Monday, October 8, 2007

Is the Mortgage Mess a Big Deal?

There is low level of anxiety surrounding the mortgage market and the ramifications this might have for the economy in the U.S. as a whole (and to a lesser extent, on the economies of other countries). People seem concerned that we will experience some kind of dramatic recession, slamming the brakes on the growth of the U.S. I just thought of providing a little perspective on how bad things could get.

Let's assume that this mortgage crisis really is a debilitating financial event. Let's assume that financial markets seize up, credit becomes non-existent, and the Fed does exactly the wrong things at exactly the wrong time (whatever that is). Let's assume, in other words, that we experience another Great Depression. Over the worst four years of the GD (1930-1933), output fell by 8.6%, 6.4%, 13.0%, and 1.3% before starting to grow again in 1934. GDP per worker in these four years fell to only about 73% of its level in 1929. So in four years, one quarter of your income disappeared.

So if income fell to 73% of its 2006 level over the next 4 years, where would that leave us? About as rich as Japan or France. Did we lose a lot of money? Yes. Are we staring at a cultural and economic disaster of epic proportions? No. Even if we re-live the worst four years of our economic history, we'd still be drinking Starbucks and buying Halo III.

How about if we had back to back four year episodes like the GD? Now income would only be 73% x 73% = 53% of our current income. We'd be as poor as those desperate souls in --- Greece. Or Portugal. Or South Korea. Again, catastrophic losses in income, but the world is not coming to the end. We'd still have cars, phones, computers, movies, etc. The country wouldn't dissolve into some state of nature where we hunted our own food and had to defend our caves with stone implements.

If we go on and consider a string of N straight four year periods matching the Great Depression, this is how we'd move down the list of income per capita:
1 GD: Japan, France
2 GD: South Korea, Greece, Portugal
3 GD: Estonia, Hungary
4 GD: Botswana
5 GD: Turkey, Thailand
6 GD: Algeria, Venezuela
7 GD: Paraguay, Gabon
8 GD: India, Honduras
12 GD: Nigeria, Congo, Zambia

In other words, we'd have to live through 48 years of continual economic disaster to reach the state of Nigeria, Congo, or Zambia. The chances of ONE Great Depression happening again have to be extremely low, so the chances of 12 happening in succession is just ludicrous. So when contemplating the possible economic ramifications of the mortgage mess, or any other recession/panic/crisis that arises in the macroeconomy, let's keep our heads about us and recall that we'll still be fantastically rich (on average - of course there would be distributional issues, but that's for another post).

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