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.
The government only ended the financial crisis when it tested all banks to determine which were healthy and which were not. Results of these so-called “stress tests” were made public to inform investors and depositors which banks could safely absorb expected losses. Just as critical, the weak banks received government funds to make them healthy so they could withstand future losses.
From early 2007 to early 2009, a measure of how investors viewed the risks of large banks set a new record, increasing by 3,000%. Even after Bear Stearns, Lehman Brothers and Citibank had been bailed out or failed, markets still expected more large banks to fail.
But from the announcement of the stress test program to the release of its results, this measure of bank risk quickly fell by two-thirds and returned to pre-crisis levels.
Bank stress tests are now standard in the United States, the United Kingdom and the eurozone, among many other countries and regions.
In the same way, to control the spread of COVID-19, we must figure out who currently has the virus and is contagious so they can stay home and not infect others. We must know who has already had the virus but is no longer contagious so they can return to work.
Today, we simply do not have the information needed to end the COVID-19 crisis.
There has been testing for COVID-19 cases, of course. About 900,000 tests were reported as of March 29 in the United States. This number of tests translates into about 3,000 tests per 1 million Americans, which is less than half of what South Korea has accomplished, and nothing compared with a country like Iceland, which has tested 40,000 per 1 million people. Thus, we still have little idea who has COVID-19 now and who has already had it.
Ideally, we would use direct testing to gather that information, but other surveillance methods could help move us in the same direction. For example, University of Minnesota Prof. Michael Osterholm has called for increased use of illness surveillance to identify the prevalence of the virus in a region given our current direct testing limitations. My colleague, Abigail Wozniak, has proposed a survey-based surveillance system that could provide decisionmakers with real-time information on infection rate trends and public responses to current restrictions.
The Federal Reserve is committed, along with federal, state and local governments, to doing all we can to support our economy during this crisis. But we also need to learn from history, which tells us that our actions will not be enough to end the crisis. Only effective identification of the problem will.
Ron Feldman is first vice president/chief operating officer at the Federal Reserve Bank of Minneapolis and co-author of “Too Big to Fail: The Hazards of Bank Bailouts” (2004).