Michael Vereb
11th Grade AP US History
What were the causes and results of the Great Depression?
Grade Level: This lesson is designed for an 11th grade US History class and meets SOL standard
USII.6d, which covers the causes of the Great Depression, it’s impact on Americans, and the
major features of the New Deal. This lesson will be taught after a lesson on the 1920’s, which
will deal primarily with the Harlem Renaissance, and will build on that knowledge to include
more information on economic policies of the 1920’s.
Topic: Critical examination of the causes and results of the Great Depression in America.
Length: 90 minutes
Instructional Model: This lesson will use the inquiry instruction model. Students will learn
about the causes of the Great Depression by developing an understanding of the economic
recklessness of the 1920’s. After learning about the Great Depression-its causes, impact, and
feature of the New Deal- they will make hypotheses about the causes of the2008 recession and
its impact on Americans. Students will be encouraged to talk to their parents and observe their
neighborhood and its changes in order to develop their own conclusion on the 2008 recession.
After discussing their predictions the class will compare secondary sources from the Great
Depression and the 2008 recession to see which predictions they believe describe the causes of
the events.
Overview: The 1920’s were a time of economic prosperity in America. There was increased
output brought about by electricity, mass production, motor transportation, and farm
machinery. The optimism resulting from the positive economy concealed systematic problems.
Such problems include over speculating on stocks and using borrowed money that could not be
repaid. High tariffs also discouraged international trade. When the Depression hit its impact
was widespread. Many banks and businesses failed and a quarter of the workers were job-less.
Many people became hungry and homeless and income levels for farmers fell. To help the
country get out of the Great Depression, President Roosevelt adopted the New Deal which had
many features. Among them were Social Security, federal work programs, environmental
programs, farm assistance programs, and increased rights for labor.
Rationale: The inquiry method is appropriate for this lesson because there is no single universal
conclusion to what caused the Great Depression. The comparison model of this lesson, where
students look at the similarities and differences between the Great Depression and the 2008
recession, will challenge students to come to their own conclusions about economic recessions.
This comparison satisfies the Virginia requirements to “Make connections between the past
and the present” (USII.1b) by relating the two events. The inquiry method will force the
students to evaluate many possible causes of the Great Depression and satisfy the SOL
requirement to “Interpret ideas and events from different historical perspectives” (USII.1d).
The inquiry method will help the students better understand both an important historical event
and the America they live in today. This model develops the student’s ability to make
hypotheses and revise their hypotheses as they use data to come to their final conclusions.
Objectives: Students will be able to…
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Identify and describe three main causes of the Great Depression (SOL Standard USII. 6d)
Predict what caused the Great Depression and the 2008 recession.
Revise their predictions about the causes of the Great Depression and the 2008
recession.
Compare similarities and difference between the causes of the Great Depression and
the recession of 2008
Assessment;
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By the end of the lesson, the student will have completed a data retrieval chart
documenting comprehension of articles.
By the end of the lesson, the student will have made and revised hypotheses about the
causes of the Great Depression and the 2008 Recession.
By the end of the lesson, the student will turn in a chart listing the causes of the Great
Depression, the 2008 Recession, and similarities between the two.
Content and Instructional Strategies:
I.
II.
Engagement In The Inquiry (Hook)
a. Students will begin the class with a news article
(http://money.cnn.com/2008/09/07/news/companies/fannie_freddie/index.htm
) that introduces the buyout of Fannie Mae and Freddie Mac.
b. They will discuss with partners their reactions to the article and how or if the
recession has affected them.
c. Following paired discussion there will be a group discussion with personal stories
and statements from the class.
Elicit Hypotheses
a. What were the possible causes of the recession of 2008 and how do they
compare to the causes of the Great Depression?
III.
IV.
V.
b. Students will make hypotheses about the Great Depression based on their
understanding of the 2008 recession using the introductory article and their
personal experience.
c. Students will write down their hypotheses so they can be re-examined during
the inquiry lesson.
