history may not repeat, but it does rhyme* looking at the 2000s through a 1930s lens *mark twain

History May Not Repeat, But It Does Rhyme*

Looking at the 2000s through a 1930s Lens*Mark Twain

Mark D. VaughanAmerican University / Economics 639

Vaughan - Eco 639 2 - 26

Disclaimer

The views expressed are mine alone and do not represent official positions of the:

National Credit Union Administration

Ghost of Career Past

Don’t look for a hidden political agenda either!


Everything Old is New Again!


Partisan DistortionEverything Old is New Again

Chicago Tribune

April 21, 1934


Great Depression vs. Great RecessionInteresting Similarities

Both preceded by good economic times.

1921-29: Annual real GNP growth = 4.4% (2 mild recessions)

1982-2007: Annual real GNP growth = 3.2% (2 mild recessions)

Both preceded by era in which Fed was highly regarded.

Both preceded by movement of banks into new business lines.1920s: Banks ramped up real-estate lending/investment banking.

1990s-2000s: Banks ramped up real-estate lending/securitization.

Both preceded by innovations in consumer finance.

1920s: Installment credit

2000s: Mortgage/credit-card lending driven by credit-scoring/securitization


Great Depression vs. Great RecessionInteresting Similarities

Both preceded by asset bubbles.1920s: Florida real estate (mid 1920s); stock market (late 1920s)

1990s-2000s: Tech stocks (late 1990s); housing (mid 2000s)

Both started in U.S., then spread around the world.1930s: Via gold standard

2008-2009: Via exposure to U.S. housing (toxic MBSs)

Both featured high-profile failure perceived as “trigger.”December 1930: Bank of United States

September 2008: Lehman Brothers

Both featured banker/financier bashing.1930s: Andrew Mellon, Pecora Commission

2008-2010: Backlash over bonuses


Great Recession*Length: 18 months*

Industrial production: ↓14.9%*

Rise in unemployment: ↑5.7 percentage points From May 2007 to October 2009 (peak)

Consumer prices: ↑1.5%*

Bank failures: 501 Since Bear Stearns crisis (3/16/08),

5.9% of U.S. banks in March 2008

Stock prices (DJIA): ↓53.8% From market peak (10/9/07)

to market trough (3/9/09)

* Indicator measured from cyclical peak in December 2007 to cyclical trough in June 2009.

Worst since World War II!


Great Contraction*Length: 43 months*

Industrial production: ↓51.7%*

Rise in unemployment: ↑19.3 percentage points 1929 average to 1932 average

Consumer prices: ↓27.2%*

Bank failures: ≈ 9,000 37% of U.S. banks in December

1929

Stock prices (DJIA): ↓89.2% From market peak (9/3/29)

to trough (7/8/32)

* Indicator measured from cyclical peak in August 1929 to cyclical trough in March 1933.

“Great Recession” not close!


Intensity of Great ContractionIt's gonna be cold, it's gonna be grey, and it's gonna last you for the rest of your life.

Industrial production (and Real GDP) did not return to pre-1929 trend until 1942.

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Aug-24 Aug-26 Aug-28 Aug-30 Aug-32 Aug-34 Aug-36 Aug-38 Aug-40 Aug-42

Min

or T

ick

= 1

.0

Minor Tick = 1 Year

Trends in Industrial Production August 1924 - December 1942

Index of Industrial Production (Seasonally Adjusted, 2007 = 100)

Recession

Industrial Production

Pre-1929 Trend Line, Industrial Production

Data SourcesFederal Reserve Bank of St. Louis (FRED)

National Bureau of Economic Research


Great Depression vs. Great RecessionComparing Default Spreads to Gauge Intensity

Default-spread peaked in Great Recession at 0.6 times the Great Depression peak.

