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The COVID-19 financial crisis that wasn’t

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. Pundits predicted an unprecedented triple shock: lockdowns would decimate demand, travel bans would devastate supply, and the “dash for cash” would freeze financial activity. Stock markets plunged and bond yields jumped.

But despite the disastrous human toll and the inevitable economic downturn, the financial crisis didn’t happen. To understand what went right, our research team at the Yale Program on Financial Stability 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 across the world acted swiftly amidst extreme uncertainty. They used tools employed during the 2008 financial crisis, adapted for the deeper and faster events of the pandemic. They pledged extraordinary sums and took risks on new programs. Even as some of the worst fears came to pass — in just one quarter, US annualized economic output fell by a third and unemployment tripled — there was no global depression or credit crunch.

Four lessons stand out.

• The same tools can be useful in different crises. Financial disasters share some common elements: liquidity dries up, depositors and creditors run, asset prices plummet. For that reason, many of the tools implemented during the 2008 financial crisis proved readily adaptable in 2020. The Bank of England, for example, revived its Contingent Term Repo Facility to allow distressed counterparties to exchange hard-to-sell assets for central bank cash.

Authorities also retrofitted interventions, applying their experience from crises past. For instance, the Bank of Japan revived its Special Funds-Supplying Operations, through which it provided interest-free, collateralized loans to creditworthy financial cooperatives. The purpose of the COVID-era program, however, shifted to private-sector financing and financial market stability, rather than supporting the corporate bond and commercial paper markets.

• Be willing to innovate and experiment. New problems called for new solutions. For example, many COVID-19 actions focused on bolstering vulnerable industries in the real economy, such as airlines and healthcare, as opposed to financial institutions. After the initial round of interest-rate cuts and emergency liquidity programs, many countries launched market interventions not seen during the 2008 financial crisis, including fiscal measures such as payment moratoria, tax deferrals and grants (albeit not without some unintended consequences).

• Go big and the market will do your job for you. When governments and central banks pledged trillions of dollars to purchase 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 purchase program and the US Federal Reserve’s Term Asset-Backed Securities Loan Facility, the mere announcements restored the confidence required for private investors to go back into action.

• Prepare during calm times. Reforms instituted in the years following the 2008 financial crisis made a crucial difference in 2020. Most importantly, banks operated with substantially more equity capital, which absorbed losses and allowed them to act as a source of strength rather than contagion (although central bank efforts to provide liquidity and prop up asset prices helped a lot, too). A dozen countries had also required banks to have a countercyclical capital buffer, which provided extra resilience as lockdowns began.

Meanwhile, the pandemic revealed gaps in countries’ crisis-management toolkits — gaps they are addressing now that markets have calmed. For example, central banks are considering how to redesign liquidity buffers, which require banks to hold extra cash to cover their obligations in difficult times. During the pandemic, banks proved reluctant to deploy the cash, fearing stigma or regulatory backlash. So, regulators are pondering how to make the buffers more usable.

Financial regulators are often accused of “fighting the last war” — that is, reacting to crises with burdensome reforms that won’t help next time around. Yet the experience of the pandemic demonstrates that many lessons and tools are perennial, that preparation is possible and useful, and that officials can adjust and innovate in the midst of battle. The global financial system survived COVID thanks to years of evaluating the previous crisis, and authorities can build on that experience to prepare for the next.


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