Chris Lau - Seeking Alpha

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Monday, January 05, 2009

Summary Notes from

  • Since their peak in July 2006, existing home prices have now fallen 23.42% with no end in sight. This followed last week’s revelation that both new and existing home sales were still falling rapidly
  • “Broadly speaking, financial crises are [more] protracted affairs [than recessions]. More often than not, the aftermath of severe financial crises share three characteristics:

First, asset market collapses are deep and prolonged. Real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years.

Second, the aftermath of banking crises is associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, although the duration of the downturn, averaging roughly two years, is considerably shorter than for unemployment.

Third, the real value of government debt tends to explode, rising an average of 86 percent in the major post–World War II episodes. Interestingly, the main cause of debt explosions is not the widely cited costs of bailing out and recapitalizing the banking system. Admittedly, bailout costs are difficult to measure, and there is considerable divergence among estimates from competing studies. But even upper-bound estimates pale next to actual measured rises in public debt. In fact, the big drivers of debt increases are the inevitable collapse in tax revenues that governments suffer in the wake of deep and prolonged output contractions, as well as often ambitious countercyclical fiscal policies aimed at mitigating the downturn.”

In summing up, the authors concluded that “recessions surrounding financial crises have to be considered unusually long compared to normal recessions that typically last less than a year. Indeed, multiyear recessions typically only occur in economies that require deep restructuring.”

Without a doubt, the aspect given shortest shift today is the severe impact past crises have had on public debt. If, after this crisis has come to its final end, we suffer the average increase in government debt, it will mean that the current $10 trillion will be nearly $19 trillion. But such a situation would also see total credit market debt, currently at 350% of GDP nearly double as well to new uncharted territory, debt that could well take decades after the recovery has arrived to finally bring back under control.

That is certainly not the kind of legacy baby-boomers intended to leave their children and children’s children.

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