Reminders From The 1970s and 1980s: Financial Crises Happen; The Latest Wasn't Unique Or Even Rare; It Was Just A Big One

To hear some talk, one would think our Financial Crisis of 2007-08 was a bizarre event that must have been caused by exceptional circumstances. In size, it may have been somewhat unusual. It came with quite a large market bubble from private institutions going hog-wild for leveraged investments. But we don't even have to go back nearly as far as the Great Depression to find similar -- if smaller -- troubles. The market does this sort of thing quite a bit. Really, we rarely go long without such crises.

Hyman Minsky describes several in "Stabilizing an Unstable Economy", such as:

"The sharp drop in output and the explosive rise in unemployment in the third quarter of 1974 and the first quarter of 1975 were accompanied by the failure of Franklin National Bank, the troubles of the REITs, and a spate of business bankruptcies. It looked as if the economy was on the verge of a great depression; as if the sky were about to fall. But the disaster failed to occur. The combination of a massive government deficit (augmented by a tax rebate) and the lender-of-last-resort interventions contained the recession and reversed the course of the economy. 

... 

Aside from the details of who failed and the nature of the organizations involved, the 1981-82 recession conforms quite remarkably to that of 1974-75. Once again there was a sharp decline in income and output and a dramatic rise in unemployment; once again there was a massive increase in deficits (the extreme Keynesian side of Reaganomics), once again there were both quiet trauma and spectacular declines, and once again there was a spate of lender-of-last-resort interventions by the Federal Reserve. Once again, as the unemployment and bankruptcies situations were getting worse, some six months after a major lender-of-last-resort intervention there was a sharp turnaround in income and employment. Once again the sky did not fall."

The tools of deficit spending and lender-of-last-resort intervention aren't new, radical approaches. They're tried and true; they're traditional methods of kicking the economy back into gear. They've repeatedly shown success.

Unfortunately, our efforts this time were trimmed down by deficit-hawk opposition and not sufficiently scaled to achieve a serious kick start rather than just propping up the sky a bit. And now, with budget cuts, we're on track to the usual means by which recoveries have been sabotaged by fiscal conservatism.

When It Went Wrong

When did things start down? Where was the bump in the road that triggered the Great Recession? In this election season, that question matters in the short term for trying to choose the folks most likely to not send us back down the same path. Partisans from both major parties would love to tell us things when wrong under the other party's watch, but only one side can say it accurately. So when did it start?

To begin answering that question, we can't just look at GDP or unemployment alone. While those may tell us when things really got bad, they don't tell us when the problem started. To get a better idea of when the problem started requires focusing further back than when it became obvious to everyone. The overall economy was hammered by a financial crisis, but that financial crisis didn't just spring up on its own. The financial crisis was triggered by a stumbling housing market. So when did housing tumble off the cliff?

Housing fell off a cliff in 2006; in 2007/8, it was just still falling from 2006.

Building permits peaked on September 2005 and then proceeded to fluctuate through January 2006. Housing starts peaked in January 2006. Then after January 6th, both building permits and housing starts tumbled off that cliff, followed soon after by residential construction. Between the January 2006 peak and the start of the 110th Congress in January 2007, housing starts dropped by 38% and residential construction dropped by 15%. The housing industry was collapsing throughout 2006 and bringing layoffs starting with housing and spreading into related domestic industries such as window and cabinet making. Following on housing's decline, manufacturers new orders hit choppy waters in 2006, . By the end of 2006, the effects weren't yet enough to seriously shake unemployment or turn GDP negative, but the decline did start to show in other measures and a slackening of quarterly GDP growth. The annual growth in consumption per capita for 2006 started back down from what we'd seen in 2005.

Demand/person slowed down in 2006 ... before getting to an actual drop.

Put it all together it's really only a technicality that the recession didn't hit until late 2007. In fact, the economy was already in rough shape in 2006, with really lousy growth evident over the 2nd and 4th quarters of 2006, to the point of quarterly GDP growth just barely staying out of negatives.

