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The four most dangerous words in finance are "this time is different." Market participants always manage to believe that some new innovation, such as decoupling or credit default swaps, has made the next crisis impossible. In their new book just released in September, This Time Is Different: Eight Centuries of
Download Audio as MP3 Financial Folly (Princeton University Press, 2009), Carmen M. Reinhart of the University of Maryland and Kenneth Rogoff of Harvard University probe an array of crises to show why these beliefs eventually prove to be false. In short, it is never truly different.
At this AEI event, Ms. Reinhart and Mr. Rogoff will discuss their book, and Stijn Claessens of the International Monetary Fund, Alex J. Pollock of AEI, and Allan H. Meltzer of AEI and Carnegie Mellon University will discuss the authors' findings.
|10:00||Presenters:||Carmen M. Reinhart, University of Maryland|
|Kenneth Rogoff, Harvard University|
|Discussants:||Stijn Claessens, International Monetary Fund|
|Allan H. Meltzer, AEI and Carnegie Mellon University|
|Alex J. Pollock, AEI|
|Moderator:||Vincent R. Reinhart, AEI|
Washington, DC 20036
Washington, DC 20036
WASHINGTON, OCTOBER 29--The current international economic crisis is the first global crisis since the Great Depression but it is unlikely to be the last. Prior to the crisis, increased confidence by central bankers, policy makers, and financial engineers convinced investors that crises were things of the past. At an AEI event on October 29, economist Carmen Reinhart discussed her book, written with Kenneth Rogoff, This Time is Different: Eight Centuries of Financial Folly (Princeton University Press, 2009). In the book they show that this delusion is perennial and always false.
Reinhart, a professor of economics at the University of Maryland, said a common thought among market participants in the months leading up to the current crisis was "Those rules apply to you, not to me, so I can ignore precedent." Reinhart also said that nations adopt this mindset. The authors' new historical data reveals that even developed countries are culpable for past offenses. "Nobody has a real clean bill of health with us; we've brought out everyone's dirty laundry," said Reinhart.
Reinhart argued that the massive spike in house prices should have signaled the coming crisis. Rogoff and Reinhart find that rising house prices are a more reliable indicator of a banking crisis than changes in stock prices or in the current account. While some countries, such as Austria, did not experience large domestic house price increases, they invested in foreign real estate bubbles that contributed to domestic financial crises.
Alex Pollock, a resident scholar at AEI, recognized these signs but warned against blaming stupidity. "In the run-up to crises, very plausible arguments are made by credible, highly placed people." Stijn Claessens, an International Monetary Fund economist, also explained that crisis damage is underestimated. "Politicians see these as nuisances," said Claessens, and do not act strongly enough to prevent them.
The authors criticize financial innovators for falling prey to the idea that "this time is different" as they have in this crisis. The surprise that hit Wall Street and high-ranking officials such as former Federal Reserve Chairman Alan Greenspan is a symptom of this effect. According to Reinhart, there were many signs, including a run-up of private debt and growing financial innovation, pointing to a coming crisis.
Reinhart and Rogoff have created a massive new dataset that that spans 800 years of financial information, much of it previously unavailable. This includes new domestic debt data. Although external debts across nations are well documented by several sources, data on domestic debts are scarce and underdeveloped. After drawing on the existing records, including records of private debt, the authors were able to build an impressive set of data.
Allan H. Meltzer, a visiting scholar at AEI and a professor at Carnegie Mellon University, called the data "illuminating." However, he also said the authors did not draw sufficient conclusions on institutional problems. Meltzer pointed out that a problem associated with finding the debt of an economy is often government obfuscation.
Many of the recent crises described in the book occur in developing countries but Reinhart and Rogoff see their relevance for the United States. Writing about the American stock markets prior to the crisis, the authors explained, "Outsized financial market returns were in fact greatly exaggerated by capital inflows, just as would be the case in emerging markets." This claim builds upon work on the risk of large international capital flows by Reinhart and AEI resident scholar Vincent Reinhart.
