1929 v 1008: Similar forces at work decades apart

15 Oct 2008

By The Record

Historians, financial experts and economists are split on the significance of the current financial crisis.


The Depression: This photo taken in 1936 at a pea-pickers’ camp in California is among the iconic images of the Great Depression. Part of the “Migrant Mother” series by photographer Dorothea Lange, the image shows Florence Thompson and two of her children. Photo: CNS/Library of Congress


By Dennis Sadowski
Historian Douglas Astolfi points to three periods of “incredible greed” on the part of wealthy corporations in American history.
The first occurred in the 1870s during a speculative boom following the Civil War. He identifies the Roaring ‘20s as the second as investors leveraged stocks to secure loans from banks to buy more stocks while the stock market took off in the post-World War I period.
And the third?
We’re living through it right now, said Astolfi, professor of history at St Leo University in St Leo, Florida.
Astolfi told Catholic News Service the latest period has been fueled by three decades of financial deregulation and a banking industry that encouraged people to buy on credit because there was plenty of money to be made off a housing bubble which no one thought would ever burst.
When the first two periods collapsed – marked by the panic of 1873 and the failure of the banking system that led to the Great Depression, respectively – the country faced tremendous hardship, especially among poor and working-class people.
It’s a bit different today, Astolfi explained, because the US government instituted protections under President Franklin Roosevelt’s New Deal in the 1930s. Steps such as federally insuring bank deposits and establishing the Securities and Exchange Commission were meant to protect the broad population from bearing the brunt of the excesses of others.
The economy has always recovered, growing robust and allowing the vast majority of people to live comfortable lives. Experts across the board credit the regulations governing financial activities as one step toward returning balance between the top of the economic ladder and the rest of the country.
Still, the question looms today: Is another depression on the way?
It’s possible, but highly unlikely in the minds of historians, economists and financial experts at several US Catholic colleges and universities. While massive consumer debt and the inability to repay it has fueled today’s financial crisis as it did nearly 80 years ago, various protections are in place that – so far – have prevented a catastrophic economic recession in the world’s largest economy.
“We hope that it’s not going to be the same,” said Kevin Forbes, chairman of the business and economics department at The Catholic University of America in Washington.
“But when people hear the term the Great Depression they usually think of the ‘29 stock-market crash. But that was only a small part of it. It’s the consensus of economists that the stock-market crash was bad, but it probably would have created only a small downturn in the economy.
“What really did us in was the collapse of the banking system,” he told CNS.
That explains why US officials jumped in so quickly in September to propose a US $700 billion bailout plan to save several banks and major financial institutions staggering under the weight of worthless mortgage-backed securities.
By pouring money into the economy to buy the securities gone bad now that the housing bubble has burst, the federal government is hoping to stave off a financial collapse.
Federal Reserve Chairman Ben Bernanke, widely acknowledged as an expert on the Great Depression, knows that history well. He and Treasury Secretary Henry Poulson walked in lock step as they took their plan to the White House and to the US Congress, convincing both that action now was preferable to letting the financial system fail.
The government action, which found President George W. Bush signing the bailout bill passed by Congress on October 3, came quickly, just two weeks after Poulson, a former CEO at Goldman Sachs, submitted his rescue plan.
The unusually fast action is in direct contrast to the government’s tight money policy in response to the 1929 stock-market crash, which symbolises the start of the Great Depression.
The boom in the market prior to the crash was fueled by speculators. The bull market was so strong that investors were borrowing money. However, as early as 1923 banks were failing, setting the stage for Black Thursday, October 24, 1929.
Without an infusion of funds at that time, the banking system had no cash to lend, stifling business activity. Depositors lined up at their bank’s doors demanding to withdraw their life savings. By 1933, 40 percent of the nation’s banks failed and millions of people had lost their life savings.
Today, the danger of lost bank accounts has disappeared because of the existence of the Federal Deposit Insurance Corporation, one of many economic reforms under the New Deal, said Joan Junkus, associate professor of finance at DePaul University in Chicago. The October 3 bailout legislation boosted the amount of deposits covered by government insurance from US $100,000 to US $250,000 per account.
On the other hand, the stock market has lost nearly 40 per cent of its value since its October 2007 peak. While it’s nowhere near as devastating as the 90 per cent decline in stock values in the 33 months after Black Thursday, the plummeting market is having repercussions worldwide.
Even with the bailout, banks and other financial institutions face a long path to solvency. And there’s some talk that US $700 billion may not be enough.
“That number is so enormous, to think of it as insufficient is frightening,” Astolfi said. “If that were the case then I think we’d move toward a crisis. There’s an awful lot of politicians and average people who just can’t see spending any more than that.”
Despite the broad support in the US for government intervention, opposition to interference with the market exists. Among those who urge a hands-off policy by the government is Larry Scheikart, professor of history at the University of Dayton in Ohio.
“It’s a cyclical recession brought on by too much bad lending,” he said of current financial conditions. But he quickly added that the current economic downturn is not “officially a recession.”
“The market will sort itself out if these guys don’t get involved,” he said.
He also blamed two other groups for the economy’s woes: those who signed for loans knowing they could not afford them and members of the US Congress who “stiff armed” lenders to expand lending opportunities to lower income people.
“There’s not a crisis in confidence in the market today,” he said. “There’s a crisis in government. The government has repeatedly screwed up.”
Still, the rescue plan is widely seen as just the first step toward rebuilding a lacklustre economy.
Forbes of Catholic University said steps to regulate the banking industry again are necessary to prevent the abuses that developed over the last decade.
“They have to,” he said. “If all they do is pass this bill and then walk away, then they’ve really done us a disservice.”
In particular, Forbes added, new safeguards will have to be put in place to prevent the aggressive practices segments of the mortgage industry used to entice people to buy into loans they eventually could not afford.
“It has to get to the point where there are standard criteria to get your mortgage approved, that the person originating the mortgage has to have some skin in the game so if the mortgage goes bad there’s some downside risk,” he explained.