emerging markets through imports and exports and investment flows. Which means that a global economic slowdown could take a toll on domestic businesses and consumers. But that needn’t be alarming, says policy analyst Gordon Gray at the American Action Forum.

“It just so happens that the Great Recession is our most recent memory of a big economic slowdown,” Gray says. “But the law of the business cycle is that at some point, you’re going to see some contraction. And contractions don’t necessarily need to look anything like the Great Recession.”

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