5 Historical Economic Crises

5 Historical Economic Crises And The U.S.

By Barry Ritholtz, TheBigPicture | 13 February 2008

Earlier this week, I received a copy of a paper co-authored by Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard University, titled Is the 2007 U.S. Sub-Prime Financial Crisis So Different?. Each of these authors have rather distinguished affiliations. Reinhart is with the NBER, the group whose Business Cycle Dating Committee officially marks the beginning and end of Recessions. And Rogoff is an adviser to the John McCain, who has (almost proudly) professed his economic ignorance. Yesterday, in the NYT, Paul Krugman linked this paper to an interesting and perhaps unique factor regarding the 2008 presidential contest.

None of the remaining 3 contenders— McCain, Obama or Clinton— are economic ideologues. No supply-siders in this group, no one from the Democratic 'old' school. If it turns out that the candidates are pragmatic centrists, more focused on problem solving than ideological belief system, it would be a good thing [[Maybe, maybe not. FDR started out famously as a 'pragmatic centrist'— he even promised to balance the budget before he was elected and made an early, half-hearted attempt to do so. Then he swung left; he may have saved us from a "Hitlerian" pusch (there were many offering themselves up for just such a role) but he also probably succeeded in extending depressionary conditions (it only lasted a few years in the UK and most of Europe) to WW II: normxxx]].

This is especially true, if the authors of the paper are correct. Why? Because, if the present situation plays out as they expect, we are going to need all of the problem solving skills available. You see, Reinhart and Rogoff draw parallels between the current U.S. financial woes and five previous financial crises. All five were "associated with major declines in economic performance over an extended period:"

• Japan (1992)


• Spain (1977)


• Norway (1987)


• Finland (1991)


• Sweden (1991)

Of course, none of these are identical to the present 2008 USA, economically, culturally, or politically. However, when one takes a closer look, some of the major parallels are disconcerting. The Chronicle of Higher Education did just that. In reviewing the Reinhart and Rogoff paper, they focused on the parallels to the Japan crisis.
Like Japan et al., the United States has seen:

• A steep rise in housing prices during the four years preceding the crisis. (The U.S. rise was more than twice as large as the average of the other five.)


• A steep rise in equity prices. (Again, the U.S. rise was larger.)


• A large increase in its current account deficit.


• A decline in per-capita growth in gross domestic product. (In this case, the U.S. situation doesn’t appear as bad as in the five predecessors.)


• An increase in the public debt. (Here again, the U.S. situation isn’t as bad as in the historical examples— but Reinhart and Rogoff add that "if one were to incorporate the huge buildup in private U.S. debt into these measures, the comparisons would be notably less favorable.")

The authors' conclusion:

"Given the severity of most crisis indicators in the run-up to its 2007 financial crisis, the United States should consider itself quite fortunate if its downturn ends up being a relatively short and mild one."

Real Housing Prices


Click Here, or on the image, to see a larger, undistorted image.

Current Account Balance/GDP Ratio


Click Here, or on the image, to see a larger, undistorted image.

Public Debt


Click Here, or on the image, to see a larger, undistorted image.

Global Financial Crises, Part II: Norway 1987

That above discussion led to a reader in Norway referring us to this 2005 commentary about the Norwegian Financial Crisis, which began circa 1987. It was the first systemic crisis in a major industrialized country since the 1930s.

As the nearby chart shows, Real Interest rates in Norway were negative from 1980-84. The crisis hit five years later.

In the United States, real interest rates were negative between 2002-03. The crisis hit five years later. (Real Interest rates just flipped negative again in 2008).

The Norwegian banking crisis had several features which will look familiar to any observer considering the present deterioration of the US financial situation. Both can be described as classic boom-bust crises, containing several universal features:

• Deregulation and liberalization pave the way for the boom

• Macroeconomic [recovery] policies are largely pro-cyclical

• Lending growth becomes exceptionally strong

• Prudential capital regulations are relaxed

• Regulatory/Supervisory efforts are eliminated/relaxed/reduced

The author notes these five factors were "a deadly cocktail." We seem to have drunk the same heady and dangerous brew here in the US. (I call it a 'Long Island Financial Iced Tea'— five liquors mixed with reckless abandon, invariably producing a pounding hangover.)

I suspect where there will be significant differences in the manner of how the two crisises will be resolved. The Norwegian crisis resolution contained five features:

Norwegian Hangover Cure

• Private solutions were explored/exploited before the government intervened.

• Share capital was written down to zero before committing public funds.

• The government acted swiftly to limit contagion, but did not provide a blanket guarantee.

• Liquidity support was given to illiquid, but solvent institutions [[NOT the reverse!: normxxx]].

• The government did NOT use an asset management company.

This is a rather intriguing guide to resolving the current sub-prime debacle. Note that the Norwegians avoided any moral hazard, they steadfastly refused to bail out speculators. It will be interesting to see if the US can follow a similar path— especially with the monoline insurers. Will share capital be written down to zero before committing public funds in firms such as Ambac (ABK), MBIA, FGIC?

The alternative leads us to a situation where grossly speculative profits remain intact, private and beyond the law, but systemic risk is public and shared by all [[which has been the traditional US approach, pretty much since the Great Depression: normxxx]]. This would be a wholly unsatisfactory conclusion [[but vastly safer, according to our not unbiased financial 'leaders'.: normxxx]].

SOURCES:

Is the 2007 U.S. Sub-Prime Financial Crisis So Different?
An International Historical Comparison (PDF)
Carmen M. Reinhart, University of Maryland and the NBER
Kenneth S. Rogoff , Harvard University and the NBER, January 14, 2008
http://www.economics.harvard.edu/faculty/rogoff/files/Is_The_US_Subprime_Crisis_So_Different.pdf

http://www.nytimes.com/2008/02/08/opinion/08krugman.html
Paul Krugman, NYT, February 8, 2008

Portents of Financial Doom
David Glenn, The Chronicle of Higher Education, February 8, 2008
http://chronicle.com/blogs/footnoted/1629/portents-of-financial-doom

A Norwegian Perspective On Banking Crisis Resolution
Kristin Gulbransen, Norges Bank, 16 June 2005
Conference on Banking Crisis Resolution— Theory and Policy, Oslo
http://www.norges-bank.no/Pages/Article____13822.aspx

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Normxxx    
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