Data Gathering and Processing through JIGSAW Method
a. The class will be divided up into groups of 5. Each group will be given article to
read.
b. After the students have read their article individually they will discuss as a group
how to answer two questions.
i. What hypothesis, or hypotheses, does the article suggest is the cause of
the financial crisis?
ii. What data does the article give in support of the hypothesis/hypotheses?
c. Each group will write the answer to those questions in their respective boxes on
the data retrieval chart.
d. Next the groups will be split up and reformed so that each new group has a
student representative for each article.
e. The students will report their observations and hypotheses about their article to
the other members of their group so each student can fill in the first two boxes
on the data retrieval chart.
Revising Hypotheses
a. Together each group must fill out the final box of the data retrieval chart, which
asks “Does the article disprove any of the other hypotheses? If so, how? Does it
modify any hypotheses?”
b. As they go through each article, students will be constantly revising their
hypotheses about the causes of the Great Depression and 2008 recession.
c. Following the group work, the teacher will conduct a classroom discussion where
students from each group share their relevant findings.
Conclusion
a. Students will individually complete a chart listing the similarities and differences
between the Great Depression and the 2008 recession.
Resources:
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Classroom set up for paired and group work.
Articles for each group.
Data Retrieval Charts for each student
Differentiation: The lesson requires many different skill sets that are necessary in a group
context. This means that differentiation occurs through distribution of responsibilities and
roles within each group. Students that struggle more in reading comprehension may rely on
their classmates to complete that part of the assignment but can choose to provide input when
developing or revising hypotheses. The lesson is also designed to draw direct correlations with
today’s economic environment. It includes reflection on the recession’s impact on each
student so all may choose how they participate.
Adaptations: A few adaptations are available in this lesson for students with IEP’s, 504’s, or
other needs. Students with specific needs can be strategically placed in a together so that the
teacher may interact with that group during the designated time. In this way, student’s with
difficulty reading or comprehension may have individualized teacher attention when these
difficulties are most challenged.
Reflection: This lesson involves longer articles to read that could pose a possible challenge in
implementation. Each article reflects a differing perspective on the economic crises and
contains the causes defined by the SOL Standards but they are not very succinct in getting to
their arguments. The JIGSAW model also places great responsibility on each individual student
to know their material so they can teach it to their classmates. Ideally, the fact that each
student gets to reflect on their article with a group means that they should have an adequate
understanding of the article to pass on to the second group. Given the relevance of the
material to each student today, the lesson will hopefully be an enjoyable and informative one.
Financial Crisis Was Avoidable, Inquiry Finds
Sewell Chan, New York Times
January 25, 2011
WASHINGTON — The 2008 financial crisis was an “avoidable” disaster caused by widespread
failures in government regulation, corporate mismanagement and heedless risk-taking by Wall
Street, according to the conclusions of a federal inquiry.
The commission that investigated the crisis casts a wide net of blame, faulting two
administrations, the Federal Reserve and other regulators for permitting a calamitous
concoction: shoddy mortgage lending, the excessive packaging and sale of loans to investors
and risky bets on securities backed by the loans.
“The greatest tragedy would be to accept the refrain that no one could have seen this
coming and thus nothing could have been done,” the panel wrote in the report’s conclusions,
which were read by The New York Times. “If we accept this notion, it will happen again.”
While the panel, the Financial Crisis Inquiry Commission, accuses several financial institutions of
greed, ineptitude or both, some of its gravest conclusions concern government failings, with
embarrassing implications for both parties. But the panel was itself divided along partisan lines,
which could blunt the impact of its findings.
Many of the conclusions have been widely described, but the synthesis of interviews,
documents and testimony, along with its government imprimatur, give the report — to be
released on Thursday as a 576-page book — a conclusive sweep and authority.
The commission held 19 days of hearings and interviews with more than 700 witnesses;
it has pledged to release a trove of transcripts and other raw material online.
Of the 10 commission members, the six appointed by Democrats endorsed the final
report. Three Republican members have prepared a dissent focusing on a narrower set of
causes; a fourth Republican, Peter J. Wallison, has his own dissent, calling policies to promote
homeownership the major culprit. The panel was hobbled repeatedly by internal divisions and
staff turnover.
The majority report finds fault with two Fed chairmen: Alan Greenspan, who led the
central bank as the housing bubble expanded, and his successor, Ben S. Bernanke, who did not
foresee the crisis but played a crucial role in the response. It criticizes Mr. Greenspan for
advocating deregulation and cites a “pivotal failure to stem the flow of toxic mortgages” under
his leadership as a “prime example” of negligence.
