Benchmarking the Financial Crisis

Here's a great source of information about past financial crises. Carmen Reinhart and Kenneth Rogoff, economics professors at Maryland and Harvard, respectively, have surveyed major post-war financial crises from around the world. Key findings are:

• Past financial crises have led to severe, prolonged recessions. The average fall in real per capita GDP was 9 percentage points, and the average period of falling output was 2 years. ('Ordinary' recessions generally last less than a year.) The NBER puts the beginning of the current recession at December, 2007. That suggests that the economy will continue contracting through the end of 2009.
  
• The average increase in unemployment was 7 percentage points, and the average period of rising unemployment was 5 years. (That's bad news for anyone who's looking for work.


• The average real (i.e., inflation-adjusted) stock price decline was 55%, and the average period of declining prices was 3.4 years.


• The average real home price decline was 35%, and the average period of declining prices was 6 years.

Reinhart and Rogoff point out that the 9 percentage point average contraction in GDP may be distorted by the inclusion of emerging market economies, which are subject to "abrupt reversals in the availability of foreign credit." Nonetheless, they maintain that the current crisis shares many of the same characteristics of the other crises in their study.

In other words, we shouldn't expect the current downturn to play out dramatically better than the numbers above would suggest.

The good news (if there is any) is that real home prices have already fallen almost 35% from the peak, which occurred in the summer of 2006. If the current crisis follows the historical script, prices might actually stabilize at their current levels and remain there until 2010 or 2011. Throw in declining mortgage rates and (with any luck) a relaxation of the current tough lending standards, and buyers may finally get a break. (Remember, however, that we're talking about the national housing market, not just San Francisco. Prices here have fallen only about 25%, in real terms. And of course, the survey statistics quoted above are historical averages, not laws of nature.)

By the way, the Reinhart-Rogoff paper is easily readable by anyone who isn't intimidated by ordinary bar charts. If you prefer something even lighter, however, you can try their recent Wall Street Journal article. Unfortunately, the Journal often restricts access to subscribers, so I can't promise how long the article will be accessible.