What’s So Special About the Subprime Mess?

The answer, according to the economists Carmen Reinhart and Kenneth Rogoff, is … “not much.” Here’s what they describe in a new NBER working paper about the causes and consequences of the current subprime crisis:

Our examination of the longer historical record finds stunning qualitative and quantitative parallels to 18 earlier post-war banking crises in industrialized countries. Specifically, the run-up in U.S. equity and housing prices (which, for countries experiencing large capital inflows, stands out as the best leading indicator in the financial crisis literature) closely tracks the average of the earlier crises.

As to the differences between this crisis and others, they offer some good news and some bad:

Among other indicators, the run-up in U.S. public debt is actually somewhat below the average of other episodes, and its pre-crisis inflation level is also lower. On the other hand, the United States[‘s] current account deficit trajectory is worse than average.

On the question of whether the current crisis will deepen and cause widespread financial harm, or level out and lead to recovery, Reinhart and Rogoff are — unlike every financial pundit you see on TV these days — mercifully not tossing out bold predictions:

Much will depend on how large the shock to the financial system proves to be and, to a lesser extent, on the efficacy of the subsequent policy response.

I am continually surprised at how widespread the perception is that our economy is in a complete nosedive, despite much evidence to the contrary. I recently saw a poll in which 12 percent of Americans said that we are currently in a depression, not just a recession.

If I were an insurance salesman — any type of insurance at all — I would like to find those 12 percent. I think they would be terrific customers.

Jim Bob

Speaking of polls....it's interesting that I saw one poll where a majority of Americans say that the financial picture for everyone else is worsening. However, 84% of Americans feel that their financial situation is good to very good. What's up with that?

I don't think that Stephen is saying that the subprime mess (and possible recession) is a non-event. I think he's trying to put it into historical context and say that relative to what has happened before, while it's still bad, it's still not the end of the world. Considering 95% of the US population is gainfully employed, most have several TVs, cars, A/C, and other comforts, I don't think we'll be seeing the dark ages anytime soon.


"I am continually surprised at how widespread the perception is that our economy is in a complete nosedive, despite much evidence to the contrary."

Hmm, I guess you didn't see today's WSJ article indicating that the number of people unable to pay for heat has risen sharply, or Fidelity's announcement that the number of people taking early withdrawals (and penalties) from their 401ks has hit record levels.

You should talk with some people who don't read blogs.

scott cunningham

Well count Ben Bernanke as one of those who is worried.


My US History teacher jokingly gave us the following definition of recession and depression. He said that if your neighbor has fallen on hard financial times we're in a recession, and if you yourself have fallen on hard financial times it's in a depression. So maybe that 12% were all people who have maybe recently lost their house or job?

James R

Charles D - my conversations with strangers have reflected what the polls say people believe about 9/11 and Iraq, much to my horror.

Moon Mullins

Those 12% would NOT be terrific insurance customers because, I would guess, the majority of them are tapped out (see comments 7 & 9). On second thought, though, they might be IDEAL insurance customers because you can play on their fears, get them to pay a premium or two, then they default on their payments because they have to eat. The salesman makes his/her commission and the insurer has no further risk.

Doug Wolkon - Author of The New Game

Subprime is a fancy word for too much debt. Adam Smith would actually say that housing over and above shelter has no utility value. If that is true, we are in for some serious additional write downs (think second homes).

On another note, Subprime could have worked if the loans stayed true to their risk and were made at "loan shark" type rates (5% "money-down" should have warranted a 20% rate; instead we were lending it at 7-10%). As a result, we were only realizing less return on a greater expense in the form of lower and lower investment rates (Menger, Say, Smith, Jevons and others), but more risk.

At the end of the day, its all about (un)employment. As the construction industry (contractors will contract), related materials (steel, wood, etc.), autos (Detroit is the worst economy in the country) and financial services (the mortgage industry will certainly downsize) are forced to lay employees off (that is what happens whey your company loses a billion dollars, but the crains are still in the sky adding to supply and falsely buoying employment), we will be forced to find new jobs elsewhere for these people or we will surely have a recession, depression or whatever you want to call it.

Unemployment only leads to more unemployment as production and consumption fall back into equilibrium. That will be the critical question. Where will the new jobs come from to keep up production and consumption or employment and trade? Its all about renewable energy.


Charles D

I stopped trusting polls long ago, but that idea was strengthened when polls showed that almost half of Americans believed Iraq was involved in 9/11 when Bush himself said they weren't.

Not trying to make this another political issue, just a huge distrust in polling. I'm sure it was all in how the pollster made the question. I'm positive a good pollster could get much higher numbers if they wanted.


The best layman definition that I have heard is:

recession -- when your neighbor loses his job.
depression -- when you lose your job.


I'm not really sure I buy this logic. Because this isn't one of the top 5 banking crises, but bears similarities to the top 18 banking crises of the last 50-60 years, things aren't that bad!? Your logic is that among rare events, this rare event isn't that bad.

