history may not repeat, but it does rhyme* looking at the 2000s through a 1930s lens *mark twain
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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. - PowerPoint PPT PresentationTRANSCRIPT
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!
Vaughan - Eco 639 3 - 26
Everything Old is New Again!
Vaughan - Eco 639 4 - 26
Partisan DistortionEverything Old is New Again
Chicago Tribune
April 21, 1934
Vaughan - Eco 639 5 - 26
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
Vaughan - Eco 639 6 - 26
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
Vaughan - Eco 639 7 - 26
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!
Vaughan - Eco 639 8 - 26
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!
Vaughan - Eco 639 9 - 26
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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2.0
4.0
6.0
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10.0
12.0
14.0
16.0
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
Vaughan - Eco 639 10 - 26
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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0.50
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1.50
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2.50
3.00
3.50
4.00
4.50
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5.50
6.00
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
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
Vaughan - Eco 639 11 - 26
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%
Vaughan - Eco 639 12 - 26
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.
Vaughan - Eco 639 13 - 26
What Caused the Great Depression?Phase I – The Great Contraction (1929-33)
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Aug-24 Aug-26 Aug-28 Aug-30 Aug-32 Aug-34 Aug-36 Aug-38 Aug-40 Aug-42
Per
cent
, Min
or T
ick
= 10
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!
Vaughan - Eco 639 14 - 26
What Caused the Great Depression?Phase I – The Great Contraction (1929-33)
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
Vaughan - Eco 639 15 - 26
What Caused the Great Depression?Phase I – The Great Contraction (1929-33)
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!
Vaughan - Eco 639 16 - 26
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)
Vaughan - Eco 639 17 - 26
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)
Vaughan - Eco 639 18 - 26
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%
Cash/Assets (1940)= 37.2%
Cash/Assets (2013)= 11.9%
Investments/Loans (1934) =124.3%
Investments/Loans (1945) =384.2%
Investments/Loans (2013) =37.6%
0.0%
50.0%
100.0%
150.0%
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300.0%
350.0%
400.0%
0.0%
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35.0%
40.0%
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%
Vaughan - Eco 639 19 - 26
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 (%
)
Minor Tick = 2 Years
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
Vaughan - Eco 639 20 - 26
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?
Vaughan - Eco 639 21 - 26
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%.
Vaughan - Eco 639 22 - 26
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
$200.0
$400.0
$600.0
$800.0
$1,000.0
$1,200.0
$1,400.0
$1,600.0
$1,800.0
$2,000.0
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
Minor Tick = 3 Years
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
Vaughan - Eco 639 23 - 26
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).
Vaughan - Eco 639 24 - 26
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.
Vaughan - Eco 639 25 - 26
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!
Vaughan - Eco 639 26 - 26
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