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The Financial Crisis at the Economics Convention

Posted by: Michael Mandel on January 04

I’m at the annual economics conference in San Francisco. I’ve been going to these things, on and off, since I was a grad student in the early 1980s. Because of the combination of the financial crisis and the new president, there’s a sense of urgency here which I don’t recall from the past, even during previous downturns.

So far, the star of the first day of the conference has been Ken Rogoff of Harvard, with a paper in the morning, being the featured speaker at lunch, and then participating in the afternoon on a panel on the crisis. His message is a gloomy one: There’s a lot further down to go.

He compared the U.S. crisis to the big financial disasters in the past, and suggested that we are following much the same path. In each of these, the devastation was enormous.

Here’s some historical data he showed at lunch, taken from his new paper with Carmen M. Reinhart, entitled “The Aftermath of Financial Crises.” (I copied the data from his slide, and then checked it against his paper). The data represents the average from a large number of historical financial crises.

Rogoff: Past Financial Crises
Peak-to-trough change Duration (in years)
 Home Prices* -36% 6
Equity* -56% 3.4
Unemployment Rate** 7 4.8
GDP per capita* -9.3% 1.9
Government debt* 86% ***
* Adjusted for inflation
**Rise in percentage points
*** Three years after the crisis started
Data: Reinhart and Rogoff

Rogoff made particular note of the enormous rise in government debt in a crisis. Historically, government debt balloons not just because of the cost of bailouts,but because of the fall in tax revenues and rise in government spending.

A couple more Rogoff points: At lunch he predicted “what we will see next is a wave of sovereign defaults.” At the afternoon panel, he added “We’ll be seeing second and third bailouts of the big banks.”

Finally, Rogoff observed at lunch that “A depression is to economists like a plague is to morticians.” I’m not quite sure what that means, but it doesn’t sound good.

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Reader Comments

Mike Reardon

January 5, 2009 01:38 AM

The Fed and Treasury have admitted they are passing from monetary policy to deal with the crisis to what can be called investment banking activity and insurer of last avail.

The Fed and Treasury have pushed into the markets, capital injections in Trillions, the TARP is still in Billions.

Government debt is smallish when placed against the other injections. The size of this Bailout and Fed actions to this point are very different from past stimulus.

The TARP which is Government debt and the injects from the Fed and Treasury expect a return from the borrowers of these investment.

With first call against assets and returns. It has becomes a transfer of stake into hands of government, from the concern that accepts Bailout loans. Think Bank of China when seeing expected returns. Not really!!

Treasury can recover TARP investments by selling these assets to private capital at a market price, think establishing Oligarchs. Or they can retain position until the end.

The problem is there can’t be that sell into the private market if assets continue their slide, Government leads consolidations and the stake the government holds can become substantially larger.

And a still bigger government stake means bigger returns go to the general fund and offset failing tax receipts. Even contraction can leads to greater stake and greater returns to Government.

We end with a full mixed market and the half private pays the government investor twice, once as returns and once as tax.

Obama’s stimulus aside, look at the size of the FED and Treasury injections, they now are as great as the full Bush debt. Trillions already that expect a return on the investment.

Joe Cushing

January 5, 2009 09:53 PM

You talked about sovereign default. I heard a couple months ago on NPR that many 1st world nations have taken on debt of the level that 3rd world nations, that defaulted, took on before their default. What would be the impact to the global economy if one or more of these nations defaulted? What would an English, or French default do for example?


January 6, 2009 01:13 AM

English or French default....?
Go bush and live with the Natives.


January 6, 2009 09:37 AM

At least we know America won't "default". We'll just print money and give it to our creditors with a straight face.


January 6, 2009 12:26 PM

The chart's 36% average housing decline sent me off trying to confirm the many reports I thought I recalled that housing never declines. It wasn't easy, although there are plenty who sum up what's happening now as "unprecedented". I finally did find a major network news anchor that shall remain unnamed saying in 2007 that housing never goes down, without caveat. That kind of thing added to the cynicism of those of us who knew better, and I assume that it has created a whole new crop of cynics by now.

