1929 vs. 2008 news article

I thought this was at least a fairly level headed article. There is a lot of craziness in comparisons lately, but it's good to at least look at history for lessons for the present.


Run-up to Great Depression and today's recession havesome eerie similarities, but many important differences
By Dean Calbreath
UNION-TRIBUNE STAFF WRITER

October 5, 2008

On the campaign trail, Republican vice-presidential nominee Sarah Palin worries aloud that the nation “could be on that path” to the Great Depression. Her Democratic rival, Joe Biden, compares this year's election to the Depression-era clash between Herbert Hoover and Franklin Roosevelt.


Associated Press
Stockbrokers at the New York Stock Exchange on Oct. 25, 1929, the day after "Black Thursday."


Associated Press
Traders Peter Edelson (right) and John Porcelli Jr. worked the NYSE floor last week.
On Capitol Hill, politicians argue that last week's $700 billion bailout was necessary to stave off the threat of another depression.

On Wall Street, bearish market analysts have been arguing for months that a repeat of 1929 is possible. “It seems to me a near certainty that we're about to enter something I have long called 'The Greater Depression,' ” Doug Casey, author of the best-selling “Crisis Investing,” warned subscribers to his newsletter last week.

Most economists downplay the idea that we're approaching another depression. The general consensus is that even though we are almost certainly in a recession, the downturn will not reach the depths of the Great Depression, in which one in four Americans lost their jobs, hundreds of factories shut their doors and thousands of banks closed as depositors pulled out their money.

There are, after all, a number of important differences between 1929 and 2008, including government safeguards created in the 1930s to prevent a similar collapse from occurring again.

The Federal Deposit Insurance Corp. stands ready to prevent the type of bank run that marked the true beginning of the Great Depression. Thanks to changes introduced over the past two weeks, the FDIC guarantees bank deposits of up to $250,000, as well as the health of the nation's money market funds.

Unemployment insurance, another 1930s innovation, is designed to prevent Americans from going homeless or hungry after losing their jobs. The program typically offers at least six months' pay to jobless workers, but because of the recent spike in layoffs, Congress last week extended the pay by seven to 13 weeks.

Nevertheless, some of the similarities between 1929 and 2008 are eerie.

Not unlike today, the crash of 1929 was preceded by a decade of deregulation, cheap credit, housing bubbles, rising inflation, rampant stock market speculation, faltering employment, stagnant wages and a growing gap between the wealth of executives on Wall Street and the cash-strapped consumers on Main Street.

To jump-start the economy after a recession in 1920-21, the Federal Reserve slashed interest rates, similar to what then-Fed Chairman Alan Greenspan did following the recession of 2001.

Although wages for most workers were stagnant during the 1920s, Americans tried to keep pace with rising inflation by borrowing money. They used credit for such newfangled gadgets as cars, radios, refrigerators, washers, dryers and vacuum cleaners.

Lawrence Mishel, who heads the Economic Policy Institute, said that such overreliance on credit – similar to the recent reliance on credit cards and home equity loans – could not be sustained over the long run.

“You can't run an economy without having enough income for workers to spend on consumption,” Mishel said. “It's important to grow an economy the old-fashioned way: earning money, and then spending what you've earned.”

As in the recent past, the cheap credit in the 1920s led to a housing boom, fueled by five-year, balloon-payment mortgages. When the mortgages came due, the homeowners had the choice of paying the balance, refinancing, selling the property or going into default – similar to the choices facing adjustable-rate mortgage holders today.

Of course, as long as interest rates were low and real estate prices were going up, there was no reason to default. A mania for real estate developed, especially in Florida and Southern California.

In San Diego, for instance, the total value of building permits jumped 80 percent between 1920 and 1926. The supply of homes soon outstripped demand. In 1927, five times as many homes were built in San Diego as were sold. Home values dropped and construction faltered. Between 1927 and 1928, the value of building permits in San Diego plummeted 86 percent.

By 1929, homeowners could not keep up with their payments. Months before the stock market crashed, home-sale ads in The San Diego Union were full of phrases such as “price slashed,” “must sacrifice all,” “big reduction” and “must sell immediately.”

“Asking 60 percent of what property is worth,” a homeowner in Hillcrest wrote back then. “Any offer above 1/2 considered.”

By that point, the “smart money” of investors and speculators had left the housing market in favor of the stock market – a reverse of what happened this decade, when the smart money left the stock market after the dot-com crash of 2000-01 and started flooding the housing market.

The speculators were aided by the close ties between banks and Wall Street investment firms. When the home mortgage market was drying up, banks built a new line of business by lending money to stock investors.

Using this borrowed cash, the speculators furiously bid up share prices. Between December 1927 and December 1928, the Dow Jones industrial average jumped 50 percent, from a record-breaking 200 points to an even more astounding 300 points. Money from foreign investors – mostly English and Canadians, instead of today's Chinese, Saudis and Japanese – flooded the market.

By early 1929, the skyrocketing prices caused a number of economists to worry that a bubble was forming in the stock market, fueled by credit. The Fed tried to choke off speculative trading by raising interest rates on the loans that investors used to buy stocks.

In late summer 1929, stock prices began to fall. Banks stopped lending to investors, jacked up interest rates to cover the risk and began calling in loans. This credit crunch accelerated the downturn on Wall Street, just like the current credit crunch, which is related to fears about the value of mortgage-backed securities.

Between September and October 1929, the market lost 40 percent of its value. The decline continued through 1933, when the Dow was 89 percent below its peak. Hundreds of companies went out of business. Others were forced to shed workers. Jittery bank customers, concerned about the safety of the financial system, cashed out their savings accounts, causing widespread bank failures.

With those runs on banks, which occurred months after the stock market collapsed, the Great Depression had begun.

Most economists doubt that the nation could see a repeat of that kind of economic collapse.

Most important, economists say, Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke have studied the Depression and are working to avoid its pitfalls. Bernanke's studies concluded that the Great Depression could have been blunted if the government had pumped more money into the financial system.

Bolstered by that belief, Bernanke and Paulson have adopted a much more activist stance than their counterparts did in the 1930s – pumping hundreds of billions of dollars into the market, bailing out failing financial firms and keeping interest rates low to ward off a credit crunch.

Ross Starr, an economist at the University of California San Diego who knew Bernanke during his days at Stanford in the 1980s, said that if the Fed had not taken the type of action it has in recent months, “you would be faced with a lot of businesses going under and a rise in bankruptcies, since capital could not be mobilized to help the economy.”

Under a best-case scenario, Starr said, the economy may be in a recession that lasts through the end of this year or the beginning of 2009. “If we're lucky, that's all we'll get,” he said. “But if we're unlucky, it will probably be the worst thing we've seen since the 1940s.”

Indeed, some economists warn that even some of the steps the government has taken could lead to a different set of economic problems.

For instance, the multibillion-dollar bailouts and low interest rates could lead to a spike in inflation. And Congress' decision to float a $700 billion bailout bill while introducing multibillion-dollar tax breaks could rob the next president of the ability to introduce New Deal-like economic stimulus programs.

Instead of a depression, then, some economists say our current situation could be more analogous to the oil-related “stagflation” of the 1970s, which haunted the presidencies of Gerald Ford and Jimmy Carter; or the collapse of the Tokyo real estate and stock markets in the early 1990s, leading to a “lost decade” for the Japanese economy.

“Comparing 1929 to 2008 is a bit like comparing a Model T to a 2008 Chevy,” said Sung Won Sohn, an economist at California State University Channel Islands. “They're both cars, but that doesn't mean they're both the same.”

Dean Calbreath: (619) 293-1891; dean.calbreath@uniontrib.com