15 transformational events: The Great Recession scars investors

The recession of 2008-09 may not be the most severe economic downturn the United States has ever suffered,…

The recession of 2008-09 may not be the most severe economic downturn the United States has ever suffered, but it is the defining experience of the 21st century so far for the investment markets.
When Lehman Brothers Holdings Inc. collapsed in a heap in the fall of 2008, the loss of confidence in the financial markets became extreme as counterparties around the globe worried about which institution would be next to fall. Even the safest places, such as the commercial-paper market and money market funds, became sources of anxiety for investors.
“We were clearly in panic mode,” said Scott Brown, chief economist at Raymond James Financial Inc. “The saying at the time was, ‘This is not your father’s recession; it’s your grandfather’s depression.’”
The collapse of the housing market and the banking system due to the trillions of dollars in mortgage-backed securities manufactured by the banks certainly had the potential to cause an economic downturn rivaling the Great Depression of the 1930s.
“What made it so ugly was the combination of a real estate and banking crisis,” said Ethan Harris, co-head of global economics research at Bank of America. “It hurt bank balance sheets and family balance sheets, and it’s taken years for households and banks to heal themselves.”
The difference this time around was the concerted global effort by central bankers to open up their coffers and provide unprecedented amounts of liquidity to banking systems around the world.

PHOTO GALLERY 15 transformational events

Federal Reserve Chairman Ben S. Bernanke, a student of the Great Depression, made sure he wouldn’t make the same mistakes policymakers did back in the 1930s when banks were allowed to fail, leaving consumers and investors to suffer the consequences. Whether the ultraloose monetary policy ultimately leads to inflation remains to be seen, but few economists fault Mr. Bernanke for his response to the financial crisis.
“You have to give the Fed credit for fighting the right war,” Mr. Harris said. “It’s too early to give them a final grade, but I think it will go down as a big success.”
A big success in the context of a deleveraging economy has meant an anemic recovery. Despite recent signs that the U.S. economy is starting to grow faster, the hangover from the financial meltdown will continue to hobble the country. The now abysmal fiscal situation in which the government finds itself will be a drag on the economy for years to come.
“We call this a rehab recovery,” Mr. Harris said.
Besides the obvious economic consequences of the last recession, the effects on investor sentiment have been profoundly negative. A recent survey of investors by UBS Wealth Management Americas found that despite a market rebound and an increased sense of optimism among investors, they continue to behave in a very cautious way.
“Optimism is up, but investors’ behavior and attitudes toward risk reflect a new normal out of the financial crisis,” said Emily Pachuta, head of investor insights at UBS Wealth Management Americas. “Usually, investors have amnesia when markets start improving. We’re not seeing that now, however.”
The impact of the recession and financial crisis on both consumer and investor sentiment has been deep and debilitating, and no amount of fiscal and monetary stimulus can make up for that fundamental change in attitude.
“Normally, Americans are optimistic, but many people questioned the very future of the U.S. during the financial crisis,” said Lewis Altfest, a financial adviser based in New York. “In this recession, people had a lot of fear that we were headed for another depression.”
That fear has yet to fully dissipate, but Mr. Altfest said he thinks the recent record highs achieved in the stock market are starting to rekindle his clients’ enthusiasm for risk.
“It’s like a heart attack. People are afraid they’re going to have another one,” he said. “It’s taking time to heal the American psyche, but it is getting better.”
That alone could go a long way toward a more meaningful recovery from the last downturn.