Authors: U.S. economic crisis was long time in the making

McClatchy NewspapersSeptember 29, 2009 

'This Time Is Different: Eight Centuries of Financial Folly' by Reinhart and Rogoff, Princeton University Press, NJ.

KEVIN HALL

WASHINGTON — Americans have always assumed that financial crises happen in basket-case countries, not here. So how then did the U.S. follow the lead of Argentina, Mexico and Thailand by plunging into this one?

Economists Carmen Reinhart and Kenneth Rogoff answer that question in a provocative new book, "This Time Is Different."

The authors, both former top economists at the International Monetary Fund who're now teaching, respectively, at the University of Maryland and Harvard University, offer examples of mistakes made repeatedly over "eight centuries of financial folly."

In the preface, they offer a crystal-clear analysis of why we are where we are.

"If there is one common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom," they wrote.

"Infusions of cash can make a government look like it is providing greater growth to its economy than it really is. Private-sector borrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels, and make banks seem more stable and profitable than they really are."

Sound familiar?

Reinhart and Rogoff discussed their new book Tuesday with McClatchy. Here are some of their thoughts, edited into a question-and-answer format.

Q: What's the biggest lesson from today's U.S. financial crisis?

A: Reinhart: "All rules apply about indebtedness of the private sector, of the household sector, of price-earnings ratios, of real estate prices to income ratios. In summary, all rules apply."

Q: That suggests there were signals of trouble?

A: Rogoff: "When you see a lot of macroeconomic indicators out of line, you have a problem. The story is often told that if you hadn't let Lehman (Brothers) go, everything would have been fine . . . The fact is, there were a lot of markers showing that you were going to have a deep crisis. We were already writing a couple of years ago, based on the work on this book, that the U.S. would be very lucky not to have a deep financial crisis."

Q: Should regulatory reform efforts seek to prevent future crises?

A: Rogoff: "You don't want to prevent every financial crisis . . . You don't want to have no creativity, no dynamism in the financial sector. There's a balance. But there's no question things got way out of kilter. And there are hard quantitative measures where you can look at this. I think the official community — the regulators — and even politicians need to look at them and not ignore them as they did."

Q: Are financial crises inevitable?

A: Reinhart: "I think one can see a financial crisis as a cycle in an extreme. You can't really avoid the cycles. You can mitigate the severity of the crisis."

Q: Where does government come in?

A: Reinhart: "Banking crises are protracted for a variety of reasons, the breakdown of credit, all kinds of things. But policy can shorten the duration by more (closely) addressing the underlying problem, i.e., the bank balance sheets. That's a lesson we're not learning."

Q: Isn't the recession over, and aren't banks profitable again?

A: Rogoff: "The feeling of calm is because the government has guaranteed everything, and is backing everything. And how do we get out of it? And precisely because the balance sheets really aren't fixed, it (government) can't (exit). So it means we have to hang on for a long time. Hopefully it will all go really well but . . . the taxpayer is vulnerable for a long time."

Q: How bad is this crisis?

A: Reinhart: "Let us not lose sight of the fact that we are past the two-year mark already since the onset of this crisis. So that's beyond the resolution time in most of the other postwar crises. Japan and Spain are the two exceptions, because the 1977 Spanish crisis also took forever to mop up."

Q: Any parallel with Japan's elusive recovery in the '90's?

A: Reinhart: "We're speaking Japanese without knowing it. When you look at the combination of forbearance and zero (percent) interest rates, doesn't that sound Japanese? And let's pretend that all these bad loans, all these zombie loans don't exist. That sounds real Japanese to me."

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