TOPICS > Economy

Arrogance, Ignorance Recurring in Economic History

November 2, 2009 at 6:26 PM EDT
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Paul Solman speaks with economists Carmen Reinhart and Ken Rogoff about the financial crisis and how it compares to previous economic meltdowns.

GWEN IFILL: Next: a conversation about the financial meltdown and whether it’s really any different from crises of the past. It’s part of economics correspondent Paul Solman’s Making Sen$e of financial news.

HENRY PAULSON, former U.S. Treasury Secretary: We have experienced significant turmoil in our financial markets.

PAUL SOLMAN: It’s been one year since the onset of the financial crisis.

WOMAN: Stocks all around the world are tanking because of the crisis on Wall Street.

WOMAN: One of the biggest financial failures in U.S. history.

WOMAN: A near-total collapse of the financial system.

PAUL SOLMAN: So, a world economy in unprecedented peril? No, says Harvard economist Ken Rogoff — more like crisis as usual.

KENNETH ROGOFF, coauthor, “This Time Is Different: Eight Centuries of Financial Folly”: The U.S. economy is driving down the tracks of a typical deep postwar finaincial crisis.

PAUL SOLMAN: In a new book, “This Time Is Different,” Rogoff and co-author Carmen Reinhart document the long history of financial crises. And we do mean long.

If you looked at financial crises across virtually every continent for something like 800 years, is it just something in the nature of human beings that we go through these cycles?

KENNETH ROGOFF: There’s no doubt about it. I mean, the recurring theme is arrogance and ignorance: ignorance that this has happened before in other places, in other countries; and arrogance thinking we’re special, this time is different. We have financial globalization. We’re running our economy better. “They’re lending us a lot of money because they love us and we’re doing a good job.” That’s what the officials think.

PAUL SOLMAN: Co-author Carmen Reinhart:

CARMEN REINHART, coauthor, “This Time Is Different: Eight Centuries of Financial Folly”: “Whatever rules of the game are, they just simply don’t apply to us.” And that is the essence of the arrogance that dominates the boom phase. And it is. The seeds of the crisis are sown during the boom.

'Telltale signs of a crisis'

PAUL SOLMAN: As Rogoff and Reinhart worked on their book in 2007, they began to see the telltale signs of crisis for America the profligate.

KENNETH ROGOFF: Housing prices rising were very typical if you're about to have a financial crisis, the equity price rise, the borrowing from abroad, and the fact the economy was slowing down. All the red lights were blinking.

PAUL SOLMAN: They say they tried to warn a convention of economists in a paper they gave in January 2008. But you didn't say to your colleagues, look, it's time to sell, sell, sell?

KENNETH ROGOFF: No. We didn't say, sell, sell, sell. But our paper said that the United States will be lucky not to have a deep financial crisis.

CARMEN REINHART: You know we're not seers, but it allowed us to say, if history is any guide, we're lucky if that doesn't happen here and now.

PAUL SOLMAN: Lucky, we were not, which would have come as no surprise to the data.

KENNETH ROGOFF: When you have a big inflow of foreign funds -- and we had a massive one -- you're at risk. When you deregulate your markets rapidly, which we did in the states, that also very often happens that you have a deep crisis. The real killer is short-term debt, debt that has to be refinanced all the time. Well, that's what the subprime was. You had to refinance it.

CARMEN REINHART: And these debt buildups often end in tears, because credit is ample during the feast phase. We also see that availability of credit manifests itself in asset price booms.

KENNETH ROGOFF: So, what happens is, is, when the going is good, interest rates low, you look good. You don't worry. Confidence is high. But, then, suddenly, confidence can evaporate. Something happened in the world, something happened to you, and boom.

PAUL SOLMAN: So, then, this time wasn't different, not different from the Asian currency crisis of the '90s, the Latin American debt crisis of the '80s, the Wall Street panic of 1907, the German crash of 1873, France's Mississippi Bubble of 1720, Florence's banking crisis of 1340, for that matter. And even when you just look at more recent crises, those after World War II, ours, so far, is just average.