I see the point that we may or my not be in a recession--and claiming we are in a depression is taking it to an extreme--but using the top 18 banking crises among the industrialized world is a dubious group to mention in the first place. Assuming there are 60 years of data and 8 industrialized countries (i.e. 480 observations), this means that this event is a bad event that happens once every 26 years. That's far more frequent than the typical number of years for a recession, so I'm willing to excuse people for overreacting to a somewhat rare event.


They wouldn't be good customers because they would expect you to go broke and therefore not buy.


Following #13's comment, how about data on the continuing wage gap, continuing rising prices of health care, education, gas, and even food now. Perception is that life might be a bit harder than it used to be. I don't think (but not completely sure) that the NBER paper inflation rate actually include these things.

Susan Weiner


Can you elaborate on WHY you don't see the U.S. economy following the pattern of the 18 crises that Reinhart and Rogoff analyzed?


"I am continually surprised at how widespread the perception is that our economy is in a complete nosedive, despite much evidence to the contrary."

And I am continually surprised by the overly rosy perception by economists that our economy is doing great, despite the evidence I see with my own eyes.


Don't worry. If a Democrat gets elected in November, the recession/depression will be over by January.

Oh, nothing will change economically, but it will suddenly dawn on the news media that everything is sunshine and roses and that they've been missing out on all the stories about great economic news. Any bad economic news will get buried on an obscure AP website somewhere.

Do you ever wonder why some growth rates in Europe get reported as great news, when in the same paper growth rates in the US that are much higher are reported as dismal news?

Sci Ed

"I am continually surprised at how widespread the perception is that our economy is in a complete nosedive, despite much evidence to the contrary."

People's perceptions are driven largely by what they hear rather than what they experience personally. Thus we need to ask who stands to gain by encouraging ill sentiment about the economy among the public.

Bad news sells, so the media encourages the perception of the world coming to an end. To compound the problem, the Democrats (and much of the media) like to blame the President for all problems. They remember that Bill Clinton won the presidency with the slogan "It's the economy, stupid" and hope to do same in 2008. Is it a wonder that we are inundated with people talking down the economy? When it comes to the economy, perception becomes reality. Many people curtail spending when they believe the economy is in trouble, thus providing positive feedback to the notion that the economy is in trouble.

I agree with Sharper @25 who projected that negative talk of the economy will be over right after January 2009 if the Democrats win the election. Of course, silly me remembers Nancy Pelosi promising that gas prices would come down when the Democrats took over Congress. Didn't Hillary promise the same for her first day as president?

Science Editor
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"I am continually surprised at how widespread the perception is that our economy is in a complete nosedive, despite much evidence to the contrary."

As far as the "unwashed masses" go, it's easy to think that the US is in a nosedive. Heating your home, buying gas for your car, and buying food are all much more expensive than 10 years ago.

What if they want to take a trip overseas? Surprise, it may cost twice as much now as it did 10 years ago for some countries! I hope they like Florida and California.

If your income hasn't risen proportionately, you have much less money for leisure, much less money to spend, and when you hear the word "recession" on TV, it sounds like as good an explanation as any.

As far as why economists think we're in a recession, I imagine it has to do with different tea leaves.


With all the polls about who thinks we're in a recession when, I'd just love to see a single poll ask Americans to define "recession." I'm guessing less than 5 percent can get it right. (Not that this is a travesty...I just wish people would understand that this is a specific economic condition, not a word to get thrown around by anyone who lost their GM job.)


Thanks for the link.

The banking industry is amazing; they regularly devise new ways to lose great sums of money, except those new ways are versions of the old. They never learn. I've lived through many cycles of this and the simple reality is that each attempt to build in controls merely hides the underlying issue better. That issue is that short-term profits and fees count a lot for personal bonuses and stock prices, same as for any corporation except that banks are not typical corporations.

In this latest mess, they self-deluded that securitized pools adequately spread risk which was then adequately priced. Any understanding of the history of these cycles shows that crap gets bid up - and that made competing for that debt more important. Almost a version of auction fever, with money competing against money because no one wants to give up the market share, the fees, the bonuses.

It would be interesting to see if one could consistently identify the point at which these cycle become invested in the necessity of a best case scenario.

Now of course, they're busily marking down every asset they can so their books will look great next year and they'll be heroes then and will get their bonuses. The best time to take a bath is when everyone is because then it's not your fault.


Walter Wimberly

The only thing that the media tends to require for a recession is the need to sell more advertising/papers. The people who think we are worse off than the information shows are those that blindly are reading the news media headlines. Bad news sells, good news is left out. Combine that with people now truly understanding things around, and they have to assume all is bad - not that it is good news if you are one of the thousands that lost your job at Yahoo or GM - but the facts aren't all bad either.