The Covid-19 financial crisis that was not


The sudden realization in mid-March 2020 that Covid-19 was going to be a once-in-a-century pandemic created the kind of disruption that financial crises are made of. Experts have predicted an unprecedented triple shock: lockdowns would decimate demand, travel bans would devastate supply and the “money rush” would freeze financial activity. Stock markets plunged and bond yields jumped.

But despite the disastrous human toll and the inevitable economic slowdown, the financial crisis did not occur. To figure out what went right, our Yale Financial Stability Program research team compiled a database of some 9,000 government actions in 180 countries. The lessons: Go big, go early, and prepare for next time.

Fiscal, monetary and other authorities around the world acted quickly amid extreme uncertainty. They used tools employed during the 2008 financial crisis, adapted to the deeper and faster events of the pandemic. They promised extraordinary sums and took risks on new programs. Even though some of the worst fears have come true – in just one quarter, annualized US economic output has fallen by a third and unemployment has tripled – there has been no global depression or credit crisis. .

► The same tools can be useful in different crises. Financial disasters share some common elements: liquidity runs out, depositors and creditors flee, asset prices crash. For this reason, many of the tools implemented during the 2008 financial crisis have proven easily adaptable in 2020. The Bank of England, for example, relaunched its Contingent Term Repo Facility to enable struggling counterparties to trade hard-to-sell assets for central bank cash. .

The authorities have also modernized the interventions, applying their experience of past crises. For example, the Bank of Japan relaunched its special fund operations, through which it provided interest-free guaranteed loans to creditworthy financial cooperatives. However, the focus of the Covid-era program has shifted to private sector financing and financial market stability, rather than supporting corporate bond and commercial paper markets.

► Be ready to innovate and experiment. New problems call for new solutions. For example, many Covid-19 actions have focused on bolstering vulnerable real economy industries, such as airlines and healthcare, as opposed to financial institutions. After the first round of interest rate cuts and emergency liquidity programs, many countries launched unprecedented market interventions during the 2008 financial crisis, including fiscal measures such as payment moratoriums, tax deferrals and subsidies (but not without unintended consequences).

► Go big and the market will do your work for you. When governments and central banks pledged trillions of dollars to buy everything from municipal bonds to exchange-traded funds, they often didn’t need to spend even a small fraction of the money. In cases such as the Swedish Riksbank’s corporate bond buying program and the US Federal Reserve’s term asset-backed securities lending facility, mere announcements have restored much-needed confidence to private investors. to get them back into action.

► Prepare for quiet times. Reforms put in place in the years following the 2008 financial crisis have made a crucial difference in 2020. More importantly, banks have operated with significantly more capital, which has absorbed losses and enabled them to recover. act as a source of strength rather than contagion (although the central bank’s efforts to provide liquidity and support asset prices also helped a great deal). A dozen countries had also required banks to have a countercyclical capital buffer, which provided additional resilience at the start of the shutdowns.

Meanwhile, the pandemic has exposed gaps in countries’ crisis management toolkits – gaps they are filling now that markets have calmed down. For example, central banks are considering how to redesign liquidity buffers, which require banks to hold additional cash to cover their obligations in difficult times. During the pandemic, banks have been reluctant to deploy liquidity, fearing stigma or regulatory backlash. So regulators are thinking about how to make buffers more usable.

Financial regulators are often accused of “waging the last war”, that is to say of reacting to crises with heavy reforms that will be useless the next time around. Yet the experience of the pandemic demonstrates that many lessons and tools are enduring, that preparedness is possible and useful, and that leaders can adapt and innovate in the midst of battle. The global financial system survived Covid through years of assessing the previous crisis, and authorities can draw on that experience to prepare for the next one.

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Adam Kulam is an MBA and MMS candidate at the Yale School of Management. He was previously a Senior Research Associate in the Yale Financial Stability Program.

Lily Engbith is an MBA candidate at the Yale School of Management. She was previously a senior research associate at the Yale Financial Stability Program.

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