Transcript Vaughan_Great Depression

History May Not Repeat,
But It Does Rhyme*
Looking at the 2000s through a 1930s Lens
*Mark Twain
Mark D. Vaughan
American University / Economics 639
Disclaimer
The views expressed are mine alone and
do not represent official positions of the:
 National Credit Union Administration
Don’t look for a hidden political agenda either!
Ghost of Career Past
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Everything Old is New Again!
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Partisan Distortion
Everything Old is New Again
Chicago
Tribune
April 21, 1934
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Great Depression vs. Great Recession
Interesting 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
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Great Depression vs. Great Recession
Interesting 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
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Great Recession*
 Length:
18 months*
 Industrial production:
 Rise in unemployment:
↓14.9%*
↑5.7 percentage
points
 Consumer prices:
 Bank failures:
↑1.5%*
501
 Stock prices (DJIA):
From May 2007 to October 2009 (peak)
↓53.8%
Since Bear Stearns crisis (3/16/08),
5.9% of U.S. banks in March 2008
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!
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Great Contraction*
 Length:
43 months*
 Industrial production:
↓51.7%*
 Rise in unemployment:
↑19.3 percentage
points
 Consumer prices:
↓27.2%*
 Bank failures:
≈ 9,000
 Stock prices (DJIA):
↓89.2%
1929 average to 1932 average
37% of U.S. banks in December 1929
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!
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Intensity of Great Contraction
It's gonna be cold, it's gonna be grey, and
it's gonna last you for the rest of your life.
Trends in Industrial Production
August 1924 - December 1942
Index of Industrial Production (Seasonally Adjusted, 2007 = 100)
16.0
14.0
12.0
Pre-1929 Trend Line,
Industrial Production
Minor Tick = 1.0
10.0
8.0
6.0
Recession
Industrial Production
4.0
Data Sources
Federal Reserve Bank of St. Louis (FRED)
National Bureau of Economic Research
2.0
0.0
Aug-24
Aug-26
Aug-28
Aug-30
Aug-32
Aug-34
Aug-36
Aug-38
Aug-40
Aug-42
Minor Tick = 1 Year
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Industrial production (and Real GDP) did not return to pre-1929 trend until 1942.
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Great Depression vs. Great Recession
Comparing Default Spreads to Gauge Intensity
Default Spreads and the Business Cycle
Yields on Moody's Seasoned Corporate Bonds (Baa - AAA)
January 1919 - July 2014
Minor Tick = 25 basis points
(Monthly Averages of Daily Data)
6.00
Peak (May 1932) = 5.64%
5.50
5.00
Data Sources
Federal Reserve Bank of St. Louis (FRED)
National Bureau of Economic Research
Baa Yield minus AAA Yield (%)
4.50
4.00
Peak (December 2008)
= 3.38%
3.50
3.00
2.50
2.00
1.50
1.00
0.50
Recession
Current (May 2012)
= 0.57%
Baa - AAA Default Spread
0.00
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
Minor Tick = 2.5 Years
Mean (1919-2014) = 1.19%
Median (1919-2014) = 0.95%
Recession Mean (1919-2013) = 1.68%
Recession Median (1919-2013) = 1.34%
Default-spread peaked in Great Recession at 0.6 times the Great Depression peak.
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Great Depression vs. Great Recession
Comparing Unemployment Rates to Gauge Intensity
Joblessness during the Great Depression
Bureau of Labor Statistics (BLS) Unemployment Rates, 1929-1943
Annual Average, with / without (corrected) Federal Emergency Workers Counted as Unemployed
25.0%
24.9%
23.6%
Recession Years
21.7%
22.5%
Official BLS Unemployment Rate
Corrected BLS Unemployment Rate
20.6%
Minor Tick = 1 Percentage Point
20.0%
20.1%
15.9%
19.0%
17.2%
16.9%
16.0%
15.0%
15.3%
14.6%
14.3%
14.2%
12.5%
10.0%
9.9%
8.7%
9.9%
11.3%
9.1%
8.7%
9.5%
Peak Post-WWII Unemployment,
November/December, 1982 = 10.8%
6.0%
5.0%
3.2%
4.7%
3.2%
Data Sources
1.9%
3.1%
Darby , JPE (1976)
Federal Reserve Bank of St. Louis (FRED)
1.8%
0.0%
1929
1930
1931
1932
1933
1934
1935
1936
1937
1938
1939
1940
1941
1942
1943
Minor Tick
= 2.5 Years
Unemployment rate exceeded Great Recession peak (10.1%) for better part of 9 years.
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What Caused the Great Depression?
Phase I – The Great Contraction (1929-33)
Early 1928
Fed tightened money to stop stock speculation; resulting hike in real
interest rates discouraged spending.
 Construction sector weakened first.
Fall 1929
Stock-market crash reduced household wealth/liquidity and increased
uncertainty, thereby provoking larger decline in spending.
Fall 1930 - Spring 1933
Four 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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What Caused the Great Depression?
