The Great Recession and financial markets
The housing market bubble burst. There was also the 2008 financial crisis. These two events led to the Great Recession. This was the worst economic downturn since the Great Depression more than 80 years ago. Several financial sector firms declared bankruptcy—including Lehman Brothers in September 2008.
Financial markets were severely affected. The SPDR Dow Jones Industrial Average ETF (DIA) lost ~38% of its value from December 31, 2007 to December 31, 2008. The PowerShares QQQ (QQQ) ETF tracks the NASDAQ-100. It lost ~42%.
Spreads on corporate bonds reached historic highs. This reflected the higher risk environment. However, Treasury yields fell. This was partly as a result of the Fed’s accommodative monetary policy. It was also due to investor preference for safe-haven investments. Investors preferred safe-haven investments because of financial market volatility. 30-year Treasury yields fell by 1.76% over the course of 2008. The yields benefited exchange-traded fund (or ETF) prices like the iShares 20+ Year Treasury Bond ETF (TLT). It increased by ~33% from December 31, 2007 to December 31, 2008.
As a result of the 2008 financial crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. The Act includes provisions for enhanced liquidity. It also includes provisions for capital and risk-management requirements for large financial intermediaries—for example, financial firms like Goldman Sachs (or GS), JPMorgan (or JPM), Bank of America (or BAC) and Citigroup (C). The large financial intermediaries are systemically important. Both C and GS are part of the SPDR Financial Select Sector ETF (or XLF) and the SPDR S&P Bank ETF (KBE).
Governor Tarullo’s update on the Dodd-Frank Act implementation
“Since the passage of the Dodd-Frank Act more than four years ago, the Federal Reserve and the other agencies represented at this hearing have completed wide-ranging financial regulatory reforms that have remade the regulatory landscape for financial firms and markets,” said Federal Reserve Board Governor Daniel Tarullo. He testified at the Senate Committee on Banking, Housing, and Urban Affairs in Washington D.C. on September 9.
You can read his update on implementing the Dodd-Frank Act provisions in the next part of the series.