Crisis is the normal state

by Daniel on March 23, 2010

I find myself disagreeing with Paul Krugman, though not about anything important.

” I’m reading Gary Gorton’s Slapped by the Invisible Hand, which tells us that there were bank panics — systemic crises — in 1873, 1884, 1890, 1893, 1896, 1907, and 1914.

On the other hand, there were no systemic crises from 1934 to 2007.

The problem, as Gorton makes clear, is that the Quiet Period reflected a combination of deposit insurance and strong regulation — undermined by the rise of shadow banking.

I don’t think this is right. If we’re going to include things like the First Baring Crisis and the Panic of 1893 (which were big news at the time, but by no means earth-shattering), then I can give you a list. Even using a selective criterion of only crises with significant US involvement (ruling out the Nordic, French, Spanish and Japanese banking crises), we have the following list …

2007 – current crisis
2002 – Enron/Worldcom/Global Crossing crises
2000 – dot com bust
1998 – Asia/Russia/LTCM crisis
1994 – Tequila crisis
1991 – commercial real estate crisis
1987 – Black Wednesday
1985 – Savings & Loans crisis
1982 – LDC debt crisis
1975 – New York City bankruptcy
1971 – Collapse of Bretton Woods
1970 – Penn Central commercial paper crisis

As far as I can see, things were pretty stable between 1934 and 1970 (give or take the odd war), but that in the era of floating exchange rates it’s been very unusual to go seven years without a crisis and the modal gap looks closer to three years than four.



Ginger Yellow 03.23.10 at 11:15 pm

2001 – Argentina debt crisis


Metatone 03.23.10 at 11:30 pm

Strangely, I’ve read a lot more about the 3 year recession/depression in 1893 than the 1975 NYC bankruptcy… are they really comparable events?


wkw 03.23.10 at 11:35 pm

I said basically the same thing at IPE@UNC (link above), except I think it kind of is important: if we know these things are going to happen with some frequency no matter what regulatory structure we have, then there are vastly different policy prescriptions than the ones Krugman makes. We should be focusing on transparency and the orderly winding-up of affected firms rather than simply raising capital adequacy ratios and assuming that will take care of things.

In other words, we should spend more time talking about quarantine and less time talking about vaccine.


Nathan 03.23.10 at 11:35 pm

The events you have listed are financial crises but not bank panics. As I understand the term, a bank panic is where a crisis of confidence in the ability of one or more banks to repay its depositors results in systemic withdrawals across the banking system. Rumours that banks are not sound thus leads to massive withdrawals, which leads to the collapse of otherwise healthy banks and losses to depositors.

None of the events you listed resulted in systemic runs on banks, so I don’t think it’s fair to call them bank panics in particular, as opposed to financial crises in general.


john c. halasz 03.23.10 at 11:38 pm

Of course, it’s only a crisis if it happens in “the center” or has a significant effect on it, not if it occurs on “the periphery”. There, crisis is just the normal state-of-affairs.


John Quiggin 03.23.10 at 11:54 pm

Along previous lines, I’d dispute most of the crises before 1997, which were basically just big defaults by non-financial-sector debtors (the S&Ls weren’t systemically important). From 1997 onwards, we were seeing rehearsals for the GFC, so I agree with you and disagree with Krugman about those.

The collapse of Bretton Woods was certainly a huge event, but it was a success for financial markets (breaking down government restrictions) not a failure.


nadezhda 03.24.10 at 12:02 am

Yes, I too was taken aback that Krugman had wiped out the periodic financial crises of the past 4 decades from history.

Short answer re the timing of when financial crises started to reappear, at least in the US. In the late 60s we had the interest equalization tax, which created the Eurobond market, and the erosion of Regulation Q (money market funds, NOW accounts, etc). Together, those late-60s developments propelled a processs that (1) fuelled disintermediation, (2) destroyed the S&L business model (which was propped up by Congress thru major financial sector dislocations of the 70s until the S&L industry as a whole finally collapsed in the 80s), (3) threatened the commercial banks’ safe and boring corporate lending business model (the pending demise of which, among other things, spurred the banks to get into the petro-dollar recycling business leading to the LDC collapse), and (4) dismantled Glass-Steagall for all practical purposes at least a decade before it was abolished by law.