2006 wasn't technically recession; but it was darn close.

Clearly, the first wave of what became the Great Recession was well under way during the watch of the 109th Congress (2005-2006) under President Bush II, even though we hadn't reached technical recession yet. What happened during the 110th Congress was just that it became clear that the problem -- which was already under way -- was spreading from housing into finance and from there to everything else. The curtain covering over the problems was pulled away in 2007-2008, but the trouble was there before the curtain pulled away. Republicans held majorities in both Houses of the 109th Congress, as they had for almost all of the time since 1995 (except for a slim Senate flip in part of the 107th Congress). By 2006, Republican policies had held sway in both the executive and legislative for years and they were still in control. While there's room for debate as to how much involvement government had in the creating or allowing the mess, the weight of evidence says that if one were going to blame governance, the party to blame for that mess is Republican.

Deregulation, Bubbles, And The Myth That Our Two Major Parties Are The Same

Many people point the blame for our recent financial crisis towards deregulation. While there's something to that, deregulation did not cause the housing bubble to exist. All deregulation did was let it get more out of hand and have bigger consequences. While that's plenty of reason to push for strong financial regulations, we shouldn't let ourselves believe that regulations could have prevented there from being any more bubbles. Bubbles can happen without any govt interference. And they can happen despite the wisest govt efforts to prevent them. Psychology, markets, information failures, and irrational exuberance build bubbles. And those are also the factors that usually burst them.

Bubbles can form simply from too few people remembering the last time something happened ... such as a major drop in real estate prices. Then people may -- as they did -- start to think it can only go up and they need to get in now and if they get in now they can easily sell higher later. As long as people start to believe that about anything -- and I knew many people who believed that about housing -- then we will get a bubble.

That said, deregulation did arguably make the housing bubble bigger and played a part in how it popped, the impact, and the aftermath. It would have happened anyway, but it wouldn't necessarily have happened the same. It probably wouldn't have been as bad if we'd had better regulation of sub-prime mortgages, securitization, and derivatives as well as better established procedures for the orderly liquidation of large failed banks in a way that protects their customers but not the banks themselves.

Many have rightly pointed out that the Republicans championed deregulation. In response, some try to claim, "but the Democrats did some too," as if all were equal and as if it were a bipartisan failure.

Did the Democrats occasionally go along with some of those policies? Sure, at least many of their blue dogs did. But the Democrats didn't make those policies central to their platform. They didn't push that recent Republican recipe as the right answer for every situation. By contrast, the Republicans did fully, enthusiastically, thoroughly embrace and push all those bad ideas (see below). Some of the Democrats occasionally went along with the insanity and maybe some even bought parts of it -- which was bad -- but it shouldn't earn their party as much blame as the folks who were seriously pushing all those bad ideas as a central and widespread basis of their party policy.

And worst of all, the Republicans are still pushing deregulation as if it hadn't seriously messed us up in recent memory. The party used to be able to claim a proud history with folks like Ike and Lincoln. Now? They would benefit greatly from an effort to transform themselves away from all they've become. It could be back towards the Grand Old Party they used to be. Or it could be something entirely new. Just please, Republicans, get your party to stop pushing every insane position that's been demonstrated to be wrong and bad for us by recent history.

For more of the "bad ideas" referenced above, see "Republicans undiscover fire" by Mark Sumner.


Full disclosure: I'm an independent, a member of no political party. (And I'm well aware both major parties have their own flaws. ...but that doesn't make their flaws equal.)

Financial Crisis: Just One of Many

Just another one of many: some folks have likened this latest financial crisis to the Great Depression, or at least billed it as the worst financial crisis since then. It may have been as much or more like the Panic of 1873.

Of course, parts of the Panic of 1857 sound really familiar too: "...by July 1856, banks began to lend far more money than they could back up..."