It also criticizes the Bush administration’s “inconsistent response” to the crisis —
allowing Lehman Brothers to collapse in September 2008 after earlier bailing out another
bank,Bear Stearns, with Fed help — as having “added to the uncertainty and panic in the
financial markets.”
Like Mr. Bernanke, Mr. Bush’s Treasury secretary, Henry M. Paulson Jr., predicted in
2007 — wrongly, it turned out — that the subprime collapse would be contained, the report
notes.
Democrats also come under fire. The decision in 2000 to shield the exotic financial
instruments known as over-the-counter derivatives from regulation, made during the last year
of President Bill Clinton’s term, is called “a key turning point in the march toward the financial
crisis.”
Timothy F. Geithner, who was president of the Federal Reserve Bank of New York during
the crisis and is now the Treasury secretary, was not unscathed; the report finds that the New
York Fed missed signs of trouble at Citigroup and Lehman, though it did not have the main
responsibility for overseeing them.
Former and current officials named in the report, as well as financial institutions,
declined Tuesday to comment before the report was released.
The report could reignite debate over the influence of Wall Street; it says regulators
“lacked the political will” to scrutinize and hold accountable the institutions they were
supposed to oversee. The financial industry spent $2.7 billion on lobbying from 1999 to 2008,
while individuals and committees affiliated with it made more than $1 billion in campaign
contributions.
The report does knock down — at least partly — several early theories for the financial
crisis. It says the low interest rates brought about by the Fed after the 2001 recession;Fannie
Mae and Freddie Mac, the mortgage finance giants; and the “aggressive homeownership goals”
set by the government as part of a “philosophy of opportunity” were not major culprits.
On the other hand, the report is harsh on regulators. It finds that the Securities and Exchange
Commission failed to require big banks to hold more capital to cushion potential losses and halt
risky practices, and that the Fed “neglected its mission.”
It says the Office of the Comptroller of the Currency, which regulates some banks, and
the Office of Thrift Supervision, which oversees savings and loans, blocked states from curbing
abuses because they were “caught up in turf wars.”
“The crisis was the result of human action and inaction, not of Mother Nature or
computer models gone haywire,” the report states. “The captains of finance and the public
stewards of our financial system ignored warnings and failed to question, understand and
manage evolving risks within a system essential to the well-being of the American public. Theirs
was a big miss, not a stumble.”
The report’s implications may be felt more in the political realm than in public policy.
The Dodd-Frank law overhauling the regulation of Wall Street, signed in July, took as its premise
the same regulatory deficiencies cited by the commission. But the report is sure to be a factor
in the debate over the future of Fannie and Freddie, which have been run by the government
since 2008.
Though the report documents questionable practices by mortgage lenders and careless
betting by banks, one striking finding is its portrayal of incompetence.
It quotes Citigroup executives conceding that they paid little attention to mortgage-related
risks. Executives at the American International Group were found to have been blind to its $79
billion exposure to credit-default swaps, a kind of insurance that was sold to investors seeking
protection against a drop in the value of securities backed by home loans. At Merrill Lynch,
managers were surprised when seemingly secure mortgage investments suddenly suffered
huge losses.
By one measure, for about every $40 in assets, the nation’s five largest investment
banks had only $1 in capital to cover losses, meaning that a 3 percent drop in asset values could
have wiped out the firm. The banks hid their excessive leverage using derivatives, off-balancesheet entities and other devices, the report found. The speculative binge was abetted by a giant
“shadow banking system” in which the banks relied heavily on short-term debt.
“When the housing and mortgage markets cratered, the lack of transparency, the
extraordinary debt loads, the short-term loans and the risky assets all came home to roost,” the
report found. “What resulted was panic. We had reaped what we had sown.”
The report, which was heavily shaped by the commission’s chairman, Phil Angelides, is
dotted with literary flourishes. It calls credit-rating agencies “cogs in the wheel of financial
destruction.” Paraphrasing Shakespeare’s “Julius Caesar,” it states, “The fault lies not in the
stars, but in us.”