@ Nathan — Several of the financial crises in Daniel’s list would have involved bank runs but for the deposit insurance system and FDIC/FSLIC orderly sales and wind-down procedures. However, the S&L crisis did produce its share of (relatively small) bank runs. Not the FSLIC-insured S&L deposits. But a lot of dodgy S&Ls were state chartered, and we indeed had some significant bank runs with folks camping out in parking lots for days demanding to withdraw their deposits. Also, some of the worst offending S&Ls sold uninsured Certificates of Deposit, which also produced lines of (especially elderly) angry and confused customers trying to get their hands on their money.


wkw 03.24.10 at 1:43 am

@ John Q –

Sure, but “defaults by non-financial-sector debtors” are what happens right before “defaults by financial-sector debtors”. When governments default on their debt, banks holding that debt are put under pressure. When subprime borrowers default on their mortgages it has major ramifications for banks holding those loans. If counterparty risk is high you get crisis.

One definition of “systemic crisis” hinges on whether or not the government felt the need to bail out financial firms to prevent contagion. Bailouts are politically unpopular, so (presumably) governments won’t do it unless they have to. Under that definition several of the pre-’97 events qualify: ’75, ’82, ’85 and onward (747 failed S&Ls and the ’90-’91 recession qualifies as systemically important I think), ’94. Maybe others, but those are the ones I know off the top of my head. In any case, Dimon’s definition — which echoes Kindleberger and probably came from him — holds up much better than Krugman’s.

Bretton Woods was a different animal of course, but we’re not going back there.


andrew 03.24.10 at 5:47 am

The Panic of 1893, in the US at least, really was a pretty big [fucking] deal. Much more than 1884, 1890, 1896, 1907 (though this did lead to the Pujo Committee investigation of banking), 1914. Probably bigger than 1873 too. 1873 and 1893 were more than just bank panics.


dsquared 03.24.10 at 7:23 am

the S&Ls weren’t systemically important

Are you kidding me?


Brownie 03.24.10 at 9:45 am

How could you forget the China Crisis of the late 80s? That blend of post-punk new wave rocked the markets to its foundations.


Bunbury 03.24.10 at 11:35 am

I think any crisis that ends with interest rate policy being dictated by the need to keep banks afloat is reasonably described as systemic so the early 90s has to be in there. Even Goldman had to be recapitalised and that was when investment banks weren’t banks and didn’t need much capital.

I’m surprised that John wants to dismiss the S&L crisis so lightly. Even if it seems small potatoes compared to what we’ve just experienced, it is a pretty good prototype. Isn’t the GFC just the ‘seventh wave’ of financial crises? In so far as it is different to the very many other crises it just involved larger, more globalised and faster moving organisations.


dsquared 03.24.10 at 11:51 am

I think Bunbury’s criterion is sensible – a crisis is “systemic” if it requires a monetary policy response. On that basis I’d probably strike out NYC bankruptcy.


MQ 03.24.10 at 2:41 pm

The S&L crisis was systemic, for sure. It was a major factor leading to the early 90s recession.

On Gorton, here’s a crosspost of something I posted on Yglesias’s blog:

Look, Gary Gorton is an excellent economist and this book has a lot to recommend it. But he was also the MAIN RISK MODELLING CONSULTANT FOR AIG, responsible for doing their credit default swap risk modelling. He was paid a million dollars a year for that. His picture of the crisis is of a collateral run on assets that really weren’t so bad (specifically, on firms that would have been able to stay healthy given the normal decline in asset values absent the run). There’s definitely truth to that, there was a bank run. But it is also the model that makes his own risk forecasts look the best. He didn’t call what happened the housing market at all, but he can say this is because of the underlying financial instability instead of the fundamental weakness, the overexposure to debt on the part of the American consumer.


dsquared 03.24.10 at 2:44 pm

Yes, MQ, it did also strike me that since Gary Gorton really wasn’t saying that a lack of regulation and an excess of leverage on opaque assets was a problem back when it would have made a difference, I’m not particularly interested in hearing him say it now.


MQ 03.24.10 at 4:28 pm

Dsquared in 15: Yeah, there’s that, there’s understandable irritation at his role in the crisis. But I welcome all converts, even late ones. It’s that when you listen to him talk about this, he really hammers on his belief that the decline in the value of the underlying assets would not have been enough to trigger massive CDS payments, it was the run on collateral that did the damage. In other words, his credit risk modelling was right, and if there had been a mechanism in place to stop the run (e.g. government backstop on collateral, like deposit insurance) then it would have been proved correct in the long run. It’s the old solvency vs. liquidity argument. (I don’t really believe one can counterpose those two as opposites, but that’s the role they end up playing).

