NCPA - National Center for Policy Analysis

Is the Current Crisis Worse Than the Lehman Collapse?

September 14, 2011

The United States is close to another recession: the first-half growth rate is 0.7 percent and employment growth is weak.  The stimulus measures failed during the first half of 2011 and stock markets have dropped sharply.  The risks to global economic health from this possible financial collapse are as bad as, or perhaps worse than, those that emerged in September 2008 with the Lehman Brothers crisis because policymakers have few tools left to combat a new crisis, says John H. Makin, a resident scholar at the American Enterprise Institute.

By June of 2011, it became clear that the second round of monetary and fiscal policy stimulus had not significantly reenergized the U.S. economy.  Sharply higher energy prices and supply-side disruptions from Japan's March tsunami were partially to blame, but even as energy prices fell and Japanese production began to recover, U.S. and European growth continued to slow.  Additionally, U.S. financial uncertainty was compounded by the exposure of American banks and money market funds to an increasingly unstable European financial system.  A few things to consider:

  • This year, the Federal Reserve and global policymakers face a much more complicated situation that is rapidly turning into a systemic crisis.
  • The European sovereign debt problem remains unresolved and has in fact become more serious, with a rush away from currencies and into gold.
  • The U.S. debt crisis has intensified, with only a weak last minute agreement to reduce future deficits preventing outright default.

Current conditions point to a threat of systemic risk, otherwise known as a breakdown of the financial system.  The emergence of systemic risk is tied to three conditions:

  • The suddenness of the onset of shocks hitting the global economy or the global financial system.
  • The pervasiveness and interconnectedness of the effects of the shocks.
  • The absence of obvious solutions to the problems resulting from the shocks.

We need good economics over politics now more than ever.  That means sensible tax reform, a Fed focus on maintaining liquidity and rationalization of the European monetary system.  Economic reality needs to be placed ahead of political discord and expediency if the global economy is to move past its second systemic crisis in less than three years, says Makin.

Source: John H. Makin, "Systemic Risk Returns: Is the Current Crisis Worse Than the Lehman Collapse?" American Enterprise Institute, September 2011.

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