Dysfunctional capital markets, frantic central banks, stressed-out consumers, fear and uncertainty – all these are alarming echoes of the global economic cataclysm of the 1930s. Which raises the inevitable question: Could another Great Depression be lurking over the horizon?
TV news programs show grainy footage of Depression-era bankers as reporters tick off grim economic statistics. The Federal Reserve invokes powers it hasn’t used since the 1930s. Critics of President Bush’s economic policies are emboldened to use the “H” word: “Hoover.”
On the surface, there are disquieting parallels between economic conditions in the early 1930s and those of 2008. There was the popping of an enormous asset bubble – stocks then, housing now.
And, as in the Depression, the financial system is in disarray. It was symbolized back then by the failure of thousands of banks, mostly small local outfits – 2,300 in 1931 alone. The parallel today is the crippling of onetime giants such as Bear Stearns, Countrywide Financial and Ameriquest Mortgage.
Many economists believe the United States will find it almost impossible to avert a recession, if one has not started already. Housing remains mired in a deep slump, with some analysts projecting that Southern California home values, for example, could plunge 40 percent from their peaks in 2007. The Commerce Department reported this week that new residential building permits nationwide plummeted 36.5 percent in February from a year ago.
Then, as now, stock prices were highly volatile. The S&P 500 Index, which fell more than 56 percent from 1928 through 1940, nevertheless recorded four up years in that span, including a 46.5 percent gain in 1933.
The shadow of the ’30s looms over every economic downturn or crisis, no matter how modest. Pundits loved to invoke the Depression as a cautionary model during the stock market crash of 1987, the bailout of hedge fund Long-Term Capital Management in 1998 and the dot-com meltdown of 2000 and 2001.
But there are differences between the 1930s and today. U.S. unemployment reached 25 percent during the Depression; in February 2008, it was reported at 4.8 percent. The worldwide industrial economy was in a shambles in the 1930s because of World War I. Today, it is coming off a global boom.
“I’ve been asked many times whether we will have another Great Depression,” says David M. Kennedy, a Stanford University history professor and author of “Freedom From Fear,” a Pulitzer Prize-winning history of the Depression and World War II.
“My standard answer is that we won’t have that one again – I’d be surprised to have one of that seriousness and duration. But that doesn’t mean we wouldn’t have a catastrophe we haven’t seen before.”
The biggest difference
Economists and historians say the most important difference between today’s economic environment and that of the old days is the governmental response.
“There’s a perception now that you don’t stand around at the central bank and whack people with a ruler for making bad decisions,” says Robert Brusca, chief economist at New York-based Fact and Opinion Economics. “Instead, you do something.”
Nothing demonstrates that as vividly as the Fed’s orchestration of the takeover of Bear Stearns by JPMorgan Chase last weekend. The deal staved off a possible Bear Stearns bankruptcy, which the central bank feared might traumatize financial systems worldwide.
The resolution was in stark contrast to the Fed’s role in the 1930 collapse of the Bank of the United States, a New York bank largely serving Jewish immigrants. The failure was then the largest in American history, and the Fed’s inability to arrange a rescue by Wall Street banks – including J.P. Morgan, predecessor of the “white knight” in the Bear Stearns case – caused a cataclysmic loss of confidence in the entire national banking system. That fueled a banking panic that modern historians regard as a key cause of the Depression.
The Fed’s relative powerlessness in 1930 led directly to New Deal reforms that expanded its authority. Some of its new powers, such as the ability to lend directly to brokers and investment banks, were seldom or never used until the current crisis.
Bernanke’s expertise
Fed Chairman Ben Bernanke, an expert in the Fed’s Depression-era history, is knowledgeable about the instruments at its disposal in a crisis.
In a 2002 speech – he was then a member of the bank’s Board of Governors but not yet chairman – he outlined a number of drastic steps the Fed could take in extreme conditions and still remain within its legal authority.
But as Fed Vice Chairman Donald L. Kohn conceded in testimony before a Senate committee this month, the most serious challenges before the Fed and other policy-makers generally arise not from scenarios that can be forecast, but from the unforeseen.
Brusca adds that the most dangerous behavior often occurs just beyond regulators’ reach – in the hedge fund industry, to use a contemporary example.
“We have a far more extensive regulatory network now,” he says, “but it’s always the unregulated sector that pushes change. Does it make sense to put a capital ratio rule on banks, but let them have an unregulated hedge fund?”
There are also limits to what monetary policy – the Fed’s responsibility – can achieve on its own to forestall a drastic economic downtown. President Franklin D. Roosevelt’s administration not only reformed the Fed, but experimented with stimulative fiscal policy, too.
New Deal programs aimed at staving off a wave of home foreclosures may be especially relevant today. Among the most important was the Home Owners Loan Corp., which is one of several models for homeowner relief being considered by Congress.
Starting in 1933, the corporation took over 1 million residential mortgages in default, worked to keep the owners in their homes, and made new loans to strapped mortgage holders. When the agency was liquidated in 1951, it even returned a small profit to the U.S. Treasury.