He might be correct, but I wonder about the ways in which his own involvement has affected his views on this. I haven’t read the book, but there are a number of obvious issues with introducing deposit-insurance type mechanisms to back up financial leverage. If we did have a government collateral backstop, should responsible regulators have permitted the credit risks to be taken that were taken?


Quiblers 03.24.10 at 7:44 pm

This entire thread of comments misses the problems entirely. Not one single economic model predicted anything like the list of problems up above. Not one.

Therefore the model is crap based on crap.

From the tone of the writers, I would guesstimate that about 80 percent are heavily invested in the model. Until serious people stop and think this double think is going to persist.

You have not a clue in hell as to what is going on.

You have an insane military budget that continues to threaten the economic life of the United States. This is the elephant in the bathroom that not one recognized economists even remarks on.

You want to use a freaking model? Get a pen and paper and calculate the amount of pure waste in the “defense” “budget.” Total it up since 1980 and it is almost the exact same sum as the national debt, without adjusting for inflation. Then shove that in your damn models. Add in the total waste on “intelligence” and subsidies to Archer Daniels Midland and the other entitlements that you knowingly ignore. No one gives a damn about how the price of marijuana and coke and heroin taken out of the economy. “Oh, we can’t measure that so we’ll just ignore it.” The drag on the economy of the tacit and explicit monopolies can’t be measured so we will assume an equal opportunity business mode. People Monsanto is trying to monopolize the entire grain production of the world and you wander around in a fair market theory. This is total crap. There is not a single item in the economy that is in a fair market value set. Not one.

Apparently the open bribery of government officials is so accepted that Dodd from Connecticut can write a reform bill when his wife is a director of “CME Group Inc., which became the world’s largest futures exchange through a 2007 merger with the Chicago Board of Trade and the 2008 acquisition of the parent company of the New York Mercantile Exchange.” – CREW.

Clarence Thomas’s wife is now legally covered for accepting bribes since she does not discuss her business with her husband.

And you sit around talking about trivial crap that is just flat damn wrong.


Stuart 03.24.10 at 7:58 pm

As there wasn’t a government collateral backstop doesn’t it still amount to an admission that he failed to do his job correctly – he ignored/forgot/didn’t factor in at least one type of risk. Surely the point of risk management is to rate and price ALL risks, not just the ones you think you can most easily model. Of course one of the fundamental problems of the free market in these types of insurance is that the most optimistic risk models gets the majority of the business, so especially in a bonus led corporate culture the boom/crisis/bust cycle seems likely to continue for the foreseeable future.


TomF 03.24.10 at 8:47 pm

the S&Ls weren’t systemically important
Are you kidding me?

I think I agree with Mr Quiggin that the S&L crisis, while very large and costly to the government, wasn’t “systemic” in that it didn’t trigger widespread bank runs or other knock-on effects throughout the banking and monetary systems. Rather, it was several years of drip-drip-drip S&L failures due to fraud and/or mismanagement.

A good contrast from earlier in that era was the failure and government takeover of Continental Illinois Bank in 1984. It was one of the ten largest banks in the U.S. (and in nominal $ terms the largest failure until IndyMac in 2008). Due to the unit-banking legacy of Illinois and the midwest, it was deeply intertwined as a correspondent bank with hundreds of smaller midwestern banks, was banker to the Chicago security and futures exchanges, and had money-center operations trading with other major banks internationally. Had it been allowed to fail and close its doors without government receivership, you likely would have seen a larger “systemic” effect (though nothing like you might have seen had the likes of Citi, BofA, etc., etc. been allowed to simultaneously fail in 2008).


Barry 03.24.10 at 9:41 pm

Daniel, the key is magnitude. How big were these various crises? For example, if the relative sizes were from 1-5 between the late 1930’s and 1980, and then 10’s during the 1980’s and 90’s, and then 100 for the 2007 crash, then Krugman’s point is valid.


