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Ask The Experts: What are the Great Recession’s Lessons?

Ask The Experts Great Recession Lessons

Five years ago, in October 2008, the stock market plunged while businesses eliminated hundreds of thousands of employees, almost overnight. The recession of 2007 had suddenly become the Great Recession, the biggest shock to the U.S. economy since the Great Depression.

In the preceding months the U.S. housing bubble had popped, creating a crisis in real estate as well as in banking. The venerable investment banking house of Lehman Brothers had filed for bankruptcy, undone by investments in mortgage-backed securities that had suddenly become “toxic” because of a swelling wave of foreclosures.

The recession officially ended the following year but the economy, in many respects has been slow to recover. The job market, in fact, still hasn’t recovered.

Uncharted Waters

There is a feeling that what we are experiencing is new, that we have entered uncharted waters. The experts CardHub spoke to believe there is an element of truth to that, but that recovery will come, in its own time.

“When there is a recession, be it minor or significant, the labor market is always slow to adjust,” said Louis Pantuosco, professor of economics at Winthrop University. “Even the 1990-1991 two quarter recession impacted the labor market for years after. The structural changes, particularly in terms of health care policy and manufacturing, has slowed the adjustment.”

Joel Auerbach, adjunct professor of economics at Nova Southeastern University, doesn’t believe there has been a structural shift in the economy. He thinks part of the problem in the job market can be traced to the very rapid downsizing in the labor force five years ago. Regulatory reactions to the Great Recession, such as Dodd-Frank, has yet to be fully felt, he says.

“Some of the features greatly enhance the regulation of markets,” Auerbach said. “Others, regulating  underlying causes –derivatives — are curiously still missing. Much of the legislation will be amended as the choices between economic growth, profitability and regulation strangulation are sorted to allow business to flourish match what public safeguards are absolutely essential.”

What’s the overriding lesson of the Great Recession? Perhaps it is the dominant role of the financial services industry in the global economy. When things go bad, they can go very bad.

“Even a strong, vibrant and advanced economy as that of the U. S. is not immune to financial sector’s excesses,” said Tayyeb Shabbir, professor of finance at California State University Dominguez Hills. “The financial sector has become increasingly more important in a globalized economy. While it may not be directly making products in a traditional sense, it is the life blood of a modern economy. Thus it is important to have the financial sector healthy and well-functioning.”

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Louis J Pantuosco

Professor of Economics, Winthrop University

The Lehman Brothers bankruptcy five years ago is viewed by some as the start of major changes in the economy.

I don’t put too much into one company’s demise. The foundation of the boom was on sand. If it wasn’t Lehman it would have been someone else.

Do you think the high unemployment we are still experiencing is the temporary effect of a weak economy or a structural change that has long-term implications?

Both. When there is a recession, be it minor or significant, the labor market is always slow to adjust. Even the 1990 -1991 two quarter recession impacted the labor market for years after. The structural changes, particularly in terms of health care policy and manufacturing has slowed the adjustment.

Have the reforms enacted by Congress in response to the events of 2008 achieved positive results or made the situation worse?

In the financial market it has made it more difficult for banks to lend. Was all of the regulation necessary? That’s debatable.

What do you see as the over-riding lesson we should have learned from the Lehman bankruptcy and the dramatic economic events that followed?

You can’t stop everything bad from happening. Over-regulating will cause it’s own set of issues. Build on rock, then the waves will not have as significant an impact when they hit.
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Joel Auerbach

Adj Professor of Economics, Nova Southeastern University

The Lehman Brothers bankruptcy five years ago is viewed by some as the start of major changes in the economy.

Undoubtedly the Lehman Brothers bankruptcy is a precipitating act for some major changes. Arguably some things were rotting underneath the excitement of profits and growth, but this bankruptcy unveiled some big structural defects and allowances for “domino” collapses. For one, it revealed that the Federal Reserve and the Treasury would be selective in what “rules” they broke: they bailed out AIG but not Lehman (Couldn’t find a buyer, they say). Or in truth, a buyer at the price. We all learned that we greatly under-estimated the negative aspects of leverage whilst we can afford to be living the better high life because of it.

For another, it is now realized that the U.S. accounting rules, banking policy and monetary policy may be “harmonized” but are not shared equally in world. For example, bankruptcy in the UK means the doors are closed, workers escorted out, operations stop and administrators are brought in to “wind down” the business. In the U.S. it is a pause as everyone gets a chance to be on a better footing. The difference is that all “trades” in Lehman London stopped cold. The knock on effect pretty much caused a global liquidity knock down and a crash of valuation for underlying asset financing.

