The markets have been volatile in the first weeks of March due to the collapse of Silicon Valley Bank and the crisis at Credit Suisse. In light of this, it's natural to recall the 2008 Global Financial Crisis. The question is: Are we facing a scenario similar to what happened 15 years ago, or is this time different?

In this article by Hapi, we’ll explain what a financial crisis is, the causes behind it, and how these lessons help us understand what is currently happening with the financial markets.

What is a financial crisis?

A financial crisis is a situation in which the financial system suffers widespread severe problems, such as bank failures and significant declines in stock markets. If not controlled, economies could plunge into a depression.

During these crises, there is panic and a lack of trust in the financial system, often resulting in bank runs, which are massive, widespread withdrawals by depositors. This phenomenon has been present in financial crises since the 19th century through to the present.

These are debt crises, meaning the debtor cannot pay what is owed to the lender. If this happens in the private sector, it is called a banking crisis. When it happens in the public sector, it is a fiscal crisis.

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What causes a financial crisis?

Most financial crises start with a financial bubble when an asset is overvalued. This creates a cycle of sharp rises and falls in an asset's price (stocks, real estate, metal prices, etc.), driven by excessive debt and speculation.

Crises can be triggered by systemic failures, irrational human behavior, lack of regulation leading to excessive risk-taking, and other factors.

In the banking sector, specifically, there are three main risks:

1. Credit risk: when loans and other assets start to default (fail to pay the debt).
2. Liquidity risk: when depositors’ withdrawals far exceed available funds.
3. Interest rate risk: rising interest rates can reduce the value of bonds on banks' balance sheets and force banks to pay more for deposits than they earn on loans.

These risks, either separately or combined, have troubled large banks in the past and have heavily impacted SVB and Credit Suisse recently.

What happened in the 2007-2008 Global Financial Crisis?

It was one of the deepest recessions in modern history and the biggest economic disaster since 1929. Trust in the system collapsed, and the global economy ground to a halt. The primary cause was subprime mortgages, which were high-risk home loans given to borrowers with low creditworthiness. These loans were bundled into [mortgage-backed securities (MBS) which were sold to investors through banks and other financial institutions.

Some investment banks developed collateralized debt obligations (CDOs), which were complex investments sold to investors. These instruments bundled different types of loans, including subprime mortgages.

When many borrowers began defaulting on their mortgages, investments in MBS and CDOs quickly lost value. Banks and other institutions had high exposure to these "assets," causing a chain reaction of bank failures and a widespread financial market crash. To avoid further damage and limit contagion to other sectors, massive bailouts were provided to institutions deemed too big to fail.

Despite these efforts, the financial crisis had significant impacts on the global economy. The S&P 500 fell more than 50% from its pre-crisis peak to its lowest point. Along with bank failures and stock market crashes, there was a wave of layoffs, a recession, and a decline in investment that lasted for years.

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Silicon Valley Bank and Credit Suisse: What happened?

Since March 10, a series of U.S. bank collapses has caused panic in the markets and prompted intervention by central banks. The crisis began when Silicon Valley Bank (SVB) collapsed due to a bank run by its customers, mostly startups and venture capital investors.

These clients withdrew their money after seeing warning signs when the bank reported huge losses from selling U.S. Treasury bonds, which had dropped in value following interest rate hikes. The Federal Deposit Insurance Corporation (FDIC) had to step in to manage the situation and secure the deposits.

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Credit Suisse, one of the most prestigious banks globally with over 160 years in business, was also on the verge of collapse due to poor credit management in response to rising interest rates. It was rescued by UBS, Switzerland's largest bank. Its market capitalization dropped to $3.3 billion from $50 billion before the pandemic.

Since then, central banks have injected large amounts of emergency cash to restore calm in the markets and have lent to other banks, with the total cost of the bailout exceeding $400 billion in direct support. Investors and bank customers remain nervous and distrustful of the strength of banks' balance sheets. Short-term tensions are expected to continue.

Is a financial crisis looming? What should you do with your investments?

The current financial stress is due to the Fed's interest rate hikes. The goal of this policy is to control inflation, but it can have adverse effects on economic recovery in terms of employment and bank liquidity. Typically, it takes about 18 months after the Fed's rate hike cycle for inflation to start easing. So, we still have to wait to see the results of this monetary policy.

On the other hand, market expectations suggest that problems at some U.S. banks do not pose risks to the entire banking system. The balance sheets of most U.S. and European banks are stronger than in the past. Before the Global Financial Crisis, financial institutions held many toxic assets that aggressively declined in value. Today, they don't hold such assets and are more solvent.

Although expectations of a deeper recession have increased due to the current financial turmoil, investors are not as pessimistic as they were 15 years ago. Finally, the strong measures taken by various U.S. economic authorities are useful in preventing contagion that could lead to a systemic crisis. Today, the Fed has more experience in handling banking crises.

While it’s impossible to predict when and how the next financial shock will occur, we can say with some certainty that, in the long run, U.S. stocks yield positive returns above other investment alternatives. Therefore, anyone seeking greater financial independence should consider investing in these types of assets.

However, we understand that it can be challenging to invest in American securities from Latin America: long processes, high fees, high minimum amounts, and complex investment mechanisms.

At Hapi, we know these barriers prevent the democratization of investments in our region, which is why we’ve created an app that makes everything easy and accessible. With this application, you can invest any amount in stocks without commissions and trade cryptocurrencies instantly.