Of the banks that bought, created, packaged and sold trillions of dollars in mortgagerelated securities, it says: “Like Icarus, they never feared flying ever closer to the sun.”
What Caused the Financial Crisis? Expert Points to Government Policy, Not Greedy Bankers
Richard W. Rahn, Washington Times
November 15, 2010
Was the great financial crisis caused by greedy and reckless bankers and Wall Street players or
by a broad range of individuals, financial institutions and governments who became less riskaverse and prudent or by government housing policies that brought on the housing bubble and
mismanaged the risks? The lame-duck Congress now in session is about to make some major
decisions on spending and taxes - when all too many members still are operating on the idea
that greedy bankers and Wall Street players, rather than government housing policies, are the
problem.
Without waiting for the evidence, many in the political class, and particularly those on
the left, immediately bought into the argument that the financial crisis was caused by greed.
This view of the cause provided much of the political energy behind the passage this year of the
Dodd-Frank Act, also known as the financial reform act. Somewhat more sophisticated
observers have claimed that all of the actors in the financial system are implicated. Peter J.
Wallison, a former general counsel of the U.S. Treasury and now a fellow at the American
Enterprise Institute (AEI), debunks these arguments and conclusively shows in a study that
those were primarily government housing policies that caused the crisis. Mr.
Wallison summarized the arguments of the collective responsibility/guilt crowd as follows:
 Wall Street did not put into place sound risk-management processes.
 Government regulators did not properly or effectively oversee these processes or the
banks, investment banks, and Fannie Mae and Freddie Mac.
 The rating agencies’ models were flawed and the agencies themselves had conflicts of
interest, allowing complex and ultimately toxic instruments to be released into the
financial market.
 Borrowers obtained mortgages under false pretenses, and unregulated mortgage
brokers took advantage of unsophisticated buyers.
 Homebuyers mistakenly believed housing prices would always go up.
All of the above-mentioned factors probably played some small part in the financial crisis, but
greed and incompetence have always been with us, and so it is hard to believe that suddenly
these factors combined to create the perfect financial storm. Brookings
Institution scholars Martin Neil Baily and Douglas J. Elliott have argued that the quarter-century
of record prosperity from 1982 to 2007 caused all of the financial players to become less riskaverse, and hence less prudent. Perhaps, but Mr. Wallison has set forth in the AEI OctoberNovember 2010 issue of Financial Services Outlook a much stronger and empirically based
explanation for the financial meltdown.
Mr. Wallison argues that the housing bubble, driven by U.S. government policy to
increase homeownership, is the primary cause of the financial crisis. He notes: “The most
recent bubble involved increases in real (not nominal) home prices of 80 percent over 10 years,
while the earlier ones involved increases of about 10 percent before they deflated.” Starting in
the late 1990s, the government, as a social policy to boost homeownership, required Fannie
Mae and Freddie Mac to acquire increasing numbers of “affordable” housing loans. (An
“affordable loan” is made to people who normally would not qualify.) By 2007, 55 percent of all
loans made by Fannie and Freddie had to be “affordable.” By June 2008, there were 27 million
subprime housing loans outstanding (19.2 million of them directly owed by government or
government-sponsored agencies), with an unpaid principal amount of $4.6 trillion. By the
middle of this year, foreclosure starts jumped to a record 5 percent, four times higher than any
previous housing bubble.
Mr. Wallison concludes his argument: “What we know is that almost 50 percent of all
mortgages outstanding in the United States in 2008 were subprime or otherwise deficient and
high-risk loans. The fact that two-thirds of these mortgages were on the balance sheets of
government agencies, or firms required to buy them by government regulations, is irrefutable
evidence that the government’s housing policies were responsible for most of the weak
mortgages that became delinquent and defaulted in unprecedented numbers when the housing
bubble collapsed.” The tragedy is that the financial crisis continues
because Congress misdiagnosed the problem and came up with a 2,000-page “solution” that
will only make matters worse.
Despite the well-known problems with Fannie and Freddie, they were ignored in the
Dodd-Frank Act. Why? Because many members of Congress had conflicts of interest in
that Fannie and Freddie were very large contributors to the political campaigns of numerous
members. More direct conflicts of interest, by Senate Banking, Housing and Urban Affairs
Committee Chairman Christopher J. Dodd and House Financial Services Committee Chairman
Barney Frank, were well publicized, forcing Mr. Dodd to retire and causing Mr. Frank to loan
personal money to his own re-election campaign.
