Tuesday, October 13, 2009
Just finished reading Carmen Reinhart and Kenneth Rogoff's This Time is Different. This book isn't intended to provide the details to answer the question what happened to us last year. Rather, the book is intended to take three steps back and provide the reader with a broader view of crises and point out themes that tie together the the financial crisis of 2008 with previous crises. Looking at the data from 1860 to 2006 they pull together it's pretty clear that that this time is, in fact, not different.
Although we hadn't experience a panic like this in many, many years, it turns out that financial and banking crises are all too common. It's a theme that Martin Wolf also argued in his Fixing Global Finance, though Reinhart and Rogoff are able to draw on much more data (global) and over a longer span of time to make their point.
I put the book down and came away with a couple of important lessons. First, financial liberalization and financial crises seem to go hand in hand. That's not to say that financial repression is a good thing, just that all those who argue this will be better if we "just let financial markets do their thing" are, well, dooming themselves to a never-ending cycle of booms and calamitous busts.
Second, when market participants are able to leverage up to the hilt, they do. Moral hazard usually takes them and the rest of the economy over the cliff. Third, stock market bubbles are better than real estate bubbles - mostly because the recovery periods from the collapse are much faster. Fourth, following a real estate bubble, it's not the bailout costs that will get you, it's the long term collapse of tax revenue associated with lower growth over time. Finally, surprise, surprise, (all) governments can and do default on their sovereign debt eventually.
There's a lot in this book to digest and it's well worth reading.
p.s. for the graduate students out there not interested in actually buying the book, a 124 page paper by the authors that covers the same material from April 2008 is online. But, buy the book.