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Michael Bosma: Comparing the economic crisis of 2008 to now (Voices)

Michael Bosma

Covering Your Assets

Michael Bosma
Courtesy photo

RENO, Nev. — Many clients have asked how the financial crisis of 2008 compares with the pandemic-driven economic crisis of today. Though both significantly impacted our economy, there are key differences between the two.

To start, the economy’s strength at the beginning of 2020, and the banking system’s ability to lend during this pandemic, has helped us avoid a full-blown financial crisis. While we saw a violent downturn in March, quick and aggressive fiscal and monetary responses resulted in a strong rebound.

But we still must understand the current constraints, as well as the necessary measures for a full recovery.

A comparison of constraints and measures

The constraint in 2008 was the impairment of the financial system. The constraint in 2020 is the coronavirus spread, which is on the rise again.

Governments not only have to determine how to reopen local economies, but also how to overcome the public’s reluctance to practice social distancing.

Ultimately, we may find the constraint to a full recovery is a medical one, which means we need a vaccine to help push impacted industries back to pre-coronavirus operating and employment levels. Some of the industries most impacted include transportation, food, retail and travel.

In 2008, the Federal Reserve (the Fed) and the government took extreme measures to address the financial crisis, spending $86 billion in total. Yet today, the Fed has spent twice as much from a balance sheet perspective, while the federal government has distributed three times the amount in federal stimulus.

In 2010 and 2011, we worried about the potential blowback from all the spending, but the pending crash that many anticipated never occurred.

The Fed took a while to begin re-normalizing after the last financial crisis. History often repeats itself, and as such we can observe very similar patterns.

Like last time, it’s possible we will be in a zero-rate environment for years to come. Since the Fed never reduced its balance sheet, 2020’s pandemic relief will compound the fiscal deficit and may lead to an even larger balance sheet for a longer period of time. If that happens, there could be two major consequences.

Potential concerns: inflation and financial system fragility

Inflation could increase due to negative impacts on the supply curve and the supply chain in a number of industries. Currently, many businesses are lowering prices in industries where it’s difficult to attract customers who have income to spend — the savings rate was upwards of 33% simply because people couldn’t spend in April as the country sheltered in place.

The fragility of the financial system is also an ongoing concern. The financial system is fine as long as it has Fed support, but low rates and large balance sheets encourage a build-up in leverage, which started back in February and bled into March. As a result, the Fed took steps to assist the Treasury market prior to the lockdown.

The impact of income replacement measures

The government also stepped in and replaced incomes through additional unemployment benefits and multiple loan programs. While not all income was recovered, the monetary support was nearly equal to the income that individuals and businesses lost, as shown in the personal income report in April.

We don’t want to minimize the pain and hardship that many households are going through — not everybody benefited from the income replacement efforts, but nevertheless personal income rose 10.5% and consumer spending dropped sharply.

The result was a record savings rate (or income replacement), which is unheard of during a recession. The May income report indicates that we may likely hold on to those income gains, particularly because of the 2.5 million increase in employment in May.

Of course, many questions still remain. What happens after July when the additional unemployment payments of $600 a week expire? What happens when Paycheck Protection Program (PPP) loans expire? What happens when state and local governments cut spending to fill those budget gaps? Similar to 2008, only time will tell — and there will be ripple effects from every measure taken.

What you can do

While there are still many unknowns about how COVID-19 will impact the economy over the long-term, the right cash management and projection strategy can help you weather the storm.

Also, keep in close connection with your banker to ensure that there are no surprises with renewing lines of credit and other term debt. With interest rates falling, you should secure as much credit capacity as you can. 

The old axiom remains true — the best time to borrow is when you don’t need to! Perhaps now is the time to acquire cash-strapped competitors and grow your top line through acquisition!

These strategies often make meaningful impacts to bottom line profitability and bolster your debt service ability. CLA’s Dean Bosco also contributed to this article.

Michael Bosma, CPA, is Principal-in-Charge of the Reno office of CliftonLarsonAllen LLP. His NNBW column, “Covering Your Assets,” focuses on effective planning strategies for every business owner. Reach him for comment at mike.bosma@claconnect.com.