Lastly, greed is an unpredictable, incredibly strong motivator that may be cloaked in much “its good for me therefore it’s good for everyone” rhetoric and action. Many strategies aren’t win-win or Pareto optimal.

Do you think the high unemployment we are still experiencing is the temporary effect of a weak economy or a structural change that has long-term implications?

It remains to be seen. Research now being published suggests it is not a structural shift but a response to down-sizing faster than typically expected. Similarly, where jobs are located–sector or geography–will also be changing as technology advances change the service sector. This is added to other factors and trends currently under study that have yet to publish conclusions. This includes changes in demographics, i.e births, aging and deaths; changes in lifestyle preferences, women in labor force and immigration.

It is also being reported that the financial sector has lost sway in proportion of new “best” hires from “best” schools transforming subjects that are selected as majors. This will have tremendous effect in economies as new human capital carriers, graduating students, grasp other career paths in other sectors and businesses.

Have the reforms enacted by Congress in response to the events of 2008 achieved positive results or made the situation worse?

On the one hand yes; Dodd-Frank is a landmark piece of legislation that has yet to be fully implemented. Some of the features greatly enhance the regulation of markets. Others, regulating underlying causes-derivatives–are curiously still missing. Much of the legislation will be amended as the choices between economic growth, profitability and regulation strangulation are sorted to allow business to flourish match what public safeguards are absolutely essential.

On the other hand, the questions of saving the financial world, free market system, too big to fail, too big too manage are still hotly debated. One might also add that Dodd-Frank provided for and there is now an integrated, coordinated bank, regulating agency government, etc., “membered” Financial Stabilization Board (to ensure the public that this type of financial meltdown doesn’t happen again). However, after one year the GAO has published its oversight review-of progress on what needs to be done and concludes little of what is needed operationally has been implemented or even put on the table for action.

What do you see as the over-riding lesson we should have learned from the Lehman bankruptcy and the dramatic economic events that followed?

It can happen again as there is always a chance someone or some agency will figure out a way to do something that looks good on the surface but has unintended consequences that will sooner or later come to pass.
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Tayyeb Shabbir

Professor of Finance, California State University Dominguez Hills

The Lehman Brothers bankruptcy five years ago is viewed by some as the start of major changes in the economy.

Undoubtedly September 15, 2008 bankruptcy of Lehman Brothers, 4th largest bank in the U.S., marks the definitive onset of the Global Financial Crisis of 2007-2009. This collapse of the global banking and credit system, to say the least, was extremely disruptive to the world trade and economic activity. It not only precipitated the Great Recession – the severest economic downturn in the U. S. since the Great Depression of the 1930, the economic recessionary effects were borne by Europe and many other countries around the world. In the U.S. the housing market collapsed, the credit froze and banking sector cratered. These sectors and the economy in general will needed short, medium and long terms structural reforms.

Ultimately, Lehman Brothers was the victim of the ‘sub-prime’ crisis. In general, a financial innovation, borne out of decades’ long trend of deregulation in the U. S., these complex financial instruments went awry and Lehman Brothers as well as others got badly burned, Lehman, of course, fatally. Lehman Brothers bankruptcy is the largest one in the U. S. history. Lehman brothers was a venerable Investment Bank founded in 1844 and had a role in the ‘birth’ of such main stay companies as Sears, Woolworth, RCA and even helped finance Halliburton. Just before bankruptcy, Lehman Brothers had $ 275 billion assets under management and 28,600 employees.

Do you think the high unemployment we are still experiencing is the temporary effect of a weak economy or a structural change that has long-term implications?

In the aftermath of the Great Recession (December 2007-June 2009) the median duration of unemployment has doubled as compared to other recessions in the past. It is generally recognized that recessions precipitated by banking crises are relatively more severe and recovery takes longer.

The extremely elevated duration of unemployment leads to atrophy of skills and structural mismatches become ingrained (construction works move on to other sectors). Thus there will be a long term structural effect of this recession which may last a generation or so. However, the labor market of the U. S. is traditionally most nimble and once housing returns to some degree of normalcy many of the ‘structural’ pressures on the U. S. unemployment rate will dissipate.

Have the reforms enacted by Congress in response to the events of 2008 achieved positive results or made the situation worse?

In general, these reforms have been positive, the real issue may be that these efforts may be too little and moving too slowly into a state of operational readiness. For example, a generally positive piece of legislation, Dodd-Frank 2010, is a blue print and needs a lot of functional detail but it is a step forward. However, it is important that this process is not short circuited by lobbyists.

