Past Financial Crises Suggest Pain Far From Over

Naked Capitalism ^ | 01/01/09

[TigerLikesRooster]

Past Financial Crises Suggest Pain Far From Over

Economists Carmen Reinhart and Kenneth Rogoff have been publishing various findings from a large-scale data set they have constructed of past financial crises. They have looked back as far as 800 years, but not surprisingly, most of their output has consisted of analyses of modern crises (you can find some earlier discussions here and here).

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Their work has shown that financial crises are more severe and protracted than "normal" recessions. In some of their previous presentations, they had parsed out financial crises in advanced economies versus those in developing countries, and were surprised to find their trajectories were remarkably similar, so their latest product looks at both types together. It also includes two prewar developed country episodes where Reinhart and Rogoff had sufficient housing price and other relevant data.

Their latest piece looks at how crises generally progress and resolve themselves. The usual outcomes are worse than most commentators forecast for the US (save the fall in average real estate prices):

1. Real housing price declines average over 35% over a six year period. Note in other crises, residential real estate was not necessarily a focus of the bubble. Even excluding Japan (which has suffered a 17 year housing price decline) the average is over 5 years.

2. Equity prices fall 55% over three and a half years.

3. GDP fall an average of 9% (read that twice)

4. Unemployment increases 7% over previous norms.

5. Government debt "explodes", increasing an average of 86%, but the cause is typically not a banking industry recapitalization, but maintaining services in the face of collapsing tax revenues and countercyclical measure ex financial system measures.

[sanchmo]

Estimating US GDP decreases, unemployment rates & equity price drops based on what we experienced in the 1930s and what was experienced by Malasia, Indonesia & Philipines is a little of a stretch - our economic, social & political worlds are much different. Prob better to estimate based on what the industrialised & technological world (mostly western world + Japan) has experienced since the early 1970s, plus weighting more strongly for US experience in the 1970s & early 80s, and for Japan’s experience in the 90s (b/c that’s the closest parallel as far as how the crisis started).

I don’t have the numbers, but that seems to suggest that GDP contraction & unemployment not be as extreme as suggested here, but that instead tha duration of the economic and stock market slump msy be much longer and the public debt growth much higher than expected based on this analysis.

[TigerLikesRooster]

tha duration of the economic and stock market slump msy be much longer and the public debt growth much higher than expected based on this analysis.

This is the best case we can see realistically. Long period of stagnation overburdened by huge debt. This situation runs the risk of becoming permanent, if there is no unexpected external shock(e.g., war, natural disaster, pandemic, or political turmoil.)

Since worldwide nature of current crisis, this kind of stagnation cannot last for long. Unlike Japan in 90's, though, there is no other countries in the world which can pick up the slack and work as cushion to absorb any unexpected negative economic problems.

So the best case(in the near-to-mid term) would be that we may stabilize the situation, albeit at very undesirable level, at the expense of killing long-term recovery momentum.