Tuesday, February 03, 2009

The WSJ gives us another history lesson

I love history. I love seeing the similarities across the ages and then seeing them (Need a "for instance"? I am currently ristening to American Creations right now on the US constitutional convention of 1787. In it James Madison (who was 5 ft 4 and seemingly taller than his statue at JMU) argued that the way to solve problems with sectional thought in voting which would lead to excessive political swings was to make the republic larger. This is much the same argument many (including myself) have used to say that more hedge funds (not fewer) may (if there is sufficient diversity of opinions and strategies) reduce market volatility.)

Which is a very long-winded way of saying, the WSJ seems to be doing the same thing this week. After looking at what prolonged the Great Depression they turn their attention to looking back at past financial crises to see what we can learn:

Opinion: Expect a Prolonged Slump - WSJ.com by Carmen Reinhart and Kenneth Rogoff:
"...when one compares the U.S. crisis to serious financial crises in developed countries (e.g., Spain 1977, Norway 1987, Finland 1991, Sweden 1991, and Japan 1992), or even to banking crises in major emerging-market economies, the parallels are nothing short of stunning...

...Financial crises, even very deep ones, do not last forever....negative growth episodes typically subside in just under two years. If one accepts the NBER's judgment that the recession began in December 2007, then the U.S. economy should stop contracting toward the end of 2009. Of course, if one dates the start of the real recession from September 2008....

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....

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..."

They go on to briefly discuss differences this time around, but (to me at least) the similarities dominate.

NOTE: Past history rarely repeats itself exactly, but there are enough similarities to learn a great deal from it.

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