Long before swine flu hit, Timothy Geithner testified to Congress about the danger of a strange new epidemic. “Contagion spreads,” he warned in 2008, “transmitting waves of distress to other markets.” The contagion was loan defaults, and Bear Stearns was patient zero. The Fed’s bailout of Bear, he hoped, would slow or stop the spread of defaults across the financial system.
Around the same time, Yale economist Robert Shiller published an essay in The Atlantic calling the housing bubble an epidemic of “infectious exuberance,” which threatened to collapse into one of “irrational pessimism and mistrust.”
Now that we’ve seen this financial pandemic come to pass, and have lived through the first wave of a new influenza epidemic, it’s a good time to ask what, if anything, the financial crisis can teach us about handling the flu.
First, both crises were predicted far in advance, but still managed to surprise us when they hit. Ignoring a drumbeat of warnings from experts, Wall Street was still caught off guard by the drop in home prices and wave of mortgage defaults that followed. While we were watching for avian flu, swine flu spread from Mexico around the globe so quickly that sealing our borders against it would have been “akin to closing the barn door after the horses are out,” to borrow a phrase from President Obama.
Both the credit crisis and a flu pandemic are problems of risk management. Banks, overestimating the health of the economy, kept too little cash on reserve to cover their liabilities. Likewise, experts warn that hospitals are too short on staff and beds to handle the surge of patients they will receive in a flu pandemic. Running with such a small margin for error in the face of a looming crisis wasn’t good for banks. It’s a lesson we should be quick to learn for our hospitals.
Second, while the news cycle is short, flu pandemics and financial crises are long. We’re used to catastrophes like Hurricane Katrina or the 9/11 attacks, where the initial shock is over in a day. But the Wall Street meltdown stretched on for months, dissolving into a recession that could last for many more. The flu isn’t much quicker. The Centers for Disease Control expect a flu pandemic to pass in waves across the country for a period of 3 to 12 months. Just because the swine flu seems to be in remission now doesn’t mean we’ve dodged the bullet yet.
Finally, blurring the line between the flu and the recession even further, there’s good reason to think a flu pandemic could inflict almost as much damage to the world economy as the Wall Street crisis has. One recent estimate put the cost of the financial crisis at $50 trillion worldwide. Gary Becker writes that a serious flu pandemic could inflict an additional $20 trillion in losses.
The good news in all this is that individual actions do matter. The mortgage crisis was stoked by homeowners willing to over-borrow themselves into poor financial health, and merrily spread by traders chasing risky rewards. As the crisis mounted, panicked investors drove stock prices down from over-valued highs to under-valued lows. If there’s a silver lining to this recession, it’s that consumers are being more cautious, saving more, and borrowing more wisely.
Likewise, the course of a flu pandemic will be affected by the actions each of us take. When a flu pandemic hits, it will be important to follow public health guidelines: wash your hands, cover your mouth, stay home from work if you’re feeling sick, and stay away from crowded places. Even simple things like social distancing (keeping about three feet between yourself and those around you) can be a powerful weapon against the spread of flu.
Systemic shocks like recessions and disease pandemics are by definition overwhelming to even our most powerful institutions. But they emerge from individual actions, and taking ownership of your little corner of the crisis isn’t just therapeutic, it’s good for everyone.
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The main parallel I’ve seen is that in both cases people panicked and overreacted.
With regard to the economic crisis, people overreacted and sold stocks indiscriminantly without analyzing individual companies to determine the extent to which they would actually be affected by the banking crisis and subsequent economic downturn.
Likewise, with the swine flu, people assumed the worst (i.e. spreads quickly, high mortality rate) only to find out that it is no more dangerous than the regular flu.
Anybody who bought stocks back in March at the height of the panic when the S&P was down around 700 is going to be sitting very pretty ten years from now.
I put $20,000 into three stocks on March 12th, about a week after the bottom, and have already made a 350% return even though those three companies are all still 60-70% below their October 2007 highs.
Short-term panicking always clouds long-term judgment.
one more analogy: deregulation leads to crisis- cutting regulation on what standard banks could invest in led to moral hazard of financiers corrupting balance sheets- and industrial farms cutting regulations by fiat via moving to third world/laissez faire markets leads to public health moral hazard of rampant antibiotic use/unsanitary (cheap) conditions creating the perfect storm for avian flu (chicken farms) and swine flu (pig farms)
I agree about the short term panic that mfw13 notes, but I don’t think we are at the end of the cycle either situation.
The swine flu ‘panic’ happened at the very end of the normal flu season but the pandemic experts are saying it will be the next flu season when the danger is the highest. Agencies are preparing vaccines for 300 million in the event of the worst – a prudent move. I wish we could say the same for the economy.
What’s going on in the stock market right now is a suckers rally in my opinion (albeit an elongated one). We have yet to feel the full brunt of related events; unemployment continues to climb, businesses continue to close, credit remains tight, and – if some experts are to be believed – commercial real estate is about to take it on the chin worse than residential real estate did. The fundamentals still say things are going to be grim for awhile, and from my perspective, we still haven’t corrected fundamental problems in the system.
Yes, we overreacted and panicked on both counts early. But that doesn’t mean we were wrong in the long run. I’ll be more diligent with my health come next flu season, and I continue to be more diligent with my money now.
Tim…you are right that things are probably going to be fairly grim for a while and that the market is probably going to re-test it’s lows before moving higher.
But if you have a long-term time horizon then what the market does over the next 6-12 months is pretty much irrelevant. I’m in my thirties, for example, and won’t be retiring for at least 20-25 years. And I know that the market will be higher 20-25 years from now.
The people who have gotten crushed in this market have been retirees and those close to retirement who are going to need to access their now diminished savings before the market has time to recover as well as people who had too much money invested in the market and were forced to sell low in order to generate cash for living expenses (since they had not kept the 6-12 months worth of cash on hand that all investment advisors recommend).
mfw13 – Like you I’m relatively young (early 40s) and assuming we’re near the bottom, you are right that buying now will be a boon 25 years from now. But what if the next dip is as big as the last one – say Dow 3,000?
I’m just don’t believe that ‘historical norms’ apply anymore given the current climate. Until I can be convinced the systemic problems have been fixed, I remain a skeptic.