The government and the Federal Reserve are providing much-needed support to the economy right now. But this will not end the pandemic crisis. Only testing results ended the financial crisis, roughly 10 years ago. In a similar fashion, we will not end the COVID-19 crisis until we distinguish and separate those who are sick from those who are well.
On the surface, the financial crisis may not seem to teach direct lessons for solving the pandemic crisis. A decade ago, we were focused on mortgage-backed securities and credit default swaps, and today we must address a virus.
However, the financial crisis was always about a "contagious" risk that spread across the banking system, making some banks effectively sick and causing them to fail. We should look closely at how we ended the last contagion crisis if we want to succeed at ending this one.
The financial crisis started with banks and spread to the overall economy. The crisis could only end when depositors and other funders of banks knew which institutions were healthy and which were sick.
Not all mortgages and bank loans were toxic, but even sophisticated investors could not tell which banks held bad loans and which held good ones. Indeed, even a good bank could fail if it were exposed to a weak bank that could bring it down. With so much uncertainty, depositors and funders pulled their money from what seemed like safe places.
The economy could not function in such a panic. We needed to stop the self-quarantining of funds from healthy banks.
As it is doing today, the government took many steps to keep the system functioning. The Federal Reserve provided funds to the financial sector to replace the money pulled out. These steps were hugely important in keeping a doomsday scenario from occurring. But these special liquidity programs did not end the crisis.
The Fed has recently restarted almost all of the special programs from the 2008 financial crisis. Again, these programs are needed to prevent conditions from getting worse. But these programs alone will not end the COVID-19 crisis.