Storm Ahead

Financial crisis fact sheet

Stimulus package or not, the history of past financial crises suggests America can expect grim economic times for a while. In a January working paper from the National Bureau of Economic Research, economists Carmen M. Reinhart of the University of Maryland and Thomas S. Rogoff of Harvard studied eight postwar and two prewar episodes of protracted national financial crises of the sort we now suffer.

While past performance is no guarantee of future bad results, the effects of the current type of economic crisis, as opposed to a typical recession, tend to be grim and long-lasting. From highest point to lowest point, on average over all the calamities studied, real housing prices shrunk 35 percent over six years; equity prices fell 55 percent over three and a half years; unemployment during the downward phase of the cycle rose 7 percentage points over four years; and national output plummeted 9 percent overall in the two-year cycle.

Such financial crises leave big bills to pay. Government debt, studied in only the postwar downturns, rose an average of 86 percent. Lending some credence to the notion that an inflationary housing bubble is the key problem today, Reinhart and Rogoff note that the "housing price decline experienced by the United States to date during the current episode…is already more than twice that registered in the U.S. during the Great Depression." So far output and employment declines have not nearly reached that period's grim results.

There is a widespread feeling among economists that contemporary improvements in international economic management mean that this downturn might be less severe than past ones. But the authors argue that "one would be wise not to push too far the conceit that we are smarter than our predecessors. A few years back many people would have said that improvements in financial engineering had done much to tame the business cycle and limit the risk of financial contagion."