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http://www.aeaweb.org/articles.php?doi=10.1257/aer.98.2.339
The first major financial crisis of the twenty- Norway, Spain, and Sweden), the drop in annual
first century involves esoteric instruments, output growth from peak to trough is over 5 per-
unaware regulators, and skittish investors. It cent, and growth remained well below pre-crisis
also follows a well-trodden path laid down by trend even after three years. These more cata-
centuries of financial folly. Is the special prob- strophic cases, of course, mark the boundary
lem of sub-prime mortgages really different? that policymakers particularly want to avoid.
Our examination of the longer historical
record, which is part of a larger effort on cur- I. Postwar Bank-Centered Financial Crises:
rency and debt crises, finds stunning qualitative The Data
and quantitative parallels across a number of
standard financial crisis indicators. To name a Our comparisons employ a small piece of a
few, the run-up in US equity and housing prices much larger and longer historical dataset we
that Graciela L. Kaminsky and Reinhart (1999) have constructed (see Reinhart and Rogoff
find to be the best leading indicators of crisis 2008.) The extended dataset catalogues bank-
in countries experiencing large capital inflows ing and financial crises around the entire world
closely tracks the average of the previous 18 dating back to 1800 (in some cases earlier). In
postWorld War II banking crises in industrial order to focus here on data most relevant to the
countries. So, too, does the inverted v-shape present US situation, we do not consider the
of real growth in the years prior to the crisis. plethora of emerging market crises, nor indus-
Despite widespread concern about the effects on trialized country financial crises from the Great
national debt of the tax cuts of the early 2000s, Depression or the 1800s. Nevertheless, even in
the run-up in US public debt is actually some- the smaller sample considered in this paper,
what below the average of other crisis episodes. the this time is different syndrome has been
In contrast, the pattern of US current account repeated many times.
deficits is markedly worse. First come rationalizations. This time, many
At this juncture, the book is still open on how analysts argued, the huge run-up in US housing
the current dislocations in the United States will prices was not at all a bubble, but rather justified
play out. The precedent found in the aftermath by financial innovation (including sub-prime
of other episodes suggests that the strains can be mortgages), as well as by the steady inflow of
quite severe, depending especially on the initial capital from Asia and petroleum exporters.
degree of trauma to the financial system (and to The huge run-up in equity prices was similarly
some extent, the policy response). The average argued to be sustainable thanks to a surge in
drop in (real per capita) output growth is over US productivity growth and a fall in risk that
2 percent, and it typically takes two years to accompanied the Great Moderation in mac-
return to trend. For the five most catastrophic roeconomic volatility. As for the extraordinary
cases (which include episodes in Finland, Japan, string of outsized US current account deficits,
which at their peak accounted for more than
* Reinhart: School of Public Policy and Department of two-thirds of all the worlds current account
Economics, University of Maryland, 4105 Van Munching surpluses, many analysts argued that these, too,
Hall, College Park, MD 20742 (e-mail: creinhar@umd. could be justified by new elements of the global
edu); Rogoff: Economics Department, Harvard Univer- economy. Thanks to a combination of a flexible
sity, Littauer Center, Cambridge, MA 02138-3001 (e-mail:
krogoff@harvard.edu). We would like to thank Adam economy and the innovation of the technology
Posen, Vincent Reinhart, and Alan Taylor for their helpful boom, the United States could be expected to
comments. enjoy superior productivity growth for decades,
339
340 AEA PAPERS AND PROCEEDINGS MAY 2008
while superior American know-how meant Some of the other 13 crises are relatively minor
higher returns on physical and financial invest- affairs, such as the 1995 Barings (investment)
ment than foreigners could expect in the United bank crisis in the United Kingdom or the 1994
States. Credit Lyonnaise bailout in France. Excluding
Next comes reality. Starting in the summer of these smaller crises would certainly not weaken
2007, the United States experienced a striking our results, as the imbalances in the run-sup
contraction in wealth, increase in risk spreads, were minor compared to the larger blowouts.
and deterioration in credit market functioning.
