Examining the Similarities Between and PacWest’s Current Situation
The current banking crisis may appear similar to the 2008 crisis through abductive reasoning, but experts explain that it is a separate, smaller issue. In 2008, 25 banks failed, while only three banks have failed so far this year. PacWest Bancorp is one bank that may be on the verge of failing, causing worry among investors. The causes of the two crises differ, as banks in 2008 lent money without discretion and marketed faulty loans as safe investments. In contrast, recent bank failures were due to poor investment choices and not properly managing interest rate risk. These recent failures are not causing as much damage since they are not as intertwined with the entire banking system as in 2008. Despite the differences, regulators were asleep during both crises, and there is cause for concern when no banks are failing.
The similarities between the current banking crisis and the 2008 financial crisis are striking. However, experts agree that the current crisis is a smaller, separate issue with different underlying causes. This article will explore the differences between the two crises, focusing on the reasons for bank failures in 2008 versus the recent bank failures, and how they affect the larger financial system.
Bank Failures: Then and Now
In 2008, the US witnessed a record-breaking number of bank failures. Over the three years that followed, nearly 400 banks failed, including Washington Mutual, the largest bank failure in US history. In contrast, there have been only three bank failures so far in the current crisis, with investors fearing that more will follow. PacWest Bancorp is one of the banks that could be a potential domino, as its shares recently dropped 30% after customers withdrew 9.5% of its total deposits.
While no bank failure is cause for celebration, the lack of bank failures prior to the 2008 crisis and the current crisis is concerning, according to Aaron Klein, a former deputy assistant secretary at the Treasury Department. He believes that “financial regulators were asleep at the switch,” allowing banks to take on risky investments and failing to protect them from potential failures.
Reasons for Bank Failures in 2008
Banks failed in 2008 because they lent money to virtually anyone who wanted a loan, without sufficiently questioning whether they were capable of repaying the loan on time. To make matters worse, banks marketed their risky loans as safe investments and sold them to other financial institutions. When the housing bubble burst, the entire global financial system was infected with faulty loans.
The interconnectedness of the global financial system led to the downfall of even the largest banks, as University of Chicago Harris School of Public Policy professor Dave Schabes notes. The financial crisis affected not only the US but the entire world, leading to a recession that lasted for years.
Reasons for Bank Failures Recently
Unlike in 2008, the recent bank failures were not caused by faulty loans. Instead, the banks failed to properly manage interest rate risk. They invested in long-term Treasuries, which were considered a safe investment, but when the Federal Reserve hiked interest rates, the value of these investments fell. As a result, when the banks experienced bank runs, they were forced to sell these investments at a loss, leaving them without adequate cash to back depositors’ funds.
These poor investment choices are not bringing down the entire banking system, in part because there aren’t as many secondary markets tied up, according to Schabes. Additionally, the banks that failed recently did not have issues with their underlying loans, which is a significant difference from the 2008 crisis. Klein, a senior fellow at the Brookings Institution, believes that the current banking crisis will be short-lived because of these factors.
Conclusion
While there are similarities between the current banking crisis and the 2008 financial crisis, the causes and effects of the two crises are distinct. The current banking crisis is a smaller, separate issue that has not yet had the same impact on the global financial system as the 2008 crisis. The recent bank failures were caused by poor investment choices rather than faulty loans, which makes them less likely to bring down the entire banking system. As we move forward, it is important to learn from the mistakes of the past and ensure that financial regulators are vigilant in protecting the banking system from potential failures.