KENNETH ROGOFF: So, for example, the average fall in stock prices from peak to trough in a financial crisis like this is 56 percent in real terms. That's how much the S&P fell. Housing prices, the typical fall is 35 percent. We have fallen, by the Case-Shiller index, just over 32 percent.

PAUL SOLMAN: So, you mean Spain, Japan, Sweden, when you average out what happened during their severe downturns, we're right on track?

KENNETH ROGOFF: Were right on the average, absolutely. In fact, you can throw in countries like Argentina, Brazil, the Asian crisis countries, and they're not very different either.

A typical recovery

PAUL SOLMAN: And, so far, it turns out, the recovery, too, is typical, housing prices, for instance.

KENNETH ROGOFF: They tend to collapse and stay down for a long time.

PAUL SOLMAN: And the stock market?

KENNETH ROGOFF: Well, believe it or not, it goes back to where it was after two to three years.

PAUL SOLMAN: And unemployment?

KENNETH ROGOFF: Unemployment lingers. It goes on almost five years from the beginning with unemployment rising.

CARMEN REINHART: It takes a little under two years to go from peak to bottom, which is roughly where we are right now. But it takes about another two years, on average, to get back to your income level before the crisis.

PAUL SOLMAN: So, will we be out of the woods come the fall of 2011? Or is that unfortunately named season an ill omen?

KENNETH ROGOFF: Financial crises eventually can morph into a debt crisis. Debt explodes, government debt. It almost doubles within three years.

PAUL SOLMAN: On average?

KENNETH ROGOFF: On average. On average.

Specter of government defaults

PAUL SOLMAN: Does that, then, raise the possibility of yet another crisis, which is governments, even ours, not being able to pay off their debts?

KENNETH ROGOFF: Well, we can handle it, if we're willing to tax ourselves. And that's an open question. But it's a problem for the world, because all the governments are doing that. They're all trying to borrow. Right now, it's OK, but, as things normalize, it's going to get expensive. So, the defaults, the actual governments saying, we're not going to pay, might not happen in the United States. It might be off in the Ukraine, or it might be in Eastern Europe.


KENNETH ROGOFF: Ireland. It could be in Ireland.

PAUL SOLMAN: Or a state like California. Hey, Pennsylvania defaulted on its debts. Granted, it was back in 1842, but it didn't repay its bondholders before one of them, poet William Wordsworth, immortalized Pennsylvania's "dishonour black," a once-great state whose "high repute, with bounteous nature's aid, won confidence, now ruthlessly betrayed."

Look, says Rogoff, history is littered with post-boom deadbeats.

KENNETH ROGOFF: Spain has defaulted on its debt 13 times, France almost as much. People: What? Spain? France?

PAUL SOLMAN: Yet, when Rogoff and Reinhart published a paper on global defaults.

KENNETH ROGOFF: We received letters from officials from all over the world saying: We never defaulted. Our country never defaulted. I mean, Japan wrote to us, a very high Japanese official, saying: "Please correct this. We did not default in 1942." And we finally ended up sending them back a bold headline from The New York Times: Japan defaults on its debts. And, finally, the official said, "Well, OK, but it was only to our enemies."

PAUL SOLMAN: And thus the title of Rogoff and Reinhart's book.

CARMEN REINHART: More money has been lost because of the four words "This time is different" than at the point of a gun.

KENNETH ROGOFF: These are very traumatic events. They have political consequences that you can see for decades. They have profound consequences on how the economy is structured. This is going to influence a whole generation that's been through this.

PAUL SOLMAN: As might this data-drenched scholarly tome that, to the amazement of its authors, has cracked the top 100 bestsellers on

GWEN IFILL: Ken Rogoff and Carmen Reinhart will answer your questions in a special Insider Forum on our Web site,