Wednesday, November 07, 2007

Why Subprime Mortgage Crisis Won't Cause A Recession: The U.S. Economy Survived S&L Crisis

Remember the Savings and Loan crisis of the 1980s? Does it offer any lessons about how the U.S. economy and financial system will absorb the current "subprime mortgage crisis" (a phrase so common and popular now that you'll find 349,000 Google hits).

The top chart above shows the annual number of bank failures in the U.S. from 1979 to 2007, using data from the FDIC. Between 1982 and 1993, 1456 banks (mostly S&Ls) in the U.S. failed, and at the peak of the banking crisis in the late 1980s about 200 banks were closed in each year from 1987 to 1989 (see bottom chart above). That's almost one bank failure on each business day of the year, for three years in a row!

One lesson we can learn is that even at the peak of the "S&L crisis," the overall economy performed well, with pretty impressive real GDP growth at above-average rates (3.4%, 4.1% and 3.5% from 1987-1989), and most importantly, the economy did not go into a recession even at the peak of the most serious banking crisis since the Great Depression!

In some ways, today's economy is in much better shape than the U.S. economy of the 1980s, e.g. unemployment rates today (4.6% average over the last two years) are much lower than the 1980s (7.3% average).

Consider also that not a single U.S. bank failed in 2005 or 2006 (see chart above), and only 3 banks have failed in 2007, which a very impressive record of only 1 bank failure per year on average over the last 3 years. I am pretty sure that there has never been any two-year period in U.S. history without a single bank failure in the U.S., and no three-year period in U.S. history with only 3 bank failures. The U.S. banking system has never been as strong and as stable as it is today.

Bottom Line: If the economy of the 1980s could withstand a banking crisis as serious as the S&L crisis (with almost 1500 bank failures) without going into a recession, a much stronger and more resilient 2007-2008 U.S. economy and banking system will not go into a recession because of the current "subprime mortgage crisis."


At 11/07/2007 10:43 AM, Anonymous Anonymous said...

Commodity currencies led the gains today. The Canadian dollar advanced to $1.1040. The Australian dollar gained to 93.98 U.S. cents, the highest since April 1984, from 92.87 U.S. cents. The rand rose to as high as 6.4294 per dollar, the highest since May 2006. The pound rose to $2.1052, the highest since May 1981...

...The dollar fell against the Norwegian krone as traders added to bets Norway's central bank will increase its 5 percent deposit rate. It declined to 5.2835 kroner, from 5.3474. The dollar also dropped as losses from subprime-mortgage defaults added to pressure on the Federal Reserve to lower its target for the overnight lending rate between banks to 4.25 percent next month.

A falling dollar would mean higher oil prices and higher imported goods prices, less domestic and much less international travel, less consumer spending and etc. all leading to a decrease in quality of life while our incomes increase. Technically it might not be a recession but it sure won't feel good as we become an also ran in the global economy..

All we would need for the "perfect storm" is for the U.S. currency holders like China to dump the dollar in something of a panic and our goose is cooked. But that would never happen... :D

At 12/01/2007 2:41 AM, Anonymous Anonymous said...

Remember the Great Depression? Does it offer any lessons about how the U.S. economy and financial system may not absorb the current "subprime mortgage crisis"?

At 12/15/2007 11:47 AM, Anonymous Anonymous said...

Subprime lending had nothing to do with the Great Depression and nor will it cause another Great Depression. The Great Depression occurred because of two main reasons: substantial bank failures due to bank runs (both at member banks and non-member banks) and the Federal Reserve's inadequate monetary policy. The Federal Reserve has dramatically changed since the 1930's and it much more transparent. Obviously the catalysts for the 1929 Great Depression will not cause the next one. However, I feel it to be more far-fetched in todays era due to a more transparent and more adequate Federal Reserve who finally recognize their role as our central bank (lender of last resort), and the availability of liquidity across the globe. These views were rather distorted during the 1930's due to the Real Bill's Doctrine. Also at the time the world was much more protectionist than we are today. I agree with Dr. Perry in his view that we will not experience another Great Depression due to the subprime mortgage crisis.

At 3/25/2008 4:03 AM, Blogger Kelly said...

Subprime mortgage crisis won't cause a recession, however it's a big problem and we should think how to stop it. What can be done to curb bad credit mortgage booms? In response to aggressive lending practices by mortgage lenders anti-predatory lending laws can be enacted that regulated the provision of high-risk mortgages. However, research shows that these laws have not been effective in limiting the growth of such mortgages. But on the other hand with lending standards now tightened, fewer borrowers will qualify for loans. That's a double whammy for housing — more homes on the market and fewer buyers. For example, in markets where home prices might have fallen 3 percent because of the general housing downturn, the presence of a lot of subprime borrowers in trouble could magnify that to a 6 percent price drop.

At 9/29/2008 10:31 AM, Anonymous Anonymous said...

HMMM, if only you could have seen a year into the future huh? You neglected to mention that it might take 1 trillion dollars to stop the recession.

At 1/03/2009 11:20 PM, Anonymous Anonymous said...

funny to read this article and now hear that the economy was already in recession when it was written. it is now literally a certainty that we are heading for depression.


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