The numbers show that government policies (including actions by the Fed), not greedy
bankers, caused the financial meltdown. As long as the government continues to force its
agencies and private parties to give housing loans to those who cannot afford them, taxpayers
will be on the hook for hundreds of billions of dollars in additional debt.
Everyman’s Financial Meltdown
Ron Chernow, The New York Times
October 23, 2009
FOR connoisseurs of financial mayhem, the stock market crash of October 1929, which started
80 years ago this week, still holds pride of place. Like a tautly directed drama, it unfolded with
graphic horror at the corner of Broad and Wall Streets, captured in grainy black-and-white
newsreels. It capped a stylish era in which well-tailored men and chic flappers set a racy tone
for stock investing. To the delight of historians, it possessed clear-cut villains, a riveting story
line and plenty of palpable abuses for reformers to correct.
In retrospect, the evils of the 1920s seem almost quaint in their simplicity. Finance today
is far more esoteric, marked by complex securities sure to baffle reformers as they seek
solutions to the problems exposed by last year’s crash.
Before the ’20s, common stocks were deemed unsuitable for ordinary investors. That
stigma began to fade during World War I, when Liberty Loan drives encouraged Americans to
own government bonds, feeding a taste for securities that persisted into the ’20s. To capitalize
on this trend, commercial banks on Wall Street created securities affiliates and hired thousands
of young stockbrokers who were untroubled by memories of past panics. Charles Mitchell, the
head of National City Bank, prodded his recruits with pep talks and office contests to sell stocks
with razzmatazz. The stock market quickly grew fashionable, with brokerage offices installed
even on trans-Atlantic liners.
It is tempting to deride the bull market of the ’20s as a case study in mass delusion.
There was a widespread belief that history had turned a corner, that a New Era of permanent
prosperity had dawned. Long an importer of capital from Europe, the United States had
emerged from World War I as the world’s leading creditor, and governments from around the
globe flocked to Wall Street for loans.
The stock market of the 1920s was dazzled by the technological innovations of its day.
As in every boom, irrational exuberance was merely rational exuberance run amok. Charles
Lindbergh’s solo flight to Paris fostered a perfect mania for aircraft stocks, while the invention
of “talkies” spurred film company shares to new heights. The decade witnessed an explosion in
sales of cars and radios, refrigerators and washing machines, all made affordable by installment
plans. Art Deco skyscrapers soared in Manhattan. The infectious excitement obscured the
economy’s dangerous lopsidedness, with oil, agriculture and other “sick sectors” undercutting
the general prosperity. Long before the crash, community banks were failing at the rate of one
per day.
Every stock market spree is sustained by soothing illusions. Investors in the ’20s took
comfort from the creation of the Federal Reserve System in 1913. Now buttressed by a central
bank, Wall Street believed that the business cycle had been repealed, and the presumed safety
net encouraged investors to buy the dips and ride out the most turbulent fluctuations. Three
consecutive Republican presidents — Warren Harding, Calvin Coolidge and Herbert Hoover —
cut taxes, weakened antitrust laws and promised not to meddle with Wall Street.
The stock exchange was a rigged market that made no claims to fairness. Speculators
operated more than a hundred “pools” that openly manipulated individual stocks and
sometimes bribed financial journalists. Their flamboyant managers — William Crapo Durant,
Michael Meehan, Joseph P. Kennedy and Jesse Livermore — became folk heroes, their raffish
exploits reported in gossip columns, giving Wall Street a louche glamour. Hot stock tips,
circulated by waiters and bootblacks, made old-fashioned research superfluous. For many
participants, a whiff of sin only enhanced the stock market’s seduction. Small investors
imagined that the large speculators who dominated the exchange could, if necessary, levitate
the market and prevent unpleasant crack-ups.
