Stop us if you’ve heard this one before: banks and financial institutions, saddled with bad loans and investments, set off a ripple-effect panic when it becomes clear that their toxic assets will cost billions of dollars in losses, leading to a financial crisis and ultimately a global recession. Sound familiar? The first time we heard this story was in 2008, when the toxic assets were mostly mortgage-backed securities that started to fall apart when the housing market bubble burst in dramatic fashion. Those assets, owned and subsequently insured by so many institutions who were eager to get a piece of the once lucrative pie, eventually led to the downfall of Lehman Brothers, AIG, Countrywide and many more. Today the stock market will close with losses of nearly 500 points, this time panicking about European banks holding bad assets that are often backed up by American banks. The interconnectivity of these investments—this time European bonds from troubled countries like Greece, Portugal, Spain and Italy—threatens the same kind of domino effect that happened in 2008. Reports of an impending second recession and persistently high unemployment rates don’t help matters much, but one can’t help but feel some sense of déjà vu as global markets once again mash the sell button. Is this 2008 all over again and is a second recession all but inevitable?
Campbell Harvey, professor of international business at Duke University’s Fuqua School of Business; editor of The Journal of Finance