The 2007 United States sub-prime crisis, of II. Comparisons
course, has it roots in falling US housing prices,
which have in turn led to higher default levels, We now proceed to a variety of simple com-
particularly among less creditworthy borrow- parisons between the 2007 US crisis and previ-
ers. The impact of these defaults on the finan- ous episodes. Drawing on the standard literature
cial sector has been greatly magnified due to on financial crises, we look at asset prices, real
the complex bundling of obligations that was economic growth, and public debt. We begin in
thought to spread risk efficiently. Unfortunately, Figure 1 by comparing the run-up in housing
that innovation also made the resulting instru- prices. Period T represents the year of the onset
ments extremely nontransparent and illiquid in of the financial crisis. By that convention, period
the face of falling house prices. T24 is four years prior to the crisis, and the
As a benchmark for the 2007 US sub-prime graph in each case continues to T13, except of
crisis, we draw on data from the 18 bank-cen- course in the case of the US 2007 crisis, which
tered financial crises from the postwar period, remains in the hands of the fates. The chart
as identified by Kaminsky and Reinhart (1999) confirms the case study literature, showing the
and Gerard Caprio et. al. (2005). These crisis significant run-up in housing prices prior to a
episodes include: financial crisis. Notably, the run-up in housing
prices in the United States exceeds that of the
The Big Five Crises: Spain (1977), Big Five.
Norway (1987), Finland (1991), Sweden Figure 2 looks at real rates of growth in equity
(1991), and Japan (1992), where the start- market price indices. (For the United States,
ing year is in parentheses. the index is the S&P 500; Reinhart and Rogoff
(2008) provide the complete listing for foreign
Other Banking and Financial Crises: markets.)
Australia (1989), Canada (1983), Denmark
(1987), France (1994), Germany (1977), Once again, the United States looks like the
Greece (1991), Iceland (1985), Italy (1990), archetypical crisis country, only more so. The
New Zealand (1987), United Kingdom Big Five crisis countries tended to experience
(1974, 1991, 1995), and United States equity price falls earlier on than the United
(1984). States has, perhaps because the US Federal
Reserve pumped in an extraordinary amount
The Big Five crises are all protracted, large- of stimulus in the early part of the most recent
scale financial crises that are associated with episode.
major declines in economic performance for an Figure 3 looks at the current account as a
extended period. Japan (1992), of course, is the share of GDP. Again, the United States is on
start of the lost decade, although all the others a typical trajectory, with capital inflows accel-
left deep marks as well.
The remaining rich country financial crises
represent a broad range of lesser events. The c risis was 6 percent of GDP and Norways 1987 crisis was
1984 US crisis, for example, is the savings and 8 percent. Spains post-1977 cleanup cost over 16 percent of
loan crisis. In terms of fiscal costs (3.2 percent GDP. Estimates for Japans bill vary widely, with many in
of GDP), it is just a notch below the Big Five. excess of 20 percent of GDP.
For the United States, house prices are measured by
the Case-Shiller index, described and provided in Robert
Shiller (2005). The remaining house price data were made
The fiscal costs of cleaning up after banking crises available by the Bank for International Settlements and are
can be enormous. The fiscal cleanup from Swedens 1991 described in Gregory D. Sutton (2002).
VOL. 98 NO. 2 Is the US Sub-Prime Crisis Different? 341
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US deficits are more severe, reaching over six case is quite as different as this literature sug-
percent of GDP. As already mentioned, there is gests remains to be seen.
a large and growing literature that attempts to Real per capita GDP growth in the run-up to
rationalize why the United States might be able debt crises is illustrated in Figure 4. The United
to run a large sustained current account deficit States 2007 crisis follows the same inverted V
342 AEA PAPERS AND PROCEEDINGS MAY 2008
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are worthy of note. Of course, inflation is lower intermediary between oil-exporter surpluses
and better anchored today worldwide, and this and emerging-market borrowers in Latin
may prove an important mitigating factor. The America and elsewhere. While much praised at
United States does not suffer the handicap of a the time, 1970s petro-dollar recycling ultimately
fixed exchange rate system. On the other hand, led to the 1980s debt crisis, which in turn placed
the apparent decline in US productivity growth enormous strain on money center banks. It is
and in housing prices does not provide a par-
ticularly favorable backdrop for withstanding a
credit contraction.
See Rudi Dornbuschs concise assessment of the recy-
Another parallel deserves mention. During cling of petrodollars in the third and fourth chapters of
the 1970s, the US banking system stood as an Dornbusch (1986).
344 AEA PAPERS AND PROCEEDINGS MAY 2008