*Mark Twain
American University / Economics 639

Ghost of Career Past
Vaughan - Eco 639

National Credit Union Administration
Don’t look for a hidden political agenda either!
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April 21, 1934
Partisan Distortion
Everything Old is New Again
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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:
2000s:
Installment credit
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:
1990s-2000s:
Florida real estate (mid 1920s); stock market (late 1920s)
Tech stocks (late 1990s); housing (mid 2000s)
 Both started in U.S., then spread around the world.
1930s:
2008-2009:
Via gold standard
Via exposure to U.S. housing (toxic MBSs)
 Both featured highprofile failure perceived as “trigger.”
December 1930: Bank of United States
September 2008: Lehman Brothers
 Both featured banker/financier bashing.
1930s:
2008-2010:
Andrew Mellon, Pecora Commission
Backlash over bonuses
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 Length: 18 months
*
 Industrial production: ↓ 14.9% *
 Rise in unemployment: ↑ 5.7 percentage points
 Consumer prices:
 Bank failures:
↑ 1.5% *
501
From May 2007 to October 2009 (peak)
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!
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 Length: 43 months
*
 Industrial production: ↓ 51.7% *
 Rise in unemployment: ↑ 19.3 percentage points
 Consumer prices:
 Bank failures:
↓ 27.2% *
≈ 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
10.0
Pre-1929 Trend Line,
Industrial Production
8.0
6.0
Recession
Industrial Production
4.0
2.0
Data Sources
Federal Reserve Bank of St. Louis (FRED)
National Bureau of Economic Research
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0.0
Aug-24 Aug-26 Aug-28 Aug-30 Aug-32 Aug-34 Aug-36 Aug-38 Aug-40
Minor Tick = 1 Year
Aug-42
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
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Default Spreads and the Business Cycle
Yields on Moody's Seasoned Corporate Bonds (Baa - AAA)
January 1919 - July 2014
(Monthly Averages of Daily Data)
Minor Tick = 25 basis points
6.00
5.50
5.00
4.50
4.00
3.50
3.00
2.50
2.00
Peak (May 1932) = 5.64%
Data Sources
Federal Reserve Bank of St. Louis (FRED)
National Bureau of Economic Research
Peak (December 2008)
= 3.38%
1.50
1.00
Recession
0.50
Baa - AAA Default Spread
Current (May 2012)
= 0.57%
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
25.0%
20.0%
15.0%
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
23.6%
22.5%
24.9%
21.7%
Recession Years
Official BLS Unemployment Rate
Corrected BLS Unemployment Rate
20.6% 20.1%
19.0%
17.2%
15.9% 16.9%
16.0%
15.3% 14.6%
14.2% 14.3%
12.5%
10.0%
5.0%
3.2% 3.2%
0.0%
1929
8.7%
1930
8.7%
Peak Post-WWII Unemployment,
November/December, 1982 = 10.8%
Data Sources
Darby , JPE (1976)
Federal Reserve Bank of St. Louis (FRED)
1931 1932 1933 1934 1935
9.9%
1936 1937
9.1%
1938
11.3% 9.9%
1939
9.5%
6.0%
1940
3.1%
4.7%
1.9%
1.8%
1941 1942
Minor Tick
= 2.5 Years
1943
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
8.00
Recession
Real (Ex Post) Discount Rate
Nominal Discount Rate
4.00
0.00
Aug-24
-4.00
Aug-26 Aug-28 Aug-30 Aug-32 Aug-34 Aug-36 Aug-38 Aug-40 Aug-42
-8.00
-12.00
Data Sources
Federal Reserve Bank of St. Louis (FRED)
National Bureau of Economic Research
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-16.00
Minor Tick = 1 Year
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)
REAL SPENDING CATEGORY
Consumer Durable Goods
Producer Durable Goods (Plant and Equipment)
Residential Housing
Gross Domestic Product
1930
-17.2%
1931
-13.6%
Percentage Change from Prior Year
1932 1933
-24.0% -2.6%
REAL SPENDING CATEGORY
Consumer Durable Goods
Producer Durable Goods (Plant and Equipment)
Residential Housing
Note:
Percentage changes based on 2005 chained dollars; data obtained from Bureau of Economic Analysis, U.S. Department of Commerce
2008
-5.2%
2009
-3.7%
-17.6%
-39.2%
-8.6%
-34.5%
-16.4%
-6.5%
-40.1%
-47.2%
-13.1%
-9.9%
-18.3%
-1.3%
0.3%
-24.0%
0.0%
-17.1%
-22.9%
-2.6%
Percentage Point Contribution to Change in Real GDP from Prior Year
1930 1931 1932 1933 2008 2009
-1.6%
-1.9%
-1.5%
-1.1%
-3.3%
-0.4%
-1.9%
-2.8%
-1.1%
-0.2%
-0.5%
-0.2%
-0.4%
0.0%
-1.1%
-0.3%
-2.0%
-0.7%
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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
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!
Vaughan - Eco 639
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What Caused the Great Depression?
Phase II – The Great Lingering (1933-41)
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% *
↓ Industrial production = 31.8% *
Mean % Δ in post-1959 recessions = ↑ 7.3%*
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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Took Years to Stop Hoarding Liquidity
Cash/Assets (%)
Minor Tick = 2.5%
40.0%
Cash/Assets (1940)
= 37.2%
35.0%
30.0%
Trends in Bank Liquidity
All U.S. Commercial Banks, 1934-2013
Investments/Loans (1945)
=384.2%
(Year-end Balance-Sheet Data)
Investments/Loans (%)
Minor Tick = 25.0%
400.0%
Recession
Cash & Due / Total Assets
Investments / Total Loans
350.0%
300.0%
25.0%
Cash/Assets (1934)
= 24.1%
20.0%
250.0%
200.0%
15.0%
Cash/Assets (2013)
= 11.9%
150.0%
100.0% 10.0%
Investments/Loans (1934)
=124.3%
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5.0% 50.0%
DATA SOURCES
FDIC, Historical Statistics on Bank ing
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
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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Took Years to Get Comfortable with Credit Risk
Minor Tick = 25 basis points
3.75%
3.25%
1934 = 3.42%
Cyclical and Secular Trends in Asset Quality
Aggregate Charge-Off Rate (Net Charge-Offs / Total Loans)
All U.S. Commercial Banks, 1934-2013
(December Balance-Sheet Figures)
Recession
Net Charge-Off Rate
2010 = 2.69%
2.75%
2.25%
1.75% 1991 = 1.60%
1.25%
DATA SOURCES
FDIC, Historical Statistics on Bank ing
National Bureau of Economic Research
2002 = 1.07%
2013 = 0.68%
0.75%
1975 = 0.55%
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0.25%
2006 = 0.39%
-0.25%
1934 1938 1942 1946 1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010
Minor Tick = 2 Ye ars
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What Ended the Great Depression?
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
 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
Minor Tick =
$100 Billion
$2,000.0
$1,800.0
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
Post-August 2008 Maximum,
May 2013 = $1,863.3 billion
$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
September 2001
(9/11) = $24.8 billion
$200.0
$0.0
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
DATA SOURCES
Board of Governors of the Federal Reserve System
Federal Reserve Bank of St. Louis (FRED)
National Bureau of Economic Research
Minor Tick = 3 Years
*Depository institutions subject to Federal Reserve reserve requirements.
Vaughan - Eco 639
Average excess reserves since advent of financial crisis exceed 500 times pre-crisis average.
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The Economy
 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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The Economy
 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
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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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2013
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This is a great time to be an economist !
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Questions over
American University / Economics 639