In a question and answer session following the presentation, Reinhart responded to a question about the ability to establish new legal safeguards with concern that governments may fail to make credible their promises on how they will react to crises. Meltzer proposed that such commitment is difficult but possible. He explained that the United States ran fiscal surplus for most of it history but has changed course, believing that this time is different. "We've given that up because we think that we are smart enough to avoid those restrictions. I think that we are learning that we need some rules to govern our behavior."
Stijn Claessens is an assistant director of research at the International Monetary Fund, where he heads the financial studies division. Mr. Claessens worked for fourteen years at the World Bank in various positions and taught for three years at the University of Amsterdam, where he remains a professor of international finance policy. Mr. Claessens has provided policy advice to emerging markets in Latin America and Asia and to transition economies. His research has been published in the Journal of Financial Economics, The Journal of Finance, and The Quarterly Journal of Economics, among others. He has edited several books, including Resolution of Financial Distress (World Bank Institute, 2001) and A Reader in International Corporate Finance (World Bank, 2006). He is an editor at the Journal of Financial Services Research; a fellow at the Centre for Economic Policy Research, the European Corporate Governance Institute, and the Asian Institute of Corporate Governance; and a member of the advisory board of the Millstein Center for Corporate Governance and Performance at Yale University.
Allan H. Meltzer is a visiting scholar at AEI and the Allan H. Meltzer Professor of Political Economy and Public Policy at Carnegie Mellon University. He studies monetary policy and history, tax and budget issues, international finance, and financial services. He was chairman of the International Financial Institution Advisory Commission, which issued its final report to Congress in 2000. Mr. Meltzer is the author of the monumental two-volume History of the Federal Reserve (University of Chicago Press), the second volume of which is due out in January 2010.
Alex J. Pollock has been a resident fellow at AEI since 2004, focusing on financial policy issues, including housing finance, government-sponsored enterprises, retirement finance, corporate governance, accounting standards, and the banking system. Previously, he spent thirty- five years in banking, including twelve years as president and chief executive officer of the Federal Home Loan Bank of Chicago. He is the author of numerous articles on financial systems and the organizer of the "Deflating Bubble" series of AEI conferences. In 2007, he developed a one-page mortgage form to help borrowers understand their mortgage obligations. He is a director of Allied Capital Corporation, the Chicago Mercantile Exchange, the Great Lakes Higher Education Corporation, the International Housing Union for Housing Finance, and the chairman of the board of the Great Books Foundation.
Carmen M. Reinhart is the coauthor of This Time Is Different: Eight Centuries of Financial Folly (Princeton University Press, 2009). Ms. Reinhart is a professor of economics and director of the Center for International Economics at the University of Maryland. Ms. Reinhart held positions as chief economist and vice president at the investment bank Bear Stearns in the 1980s. Subsequently, she spent several years at the International Monetary Fund. She is a research associate at the National Bureau of Economic Research, a research fellow at the Centre for Economic Policy Research, and a member of the Council on Foreign Relations. Ms. Reinhart has been published on a variety of topics in macroeconomics and international finance and trade in scholarly journals such as American Economic Review, the Journal of Political Economy, and the Quarterly Journal of Economics.
Vincent R. Reinhart is a resident scholar at AEI. A former director of the Federal Reserve Board's Division of Monetary Affairs, he has spent more than two decades working on domestic and international aspects of U.S. monetary policy. Mr. Reinhart held a number of senior positions in the Divisions of Monetary Affairs and International Finance and served for the last six years of his Federal Reserve career as secretary and economist of the Federal Open Market Committee. Mr. Reinhart worked on topics as varied as economic bubbles and the conduct of monetary policy, auctions of U.S. Treasury securities, alternative strategies for monetary policy, and the efficient communication of monetary policy decisions.
Kenneth Rogoff is the coauthor of This Time Is Different: Eight Centuries of Financial Folly (Princeton University Press, 2009). Mr. Rogoff is the Thomas D. Cabot Professor of Public Policy at Harvard University. From 2001 to 2003, Mr. Rogoff served as chief economist and director of research for the International Monetary Fund. Mr. Rogoff's 1996 book with Maurice Obstfeld, Foundations of International Macroeconomics (MIT Press, 1996), remains a standard reference guide. Mr. Rogoff writes a monthly syndicated column, The Unbound Economy, and is a frequent commentator elsewhere in print and television.