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Past financial crises

According to this pair of economics professors from Maryland and Harvard, the U.S. crisis is following a very similar path to past serious financial crises in developed countries. Naturally, this doesn't mean our experience will be exactly like these others. But the information in "What Other Financial Crises Tell Us" does provide a frame of reference for what might be in store.

Here are a few excerpts, though it's worth reading the whole thing.

Let's start with the good news. Financial crises, even very deep ones, do not last forever. Really. In fact, negative growth episodes typically subside in just under two years. If one accepts the NBER's judgment that the recession began in December 2007, then the U.S. economy should stop contracting toward the end of 2009. ...

In the typical severe financial crisis, the real (inflation-adjusted) price of housing tends to decline 36%, with the duration of peak to trough lasting five to six years. Given that U.S. housing prices peaked at the end of 2005, this means that the bottom won't come before the end of 2010, with real housing prices falling perhaps another 8%-10% from current levels. ...

Equity prices tend to bottom out somewhat more quickly, taking only three and a half years from peak to trough -- dropping an average of 55% in real terms, a mark the S&P has already touched. However, given that most stock indices peaked only around mid-2007, equity prices could still take a couple more years for a sustained rebound, at least by historical benchmarks. ...

Needless to say, a near doubling of the U.S. national debt suggests that the endgame to this crisis is going to eventually bring much higher interest rates and a collapse in today's bond-market bubble. The legacy of high government debt is yet another reason why the current crisis could mean stunted U.S. growth for at least five to seven more years.

The bottom line of their analysis seems to be this: this could last a while. The good news, if there is any, is that perhaps stock prices won't decline a whole lot more than we've seen, and the economic conditions may not get tremendously worse. The bad news is that conditions could stay roughly the way they are for at least a few more years.

As usual, your outlook on this projection depends quite a bit on your personal situation. To someone in their 30s or 40s with a pretty stable job, this isn't awful news. The prospect of funneling a couple years' worth of contributions into a stock market at these levels might actually hold some appeal. But obviously for many, this is anything but a cheery forecast.

Again, it's worth reiterating, just because this is the "average path" doesn't mean it will necessarily be the course of this particular crisis.

Regardless of your outlook on this scenario, prudence dictates a continued emphasis on reducing debt and increasing emergency savings. People who have those two elements firmly under control are going to be much better positioned to withstand the rest of this economic down turn than those who don't.

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