Archive for January 10th, 2008

Is subprime crisis any different?

January 10, 2008

Whenever there is a discussion regarding growth story of an economy, there is this oft repeated phrase: “This time it is different” and how it is going to continue for an extended period of time. And then we have a crisis and all the story is found to be false.  

This phrase has been used so often in the past and found to be untrue that it has become a signal for trouble. So whenever anyone says this time it is different one should instead become careful.

On similar lines, we have an excellent paper (titled ‘Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison’) by Rogoff and Reinhart. They discuss whether this subprime crisis is any different? And they go on to show using various economic data that there is a lot of similarity between subprime and previous crisis :-)

Thanks to Martin Wolf for pointing the paper. I am sure this paper is going to be discussed widely in most blogs. Read Roubini’s comments on the same.

Read this for a sample:

This time, many analysts argued, the huge run-up in U.S. housing prices was not at all a bubble, but rather justified by financial innovation (including to sub-prime mortgages), as well as by the steady inflow of capital from Asia and petroleum exporters. The huge run-up in equity prices was similarly argued to be sustainable thanks to a surge in U.S. productivity growth a fall in risk that accompanied the “Great Moderation” in macroeconomic volatility. As for the extraordinary string of outsized U.S. current account deficits, which at their peak accounted for more than twothirds of all the world’s current account surpluses, many analysts argued that these, too, could be justified by new elements of the global economy……

We all know the reality….

They compare previous banking crises with the recent one on 5 parameters:

  1. housing prices
  2. equity prices
  3. current account balance
  4. Read GDP growth
  5. public debt as a % of GDP

And on all five, there is quite a bit of similarity atleast at time ‘t’ (the time of recession) and time ‘t-4′. They also look at t+3 but we don’t know the same for the recent crisis. The magnitude differs for instance in equity prices and current account deficit but we see presence of a broad trend.

And how abut the summary?

The correlations in these graphs are not necessarily causal, but in combination nevertheless suggest that if the United States does not experience a significant and protracted growth slowdown, it should either be considered very lucky or even more “special” that most optimistic theories suggest. Indeed, given the severity of most crisis indicators in the run-up to its 2007 financial crisis, the United States should consider itself quite fortunate if its downturn ends up being a relatively short and mild one.


So, the authors fear worse is yet to come. Let’s see how events unfold. However, the best part of the research is their comparison to the recent subprime crisis with the other crisis that originated in developing economies previously:

During the 1970s, the U.S. banking system stood as an intermediary between oil-exporter surpluses and emerging market borrowers in Latin America and elsewhere. While much praised at the time, 1970s petro-dollar recycling ultimately led to the 1980s debt crisis, which in turn placed enormous strain on money center banks. It is true that this time, a large volume of petro-dollars are again flowing into the United States, but many emerging markets have been running current account surpluses, lending rather than borrowing. Instead, a large chunk of money has effectively been recycled to a developing economy that exists within the United States’ own borders. Over a trillion dollars was channeled into the sub-prime mortgage market, which is comprised of the poorest and least credit worth borrowers within the United States. The final claimant is different, but in many ways, the mechanism is the same.


What a thought !!

How about taking this argument further and asking what were the solutions then and can the same be applied now?

Another idea is about applying the same on Indian economy. Is this growth story any different? Many say that India is a consumption driven economy (about 55% of GDP now) and hence the growth story is domestic. So there is not going to much impact of the US recession. Really? Well, India has always been a consumption driven economy and the consumption figures have actually been falling. They are still high but the argument doesn’t stand. How about other ideas on Indian growth story?


1. BTW, there is another paper from Michael Bordo which says “The same old story, only the players have changed”.

2. There is a detailed paper by Rogoff and Reinhart on six centuries of crisis. Shorter version is here

Assorted Links

January 10, 2008

1. Ajay Shah says capital controls are not working

2. TTR points the need to overhaul excessive incentive system in the finance industry.

3. WSJ Blog points to new Bill Poole (of St Louis Fed) speech. It also points to Goldman Sachs view on recession.

4. Mankiw points to the big lie of 2008.

5. PSD Blog onTata’s People Car.

6. Atlanta Fed releases a DVD for disaster management

7. MR points to new blog ranking. This blog ranks 148 amidst all economics blogs.


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