Guest post by Alan Cunningham
Economic contagion can be very damaging to society. If left unchecked, an economic disaster in one industry or business sector can easily wipe out other important industries and sectors needed for a functioning society or nation-state.
It’s economic contagion basically defined as, “economic crisis [that spreads] from a market or region to another market and can occur at the domestic or international level”. For a more complete definition of the subject, this economic or financial contagionas “a situation where a shock that initially affects only a few financial institutions spreads, or spills over, into other financial and economic systems, which then infects the financial and economic systems of other countries… Like a physical disease, financial panic is contagious not only those affected directly, but the whole system. But beyond the actual financial connection, contagion can be considered an excessive correlation [with time, the correlation between the properties such as magnitudes or variations of frequency occurs when only random relationships should exist]or the simultaneous movement of assets that exceed the amount justified by economic fundamentals”. As you can see, financial contagion can kill and not kill a country, just like a real physical disease can make people very sick or die.
An example of economic contagion that almost everyone will remember is the collapse of Lehman Brothers. Originally a dry goods store established in 1848, Lehman Brothers turned around for “commodity trading and brokerage services,” survived the Great Depression, industrial bankruptcies, and capital shortages and collapses. As a company entered the 2000sLehman Brothers was involved in widespread investments in, “mortgage-backed securities (MBS) and collateralized debt obligations (CDOs),” which generated huge profits for the company, “[seeing] A 10% increase from 2005,” and, “reporting record profits every year from 2005 to 2007”. The commodity was the backbone of the housing market and, eventually, it would be the collapse of the housing bubble and send the global financial market into recession. Finally, after accumulating 85 billion dollars from that investment, shares fell apart a lot at the end of 2007 and then again by 48% in March 2008. When the Fed and the Treasury were unable to Lehman with government funds, they do pressure Lehman“to find a buyer like Bear Sterns did,” and while there were several attempts by Lehman Brothers CEO Dick Fuld and the federal government to try and deal with the crisis, the end result was that two of Lehman’s main buyers pulled out. of the agreement, result in companies that declared bankruptcy in September 2008. With Lehman Brothers and Bear Sterns, this is one of them the first shock in the economic systembefore the final spread of contagion to AIG, the international financial giant that (when saved by the federal government) would cause the global economy to collapse.
Economic/financial contagion is a serious problem that can occur in the financial system. During the COVID-19 pandemic, the entire world is experiencing various economic contagions.
When the virus first struck, “Stock markets plunged…on terrible news about a virus spreading around the world”. It has too documented that in various locations around the world, including the United States and China, “the daily growth in the total number of confirmed cases and the total number of deaths caused by COVID-19 both have a significant negative effect on stock returns in all companies” . However, the COVID-19 pandemic has been very different from previous contagions.
according to FinReg Blog from the Duke University School of Law, “… it may signal a time of crisis and identify the main catalyst … in 2020 we do not observe the typical early warning signals; Instead, the main catalyst of contagion is the COVID-19 virus itself. While there are different views , we can try to create a clear timeline model of the spread of the virus in regions and countries, while recording the relevant government response to the pandemic… COVID-19 is different from previous episodes of financial contagion by the rapid transmission of the crisis and recovery. We can expect the escalation of the crisis of the COVID- 19 which is faster and recovers faster than the previous crisis … an important role in advancing the crisis, changing the stock market, and formulating public opinion.
with enter President Biden’s bipartisan infrastructure bill that aims to “push billions to state and local governments to upgrade roads, bridges, transit systems and more”, the ability to fight infrastructure problems and better protect against economic contagion will certainly help.
Addressing or reducing financial contagion can come in the form of private and public actions, with private actions as, “enhanced institutional capital requirements … new private liquidity requirements … and resolution procedures that lead to losses,” while public actions take the form of, “unlimited public liquidity support for, or explicit guarantees, non -short-term. -deposit liabilities issued by financial institutions, assigned either in the form of a central bank lender-of-last-resort or as a publicly published insurance regime modeled on deposit insurance. Although this is an effective solution for normal economic contagion, it may not be useful when considering the COVID-19 pandemic.
In 2020 Harvard Business Review articlemany economists and members of the private financial industry discuss the economic fallout of COVID-19 while also offering some potential solutions to the problem, writing that, “vaccines will reduce the need for social distancing and thus stop the policy. global economy” while noting that , from an economic perspective, “policy innovation must also occur. For example, central banks operate “discount windows” that provide unlimited short-term finance to ensure liquidity problems do not damage the banking system. What is needed now, right now, is a “real economic discount window” that can also provide unlimited liquidity to well-off households and companies. The emerging policy landscape includes many worthwhile ideas. Among them are “bridging loans” that offer interest-free loans to households and companies during crises and repayment periods; moratorium on mortgage payments for residential and commercial borrowers; or use bank regulators to rely on banks to provide finance and rework the terms of existing loans”.
Despite all this, the author writes that the implementation of economic policies to help anti-COVID-19 measures must be implemented with “agile and efficient execution”.
If there is another economic contagion caused by an infectious disease like COVID-19, it will be beneficial for governments, companies, and private industry organizations to better protect the economy and financial services from these diseases and deadly pathogens.
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