Debt Crisis: Similarities And Differences Between The Crises of 2008 And 2011

NEW YORK (ForexNewsNow) – Over the past few weeks financial observers across the world, especially in New York, Paris, and London have had a strange feeling of déjà vu – many are asking themselves if the Europe and the United States are going through a repetition of the 2008 crisis.

But while the crises of 2008 and 2011 may appear disturbingly similar on the surface, a deeper examination reveals that the current Debt Crisis – and its solutions – are quite different from the crisis that occurred in 2008.

A Loss of Confidence

Let’s begin with the similarities. Both crises were essentially born out of a lack of confidence. Prior to the summer of 2007 no financial analyst in their right mind would have predicated, or even believe possible, that some of the largest US banks could go under. Fast forward just a few months later and the U.S. mortgage crisis toppled some of the industries largest firms.

Since the market shake up of 2008, many financial investors have begun doubting the long term financial capabilities of the US economy. Add the indebtedness of many countries in the Euro Zone to the mix and it quickly created a self-feeding fear of the instability of the global markets. In stock exchanges across the world, the lack of confidence in the global economy over the past 3 years has both created and encouraged a healthy fear of the markets, as seen last week when a false rumor quickly spread that France’s debt rating would be downgraded.

The rise of fear and skittishness in the markets also revolves around the changing role of the United States in the global economy. Many investors are now questioning whether the United States will be able to continue to hold the position of world leader and whether the US will be able to steer itself out of the crisis and reignite their economy.

The downgrade of the US’s seemingly untouchable Triple-A rating by Standard & Poor’s on August 5, only served to amplify fears to a level not seen since the collapse of Lehman Brothers.

The Banking Sector in Turmoil

Banks are also worrying analysts again. As in 2008, many questions are arising about the banking sectors ability to absorb major shocks in the market. And as confidence in the market fall, banks are less and less interested in lending money, creating a shortage of liquidity in the market.

According to most observers, this pattern is reminiscent of the ‘post-Lehman’ period. Nevertheless there is one slight difference – subprime mortgages have now been “replaced” by US debts that do not have the same toxicity, so in at least in this respect the current crisis is on better footing than the crisis of 2008.

In addition, tensions observed in the Interbank lending market – in which banks lend to each other – are much lower than in 2008. Especially since the European Central Bank (ECB) launched an unlimited loan program in order to make a total economic gridlock almost impossible.

But, just as in 2008, the markets are calling into question the capitalization of banks. Do these institutions have enough capital to cope with significant losses? Although a vast movement of recapitalization was already launched across Europe, the markets do not seem to be responding in any significant way to this effort.

The Over-Indebtedness Issue

Now, just as then, debt is the main problem.

But the debt in the 2008 financial meltdown was largely private sector debt (households and businesses), which the government simply took in order to jump-start the economy. While this plan did help reinvigorate the economy it eventually led to an over-indebted public sector. At the end of 2010, public debt in developed countries accounted for 92% of their gross domestic product (GDP), as opposed to 78% before the Subprime Mortgage crisis.

So in many ways, we never fully solved the problem of the 2008 crisis – we simply moved the problem from the private sector to the public sector. Whereas in 2008 we suffered from a massive Private Debt Crisis, in 2011 we are currently experiencing a massive Public Debt Crisis.

Today the only solution is to reduce the total amount of debt in the market – in both the private sector and the public sector. This was the solution we should have embarked on in 2008 and it is unfortunate that it took us billions of dollars and 3 years to come to the same conclusion again. Only by decreasing the gross debt in the market can we rehabilitate the health of the ailing Western economy. Yet the common solutions in order to accomplish this include austerity measures, spending cuts, and tax hikes – all of which are unpopular policies for any democratically elected leader.

Authorities Are Reactive, But …

On October 8, 2008, after the shock of Lehman Brothers collapse, seven central banks, including the U.S. Federal Reserve and the European Central Bank, joined forces in order to respond to the crisis in a coherent and unified manner. In 2011, the political and economic rhetoric remain the same – everyone agrees that the US and Europe need to form a unified front to deal with the crisis – yet it seems that actions have fallen short of promises.

In Europe, several nations launched the European Financial Stability Facility (EFSF) in 2010 with a glimmer of hope, but divisions between European national governments slowed down the implementation of its tools and prevented it from finding a lasting solution to reassure markets of the strength of the Euro Zone.

In the United States, internal differences have triumphed national cohesion. The differences between Democratic and Republican economic thought has led to deep disagreements on national policy and in the end resulted in the adoption of severely watered down economic policies. Last but not least, on both sides of the Atlantic, political and economic leaders have exhausted their cartridges – interest rates are at their lowest and the coffers of the state are empty.

Thus, the major difference between the economic crises of 2008 and 2011 is that today there is no more room to maneuver.

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