Same Shit, Different Financial Meltdown

While American's like to think of themselves as unique, I wonder how unique our financial crisis actually is. At first glance, it certainly seems unique in its combined breadth and severity, but if its symptoms look so much like those that affected, say, Japan between 1989-Judgment Day, an understanding of that fact might help us pick the right medicine. Or not.

In any event, here is a run down of some of the more obvious similarities between the U.S. crisis and 5 historical examples (Japan, 1989; Spain, 1977; Norway, 1987; Finland, 1991; Sweden, 1991):

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 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.”) (Source: CHE)
  

Of course all six of the listed countries are different economically, not to mention demographically, culturally, politically and geopolitically. So how helpful can these comparisons be? Reinhart and Rogoff compare the current crisis to the historical "standard" of economic crises as a way of predicting the future. This is obviously pretty unscientific, but if nothing else, it's an interesting article:

On other fronts the news is similarly grim, although perhaps not out of bounds of market expectations. In the typical severe financial crisis, the real (inflation-adjusted) price of housing tends to decline 36%, with the duration of peak to trough lasting five to six years. Given that U.S. housing prices peaked at the end of 2005, this means that the bottom won't come before the end of 2010, with real housing prices falling perhaps another 8%-10% from current levels.

Equity prices tend to bottom out somewhat more quickly, taking only three and a half years from peak to trough -- dropping an average of 55% in real terms, a mark the S&P has already touched. However, given that most stock indices peaked only around mid-2007, equity prices could still take a couple more years for a sustained rebound, at least by historical benchmarks.

Turning to unemployment, where the new administration is concentrating its focus, pain seems likely to worsen for a minimum of two more years. Over past crises, the duration of the period of rising unemployment averaged nearly five years, with a mean increase in the unemployment rate of seven percentage points, which would bring the U.S. to double digits.

Interestingly, unemployment is a category where rich countries, with their high levels of wage insurance and stronger worker protections, tend to experience larger problems after financial crises than do emerging markets. Emerging market economies do have deeper output falls after their banking crises, but the parallels in other areas such as housing prices are quite strong.

Perhaps the most stunning message from crisis history is the simply staggering rise in government debt most countries experience. Central government debt tends to rise over 85% in real terms during the first three years after a banking crisis. This would mean another $8 trillion or $9 trillion in the case of the U.S.

Interestingly, the main reason why debt explodes is not the much ballyhooed cost of bailing out the financial system, painful as that may be. Instead, the real culprit is the inevitable collapse of tax revenues that comes as countries sink into deep and prolonged recession. Aggressive countercyclical fiscal policies also play a role, as we are about to witness in spades here in the U.S. with the passage of a more than $800 billion stimulus bill. (Source: WSJ/BigPicture)

But even if the U.S. crisis is standard, it does more acute deflation in the stock market, for example, indicate that we will hit a market bottom sooner or just deeper? And can we compare our crisis to that of Japan considering the policy blunders that Japan made and that we have surely learned from? Actually, forget that last point. And to throw out another miscellaneous criticism, can we expect such a sharp rise in public debt given the stimulus package if that package can be expected to at least slow the decline in tax revenue?

Ultimately, it's pretty difficult to draw any historical comparisons between historical events, particularly in discussing something so politically charged as policy prescription. As Dave and I were listening to Planet Money's profile on Keynes last night, one thing was abundantly obvious: ask four economists to explain something as fundamental as the Great Depression and get five equally convincing narratives. But on the other hand, while turning economic phenomena into typologies is both scientifically and politically problematic, what else do we have to work with?