Phase I – The Great Contraction (1929-33)
Trends in Real and Nominal Discount Rate
August 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)
16.00
12.00
Recession
Real (Ex Post) Discount Rate
Nominal Discount Rate
Percent, Minor Tick = 100 Basis Points
8.00
4.00
0.00
Aug-24
Aug-26
Aug-28
Aug-30
Aug-32
Aug-34
Aug-36
Aug-38
Aug-40
Aug-42
-4.00
-8.00
-12.00
Data Sources
Federal Reserve Bank of St. Louis (FRED)
National Bureau of Economic Research
-16.00
Minor Tick = 1 Year
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Fed tightens money – explicitly and implicitly!
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What Caused the Great Depression?
Phase I – The Great Contraction (1929-33)
Declines in Interest-Sensitive Spending/Real Output
Great Contraction vs. Great Contraction (Benchmark)
Percentage Change from Prior Year
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%
Percentage Point Contribution to Change in Real GDP from Prior Year
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
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What Caused the Great Depression?
Phase I – The Great Contraction (1929-33)
Policy Mistakes
Mortal 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
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Not helpful, but not as
bad as once thought!
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What Caused the Great Depression?
Phase II – The Great Lingering (1933-41)
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!
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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.
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Bankers Have Long Memories (I)
Took Years to Stop Hoarding Liquidity
Trends in Bank Liquidity
Cash/Assets (%)
All U.S. Commercial Banks, 1934-2013
Minor Tick = 2.5%
Investments/Loans (%)
(Year-end Balance-Sheet Data)
Minor Tick = 25.0%
400.0%
40.0%
Cash/Assets (1940)
= 37.2%
Investments/Loans (1945)
=384.2%
35.0%
Recession
Cash & Due / Total Assets
Investments / Total Loans
30.0%
300.0%
25.0%
250.0%
Cash/Assets (1934)
= 24.1%
20.0%
200.0%
15.0%
10.0%
5.0%
Cash/Assets (2013)
= 11.9%
Investments/Loans (1934)
=124.3%
150.0%
100.0%
50.0%
DATA SOURCES
FDIC, Historical Statistics on Banking
National Bureau of Economic Research
0.0%
Cash-to-assets ratio did not fall below 1934 level until 1944.
1934 1938 1942 1946 1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010
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350.0%
Investment-to-loans ratio did not fall below 1934 level until
1952.
Investments/Loans (2013)
=37.6%
0.0%
Minor Tick = 2 Years
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Bankers Have Long Memories (II)
Took Years to Get Comfortable with Credit Risk
Cyclical and Secular Trends in Asset Quality
Aggregate Charge-Off Rate (Net Charge-Offs / Total Loans)
All U.S. Commercial Banks, 1934-2013
Minor Tick = 25 basis points
(December Balance-Sheet Figures)
3.75%
Recession
Net Charge-Off Rate
Net Charge-Offs (Loans & Leases) / Total Loans & Leases (%)
1934 = 3.42%
3.25%
2010 = 2.69%
2.75%
2.25%
1991 = 1.60%
1.75%
1.25%
2002 = 1.07%
DATA SOURCES
FDIC, Historical Statistics on Banking
National Bureau of Economic Research
2013 = 0.68%
0.75%
1975 = 0.55%
0.25%
1934
-0.25%
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2006 = 0.39%
1938
1942
1946
1950
1954
1958
1962
1966
1970
1974
1978
1982
1986
1990
1994
1998
2002
2006
2010
Minor Tick = 2 Years
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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%
Why?
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%]
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Great Depression vs. Great Recession
Key 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%.
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Fed Provided Ample Liquidity
EXCESS RESERVES OF DEPOSITORY INSTITUTIONS*
Minor Tick =
$100 Billion
$2,000.0
January 1929 - May 2013
Billions of May 2013 Dollars; Converted with Consumer Price Index (All Items), Neither Series Seasonally Adjusted
Recession
$1,800.0
Post-August 2008 Maximum,
May 2013 = $1,863.3 billion
Real Excess Reserves
$1,600.0
$1,400.0
$1,200.0
$1,000.0
$800.0
$600.0
$400.0
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
$200.0
September 2001
(9/11) = $24.8 billion
$0.0
Jan-29
Jan-35
Jan-41
Jan-47
Jan-53
DATA SOURCES
Board of Governors of the Federal Reserve System
Federal Reserve Bank of St. Louis (FRED)
National Bureau of Economic Research
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Jan-59
Jan-65
Jan-71
Jan-77
Jan-83
Jan-89
Jan-95
Jan-01
Jan-07
Jan-13
Minor Tick = 3 Years
*Depository institutions subject to Federal Reserve reserve requirements.
Average excess reserves since advent of financial crisis exceed 500 times pre-crisis average.
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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).
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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.
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Index of Economic/Policy Uncertainty
Currently at Post-1985 High!
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Source: “Measuring Economic Policy Uncertainty” by Scott Baker,
Nicholas Bloom and Steven J. Davis, September 2011
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Any Good News?
2013
This is a great time to be an economist!
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Questions
over
History May Not Repeat,
But It Does Rhyme:
Lessons from the 1930s for the 2000s?
Mark D. Vaughan
American University / Economics 639