This Time is Different: Eight Centuries of Financial Folly Carmen M. Reinhart, University of Maryland, NBER, and CEPR Kenneth S. Rogoff, Harvard University and NBER (Princeton University Press, forthcoming 2009) Reinhart and Rogoff, 2009 1 This talk is based on the following references (in chronological order): Reinhart, Carmen M., and Kenneth S. Rogoff, Is the 2007 U.S. Subprime Crisis So Different? An International Historical Comparison, American Economic Review, Vol. 98 No. 2, May 2008, 339 344. (RR, 2008a) Reinhart, Carmen M., and Kenneth S. Rogoff, Banking Crises: An Equal Opportunity Menace, (with Kenneth S. Rogoff), NBER Working Paper 1487, December 2008. (RR, 2008d) Reinhart, Carmen M., and Kenneth S. Rogoff, The Aftermath of Financial Crises, (with Kenneth S. Rogoff), American Economic Review, forthcoming, May 2009. (RR, 2009) Reinhart and Rogoff, 2009 2 1
Recent examples of the this time is different syndrome US in the run-up to the 2007 financial crisis: This time was different because of globalization, the technology boom, our superior financial system, our better understanding of monetary policy, the phenomenon of securitized debt. Sure, housing prices doubled, equity prices soared, all fueled by record borrowing from abroad. But it is not like the United States can have an emerging market type financial crisis Asia following the Mexican 1994-199 crisis: Sure, Latin America may experience recurrent problems, but Asia has high savings rates and superior work ethic (not to mention Asian values). Record current account deficits owe to high investment rates not consumption booms. Financial crises are other people s problems. Reinhart and Rogoff, 2009 3 And a not so recent example more to follow (courtesy of Professor Peter Lindert) Reinhart and Rogoff, 2009 4 2
An advertisement for: Reinhart and Rogoff, 2009 Where are we at present in a historical global context? 4 Proportion of Countries with Banking Crises, 1900-2008 Weighted by Their Share of World Income The Great Depression The First Global Financial Crisis of 21st Century 40 3 Emerging Markets, Japan the Nordic Countries, and US(S&L) Percent of counties 30 2 20 1 The Panic of 1907 World War I 10 0 1900 1903 1906 1909 1912 191 1918 1921 1924 1927 1930 1933 1936 1939 1942 194 1948 191 194 197 1960 1963 1966 1969 1972 197 1978 1981 1984 1987 1990 1993 1996 1999 2002 200 2008 Reinhart and Rogoff, 2009 6 3
Is the U.S. subprime meltdown a new kind of financial crisis? A review of some of the antecedents of crises. Reinhart and Rogoff, 2009 7 Quantitative parallels to post-war banking crises in industrialized countries Leading indicators: Large capital inflows Sharp housing and equity price run-ups Inverted V-shaped growth trajectory Marked rise in indebtedness Reinhart and Rogoff, 2009 8 4
The Big Five post-war industrialized country financial crises Country (Start date) Spain (1977) Norway (1987) Finland (1991) Sweden (1991) Japan (1992) Reinhart and Rogoff, 2009 9 Milder industrialized country financial crises Australia (1989), Canada (1983), Denmark (1987), France (1994), Germany (1977), Greece (1991), Iceland (198), Italy (1990), New Zealand (1987), United Kingdom (1974, 1991, 199) United States (1984). Reinhart and Rogoff, 2009 10
A year ago we (RR, 2008a) compared the US 2007 crisis To the milder post-wwii crises and to the really severe ones (Big Five) Reinhart and Rogoff, 2009 11 On housing and equity price run-ups on the eve of crises This is what real housing prices looked like then Real Housing Prices and Banking Crises 13 130 12 US, 2003=100 120 Index 11 110 10 Average for banking crises in advanced economies 100 9 Index t-4=100 Average for the "Big " Crises t-4 t-3 t-2 t-1 T t+1 t+2 t+3 Reinhart and Rogoff, 2009 12 6
