If we were to have a recession today, would it be as bad as the last one?

William Chen Allio’s Quantitative Investment Strategist, explains the difference between the last financial crisis and the current situation.

-

The 2007-2008 financial crisis was one of the largest and most severe global financial disasters on record. Although the preconditions of the crisis were complex and multi-causal, the heart of problems can be traced back to unhealthy practices by financial institutions and an underregulated finance industry.?

At the height of real estate happy hour, the US home mortgage debt to GDP ratio reached an unprecedented 73%, or a whopping $10.5 trillion. The lion’s share of the US economy was dominated by the financial industry and inflated asset prices.

Today, in a post-pandemic world, with inflation at a level we haven’t seen in decades, there are signs of a weakening economy and potential recession. However, although there are similarities, this time would be fundamentally different. Just prior to the crisis, CDS (credit default swaps) spread was at an ultra-low level and market leverage ratio was unhealthily high.

Thanks to Dodd-Frank, today’s banking system in the US is well capitalized. The tier 1 capital ratio is standing at a healthy 12% vs. 6% immediately after the 2007-2008 crisis. The share of institutions that are not well capitalized is less than 0.5%. Liquid assets as percent of total bank assets is steadily growing.? Should we have a recession today, it’s highly unlikely that we’ll be jumping off a cliff like last time.??