The sluggish recovery, as GOP candidate Mitt Romney repeatedly notes, pales in comparison to previous comebacks in the U.S. economy since World War II, but studies show that recessions resulting from major financial collapses such as the one in October 2008 usually have slow and difficult recoveries.
“A severe financial crisis chills economic performance for a very long time,” said Vincent R. Reinhart, chief economist at Morgan Stanley and co-author of a study covering the 15 worst financial crises in the second half of the 20th century.
He found that the U.S. economy, while experiencing a “little ice age” as a result of the monumental housing bust and banking crisis in October 2008, is actually doing somewhat better than most crisis-struck countries.
“The financial crisis wiped out the equivalent of almost two years’ worth of income from household balance sheets in 2008 and 2009” because of the collapse by more than a third in housing prices and the loss of nearly half the stock market’s value at that time, he said.
Beyond the unprecedented loss of wealth for the middle class, nearly a third of U.S. homeowners got stuck with houses worth less than they paid and ended up over their heads in debt with mortgages that borrowers often could not refinance because they had no equity.
That led to an unprecedented wave of defaults and millions of foreclosures that hurtled the housing market into depression territory and continues to hold it back.
Banks, hobbled by breathtaking losses, cut back drastically on credit to consumers and businesses, while consumers sharply cut spending as they braced for layoffs and scrambled to recover from their loss of wealth. The legacy of such heavy debts and losses continues to weigh on banks and consumer spending to this day, Mr. Reinhart noted.
Moreover, the federal government also went deeply into debt in a bid to limit the damage to banks and consumers and coax the economy back from recession. Efforts to stem the hemorrhaging of federal debt are likely to further hold back growth for years to come, he said.
“This harsher climate is a familiar feature after a severe financial crisis,” he said. In fact, the tepid 2.2 percent average growth rate that the U.S. has eked out since the recession ended in July 2009 is actually better than what most countries experienced.
The study Mr. Reinhart co-wrote with his wife, Carmen Reinhart of Harvard University, found that economies struck by a major financial crisis typically went into deep and long recessions, followed by shallow recoveries.
It took on average about five years from the onset of the crisis for the economy to achieve the healthier pace of growth experienced before the crisis. In 10 of 15 cases, the unemployment rate never fell to its pre-crisis levels. A stunning half of the countries studied experienced two recessions within a decade.
Studies by the International Monetary Fund have also found a pattern of anemic and difficult recovery in nations suffering from major financial crises.
President Obama, under constant assault from Mr. Romney for the poor economic performance during his term, has defended himself by citing these studies.
“Keep in mind that some of this is us just working through a very, very deep worldwide financial-based recession,” he said recently on the campaign trail. “You guys are probably familiar with some of the work that’s been done on this.
“Recessions that follow a financial crash of some sort, including the popping of the housing bubble, are not regular recessions. They’re not your typical business cycle recession.”