Peak (May 1932) = 5.64%

Peak (December 2008)= 3.38%

Current (May 2012)= 0.57%

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Jan-19 Jan-24 Jan-29 Jan-34 Jan-39 Jan-44 Jan-49 Jan-54 Jan-59 Jan-64 Jan-69 Jan-74 Jan-79 Jan-84 Jan-89 Jan-94 Jan-99 Jan-04 Jan-09 Jan-14

Baa

Yie

ld m

inus

AA

A Y

ield

(%)

Minor Tick = 2.5 Years

Default Spreads and the Business CycleYields on Moody's Seasoned Corporate Bonds (Baa - AAA)

January 1919 - July 2014(Monthly Averages of Daily Data)

Recession

Baa - AAA Default Spread

Data Sources

Federal Reserve Bank of St. Louis (FRED)National Bureau of Economic Research

Mean (1919-2014) = 1.19% Recession Mean (1919-2013) = 1.68%Median (1919-2014) = 0.95% Recession Median (1919-2013) = 1.34%

Minor Tick = 25 basis points


Great Depression vs. Great RecessionComparing Unemployment Rates to Gauge Intensity

Unemployment rate exceeded Great Recession peak (10.1%) for better part of 9 years.

3.2%

8.7%

15.9%

23.6%24.9%

21.7%

20.1%

16.9%

14.3%

19.0%

17.2%

14.6%

9.9%

4.7%

1.9%3.2%

8.7%

15.3%

22.5%

20.6%

16.0%

14.2%

9.9%9.1%

12.5%

11.3%

9.5%

6.0%

3.1%

1.8%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943

Min

or T

ick

= 1

Per

cent

age

Poi

nt

Minor Tick = 2.5 Years

Joblessness during the Great DepressionBureau of Labor Statistics (BLS) Unemployment Rates, 1929-1943

Annual Average, with / without (corrected) Federal Emergency Workers Counted as Unemployed

Recession Years

Official BLS Unemployment Rate

Corrected BLS Unemployment Rate

Data SourcesDarby , JPE (1976)

Federal Reserve Bank of St. Louis (FRED)

Peak Post-WWII Unemployment, November/December, 1982 = 10.8%


What Caused the Great Depression?Phase I – The Great Contraction (1929-33)

Early 1928Fed tightened money to stop stock speculation; resulting hike in real interest rates discouraged spending. Construction sector weakened first.

Fall 1929Stock-market crash reduced household wealth/liquidity and increased uncertainty, thereby provoking larger decline in spending.

Fall 1930 - Spring 1933Four banking panics turned a bad recession into a depression. Currency / reserve hording caused money-supply collapse

[M2 ↓ = 35.2% from August 1929 to March 1933]

Real interest rates soared, further depressing spending.

Waves of failures intensified gloom/uncertainty, even further depressing spending.

Failures destroyed lending relationships, depressing spending still further.



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cent

, Min

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ick

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0 B

asis

Poi

nts

Minor Tick = 1 Year

Trends in Real and Nominal Discount RateAugust 1924 - December 1942

Simple Average of Nominal Discount Rates on All Classes of Paper (Federal Reserve Bank of New York) Minus Year-over-Year Change in Consumer Price Index (Urban - All Items)

Recession

Real (Ex Post) Discount Rate

Nominal Discount Rate

Data SourcesFederal Reserve Bank of St. Louis (FRED)National Bureau of Economic Research

Fed tightens money – explicitly and implicitly!



Declines in Interest-Sensitive Spending/Real OutputGreat Contraction vs. Great Contraction (Benchmark)

REAL SPENDING CATEGORY 1930 1931 1932 1933 2008 2009

Consumer Durable Goods -17.2% -13.6% -24.0% -2.6% -5.2% -3.7%

Producer Durable Goods (Plant and Equipment) -17.6% -34.5% -40.1% -9.9% 0.3% -17.1%

Residential Housing -39.2% -16.4% -47.2% -18.3% -24.0% -22.9%

Gross Domestic Product -8.6% -6.5% -13.1% -1.3% 0.0% -2.6%

REAL SPENDING CATEGORY 1930 1931 1932 1933 2008 2009

Consumer Durable Goods -1.6% -1.1% -1.9% -0.2% -0.4% -0.3%

Producer Durable Goods (Plant and Equipment) -1.9% -3.3% -2.8% -0.5% 0.0% -2.0%

Residential Housing -1.5% -0.4% -1.1% -0.2% -1.1% -0.7%

Note: Percentage changes based on 2005 chained dollars; data obtained from Bureau of Economic Analysis, U.S. Department of Commerce

Percentage Change from Prior Year

Percentage Point Contribution to Change in Real GDP from Prior Year



Policy MistakesMortal Sins Fed did not inject liquidity necessary to stop bank panics (1930-33).

