Don't Panic: An Economist On 2 Centuries Of Severe Economic Downturns

Don't Panic: An Economist On 2 Centuries Of Severe Economic Downturns

What helped spur the 2008 financial crisis — or for that matter, what were the major causes of panics over the last two centuries? Rutgers University Economics Professor Hugh Rockoff tried to answer this question by delving into the history books.

In a National Bureau of Economic Research paper, he found that panics were caused by 1) a short series of failures, often perpetuated by shadow banks (or less regulated institutions) and 2) excessive investment in real estate by investment firms that previously held significant public trust. By way of example, several panics — those of 1854, 1857 and 1873 — were due to overinvestment in railroads.

Financial panics, Rockoff’s paper explains, “are like the explosion of a bomb,” distorting the financial system with excessive speculation. Much of the source of that speculation lies in real estate because it’s relatively easy money to come by, and is historically a constant source of profit due to westward expansion (which often included theft and genocide), and development of suburban and urban areas, wrote the author.

“Lots of fortunes (were) being made, and that always encourages others to get into the act, and sometimes to get carried away,” Rockoff said in an email to Benzinga.

A panic begins to materialize when investors, due to fear of volatility in the markets, attempt to protect themselves by flipping their assets into cash.

This causes a cascading effect, Rockoff said, incentivizing other investors to do the same, draining banks of liquidity.

Much of the time, people don’t anticipate panics because the institutions that help manifest them are trustworthy. Even as Lehman Brothers saw its stock dropping, it was ranked second among securities firms in 2007. In 2008, the company filed for bankruptcy.

Posted In: Financial PanicsEducationEconomicsGeneral