You inspired me to skim some of the AEA conference papers -- a fascinating collection of titles. Unfortunately, the first paper I purused, on climate shocks and economic growth, relegated "changing sea levels, increasing frequency of natural disasters, and issues of biodiversity" to a footnote mention that those costs would not be captured, which makes the cynic in me wonder why anyone should bother to consider the conclusions. It will fall to the pollyanna in me to give the rest a chance.


January 7, 2009 01:44 PM

The 'housing never goes down' crowd are so detached from common sense that they get what they deserve.

The same people have no trouble accepting that COMMERCIAL property goes down. Yet somehow they think that the presence of a kitchen and shower makes a property magically immune to price declines.

I smartly chose to not buy a house. Now, my purchasing power as measured in houses is twice what it was just a couple of years ago.

But I still will not buy.


January 7, 2009 04:40 PM

you mean the majority of the banking industry?

My wife made me buy a house. It'll go down, but it'll go back up. And in the meantime, my kids get to live in a good neighborhood. As long as I don't lose my job and have to move, it's all good.


January 7, 2009 06:28 PM

The problem is focused actually on the M1.

Does anybody see that ¿?

Patric Hale

January 8, 2009 12:54 PM


What Really Pulled America Out of the Great Depression – And How We Can Apply It Today

America is facing an economic crisis on the same proportion as the Great Depression. This is something we all don’t want to hear because the prospect quite rightly frightens all of us. Nonetheless, it is the white elephant in the room and ignoring it won’t make it go away. The only thing that will make it go away is to try to figure out how it came in and then what it will take to leave as quickly as possible.

Up to this point, Messrs. Paulson and Bernanke have frankly done a miraculous job as the Hans Brinker twins plugging the myriad of holes that keep springing out of the dike while Congress seems to think that there’s nothing wrong with the dike at all and they shouldn’t waste their time. “Let the dike break!” seems to be their response with no comprehension, it would seem, of what would happen if the dam truly did break, hence their unbelievable prescription to Detroit to simply “drop dead!” So what do we need to do next?

The first thing is vitally important: We – the American people – severally and individually have to recognize that this is OUR economy! What affects it, affects us all. Detroit is not Fallujah, Densapar, Krakow, or any other city far, far away – it is OUR Detroit, just as its auto industry is OUR auto industry. Those workers in the auto industry are Americans. We’re all in this together and it will require a united country to resolve it together.

The second thing is this: OK, this economic crisis was caused by stupid, greedy people on Wall Street who were playing by their own rules for their own purposes and in so doing brought down our economy. Our anger is palpable and understandable. But now it’s time to get over the anger and get on with the solution quickly. If we don’t want to refer to this time as the Greater Depression we need to come up with solutions that actually solve the problems instead of merely soften the continued decline – and we need them now.

Given the scope of the economic crisis, most economists who understand the problem return to FDR and his New Deal to try to find answers on how to get us out of this mess. Unfortunately, in my opinion, they are looking in the wrong place for the answer because the New Deal was NOT what really resolved the Great Depression for one fundamental reason: It took the Federal Government too long to get the economy moving again.

From the stock market crash of 1929, our GDP decline until 1934, and then rose slowly over the next five years before finally returning to its pre-crash level in 1939. That’s ten years of misery! Who amongst us today wants to wait that long – or even half that long – to see our economy rebound? While there’s no question that the New Deal did put people to work and did build some truly lasting monuments to the nation, the process simply took too long and didn’t really complete the job: Even though by 1939 the budget and our GDP returned to the level of 1929, there were still 8 million people unemployed, 15% of America’s workforce.

Indeed, because of the slowness in response, the global misery led to the age of collectivism and fascism around the world, which contributed to World War II. Surprisingly, however, it was the war that became the solution – as sad and depressing a thought as that might seem. And in that is the kernel for the resolution of our current economic crisis, too.

