Today, many experts say that the COVID-19 pandemic and its unexpected ubiquitous quarantine make an economic global crisis inevitable. We decided to look through previous crises to understand their impact on the financial services industry. Moreover, we want to understand what actions companies took to survive these crises.
The Great Depression
Let’s start with the Great Depression. During this crisis, the unemployment rate reached 25 percent; in some US states it was almost 80 percent. Because of Roosevelt’s Emergency Banking Act of 1933, the banking system was reorganized and about 50 percent of US banks were closed.
Reformed regulations of the financial system restricted banks from making risky investments and lenders from encountering inexplicable interests. The global economy needed more than a decade to recover.
Although the Great Depression was trying for most companies and services, some of them not only survived but also had success. They looked for new opportunities, changed their strategies to attract customers, and diversified their offering.
Unlike during the Great Depression, when a number of prerequisites warned about the nearing crisis, nothing similar was expected on the verge of a new century when the dot-com bubble burst. Then, investors, venture capital firms, and banks were confident of technological advancements and eager to invest in technology companies, even though most of them were not profitable.
Once the Internet companies started running out of cash, their stock market indexes went down by close to 60 percent in a day. Only about 48 percent of companies created during the boom survived. Ignoring the trend of growing as quickly as possible to beat off the competition, most of those who survived had seen opportunities in micro niches. Some companies survived and even grew by acquisitions and diversifying the services they offer.
E*Trade is one of those companies that were wounded by the crisis and had to fight hard to keep afloat. New financial products offered by the company interested private investors, which allowed E*Trade to survive.
Charles Schwab continued to add innovation even through the dot-com crash. Schwab was one of the first to offer online trading. Although the firm had to lay off more than half of its employees, it was still diversifying its offerings and acquired wealth management firms to diversify its clientele.
The Great Recession 2008
The 2008 crash is called the worst economic crisis since the Great Depression. Then, Lehman Brothers, a venerable 158-year-old investment banking firm, collapsed. During a few years before 2008, mortgage debt had risen enormously. Americans borrowed money for houses even without proof of a job and income. Thus, mortgages were transformed into a very risky investment.
Lehman owned tens of billions of dollars in overvalued assets. In September 2008, the Reserve Management Corporation re-valued its Lehman securities at zero. This caused a chain reaction when many financial institutions and companies such as banks, mortgage lenders, and insurance firms were also suddenly proven to be untrustworthy.
As a result, 57 American banks were closed and the unemployment rate reached 8.5 percent. However, some financial firms survived because of their business model.
Wells Fargo had a diverse lending system and lent not only to real estate but also to small businesses and companies from various industries, including energy and agriculture.
The abovementioned E*Trade again survived thanks to having sold its mortgage portfolio in 2007 to Citadel, a Chicago hedge fund group. In addition, the company made management changes with a new CEO, which allowed it to hang on through the recession.
Even the worst crisis creates opportunities
Companies may explore different strategies to survive. For example, while most companies tighten their belts during a crisis, some refocus rather than cut spending and trade lower short-term profitability for long-term gain. These companies then come out winners from the crisis.
It is very important to have the right prevention–promotion balance to get the most growth after a recession. Such companies evaluate every aspect of their business model, making near-term changes that reduce costs before and after demand returns.
All those companies that survived stayed closely connected to customer needs; this was the filter through which they made investment decisions.
Winning companies also used opportunities before the recession. Bain research reveals the following actions that helped companies outperform in stormy times: early cost restructuring and a combination of balance sheet discipline, aggressive commercial growth plays, and proactive M&A. Conversely, the companies that just cut costs and R&D, scaled back on sales and marketing activities, and fired valuable talent survived a difficult period but later lost to their competition.
To finish the story, I’d like to write down the quote of Alex Chalekian from Lake Avenue Financial:
“At this time, we need to stay strong and remain positive. I don’t think, for us in the US, that the worst is over. We have yet to see the full force of this virus and the impact on our lives. That being said, my hope is that we learn from this horrible experience and come back much stronger and prepared for anything that comes at us in the future. A positive that will come from this is how technology has helped us get through this crisis, as we shelter in our homes. Tech and Fintech has helped keep us connected with our families, friends and clients. When we emerge from this epidemic, technology, especially financial technology, will prove to be invaluable to advisors and their clients.”
I leave you with this quote:
“Failure is simply the opportunity to begin again, this time more intelligently.”– Henry Ford