– Priority was given to maintaining dollar’s value in gold.

– No panics occurred in New York City.

– Failures were mostly small, non-member banks; viewed as helpful in disciplining risk-taking.

– Impact of currency / reserve hording on money supply was not understood

– Low nominal interest rates seen as evidence money was easy.

– Death of Benjamin Strong (Governor, New York Fed) created power/intellectual vacuum.

Hoover jawboned businesses to maintain wages (late 1929).– Policies premised on flawed “underconsumption” thesis (artificially high wages

explain up to 50% of real-output loss through 1931).

Venial Sins Smoot-Hawley Tariff (1930) Revenue Act of 1932

Not helpful, but not as bad as once thought!


What delayed recovery? → New Deal Policy mistakes

Most New Deal policies harmed the macro-economy. National Industrial Recovery Act (NIRA), Agricultural Adjustment Act (AAA),

National Labor Relations (Wagner Act) → lowered output, raised prices/wages.

Attacks on “economic royalism” → created regime uncertainty.

Tax increases (excise, income, corporate, Social Security) → discouraged work, savings, and

investment.

But some New Deal policies helped the macro-economy. Devaluing dollar (raising price of gold) / leaving gold standard (1933-34)

Licensing banks to re-open (1933) / Creating FDIC (1934)

IRONY: “Key” New Deal policies hurt; “by the way” policies helped!

What Caused the Great Depression?Phase II – The Great Lingering (1933-41)


What delayed recovery?

Another Policy Mistake: Doubling of reserve requirements (1936-37)

– Fed misunderstood record high level of excess reserves.

– Money supply collapsed (again), as did the real economy (again).

↓ M2 = 2.4%* Mean %Δ in post-1959 recessions = ↑7.3%*

↓ Industrial production = 31.8%* Mean %Δ in post-WWII recessions = ↓8.4%* * From May 1937 cyclical peak to June 1938 cyclical trough.

Need to Re-Start Banking / Financial System– Re-establishing credit relationships, acquiring sound collateral took time.

– Bankers reacted to 1930-33 by hording liquidity / avoiding credit risk.

What Caused the Great Depression?Phase II – The Great Lingering (1933-41)


Bankers Have Long Memories (I)Took Years to Stop Hoarding Liquidity

Cash-to-assets ratio did not fall below 1934 level until 1944. Investment-to-loans ratio did not fall below 1934 level until 1952.

Cash/Assets (1934)= 24.1%



Investments/Loans (1934) =124.3%



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1934 1938 1942 1946 1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010

Minor Tick = 2 Years

Trends in Bank LiquidityAll U.S. Commercial Banks, 1934-2013

(Year-end Balance-Sheet Data)

Recession

Cash & Due / Total Assets

Investments / Total Loans

DATA SOURCES

FDIC, Historical Statistics on BankingNational Bureau of Economic Research

Investments/Loans (%)Minor Tick = 25.0%

Cash/Assets (%)Minor Tick = 2.5%


1934 = 3.42%

1975 = 0.55%

1991 = 1.60%

2002 = 1.07%

2006 = 0.39%

2010 = 2.69%

2013 = 0.68%

-0.25%

0.25%

0.75%

1.25%

1.75%

2.25%

2.75%

3.25%

3.75%

1934 1938 1942 1946 1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010

Net

Cha

rge-

Off

s (L

oans

& L

ease

s) /

Tot

al L

oans

& L

ease

s (%

)


Cyclical and Secular Trends in Asset QualityAggregate Charge-Off Rate (Net Charge-Offs / Total Loans)

All U.S. Commercial Banks, 1934-2013(December Balance-Sheet Figures)

Recession

Net Charge-Off Rate

DATA SOURCES

FDIC, Historical Statistics on BankingNational Bureau of Economic Research

Minor Tick = 25 basis points

Bankers Have Long Memories (II) Took Years to Get Comfortable with Credit Risk


What Ended the Great Depression?

“Accidentally” Expansionary Monetary Policy Apart from 1937-38 recession, growth was impressive.

Average annual real GDP growth, 1933-1937 = 9.0%

Average annual real GDP growth, 1938-1941 = 10.6%

Leaving gold standard / devaluing dollar plus Hitler’s rise to power combined to produce rapid monetary growth.

Devaluation raised nominal value of U.S. gold reserves / attracted gold to U.S.