This is what it looks like now Real Housing Prices and Banking Crises 13 130 12 US, 2003=100 120 Index 11 110 10 Average for banking crises in advanced economies 100 9 Index t-4=100 Average for the "Big " Crises t-4 t-3 t-2 t-1 T t+1 t+2 t+3 Reinhart and Rogoff, 2009 13 For real equity prices, this is what it looked like then Real Equity Prices and Banking Crises 13 130 12 US, 2003=100 120 11 110 Index 10 100 9 90 8 80 Average for banking crises in advanced economies Index t-4=100 Average for the "Big " Crises t-4 t-3 t-2 t-1 T t+1 t+2 t+3 Reinhart and Rogoff, 2009 14 7
This is what real equity prices look like now Real Equity Prices and Banking Crises 13 130 12 120 11 110 Index 10 100 9 90 8 Average for banking crises in advanced economies Average for the "Big " Crises 80 7 Index t-4=100 US, 2003=100 70 t-4 t-3 t-2 t-1 T t+1 t+2 t+3 Reinhart and Rogoff, 2009 1 As to real per capita GDP, this was then Real GDP Growth per Capita and Banking Crises (PPP basis) 4 Percent 3 2 1 0-1 U.S. Average for the "Big " Crises Average for banking crises in advanced economies -2 t 3 t 2 t 1 t t+1 t+2 t+3 Reinhart and Rogoff, 2009 16 8
Using consensus estimates for 2009, this is what real per capita GDP looks like now. Real GDP Growth per Capita and Banking Crises (PPP basis) 4 3 2 Average for banking crises in advanced economies Percent 1 0 Average for the "Big " Crises -1-2 -3 t 3 t 2 t 1 t t+1 t+2 t+3 U.S. Reinhart and Rogoff, 2009 17 To sum up on the question: Is the US subprime meltdown a new kind of crisis? We conclude that while each crisis has idiosyncratic features (the subprime episode being no exception), the runup and unfolding of the current crisis bears many similarities to past episodes of severe financial crises. This time (once again) is not entirely different Reinhart and Rogoff, 2009 18 9
Here, we document the duration and depth of the post-crisis crash for selected indicators. Reinhart and Rogoff, 2009 19 Past and Ongoing Real House Price Cycles and Banking Crises: Peak-to-trough Price Declines (left panel) and Years Duration of Downturn (right panel) 23 Ongoing Austria, 2008 Hungary, 2008 22 21 US,1929 20 UK, 2007 19 Iceland, 2007 18 Malaysia, 1997 17 Thailand, 1997 16 Korea, 1997 1 Ireland, 2007 14 Norway, 1899 13 Argentina, 2001 12 US, 2007 11 Sweden, 1991 10-3. percent Spain, 1977 Historical Average 9 8 6 years Japan, 1992 7 Norway, 1987 6 Indonesia, 1997 Finland, 1991 4 Colombia, 1998 3 Philippines, 1997 2 Hong Kong, 1997 1-60 -0-40 -30-20 -10 0 Percent decline 0 10 1 20 Duration in years Reinhart and Rogoff, 2009 20 10
Past and Ongoing Real Equity Price Cycles and Banking Crises: Peak-to-trough Price Declines (left panel) and Years Duration of Downturn (right panel) Ongoing -.9 percent n.a. Norway, 1899 Argentina, 2001 Hong Kong, 1997 Norway, 1987 Sweden, 1991 UK, 2007 US, 2007 Spain, 2008 Hungary, 2008 Historical Average Philippines, 1997 Ireland, 2007 Japan, 1992 Finland, 1991 US, 1929 Colombia, 1998 Spain, 1977 Malaysia, 1997 Indonesia, 1997 Korea, 1997 Austria, 2008 Thailand, 1997 Iceland, 2007 23 22 21 20 19 18 17 16 1 14 13 12 11 10 9 8 7 6 4 3 2 1 3.4 years -100.0-90.0-80.0-70.0-60.0-0.0-40.0-30.0-20.0-10.0 0.0 Percent decline 0 1 2 3 4 6 Duration in years Reinhart and Rogoff, 2009 21 Past Unemployment Cycles and Banking Crises: Trough-to-peak Percent Increase in the Unemployment Rate (left panel) and Years Duration of Downturn (right panel) Malaysia, 1997 1 Indonesia, 1997 14 Japan, 1992 13 Thailand, 1997 12 Philippines, 1997 11 Hong Kong, 1997 10 Norway, 1987 9 Korea, 1997 8 Argentina, 2001 7 7 percent Historical Average 6 4.8 years Sweden, 1991 Spain, 1977 4 Colombia, 1998 3 Finland, 1991 2 US, 1929 1 0 10 1 20 2 Percent increase 0 2 4 6 8 10 12 Duration in years Reinhart and Rogoff, 2009 22 11
