This time it's different, even though it isn't

"Unprecedented" is fast becoming the adjective of choice when it comes to the current financial farce. No less august reputations than Paul Volker, Forbes magazine and the World Bank have been amongst those making such definitive pronouncements.

Yet any reading of financial history shows that the current mess has fallen neatly into the same stylised template as all the others. So with apologies in advance to the memory of the great Charles Kindleberger, here are the four conditions which seem to be common to bubble formation:

1. Inappropriately accomodative monetary policy.  The gold rush of 1849-1856 leading to crash of 1857, reparations from the Franco-Prussian War in the early 1870s causing the German crisis of 1873; the Fed inflating in 1927 for international reasons leading to 1929; Japan easing to offsett the yeb appreciation in late 80s leading to the Nikkei crash of 1989, Greenspan cutting rates during the Asian crisis of 1997 leading to the tech bust of 2001;
2. Industrial innovation involving some new "change the world" type of technology. Canals in late 18th century UK, railroads during various 19th century manias in the US, autos and radio in the 20s, internet in the 90s.
   
3. Endogenous financial innovation. The joint stock company during the South Sea Bubble, Trust companies in the run up to 1907, Investment Trusts in the run up to 1929;
   
4. Change in regulations US Banking Acts of 1863/1864 for the panic of 1873, Federal Reserve act 1913 leading to the Florida Land bubble of 1924 and arguably even the crash of 1929.
   

Actually, you don't need all four of these ingredients. For example, during this episode we've had no world-changing industrial innovation. But the more we have, the more likely we are to bubble up and we certainly had three of the above. The overly accomodative monetary policy, according to no less an authority than Anna Schwarz occured when central banks world wide (not just the Fed) were very slow to remove the "precautionary" monetary stimulus left in place during the deflation scare of 2002 (we are reassured the same thing won't happen again this time). We had the compounding effect of endogenous financial innovation in the form of hedge funds and the CDS market. And we had arguably the origins of it all in changes in the regulatory regime, one of which was the removal of the 12x leverage ceiling on broker dealers allowing them instead to leverage 30x or even 40x.  

So unprecedented this crisis is not. But is its magnitude unprecedented? I doubt very much if this compares to what the Asian economies had to deal with during their crisis of 1997, where entire nations went bust pretty much over night and the IMF provided the lender of last resort facility only on the condition that recipient countries tightening monetary and fiscal policy. 

Is its magnitude unprecedented in developed economies? I don't think so. What about the Scandinavian real estate/banking collapses in the early 90s? They then, like us today, had a cataclysmic property market collapse which bust the banks, forced massive private sector deleveraging (the bad assets were effectively nationalised in a "bad bank") and decimated aggregate demand. And they then, like us today, were working in a global economy which was completely flat (the Japanese bubble had just burst, the US was living with the after effects of the S&L crisis while Europe was struggling to deal with the high Bundesbank interest rates required by reunification, which would eventually lead to the ERM crisis.)

So ugly as it is (and as a prop trader who's just found himself unwittingly sitting on a land mine I appreciate that this fiasco isn't much fun as well as anyone), I don't think this crisis is inprecedented in form or magnitude. Why do I care? Because the more I think about it the more it seems to me that "unprecedented crisis" is the bear market brother of "this time it's different" which we're all rightly taught to be deeply suspicious of. So I just wonder to what extent it really is ... 

... and then I realise. What I think isn't relevant. None of the above is relevant. Because perception is reality, and the perception among policymakers is that this is all unprecedented. Which means that the stimulus we're now seeing and are about to see in response is also unprecedented. That is very real, and that's what will count ...