Even as the stock boom captured the national imagination, most Americans sat safely
on the sidelines. In a population of 125 million, fewer than two million took a flier in stocks, but
their impact was magnified by half a million margin accounts. Under the lax standards in effect,
investors could plunk down a small fraction of a stock’s value and borrow the rest. Banks
showered this brokers’ loan market with funds, and many corporations channeled spare cash
there as well. Since much of this money was raised on the stock exchange in the first place, it
created a self-perpetuating speculative machine. Margin loans equivalent to one-fifth the value
of listed stocks poised the market on a tall but shaky scaffolding.
Compounding the leverage problem was the vogue for mutual funds, known then as
investment trusts. Their managers were supposed to shelter small investors from speculative
swings, but these professionals proved as faddish as everyone else. Pumped up with borrowed
money, they invested in other highly indebted trusts in a never-ending chain of speculation.
Those who questioned the New Era gospel were ostracized as knaves or fools. The most
persistent spoilsport was the economist Roger Babson, whose gloomy forecasts were mocked
even as the economy stagnated in the sweltering summer of 1929. On Sept. 5, 1929, Babson
reiterated his doomsday cry: “Sooner or later a crash is coming, and it may be terrific.” This
time, instead of yawning, the market sold off sharply in what was dubbed the “Babson Break”
— the first sign of market fragility. President Hoover turned to Thomas W. Lamont, the senior
partner of J. P. Morgan & Co., for reassurance. Five days before Black Thursday, Lamont obliged
him with this stunning bromide: “The future appears brilliant.”
ON the morning of Thursday, Oct. 24, 1929, the stock market imploded from the sheer
weight of its own excesses. Stocks suffered such precipitous drops that there were tearful
scenes on the exchange floor and the visitors’ gallery was cleared. Wall Street was thronged by
distraught investors, who emitted a haunting moan as their life savings evaporated.
At noon, the crowd thrilled to the sight of Wall Street titans hurrying up the steps of the
House of Morgan. Led by Lamont, the emergency meeting included Charles Mitchell and Albert
Wiggin of Chase National Bank. Conspicuously missing were any government figures; it was a
throwback to earlier panics, when financiers orchestrated their own rescues. The bankers
pledged $240 million to stabilize the market. At 1:30, Dick Whitney, acting president of the
stock exchange, strode ostentatiously to the United States Steel trading post and barked out a
bid for 10,000 shares at a price several points higher than the previous trade. To cheers, he reenacted this inspirational scene with other stocks. Such was the residual mystique of Wall
Street bankers that the market rallied vigorously and closed only marginally lower. The next
day, The Wall Street Journal ran a hopeful headline: “Bankers Halt Stock Debacle.”
This first act of the 1929 crash suggested that the smart money was powerful enough to
tame an unruly market. Heavy selling on Monday, however, convinced investors that
Thursday’s turbulence hadn’t been a fluke, but the first tremor of an earthquake. At Tuesday’s
opening, tremendous waves of selling set off pandemonium on the trading floor. The
overloaded ticker tape lagged two and a half hours behind trading as 16.5 million shares
changed hands. When the final numbers were in, stocks had lost a quarter of their value in two
days. The shock and pain were manifest in photos of ruined men standing on Wall Street. This
time, the notion that somebody would save them — the bankers, the Fed, the big-time
speculators — had proven a cruel mirage.
On farms and in small towns, the crash was greeted with puritanical glee: the city
slickers had gotten their comeuppance. Exaggerated accounts of investors taking fancy dives
from upper-story ledges underscored the urban nature of stock investing in the ’20s. Unlike the
2009 crash, the 1929 debacle didn’t topple major banks or corporations. It simply wiped out a
generation of speculators.
In retrospect, the 1929 crash stands as the dark gateway to the Great Depression,
though not its direct cause. In its aftermath, government moved with unwonted vigor to shore
up the economy. George Harrison, head of the New York Fed, bought large amounts of
government bonds and slashed the rediscount rate. President Hoover pleaded with business to
preserve wage levels, and some major companies increased their dividends. In mid-November,
a tremendous rally drove stocks up 25 percent in a few days. By February 1930, The New York
Times editorialized that “the patient” was now headed for a complete recovery. The next
month, Hoover predicted that the “worst effects of the crash” would soon be over, and by April
the stock market had recouped almost half of its October losses.
