Learning From The Financial Crisis and Stock Market Crash

Two of the leading economists on financial crises wrote an essay on lessons that should be learned from the financial crisis. They include lessons that never should have been forgotten but that policymakers didn’t remember at key moments of the crisis.

Financial crises do so much economic damage for a simple reason: they destroy a lot of wealth very fast. Typically, crises start when the value of one kind of asset begins to fall and pulls others down with it. The original asset can be almost anything, as long as it plays a large role in the wider economy: tulips in seventeenth-century Holland, stocks in New York in 1929, land in Tokyo in 1989, houses in the United States in 2007.

From their peak at the end of 2006 to their nadir at the beginning of 2009, U.S. house prices fell so far that the average American homeowner lost the equivalent of more than a year’s worth of disposable income. The destruction of wealth was about 50 percent larger than that resulting from the previous major financial shock, the technology stock crash in 2000. The bursting of the tech bubble led to a brief and shallow downturn. The collapse of house prices triggered something far more serious. The crucial difference lay in the form of wealth destroyed.