Banking crisis: where are we now?

Posted on: 23 February 2009 by Gareth Hargreaves

Independent financial advisor Peter McGahan takes stock of the current financial climate by picking out some key investment pointers.

As normal the noise abounds regarding where our economy is today and it’s most interesting to read the views of those with vested interests.

Of course no-one wants to hear bad news and there is an abundance of that. Just as this column warned on the upside of the market, it is doing so on the downside.

Opportunities will come, but for the foreseeable future it will very much be a case of one step forward and one back, so taking gains will be important. To understand this we really need to understand exactly where we are today.

A recession is one thing, but financial crises, particular in the form of banking crises are another.

In 2007, a study by Reinhart and Rogoff accurately compared the run up to the US subprime crisis with the antecedents of other banking crisis.

They continued in 2008 to analyse the antecedents and aftermath of banking crises in both rich and emerging countries. There have been 18 post-war banking crises and the study included them all.

What was most surprising was how alike they were. One would have expected them to be very different. It's worth studying financial crises to see how they specifically affect economies as a whole.

Financial crises are not overnight events and they share commonalities, whether in developed or emerging economies:

Asset prices collapse, with fixed assets such as real estate/property falling 35% on average and the downturn lasting six years;

Equities bomb 55% and the cycles last 3.4 years;

Unemployment rises on average by 7% and lasts over four years. Output falls by around 9% and this typically takes two years;

Not to be outdone, the real value of government debt explodes by 86% with the cost of replacing lost taxes being the key factor, rather than the much whinged about ‘bailing out of banks’.

I can see why many might begin to call the low for the US housing market. I travelled the US in 2007 and they were ahead of where we are now. In every state I entered, everyone had the same view that the housing market was plummeting and there was an oversupply.

It was only a matter of time before those anchored to a previous price, or indeed in negative equity would have to let go, and face the fact that their property was worth much less and that’s when the negative surge occurred.

Consider today that the Case-Schiller index is showing that the US housing market fall is already more than twice that registered during the great depression.  (Speak to an independent Mortgage Broker for queries relating to your mortgage)

Moving through to the economy it is interesting that the cycle from peak to trough in GDP is only two years, and perhaps Mr Brown’s cash injections will prove timely with the next election.

Remember a normal recession lasts around a year. Indeed the study showed that multi year recessions only really occur in countries that require a deep restructuring such as Britain in the 70’s and Switzerland in the 90’s.

Will this study prove true in today's market?

Well, we could all say that the governments of today are not as daft as the past, but I will leave that for the goldfish to consider. Most definitely the UK and US governments have shown considerable monetary flexibility, which wasn’t shown in the past, so that might be a differentiator but it's difficult to see why this varies from the normal financial programmes of the past.

What is very different this time is that most of these analyses were individual regional crises. This one is global and is a bigger bus to get moving by pushing, than the smaller smart car of yester year.

Most interesting is the fact that defaults in emerging market economies tend to rise sharpest when many countries are simultaneously suffering their own domestic banking crises and that would be an interesting chain of events.

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