Past Real Per Capita GDP Cycles and Banking Crises: Peak-to-trough Percent Decline in Real GDP (left panel) and Years Duration of Downturn (right panel) Spain, 1977 1 Japan, 1992 2 Norway, 1987 3 Philippines, 1997 4 Sweden, 1991 Hong Kong, 1997 6 Colombia, 1998 7 Korea, 1997 8-9.3 percent Historical Average 9 1.9 years Malaysia, 1997 10 Finland, 1991 11 Thailand, 1997 12 Indonesia, 1997 13 Argentina, 2001 14 US, 1929-30 -2-20 -1-10 - 0 Percent decrease 1 0 1 2 3 4 Duration in years Reinhart and Rogoff, 2009 23 Severe financial crisis summary: Peak-to-trough changes, all countries Averages Real housing prices Real equity prices Cumulative % change -36-6 Duration years 3.4 years Unemployment, trough-to-peak Real per capita GDP 7-9.3 4.8 years 1.9 years Reinhart and Rogoff, 2009 24 12
Across severe crises in emerging and advanced economies, we find: Depth and duration of housing price cycle (peak to trough) is similar. Broad similarity also in equity prices, a v-shaped recovery more common than in housing. There are similarities in the GDP trajectory although contractions are more severe in emerging markets. Unemployment rises, if anything, LESS in emerging markets (perhaps due to sticky wages and high benefits in advanced countries) Reinhart and Rogoff, 2009 2 As to the fiscal aftermath of banking crises, we find: That the nearly universal focus on calculations of bailout costs as the centerpiece of the fiscal consequences of banking crises is misguided and incomplete. Banking crises weaken fiscal positions beyond the costs of bailouts, as government revenues contract and stimulus plans find favor. Reinhart and Rogoff, 2009 26 13
On the first point, the discrepancies across estimates of bail-out costs are large and in, some cases, staggering Country/beginning year Estimated bailout cost as a percent of GDP Upper bound Lower bound Difference Argentina, 1981.3 4.0 1.3 Chile, 1981 41.2 29.0 12.2 Ghana, 1982 6.0 3.0 3.0 Japan, 1992 24.0 8.0 16.0 Norway, 1987 4.0 2.0 2.0 1 Philippines 13.2 3.0 10.2 Spain, 1977 16.8.6 11.2 Sweden, 1991 6.4 3.6 2.8 US (S&L), 1984 3.2 2.4 0.8 Reinhart and Rogoff, 2009 27 On the second point, government revenues suffer as the crisis lingers (more details to follow) Real Government Reveues and Banking Crises (annual percent changes) 4 3 2 Percent 1 0-1 t-3 t-2 t-1 T t+1 t+2 t+3-2 -3 Bail-out costs are only part of the story why public debt surges after the crisis Reinhart and Rogoff, 2009 28 14
Stimulus packages add to the bill of the crisis Also, governments engage in stimulus packages involving sometimes wasteful expenditure programs. At the height of Japan s banking crisis in the 1990s, repaving the streets in Tokyo became a routine exercise. As a result, Japan s gross debt-to-gdp ratio is now nearly 200 percent and a drag on what once was a vibrant economy. Reinhart and Rogoff, 2009 29 Thus, the true legacy of financial crises is more government debt Cumulative increase in public debt in the three years following the banking crisis Malasia Mexico Japan Norway Philippines Korea Sweden Thailand Average Spain Indonesia Chile Finland Colombia Index=100 in year of crisis Average is 186.3 100 10 200 20 300 Reinhart and Rogoff, 2009 30 1
Banking crises and default cycles on external debt This lull may also be temporary. A high incidence of global banking crises (such as at present) has historically been associated with a high incidence of sovereign defaults on external debt Reinhart and Rogoff, 2009 31 Proportion of Countries with Banking and Debt Crises Weighted by Their Share of World Income 4 4 40 Banking Crises Debt Crises 40 3 3 30 30 Percent of counties 2 20 2 20 1 10 0 1900 1904 1908 1912 1916 1920 1924 1928 1932 1936 1940 1944 1948 192 196 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 Reinhart and Rogoff, 2009 32 1 10 0 16
Perhaps Ecuador s latest default (December 2008) on its external debt is a sign of things to come Reinhart and Rogoff, 2009 33 17