Archive for September, 2012

This Time Is Different

September 29, 2012 Leave a comment

Cover of "This Time Is Different: Eight C...I would like to bring your attention to an excellent book: This Time Is Different: Eight Centuries of Financial Folly. It’s written by two econometricians: Carmen Reinhart of the University of Maryland, and her research partner at Harvard, Kenneth Rogoff. Anyone who enjoys reading book-length academic treatises should not miss this. I mean that in the most genuine and unironic way.

Reinhart and Rogoff have spent years compiling one of the most comprehensive econometric databases in existence dealing with financial crises (typically in the form of sovereign or bank debt defaults). The data incorporates not only modern databases, but also older primary sources like the League of Nations archives, and individual researcher data going back as far as the 1300’s. The results of their massive undertaking are posted online for public consumption. It is truly an impressive achievement.

Once the data was compiled, the researchers used it to examine the nature of financial crises throughout history. The authors are quick to point out that this type of data-driven approach is rather novel in economics. Similar to psychology, the study of economics is classically theory-driven. Practitioners in the field most typically form elegant and impressive theories based on a short swath of experience, and then selectively cite data that validates the theory. This study, by contrast, first assembles a complete data set, and then looks at it dispassionately for patterns that would suggest an inference.

As the title of the book suggests, there are commonalities between financial crises. The core source of commonality between such events seems to be the mistaken notion that “this time is different.” Economic actors either have delusional estimates of the creditworthiness of some debtors, or they believe that some new technology or debt instrument all but eliminates credit risk, or that current rosy financial trends will continue indefinitely (or at least that they have the special knowledge to allow them to exit the market before all the other investors). Whatever the specific belief, they all share this common theme. Our authors submit to us that it is precisely our notion of “this time is different” that is the very reason why this time is no different from any other. Read more…