History tells us that government intervention is often ineffective.
Bernard: I don't think Sir Humphrey (the Cabinet Secretary) understands economics, Prime Minister. He did read Classics, you know.
Hacker: What about Sir Frank? He is the Head of the Treasury.
Bernard: He's at an even greater disadvantage of understanding economics: he's an economist.
From Yes, Prime Minister
I'm not an economist, so I might be able to do better than the Treasury's top civil servant, but that's not saying much. I've been looking back at financial crises of the last few decades to see if there are any patterns.
Two things most financial crises have in common
Most of the major crises have begun with excessive lending, usually private lending. Furthermore, most crises are also preceded by a bubble of some sort. Exceptions often revolve around government actions, such as joining the exchange rate mechanism in 1990, which in short order led to Black Wednesday.
That most financial crises are caused by excessive lending probably doesn't surprise you. What may or may not surprise you are the effects of measures taken to control these crises.
Japan's 1990s banking crisis
Japan's property and stock market collapse, and recession, from the beginning of the 90s is well known, but what's less well known is that it was largely based on a pile of increasingly risky debt that continued to mount for many years after the crash began. Japan had loans on top of loans and investments on top of loans on top of investments.
Attempts to get out of its troubles included zero interest rates, quantitative easing and subsidising failing banks (sound familiar?) but if these had any effect it was not to pull Japan out of its long slump. Considering that Tokyo's properties are valued now at roughly a tenth of what they were twenty years ago but the city is still featuring in most lists of the top five most expensive cities, it could well be that it just never fell far enough, which is perhaps why it's still not recovered.
In the papers I've been reading this year, Japan's situation is the one that has been compared most often to our own in terms of how they tried and failed to deal with their problems. One major difference that you might choose to cling to is that Japan didn't -- and still doesn't -- have inflation targets.
Mexico's 1994 financial crisis
Again, uncontrollable and risky debts, which weren't helped by corrupt banks, were the real cause of Mexico's problems.
The attempted cure was a dodgy kind of IOU that the Government could never hope to fulfil in the long run. Let's hope that our Government doesn't have to resort to the same.
In the end Mexico was bailed out by the US, which I don't believe is going to help the UK in this crisis!
Asian financial crisis of the mid-1990s
Personal debt based on risky loans led to the collapse of several bubbles and to recession. It was triggered when the US started putting up interest rates (after recovering from a crisis of its own) and therefore attracted back much of the foreign money that had been supporting the region.
To fight the flight of money, many of the affected countries tried to put up interest rates and to buy their own currency, but they could not sustain this. In the end, their actions perhaps led to much worse problems as they had no reserves to help pay for their debts -- which grew in real terms as their currencies plummeted. The IMF wanted to help, but only if they took the opposite action that we're taking now, namely to try to maintain high interest rates. It still didn't work.
It's interesting that IMF bailout money was only granted on the basis that bankrupt banks would be allowed to fail.
One more similarity
The nub of all this is that attempts to prevent crises seem mostly to be useless or even to make the situation worse, at best defer some of the worst effects. Now that we're coming to the end of much of our stimulus measures (according to most economists I've been reading anyway) it may be that we'll see the crisis re-emerge as it's finally allowed to run its course.
We may still have problems ahead of us and I can't say that would be surprising considering the long debt binge our nation has been on.
A quick exit
The most thorough economists who've researched this issue seem to agree that there is no huge pattern to the speed and shape of recovery following a financial crisis.
On the positive side, it seems fairly common for a rapid recovery, yet (returning swiftly to the negative side) it is also the norm that making up for the lost output during this time can take many years. This may mean that we'll be relying on another bubble to keep share prices rising over the next few years.
Notice I stopped short of actually making a forecast.
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