Crises reveal fragility. This one is no exception. Among other things, coronavirus has revealed fragilities in the financial system. This is unsurprising. As before, reliance on high leverage as a magical route to elevated profits has led to private profits and public bailouts. The state, in the form of central banks and governments, has come to the rescue of finance on a gigantic scale. It had to do so. But we must learn from this event. Last time, it was the banks. This time we must look at capital markets, too.
The IMF’s latest Global Financial Stability Report details the shocks: falling equity prices, soaring risk spreads on loans and plummeting oil prices. As usual, there was a flight to quality. But liquidity dried up even in traditionally deep markets. Highly-leveraged investors came under severe stress. The pressures on the financing of emerging economies have been particularly fierce.
The scale of the financial disarray reflects in part the size of the economic shock. It is also a reminder of what the late Hyman Minsky taught us: debt causes fragility. Since the global financial crisis, indebtedness has continued to rise. In particular, the indebtedness of non-financial companies rose by 13 percentage points between September 2008 and December 2019, relative to global output. The indebtedness of governments, which assumed much of the post-financial crisis burden, rose by 30 percentage points. This shift on to the shoulders of governments will now happen again, on a huge scale.