Crisis Identity Crisis

posted on June 25th, 2008 filed under: Real Estate News

Chatter about the economy is often sprinkled with references to the past.  The financial collapse that began in 2007 has been compared to the Asian crisis in 1997 and the Long Term Capital Management failure in 1998.  The housing bust is often compared to the downturn in the early 1990s.  But historical comparisons carry the risk of oversimplifying.  Which past crisis does the present one most closely resemble?

First, consider the major conditions of the current crisis:

  1. Financial crisis
  2. Extreme indebtedness (total, private and public)
  3. Housing bust
  4. Possible secular decline in equity valuations
  5. Commodity shock
  6. Rising inflation

How do these conditions compare with past crises?

2000-2002

  1. No financial crisis
  2. High but rising indebtedness
  3. Housing boom, not bust
  4. Declining equity valuations
  5. Cheap commodities (but starting to rise)
  6. Low inflation

1997-1998

  1. Financial crisis
  2. High but rising indebtedness
  3. Housing boom, not bust
  4. Secular expansion in equity valuations
  5. Cheap commodities
  6. Secular decline in inflation

1990-1991

  1. Financial (S&L) crisis
  2. Stalled, but not declining, indebtedness
  3. Housing bust
  4. Secular expansion in equity valuations
  5. Secular decline in commodities
  6. Secular decline in inflation

1980-1982

  1. No financial crisis
  2. Low indebtedness
  3. Housing bust
  4. Low equity valuations
  5. Commodities shock
  6. Inflation shock

1973-1974

  1. No financial crisis
  2. Low indebtedness
  3. Housing stable and rising
  4. Secular decline in equity valuations
  5. Commodities shock
  6. Inflation shock

1929-1933

  1. Financial crisis
  2. Extreme indebtedness
  3. Housing bust
  4. Secular decline in equity valuations
  5. Commodities sharply falling
  6. Inflation sharply falling

The present crisis appears especially acute in that none of the prior crises had all the pressures of this one.  And that may have consequences for our ability to make progress.  With financial institutions in trouble and extreme private and public indebtedness, we cannot expect to borrow our way out of the current slump.  With no sign of renewed debt appetites, housing remains moribund.  Equity valuations are neither extremely high nor extremely low, but have been falling since the last bear market, and in the past a new secular bull market has never begun when valuations were still this high.  Commodities and inflation are still rising despite a slowing economy, limiting the options of policymakers who might otherwise cut interest rates more.

Prior crises have never exhibited both a rise in commodities and inflation on one hand, and financial and debt destruction on the other hand.  The Federal Reserve may see a prolonged detente between those powerful forces as the least of evils.  The result might look something like what John Mauldin has called a "muddle through" economy.  Presumably, the Fed had the same intentions in prior crises.  Time will tell whether this Fed succeeds where others failed.

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posted by // This entry was posted on Wednesday, June 25th, 2008 at 4:18 pm and is filed under Real Estate News. You can follow any responses to this entry through the RSS 2.0 feed.

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