The Duck of Minerva

What, me Worry? The Financial Crisis

14 March 2010

Are we doing better or worse than in the Great Depression? Are we coming out of it, or still sinking… or, is there worse to come? Should I be frightened?? Recent reports of millions more foreclosures made me wonder what direction we are going in. A couple of things I’ve been reading recently:

Over at Vox, Eichengreen and O’Rourke answer the question on a lot of minds: is this crisis as bad as the Crash and Great Depression of the 1930s? They provide nice graphs of output, trade, and stock markets for both periods. Two things stand out to me: the collapse in trade and stock markets in the last two years was even scarier than in the past–sharper, faster, deeper (output tracks the 1930s slide pretty closely); but, all three trend lines have turned up again pretty quickly. Not recovering anywhere near to previous levels, mind you, but heading in the right direction. Eichenbreen and O’Rourke believe policy action– the stimulus–is what is saving us this time around. When the stimulus runs out, what happens?

My colleague Carmen Reinhart and co-author Kenneth Rogoff look at the aftermath of asset bubbles and really don’t give me much hope. (also see their recent book on eight centuries of financial crises) Looking at a broad range of countries in the post WWII years, they show that after a financial crisis housing assets take about six years to recover, sinking by 35%, and equity collapses over 50% in about 3.5 years. Unemployment rises and output declines, not surprisingly. And government debt explodes– not due to bailouts but due to a decline in government revenues. But bailouts will become politically more and more difficult as government debt expands.

Jayati Ghosh reminds us of Galbraith‘s work on financial euphorias, and our own role in them. After a crisis, according to Ghosh/ Galbraith, we point the finger of blame away from ourselves–yet, remember how we admired and fawned over the financial “titans” we now deplore? (on a side note, I’m not sure about the timing of Wall Street 2) Our own euphoria encourages financial speculation, and markets respond with asset bubbles. We think the problems are only caused by greedy and unscrupulous people, not the market itself. Ghosh argues that the solution is to re-think capitalism itself. But, as someone recently pointed out (can’t remember who), during the Great Depression, there were a number of readily available alternative models– fascism, communism– what is the alternative today? Populism a la Chavez? I don’t think so…

So, should I be scared? I think I’ll have to just hold my breath and wait and see.