Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when the enterprise becomes the bubble in a whirlpool of speculation.

—John Maynard Keynes,
The General Theory of Employment Interest and Money

Asset market collapses are deep and prolonged, and the depth and duration of the slump that invariably follows severe financial crises, as we are seeing now, tend to be repetitive and protracted affairs. And this is not simply because history has an uncanny knack of repeating itself either as tragedy or farce, or because we are given to frequent bouts of financial euphoria that inevitably leads to financial disasters. Not surprisingly, banking crises with profound declines in output and employment have much to do with financial profligacy that is justified with the four most dangerous words in finance, This Time is Different, that forms the title of Carmen Reinhart and Kenneth Rogoff's classic study of Eight Centuries of Financial Folly (Princeton University Press, $35), the best empirical investigation of financial crises in recent years.

Reinhart and Rogoff are professors of economics at Maryland and Harvard and this book is addressed to the academic with a textbook approach to the subject but with one big difference that would make it relevant to the serious common reader as well: all the key chapters conclude with a summary that tells the reader what it is all about, which means that with a back-to-front approach, you can figure out how to make your way through what you are looking for. And it is conveniently divided into six sections, with sub-sections, for easy reference: Financial Crises: An Operational Primer; Sovereign External Debt Crisis; The Forgotten History of Domestic Debt and Default; Banking Crisis, Inflation, and Currency Crashes; The US Sub-prime Meltdown and the Second Great Contraction; and concludes with What Have We Learned. This is followed by the usual academic paraphernalia of tables, charts and diagrams that illustrate the text.

The book provides a quantitative history of financial crises in their various guises prefaced by precise definitions of concepts describing such crises. If there is one common theme to the vast range of crises covered in the book, it is that excessive debt accumulation, whether it be by government, banks, corporations, or consumers, often poses greater systemic risks than it seems when things are seemingly going well.

Most of the focus is on two particular forms of crises that are relevant today: sovereign debt crises and banking crises. Sovereign debt crises that were commonplace among the now-advanced economies "appear to have graduated from periodic bouts of government insolvency". In emerging markets, recurring default remains a chronic disease. Banking crises, in contrast, remain a recurring problem affecting both rich and poor countries. The empirical analysis covers 66 countries over nearly eight centuries based on a massive database which looks at "long spans of history to catch sight rare events" that first gave indications of a growing financial crisis.

What conclusions can we arrive at with this massive data and subsequent analysis? First, all financial crises have common macroeconomic antecedents as well as common patterns that appear in the sequencing in which crises unfold. What is clear is that again and again, countries, banks, individuals and firms take on excessive debt in good times without enough awareness of the risks that will follow when recession hits. Many players in the global financial system often take on a debt far larger than they can reasonably expect to escape from, most famously in the US and its financial system in the late 2000s. Government-guaranteed debt is highly problematic because it can accumulate massively and for long periods without being put in check by markets, especially where regulation prevents them from effectively doing so. This is what sparked the sub-prime crisis in the US which led to the global financial crisis we are going through now.

Second, can an early warning system with improved macro-supervision of current data prevent future meltdowns? For instance, can the links between banking and external debt crises or between inflation and debt crisis provide the wake up call for a looming crisis?

Yes, both can be used as early warning systems but there is nothing that can guarantee against the foibles of human nature which is the nub of the problem. In both the present crisis and "the eight centuries of financial folly" it wasn't the lack of indicators that brought on the crises; it was human nature to speculate excessively that was the cause. In his short little classic, A Short History of Financial Euphoria (1993), John Kenneth Galbraith tells us how human greed was behind all the financial bubbles, including The Great Crash, 1929, that set off the Great Depression. That greed hasn't disappeared; if anything, it is stronger than ever before. Obviously, we have learned nothing and forgotten nothing.