America’s economy began its real recovery in 1939 when FDR finally abandoned his timidity by boldly increasing government debt to prepare America economically for the growing threat of global war. Unwilling to increase debt because of the economic collapse of the nation, he, nonetheless, was able to convince Congress that we definitely had to do it because of the “gathering storm” of war; and the country responded. And as they did, our economy recovered. One wonders what would have happened had he – or Hoover - done the same thing earlier to solve our domestic economic problems.

During the Depression, the biggest budget deficit was 5.9% of our GDP in 1934, before returning back to almost a balanced budget in 1939; then it began to increase rapidly again because of the storm clouds of war.

What happened during WWII? As By 1943, the Federal Government budget deficit ballooned to over 30% of our GDP – the highest ever in US history. Compare this to the "only" 5.9% during the Depression. You are all probably saying, “Yes, but there was a war on!” That’s true; but “war” is just another economic problem and what’s important here is the economics, not necessarily the reason.

Ultimately the American government and its people decided that winning WWII was paramount no matter what the cost, deficits be damned! Because of this, the Federal Government massively increased its budget deficit, and hence long-term debt which reached 122% of GDP in 1943. (By way of contrast, our budget deficit today is only 3.6% of GDP, and our long-term debt is “only” 68% of GDP). It used this money to buy ships, planes, tanks, trucks, uniforms, buildings, airfields, weapons, armaments, munitions, meals, socks, shoes, boots, etc. At the same time, we also improved our infrastructure, from Detroit, to Seattle (Boeing), to our railway network, to our roads, to our waterways (the Inland Waterway was build to move goods without fear of being torpedoed), to techniques in mass production, to training programs for factory workers – including women and African-Americans throughout the economy – to almost everything you can imagine. In a mere four years – 1939 to 1943 – the GDP of the country more than doubled and unemployment virtually disappeared. Ironically, what we were doing economically was going deeply into debt to produce goods that were actually being destroyed as a function of war. Yet no one seemed to mind.

As for our current crisis, increasing our debt really isn’t the issue – it must be increased! How much it will take to solve the problem and what the money will be spent on, are the real issues. The answer to this requires our leaders being really BOLD – at least much bolder than they’ve been. So in essence the bottom-line solution to our current problems is this: “Declare war on our own economy!”

Today the GDP of our economy is roughly $14 trillion. The difference between our current long-term debt of 68% to the level of 1943 - 122% - means there is at least another $7 trillion we could invest in America if we wanted to. Obama is correct to focus on our infrastructure needs. But infrastructure isn’t our only problem; the list of our needs is long and profound – and not likely to be resolved by market forces any time soon either. More than anything we need an economy that is export-focused with a leadership that recognizes that our economic success in the 21st century will depend on how well we compete in the new global economy. This means, among other things, eliminating barriers to US trade, not increasing them - especially those we place on our own export efforts.

Look at it this way: Assume you’ve lived in an old house for the past 30 years and the roof leaks, the plumbing is old, the electricity doesn’t support all the new electronics, the phone is a rotary dial with no plug-ins for computers, and the driveway needs repaving. Now you could try to fix each problem in succession with savings from your current income, but winter is approaching and your current income won’t cover what’s necessary to fix it now. The alternative is to re-mortgage the house and use the money to fix it up the way it should be which ultimately provides you with a comfortable home and increases its value, too. Well, that’s what we need to do with our economy, which is our home: Re-mortgage it and use the proceeds from the increased debt to fix the house properly so we all live in this house we call “America” in comfort and satisfaction. But at the very least let’s recognize one thing: We all live here together – it’s OUR American home!

Patric Hale, Author of "It's the Economy! (Stupid) - A Citizens Guide to the US Economy" (July 2008;


January 9, 2009 12:25 PM


Wrong. You could have rented a house instead. The kids would not know the difference, but you could have saved a ton of money and stress.

