7 Years Later: What Can Be Learned From The Financial Crisis

March 11, 2016

Editor's Note: Jill Schlesinger originally published this post on her LinkedIn profile.

Where were you when stock markets bottomed out during the last bear market? Dr. Mohamed El-Erian, author of The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse, was chief executive and co-chief investment officer of global investment management firm PIMCO. Of course we only knew that March 9, 2009 was the bottom in retrospect, but seven years later, what lessons can be learned from that painful period?

I was fortunate enough to sit down with El-Erian during a LinkedIn Live Video Webcast to discuss how far the economy and markets have come (the S&P 500 has soared over 240 percent, including reinvested dividends), as well as the significant challenges that still lie ahead for investors and for the global financial system.

Just before markets bottomed, El-Erian and his PIMCO colleagues coined the phrase “The New Normal” to describe what was likely to be a slow growth economic recovery. What surprised him is how long this sluggish period would persist. Instead of the five years or so that likely back when they were first discussing it; we are now in the seventh year of 2 to 2.25 percent GDP in the US.

El-Erian credits the actions of central banks for even that measly pace. When it became clear that government stimulus plans were not large enough, central banks were forced to adopt a “Whatever it takes” mentality. In doing so, they were able to avoid a multi-year depression, but the unintended consequence was that they also created an environment where investors relied on monetary policy to do the heavy lifting and where excessive risk taking helped drive up asset prices beyond economic justification.

Central bank actions have created a yawning gap between markets and economic fundamentals. They also helped contribute to the acceleration of income and wealth inequality, because their policies were far more accretive to those who already owned assets than those that did not.

It’s not as if the Fed, the ECB and the Japanese central bank don’t get it, but just when global central banks are looking to hand off the responsibility of promoting growth, there seem to be no takers. That could be the reason that some countries and regions (Japan and the Eurozone) seem to be grasping at straws, relying on unorthodox measures like negative interest rates. Unfortunately, instead of spurring growth, investors have been spooked by the actions.

Should we be nervous? After all, the Great Recession ended seven years ago in June, so maybe we are due for a downturn. El-Erian made it clear that while there is just a 30 percent chance of recession within next 18 months, there is a 100 percent chance that one will occur again! When it does, investors may have to adjust their expectations. Although El-Erian believes that adhering to some sort of system that can prevent you from doing the wrong thing at the wrong time is important, he also is steadfast in his belief that cash must be part of every diversified portfolio. Not only can cash provide protection against invading portfolio at the wrong time, it also allows investors to be agile and opportunistic, while the masses are frozen with fear.

So where do we stand right now, seven years after we bottomed out? We have come to what El-Erian calls a “T-Junction”. As we approach the end of this recovery road, there is an equal probability that we turn left and right. On one side of the T, we remain in a stable, but slow growth world, riddled with high unemployment, increasing income inequality and political extremism. On the other side, we have politicians who wake up and get serious about creating an inclusive economy; make pro-growth structural reforms, remove debt overhangs in problem areas like student loans and get the overall architecture right. The result would be higher growth, job creation, decreasing income inequality and a drop in financial instability.

Could the stakes be any higher this political season? That’s why El-Erian says that we desperately need candidates to acknowledge the anger that the “inequality of opportunity” can breed; and then to address that anger with policies that promote inclusive growth and restore faith in the system. In other words, we need an economic sputnik moment. Perhaps that seems like a distant possibility this moment, but El-Erian remains optimistic that one can occur.

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