Political anxiety in Europe produced a “flight to quality” / more gold flowed to U.S.

Gold boosted monetary base / banks turned additional base into additional money

Average annual growth, monetary base (1933-41) = 13.1% [1982-2007 average = 6.6%]

Average annual growth, M2 (1933-41) = 9.2% [1982-2007 average = 5.5%]

Why?


Great Depression vs. Great RecessionKey Differences

Dodging the Bullet! Presidential transition was smooth, cooperative.

GD: Election in November; inauguration in March; banking system collapses as FDR rebuffed Hoover.

GR: Election in November; inauguration in January; Obama and Bush administrations worked together.

Wealth of data / economic expertise was available.GD: Few real-time numbers to guide policy, no grasp of modern macroeconomics / money multiplier.

GR: Fed headed by foremost economic student of Great Depression (Ben Bernanke).

Federal government responded with stimulus (?)GD: Federal deficit as a percentage of GDP, 1929-1941 average = 1.3%

GR: Federal deficit as a percentage of GDP, 2009 = 8.9%

Focus remained on banking.GD: Plight of small, non-member banks ignored (some large banks, too) ignored until 1933.

GR: Policies targeted at recapitalizing banks / certifying strength.

Federal Reserve provided ample liquidity → KEY GD: Somewhat “passive” Fed allowed M2 to fell 35.2% between August 1929 – March 1933.

GR: Wide-open discount window / multiple liquidity facilities stabilized financial system; between December 2007 and June 2009, M2 rose 12.5%.


Fed Provided Ample Liquidity

Average excess reserves since advent of financial crisis exceed 500 times pre-crisis average.

September 2001(9/11) = $24.8 billion

$0.0

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Jan-29 Jan-35 Jan-41 Jan-47 Jan-53 Jan-59 Jan-65 Jan-71 Jan-77 Jan-83 Jan-89 Jan-95 Jan-01 Jan-07 Jan-13

Minor Tick = $100 Billion


EXCESS RESERVES OF DEPOSITORY INSTITUTIONS*January 1929 - May 2013

Billions of May 2013 Dollars; Converted with Consumer Price Index (All Items), Neither Series Seasonally Adjusted

Recession

Real Excess Reserves

Prior Excess Reserves High, October 1940 = $114.2 billion- Shock from Banking Crises- Weak Loan Demand- Low Short-Term Interest Rates

Average Real Excess Reserves of Depository Institutions, January 1953- August 2008 = $2.3 billion

DATA SOURCESBoard of Governors of the Federal Reserve System Federal Reserve Bank of St. Louis (FRED)National Bureau of Economic Research

*Depository institutions subject to Federal Reserve reserve requirements.

Post-August 2008 Maximum,May 2013 = $1,863.3 billion


Intermediate-Term Outlook The Economy

Sluggish Growth!

Monetary policy has done all it can do.– On the bright side, 1930s deflation did not happened.

Bank lending apt to recover slowly.– Dodd-Frank and continuing regulatory uncertainty discourage risk-taking.

– Recapitalizing takes time.

– Interest on reserves provides attractive alternative to lending.

– “Other shoe” could drop, thereby making liquidity insurance valuable (Greece and parallel to 1931 Creditanstalt failure).


Intermediate-Term Outlook The Economy

Sluggish Growth!

Anti-supply policies will impair recovery.– “Obamacare” taxes job creation.

– Increase in minimum wage taxes job creation.

– Extension of unemployment compensation discourages job search.

Economic/policy uncertainty will impair recovery.All the following will encourage businesses to defer putting capital at risk…

– Uncertainty about timetable for phasing in Obamacare.

– Uncertainty about fiscal policy due to structural deficits.

– Uncertainty about macro prospects for Euro-zone.


Source: “Measuring Economic Policy Uncertainty” by Scott Baker, Nicholas Bloom and Steven J. Davis, September 2011

Index of Economic/Policy Uncertainty Currently at Post-1985 High!


Any Good News?

This is a great time to be an economist!

2013

History May Not Repeat, But It Does Rhyme:

Lessons from the 1930s for the 2000s?

Questions over

Mark D. VaughanAmerican University / Economics 639

history may not repeat, but it does rhyme* looking at the 2000s through a 1930s lens *mark twain

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