In a recent news article, CNBC’s Jim Cramer discussed the difference between a decline in the market that is caused by a mechanical failure and one that indicates broader economic turmoil. He used the example of the 2007-2009 financial crisis, which was caused by excessive mortgage lending to individuals who wouldn’t normally qualify for loans. This led to a large number of Americans defaulting on their mortgages, ultimately causing a decline in the market.
Cramer highlighted the importance of evaluating the state of the economy to determine whether a decline is systemic or just a temporary flash crash that presents a buying opportunity. He suggested asking questions such as whether businesses are being severely impacted, if employment rates are plummeting, and whether there are signs of major firms going under or financial institutions facing runs. If any of these indicators are present, it suggests a decline that is connected to the overall health of the economy and poses systemic risks.
The root cause of the 2007-2009 decline was the irresponsible lending practices in the mortgage market, which allowed individuals who were not usually eligible for loans to obtain them. This eventually resulted in a high number of loan defaults, causing the market to plummet by over 50%. Cramer mentioned that there were signs of unsound practices in the mortgage market leading up to the crisis, which he learned through conversations with individuals in the industry. However, he emphasized that such declines are extremely rare and the financial crisis was a once-in-a-lifetime event with true systemic risk.