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Is the 2007 U.S. Sub-Prime Financial Crisis So Different?:

An International Historical Comparison

Carmen M. ReinhartUniversity of Maryland and NBER

Kenneth S. RogoffHarvard University and NBER

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Is the US Subprime crisis a new kind of financial crisis?

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“Overindebtedness simply means that debts are out-of-line, are too big relative to other economic factors. It may be started by many causes, of which the most common appears to be new opportunities to invest at a big prospective profit… such as through new industries… Easy money is the great cause of over of over-borrowing.”

One plausible diagnosis

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This diagnosis . . .

Comes from Irving Fisher (1933).

There are quantitative parallels as well.

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Quantitative Parallels to Post-War Banking Crises in Industrialized

Countries

• Leading indicators:– Sharp Housing and Equity Price Run-ups– Large Capital Inflows– Marked rise in indebtedness– Inverted V-shaped growth trajectory

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The “Big Five” Post-War Industrialized Country Financial Crises

COUNTRY (Start date)/ Fiscal cost (% GDP)

Spain (1977) 16.8

Norway (1987) 4

Finland (1991) 8

Sweden (1991) 6

Japan (1992) 20

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Milder Industrialized Country Financial Crises

Australia (1989), Canada (1983), Denmark (1987), France (1994), Germany (1977), Greece (1991), Iceland (1985), Italy (1990), New Zealand (1987),

United Kingdom (1974, 1991, 1995)

United States (1984, 2007).

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Figure 1: Real Housing Prices and Banking Crises

95

100

105

110

115

120

125

130

135

t-4 t-3 t-2 t-1 T t+1 t+2 t+3

Ind

ex

Average for banking crises inadvanced economies

US, 2003=100

Index t-4=100Average for the "Big 5"

Crises

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Figure 2: Real Equity Prices and Banking Crises

80

85

90

95

100

105

110

115

120

125

130

135

t-4 t-3 t-2 t-1 T t+1 t+2 t+3

Inde

x

Average for banking crises inadvanced economies

US, 2003=100

Index t-4=100Average for the "Big 5"

Crises

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Figure 3: Current Account Balance/GDP on the Eve of Banking Crises

-7

-6

-5

-4

-3

-2

-1

0

t-4 t-3 t-2 t-1 t

per

cen

t o

f G

DP

Average for banking crises inadvanced economies

U.S.

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Figure 4: Real GDP Growth per Capita and Banking Crises (PPP basis)

-2

-1

0

1

2

3

4

5

t-4 t-3 t-2 t-1 t t+1 t+2

Per

cent

Average for banking crises inadvanced economies

US

Average for the "Big 5" Crises

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Figure 5: Public Debt and Banking Crises

90

110

130

150

170

190

210

230

250

t-4 t-3 t-2 t-1 T t+1 t+2 t+3

Ind

ex

Average for banking crises inadvanced economies

US, 1997=100Index t-10=100

Average for the "Big 5" Crises

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A different kind of recycling

• During 1970s, US banks “recycled” Petrodollars to developing countries

• During 2000s, US recycled Petrodollars and Asian Surpluses to a developing country inside the United States

• Is the result the same?

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Is the United States different?

• Looks similar or worse by most standard run-up indicators (Kaminsky and Reinhart, 1999),

• Yet inflation is better.

• What’s in store for the United States? Will it– Experience a “mild financial crisis” (with a sustained

slowdown), or– Suffer a severe “Big Five” recession

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Looking ahead

• The bailout costs are estimated at around $1 trillion (about 7 percent of GDP)

• Monetary policy stimulus is keeping real interest rates negative

• The last time we had a combination of a sliding dollar, high commodity prices, and negative real interest rates

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Looking ahead

• Was the late 1970s—when US inflation reached its post-war high

• According to the IMF’s World Economic Outlook, two-thirds of the countries it covers reported higher inflation in 2007