Bank crises -- How long can they last?

Make no mistake about it. The credit crisis of 2007-08 is not a mortgage crisis but a banking crisis. It is not an isolated problem albeit the subprime mortgage crisis is the root cause. You can define banks in the traditional way or through the shadow banking system of financial intermediaries but the decline in credit is affecting all parts of the financial system and should be looked at in the context of as banking crisis. Bear Stearns, while not technically a bank, saw a classic bank run. The lack of liquidity or funding could not be stemmed because the asset on the balance sheet could not be converted to cash fast enough.

We should look beyond the financial history of the United States and view this bank crisis in the context of other global banking crises. We do have information on other banking crises and can use it to gauge what may be the potential length of the current US problem. These banking crises do not end overnight. The process may take years and they have not been limited to developing countries. The last banking crisis in the US was the savings and loan debacle which lead to the RTC as a bailout mechanism. A table of the banking crises in developed countries shows that they can last about a year as a median, but on average will take much longer to solve. If you measure the crisis as starting in August 2007, we have a long way to go to solve this credit crunch. The average crisis will last around 4 years.

Glick and Hutchinson (1999), two authors who have written extensively on the issue, define a banking crisis as a situation where at least one of the following conditions holds: i) the ratio of non-performing assets to total assets is greater than 2% of GDP; ii) the cost of the rescue operation is at least 2% of GDP; iii) banking sector problems result in large-scale nationalization of banks; and iv) extensive bank runs lead to emergency measures.

By their standard, we may be early in defining this as a full- fledged banking crisis, but we are showing all of the signs. The non-performing loans as a percentage of all mortgages may hit their criteria. The rescue operation is only beginning but if we follow the lead of some presidential candidates the cost to taxpayers could be substantial. While there may not be nationalization, we are heading toward more banking regulation as evidenced by the Treasury proposal for more Fed powers. The extensive bank runs and potential failures have already led to emergency powers for the Fed.

Do not expect any quick solutions; however like other banking crisis what will be notable will be the uneven impact on a economy. We are already seeing some this. The Midwest which never had the housing excesses is less affected than other parts of the country. Banks which followed traditional lending practices have good balance sheet and are thriving. All this means is that volatility will be greater and there will be greater differentiation across companies and asset sectors.

Appendix B from “Asset price crises and banking crises: some empirical evidence- Anne Vila; Bank of England Banking crises using qualitative identification method (after Glick and Hutchinson (1999))

Canada 1983-1985
Denmark 1987-1992
Finland 1991-1994
France 1994-1995
Germany 1978-1979
Italy 1990-1995
Japan 1992-1997
Norway 1987-1993
Spain 1977-1985
Sweden 1990-1993
United Kingdom 1975-1976; 1984-1984
United States 1980-1992