Study: Banking Crisis Last For Years

Book Review

by Joseph Dancy, LSGI Advisors, Inc.. December 1, 2009

rogoff Dr. Ken Rogoff and Carmen Reinhart claim that historic studies of debt driven financial crisis suggests we’ve got a long way to go before many of the global economic problems are resolved. In their new book “This Time Is Different” they note banking crises that are driven by excess debt, like the one we’re in, tend to stick around for years.

On average, Rogoff and Reinhart note that in serious financial crisis it takes six years for home prices to recover, five years for unemployment to turn around, and two years for the economy to come back. They reviewed data from 66 countries to develop a ‘history’ of what to expect during a financial crisis.

The current crisis, whether measured by the depth, breadth, effect on asset markets, and potential duration is the most serious financial crisis since the Great Depression according to the authors. The ultimate resolution will ’likely reshape politics and economics for at least a generation.’ Unemployment and underemployment issues will become a large issue politically over the next several years.

In prolonged and deep financial crisis real housing prices, from peak to trough, drop a cumulative 36 percent over an average of six years according to their study. Real gross domestic product per capita slumps an average 9.3 percent. Unemployment rises for almost five years, with the rate increasing by about 7 percentage points over ‘normal’ levels.

Government debt surges an average of 86 percent, driven mainly by plunging tax revenue. It appears that the U.S. economy is ‘on track’ with regard to these historical metrics. Recent data indicates state revenues continue to plummet – a record 16.6 percent for the third quarter.

Total state tax collections declined by 8.2 percent from the previous year, roughly twice the amount states gained in fiscal relief from the federal stimulus package. Forty-nine states saw total tax revenues fall during the quarter, with 36 states reporting double-digit declines.

These financial issues with state and local municipalities will not help the economic recovery or employment — states and municipalities employ a huge workforce and provide a number of economic stabilizers for the economy.

The bright spot in many of these financial crisis is that equity markets tend to begin to recover first and in many times recover in a ‘V’ shaped pattern. The authors note ‘V-shaped recoveries in equity prices are far more common than V-shaped recoveries in real housing prices or employment’. Companies can improve earnings by keeping employment costs low and by hiring part-time labor.

The stock market tends to lead the economy and unemployment according to their studies, so a poorly performing economy can concurrently have a recovering stock market according to historic data. The glaring exception to this was Japan’s economy, where stock prices have not recovered two decades after the economic crash.

“This Time Is Different” is a good summary of the damage financial crisis have done historically, and how investors might want to review historical comparisons to today’s economy when developing investment plans and strategies.

Contact Information

Joseph Dancy Adjunct Professor, SMU School of Law | Oil & Gas Law, SMU School of Law
Advisor, LSGI Market Letter | E-mail