Consumer protection (e. g. Consumer Financial Protection Bureau) and housing credit reforms have been a step forward as renewed efforts to make sure that the banks do not take undue risks and stay well-capitalized.

One big challenge is that diagnosis of the crisis is not unanimous and even if it were execution of policy reforms may fail anyways.

However, the jury is still out whether all of this will enable us to prevent another financial crisis. Memories are short and a return to normalcy can soon lull us into complacency.

What do you see as the over-riding lesson we should have learned from the Lehman bankruptcy and the dramatic economic events that followed?

1. Even a strong, vibrant and advanced economy as that of the U. S. is not immune to financial sector’s excesses. The financial sector has become increasingly more important in a globalized economy. While it may not be directly making products in a traditional sense, it is the life blood of a modern economy. Thus it is important to have the financial sector healthy and well-functioning.

2. Technological innovation of derivatives (Mortgage Backed Securities) can be a positive force if all the kinks get worked out and is used under ‘adult’ supervision.

3. Also, leveraging per se is not an evil force. Just need to realize that leveraged position may look like the work of a genius when the times are good but it is a double edged sword. There should be prudent leverage which though does not mean zero leverage.
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James Galbraith

Lloyd M. Bentsen Jr. Chair in Government/Business Relations and Professor of Government, University of Texas, Lyndon B. Johnson School of Public Affairs

The Lehman Brothers bankruptcy five years ago is viewed by some as the start of major changes in the economy.

It was not. The setting that produced the Lehman debacle goes back at least to the financial deregulation at the start of the 1980s. And that was a response to the instability of the previous decade. Lehman was an ending, not a start.

Do you think the high unemployment we are still experiencing is the temporary effect of a weak economy or a structural change that has long-term implications?

In my view the era of easy growth has ended. My forthcoming book, The End of Normal, will set out my reasons. They include (a) high and volatile resource costs; (b) the new-found futility of military force; (c) new technologies that radically cut labor requirements; and (d) a financial system ridden by fraud and without a reputation to speak of.

Have the reforms enacted by Congress in response to the events of 2008 achieved positive results or made the situation worse?

Neither. A general view of those who follow Dodd-Frank closely is that the rulemaking has been stalled out by the lobbies.

What do you see as the over-riding lesson we should have learned from the Lehman bankruptcy and the dramatic economic events that followed?

For an economist, the overriding lesson is that economics can’t be reformed. Simple question: how many economists who were right in warning of this debacle have since been given tenured positions — or any position — in economics departments at what are supposed to be the top universities? Answer, so far as I know: zero.
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Carlos F. Liard-Muriente, Ph.D.

Professor and Chair, Department of Economics, Central Connecticut State University

The Lehman Brothers bankruptcy five years ago is viewed by some as the start of major changes in the economy.

While true, the Lehman debacle was a significant event, we must not forget that economic fragility was already in place before Lehman. Yes, following the filing for bankruptcy we witnessed a dramatic decline in the stock market and significant bleeding in the labor market. Nevertheless, we were already in a recession before the Lehman incident with no clear signs of recovery given that the economy did not show much enthusiasm for the 2008 Economic Stimulus Act signed by President George W. Bush. We also had Bear Sterns and many small commercial banks walking the plank (granted, in a more orderly fashion) followed by an acceleration of job losses before Lehman. If anything, the housing bubble is the prime mover. The dramatic decline in home prices (about 35%) between 2006-09 prompted a negative reaction in mortgage-backed securities and with that, chaos in Wall Street.

Do you think the high unemployment we are still experiencing is the temporary effect of a weak economy or a structural change that has long-term implications?

I think it is a combination of the two. We have the typical recessionary short-term unemployment effects: firms facing uncertainty about demand for their products and production costs, therefore not willing to hire; recent graduates taking longer to find jobs. However, I also think that we are experiencing more dramatic long term effects (structural changes). On this front, Erik Brynjolffson and Andrew P. McAfee, authors of Race against the Machine, have been more eloquent. In a nutshell, manufacturing and even textile are making a comeback in the United States. A 2012 survey by Supply Chain Digest and the MIT Forum for Supply Chain Innovation shows that about half of U.S. manufacturing companies are considering returning home some of its operations. Furthermore, textile and apparel exports increased to $22.7 billion in 2012, up 15% from 2010. Nevertheless, these are not our grandparents or parents manufacturing and textile assembly lines. When you walk inside these modern factories you see fewer people (fewer jobs) and more machines!