(I am visualized your head turning into a donkey head a-la old 1950s cartoons)

" It'll go down, but it'll go back up. "

I don't think you understand the concepts of cost of capital and inflation.

If your house, 2 years from now, is the same price as when you bought it, you have not 'broken even'. You have actually lost a lot.

"My wife made me buy a house. "

Now, we're getting somewhere. Had you educated your wife on the basics of finance, and how it is wrong to consider rent payments a waste, while not considering mortgage interest a waste, you could have saved your life's savings.

You did not buy your house. You just chose to rent money from the bank, while also assuming the risk of losses on the house's value.


January 9, 2009 04:32 PM

why do you assume that my consumption was uninformed?

I looked into renting a house, but the selection was not at all comparable, because smart renters want to make money, and the foolish ones don't take care of their property. Let me make this clear: I did not buy a house as an investment: I bought it to get a nicer living space than I could rent. I do understand the concept of capital cost and inflation, and that even with government-subsidized mortgage interest, home ownership is still an expensive prospect. My point is that borrowing money to buy a house is a lot like borrowing money to buy a car. Your car depreciates, but you still get to use a new car.

Finally, I bought the house well after the housing slump had started. The irony is that, in the 5 year time range, I'm not sure I've done any worse than if I'd thrown my money in a 401K.

When I say "my wife made me buy a house", my point related to standard-of-living. My wife vetoed living in a less expensive way. But for the money I'm laying out, I think I made a reasonable decision given the information I had. I'll "lose" a certain amount of money up front, and then after an economic recovery, I expect my asset to do just slightly better than inflation on the new value curve, with traditionally less risk than, say, the stock market. Not a great investment, but not the worst possible place to squirrel away a portion of your money, either.
The trend of property value is to go up, just not relative to, say, a mutual fund. It's also historically less risky, simply because they're not making any more land. But, like all assets, you do see dips.


January 9, 2009 05:00 PM

Before you applaud FDR too much, you may want to review the following article:


January 11, 2009 02:12 PM

You guys are going back and forth about buy versus rent for homes. How about buy versus rent for your car? What about buy versus rent for your clothes, or you computer, or anything else? I can't rent food, but I can rent a plot of land in an area with sufficient seeds. Its still OK to "buy" a home. I didn't want to deal with a landlord, and I didn't want to end up in the street because the landlord kept my rent money and didn't pay the mortgage. A homeowner in good standing will be the recipient of government aid - we're the last thing left. We still pay property taxes. I'm refinancing and saving $300 a month, and when you factor in the tax deduction, I'm paying far less to "own" than rent per in a $ per month calculation. I look at my down payment (and I did buy a REO), and calculate the savings in rent as the "return" on investment. I still come out fine. We'll have to have a 10 year depression for this to end badly - I have enough cushion. Buying now at the right price with proper consideration to low down payment is still not a bad decision. How did $80K put on the market in 2007 do for ya? How will it come out for ya this year?


January 12, 2009 09:24 PM


Anyone who says a sentence like "It went down, but it will go back up" is more hopeful than informed, and is not very savvy about cost of capital.

"The trend of property value is to go up, "

Check out Japan for the last 18 years. Also, I point you again to the concept of inflation and cost of capital

"My wife vetoed living in a less expensive way. "

It seems you don't have much say in your family. You are merely a slave.


January 13, 2009 09:52 AM

1. All assets fluctuate. There was a housing bubble, but property does have intrinsic value. When bubbles burst, the values over-correct.
2. For many reasons, America is not in the same situation as Japan with respect to real estate values.
3. "You are merely a slave". Anyone who says a thing like that I can only pray for. It displays a vast ingorance in the realm of human relationships. But if you can say a thing like that, there's probably no point continuing to converse with you, because you won't care what I say.

Thank you for your interest. This blog is no longer active.



Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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