Alex 03.24.10 at 10:46 pm

There couldn’t ever have been a government backstop for him. Because you can create CDS hugely in excess of the underlying securities, and there was a market for CDOs of CDS, this would have been an obligation on the state that would grow without limit. And that can fuck well off.


roger 03.25.10 at 12:25 am

Re the crash of 1857
Dec. 8, 1857, Marx to Kugelmann

That the capitalist, who scream so much against the right to employment, now everywhere demand public assisttance from their governments in Hamburg, Berlin, Stockholm, Copenhagen, even England [in the form of the suspension of bills, thus seeking to enforce a “right to profit” at the public’s expense, is beautiful.”


carping demon 03.25.10 at 8:41 am

Quiblers @17–well, you’re right about all those things, but once you’ve noted them what do you say next? My experience has been that modelers want to talk about models, and the suggestion (which I have often made near the end of threads) that their useless and pointless knowledge counts for nothing much is usually met with bland indifference. Where do you go from here?


ajay 03.25.10 at 11:33 am

dsquared, I’d be tempted to assume that Krugman misspoke – writing “systemic crises” when he meant “bank panics”. There were lots of financial crises during that period, but how many bank panics?
Second, I don’t think you could really count Black Wednesday as a systemic crisis without weakening the term to the point of uselessness. It was just a stock market crash. Even if it threatened or brought down a few banks, it didn’t IIRC threaten the entire banking system – hence not ‘systemic’.
As for Bunbury’s definition, a lot of financial disturbances lead to monetary policy responses just because they lead to economic downturns, which tend to produce monetary policy responses. But I don’t think that cutting interest rates after the dotcom bubble (say) was aimed specifically at keeping banks afloat rather than just at helping the economy and keeping inflation near target.


ajay 03.25.10 at 11:34 am

My experience has been that modelers want to talk about models, and the suggestion (which I have often made near the end of threads) that their useless and pointless knowledge counts for nothing much is usually met with bland indifference. Where do you go from here?

“To another blog” might be one possibility.


dsquared 03.25.10 at 12:59 pm

But changing the definition to “banking crises” (and I am still claiming the S&L crisis) seems to me like a “Golden Arches Theory Of Geopolitics” move – it changes the assertion from an interesting statement about the world to a pub quiz question. When the banks are guaranteed by an OECD sovereign, fair enough they don’t have panics. But the question is – did this reduce the overall level of financial-sector-caused risk in the system as a whole?

There is reasonable evidence that there was greater macroeconomic stability in the postwar period (or in other words, that the invention of stabilisation policy did work – although this is still controversial and by no means everyone agrees with me on this one). But if what we saw was a situation in which a) most of the time, banks were more stable simply because the macroeconomy was more stable and b) some of the time, stabilisation policy was actually bent around the objective of trying to counteract the effect of financial crises, then I don’t think that supports a view of a more stable financial sector post 1934. If you then add c) (a proposition I don’t necessarily believe myself but it’s at least plausible) that a lot of the stability of the “Great Moderation” era was just the building up of a financial bubble, facilitated by the banking system and contributing to a massive crash in 2007, then I think the underlying Gorton/Krugman hypothesis really does fall down.

I also want to make another objection based on Goodhart’s Law – which is that you can’t just say that “we had a nicely working stable and well-regulated financial system, and then this awful shadow-banking thing came along”. Despite the name, shadow banking wasn’t created as a bane on mankind by the Lord of Mordor – it’s an inevitable and predictable consequence of the regulatory regime. Another application of the POSIWID principle.


Ginger Yellow 03.25.10 at 4:09 pm

Rather, it was several years of drip-drip-drip S&L failures due to fraud and/or mismanagement.

750 bank failures in six years is a lot of drips. And it wasn’t systemic in the same way as the recent crisis, because the government stepped in and shelled out what was then a huge amount of money (and still should be considered huge) to protect depositors and avoid firesales of the seized assets.


ajay 03.25.10 at 5:33 pm

But the question is – did this reduce the overall level of financial-sector-caused risk in the system as a whole?

This is a very good question. How would you go about answering it? You’d want some sort of economy-wide VAR measure or something, to measure “overall risk in the system”, and then you’d have to have some way of dividing the risk into “financial sector caused” and “other” (which I suppose would be things like, oh, the movement in oil prices caused by Opec reducing production in 1973, to pick one obvious example).
Any thoughts?


Julio Huato 03.25.10 at 5:50 pm


I think Krugman meant the rich countries or the U.S. alone. Because, in this recent speech, he described the economic history of global capitalism in the last few decades as “a history of violence,” adding that “drastic events – sudden speculative attacks that emerge out of a seemingly clear blue sky, abrupt economic implosions that slash real GDP by 5, 10, even 15 percent – are regular occurrences on the international scene.”


ejh 03.26.10 at 5:57 pm

I thought #17 deserved an answer, if only as an acknowledgement of their referencing Tombstone Blues.

Comments on this entry are closed.