Have the reforms enacted by Congress in response to the events of 2008 achieved positive results or made the situation worse?

This is a difficult question. I think that the “policies prevented another Great Depression” argument is valid. However, individuals have a difficult time understanding events that are not part of their reality. Policies prevented another Great Depression. Therefore, we did not experience such an event and we don’t relate to it. We do relate to our own economic reality and that reality, following Census numbers, is grim. For example, the decline in median non-elderly household income was 11.6% between 2000 and 2012. The decline in median income in White, Hispanic and African American households was 6.3%, 11.8%, and 14.8% respectively, with only the top 5% income group experiencing an improvement. Furthermore, for 15% of population poverty is the reality; with almost 22% of children under 18 living in poverty.

What do you see as the over-riding lesson we should have learned from the Lehman bankruptcy and the dramatic economic events that followed?

I am tempted to go on a tangent about the perils and virtues of regulation of the financial industry. However, as a professor, I think my biggest frustration is with the economic profession; particularly the way we teach (Macro) economics. At the very least, following the “we failed to anticipate the crisis” argument, we should have questioned the way and what we teach, and taken more seriously those that did anticipate the crisis following non-mainstream (Austrians, Keynesians and Post-Keynesians) approaches. These heterodox approaches should be part of the Macroeconomic story in our classrooms. Finally, we should recognize all the signs (poverty, inequality, political gridlock, market failures, state failures…) and stop calling this devastating event a Financial or Economic Crisis because it is not. We are confronting a System Crisis.
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Kajal Lahiri

Distinguished Professor of Economics and Health Policy, Mgt. & Behavior, University at Albany: SUNY

Do you think the high unemployment we are still experiencing is the temporary effect of a weak economy or a structural change that has long-term implications?

Both. Structural changes in the labor market that are happening are long term – and these correct for themselves also in the long haul. The latest recession exacerbated the sufferings due to the adjustments in the labor market. A part of the current slack in the labor market (e.g., continuing high unemployment) is certainly due to the great recession that increased uncertainty and lack of faith in the future from the standpoint of the businesses. Because of its depth, the economy is coming out of it slowly. The EU crisis has contributed to our continued misery.

Have the reforms enacted by Congress in response to the events of 2008 achieved positive results or made the situation worse?

They certainly helped – both from getting the economy from spiraling down out of control during the recession and also having some obvious regulations in place on the banking sector. The latter will help in the long run.

What do you see as the over-riding lesson we should have learned from the Lehman bankruptcy and the dramatic economic events that followed?

Recession will rear its ugly head again in another 5-7 years – the free market will find its way to get around the new regulations. Then, yet newer regulations will come!
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Robert Eyler

Frank Howard Allen Research Fellow, Director, Executive MBA Program, Sonoma State University

The Lehman Brothers bankruptcy five years ago is viewed by some as the start of major changes in the economy.

I think the Lehman Brothers bankruptcy was an effect not a cause. I think it showed, much like Enron’s historic rise and fall, that risk has rewards and serious implications when you guess wrong. I think what the bankruptcy brought to light was that major institutions can put themselves as risk of failure and perhaps not have a taxpayer/governmental solution if they begin to fail. The Too Big To Fail hypothesis in financial markets has been around since the early 1990s in earnest, and this was an example of that not holding.

Do you think the high unemployment we are still experiencing is the temporary effect of a weak economy or a structural change that has long-term implications?

I think the dynamics of the labor force are changing (boomers not retiring at the same age or rate as in past generations) and part of that includes the financial aspects of making that retirement choice. As a result, the systematic way new entrants (college grads in specific) are finding work is changing daily. It is also a function of a weak economy and that there is a large number of people working in off-payroll jobs to survive. It is key to realize that the unemployment rate is usually based on estimates of payroll unemployment, not total income-generating activity. However, the structural aspects of aging workers remaining in place will continue to change our labor markets.

Have the reforms enacted by Congress in response to the events of 2008 achieved positive results or made the situation worse?

Like any regulatory environment, the actions have stopped the bleeding and rearranged incentives for now. Most likely a lot of what Congress has done to protect consumers, banks from themselves, and also in terms of increasing federal debt will be innovated around when a market is involved. History suggests that financial innovation can move around regulatory environments toward profits like water finds air if needed to flow. Positive for now, we will see medium to long-term, when there will likely be another round of regulations.

What do you see as the over-riding lesson we should have learned from the Lehman bankruptcy and the dramatic economic events that followed?

The overriding lesson is that all institutions are vulnerable and that when excessive risks are taken, some should/must fail to temper market activity.

 
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