U.S. Economic Crisis: History and Warning Signs

Protect Yourself from the Next One

U.S. Economic Crisis
Falling home prices triggered the last U.S. economic crisis. Photo: David McNew/Getty Images

Definition: A U.S. economic crisis is a severe and sudden upset in one part of the economy. It could be a stock market crash, a spike in inflation or unemployment, or a series of bank failures. They have long-lasting effects. They don't always lead to a recession.

The United States seems to have an economic crisis every 10 years or so. They are difficult to eradicate because their causes are always different.

The results are always the same. They include high unemployment, near-bank collapse, and an economic contraction. These are all symptoms of a recession. But an economic crisis doesn't have to lead to a recession if it's addressed in time. 

Economic Crisis History

These six economic crises help you recognize the warning signs of the next one. You'll see when government action prevents complete economic collapse, and when it makes things worse.  

2008 Financial CrisisThe first warning came in 2006 when housing prices started falling and mortgage defaults began rising. The Federal Reserve and most analysts ignored it. They welcomed a slowdown in the over-heated housing market. By 2007, the subprime mortgage crisis hit. Lenders had allowed too many people to take out subprime mortgages. When they defaulted, the banks called in their credit default swaps. That drove insurance companies like AIG to bankruptcy.

By mid-summer, banks stopped lending.

In 2008, the Fed stepped in to keep Bear Stearns and AIG afloat. The U.S. Treasury nationalized mortgage guarantors Fannie Mae and Freddie Mac to keep the housing market afloat. But they could not help investment bank Lehman Brothers. Its bankruptcy caused a global banking panic.

The Dow fell 770 points, its worst one-day drop ever. Frightened companies withdrew a record $140 billion from their money market accounts. Within weeks, companies no longer have the cash to operate. Congress approved a $700 billion bailout package to restore confidence, and prevent an economic collapse. See Financial Crisis Compared to the Depression and Other Crises.

9/11 AttacksThe attacks on Wall Street stopped air traffic. The NYSE did not open on 9/11. It remained closed until 9/17. On that day, the Dow dropped 617.70 points. There was no warning for the general public. The crisis threw the United States back into the 2001 recession, extending it until 2003. Some of this was not because of the attacks themselves. It was due to uncertainty about whether the United States would go to war. The resultant War on Terror added $1.3 trillion to the national debt.

1989 Savings and Loan CrisisCharles Keating and other unethical bankers created this crisis. They raised capital by using Federally insured deposits for risky real estate investments. Five Senators accepted campaign contributions in return for decimating the bank regulator so it couldn't investigate the criminal activities.

There was no warning to the general public since the banks lied about their business dealings. The S&L Crisis resulted in 1,000 bank closures, a recession in Texas, and bailout that added $126 billion to the national debt. See 10 Booms and Busts Since 1980.

1981 Recession. High interest rates to curb inflation created the worst recession since the Great Depression. President Ronald Reagan cut taxes and increased spending to end it. That doubled the national debt during his eight years in office.

1970s StagflationThe 1973 OPEC oil embargo signaled the start of this crisis. The government's reaction turned it into a full-fledged crisis of double-digit inflation AND recession. Prices sky-rocketed after President Nixon untied the dollar from the gold standard. He froze wages and prices. That made businesses lay off workers who couldn't lower wages or increase prices.

 Federal Reserve Chairman Paul Volcker used contractionary monetary policy to end the crisis. He raised interest rates to stifle inflation. The warning signal was the announcements from OPEC and Nixon over their proposed disruptive actions.

The Great Depression of 1929The first warning was a bubble in the stock market. Wise investors could have started taking profits in the summer of 1929. In October, the 1929 stock market crash kicked off the Depression.  The Fed used contractionary monetary policy to protect the value of the dollar, then based on the gold standard. Instead, that created massive deflation. As prices dropped, many manufacturers went out of business. The Dust Bowl contributed to famine and homelessness, helping to drive the unemployment rate to 25 percent, and housing prices down 31 percent. The cycle was finally resolved by massive government spending on social programs and World War II, driving the debt-to-GDP ratio to a record 126 percent. See Could the Great Depression Happen Again?

Is the United States on the Brink of Another Crisis?

Modern U.S. economic history predicts the next crisis will occur in 2018 - 2020. That doesn't tell you where it will come from, what the result will be, and how to defend yourself. What would have protected you in previous crises might be the worst thing to do in the next one. You must watch for the warning signals. See Will the Next Stock Market Crash Cause a Recession?

The first sign is an asset bubble. In 2008, it was housing prices. In 2001, it was high-tech stock market prices. In 1929, it was the stock market. It's usually accompanied by a feeling that "everyone" is getting rich beyond their wildest dreams by investing in this asset class.

The next warning is the "get rich quick" ads everywhere. You feel like you're being left out. And, this is true for some time leading up to the crash. That's the nature of an asset bubble.

The third symptom is the experts and books calling for prosperity beyond imagination. They all predict that "this time it's different." It's called irrational exuberance. It could last for months, or even a year or two. But it never lasts forever.

How to Protect Yourself

 Prepare now by immediately taking the following five steps.

  1. Pay off all credit card debt.
  2. Save three to six months' worth of living expenses. That will cushion you if you lose your job.
  3. Find a financial planner you would trust with the key to your house.
  4. Work with your adviser to create a customized financial plan that meets your specific needs. That will determine your asset allocation. Make sure you have a diversified portfolio.
  5. Rebalance the allocation once or twice a year. That means regularly skimming off profits from the investments that have grown the most, and plunging them into the asset class that's weak. That automatically ensure you "buy low and sell high." It also protects you from losing too much when the crisis hits.