The cheerleading proved premature. In the fall of 1930, cascading bank failures signaled
a full-blown economic disaster. The stock market began to sink, not with huge selling bursts,
but in an unrelenting slide that whittled stock prices daily, shaving almost 90 percent of the
Dow’s value from its September 1929 peak to the summer of 1932. Aside from those
bankrupted by margin calls, the worst calamities occurred not among investors who sold in
panic after the crash, but among bargain-hunters who swooped down afterward in what had
seemed a once-in-a-lifetime buying opportunity.
Starting in 1933, a secret history of the crash was unearthed by Ferdinand Pecora, the
chief counsel of the Senate Banking Committee, who interrogated witnesses in sensational
hearings. He revealed that Charles Mitchell and other National City executives had cushioned
their stock losses by tapping interest-free loans from a special bank fund, while Albert Wiggin
made millions selling short his own bank’s shares. Such revelations dashed forever the notion
that Wall Street could effectively police itself. With Pecora’s help, the Roosevelt administration
created a transparent regulatory framework that has shaped financial markets to the present
day.
New Deal financial reformers were fortunate that the crash had followed the satisfying
script of a morality play, with sin and repentance followed by redemption. The wicked ways of
Wall Street in the ’20s could be comfortably told in a fireside chat. Franklin Roosevelt had a
bunch of rich rascals to chastise — unscrupulous individuals rather than irresponsible
institutions, as in our own recent decline. The blatant stock market abuses were
comprehensible to ordinary citizens, quite unlike the exotic credit derivatives and mortgagebacked securities that baffle us today. And the Great Depression that followed the 1929 crash
fostered a climate for reform that has proven hard to replicate.
However severe, our current predicament seems mild compared to the calamitous
unemployment of the early 1930s. Hence, average Americans, mystified by the complexities of
finance today, still await a new season of financial reform.
The Protectionist Temptation: Lessons From the Great Depression for Today
Barry Eichengreen and Douglas Irwin, VoxEU.org
March 17, 2009
The Great Depression of the 1930s was marked by a severe outbreak of protectionism.
Many fear that, unless policymakers are on guard, protectionist pressures could once again spin
out of control. What do we know about the spread of protectionism then, and what are the
implications for today?
While many aspects of the Great Depression continue to be debated, there is all-butuniversal agreement that the adoption of restrictive trade policies was destructive and
counterproductive and that similarly succumbing to protectionism in our current slump should
be avoided at all cost. Lacking other instruments with which to support economic activity,
governments erected tariff and nontariff barriers to trade in a desperate effort to direct
spending to merchandise produced at home rather than abroad. But with other governments
responding in kind, the distribution of demand across countries remained unchanged at the end
of this round of global tariff hikes. The main effect was to destroy trade which, despite the
economic recovery in most countries after 1933, failed to reach its 1929 peak, as measured by
volume, by the end of the decade (Figure 1). The benefits of comparative advantage were lost.
Recrimination over beggar-thy-neighbour trade policies made it more difficult to agree on other
measures to halt the slump.
Figure 1. World trade and production, 1926-1938
The impression one gleans from both contemporary and modern accounts is that trade
policy was thrown into complete chaos, with every country scrambling to impose higher
barriers. But, in fact, this was not exactly the case (Eichengreen and Irwin, forthcoming).
Although recourse to trade restrictions was widespread, there was considerable variation in
how far countries moved in this direction. Figure 2 illustrates this for tariffs. Tariff rates rose
sharply in some countries but not others. The history of the 1930s would have been very
different had other countries responded in the manner of, say, Denmark, Sweden and Japan. It
is important to understand why they did not.
Figure 2. Average tariff on imports, 1928-1938, percentage
The answer, in a nutshell, is the exchange rate regime and the policies associated with
it. Countries that remained on the gold standard, keeping their currencies fixed against gold,
were more inclined to impose trade restrictions. With other countries devaluing and gaining
competitiveness at their expense, they adopted restrictive policies to strengthen the balance of
payments and fend off gold losses. Lacking other instruments with which to address the
deepening slump, they used tariffs and similar measures to shift demand toward domestic
production and thereby stem the rise in unemployment.
In contrast, countries abandoning the gold standard and allowing their currencies to
depreciate saw their balances of payments strengthen. They gained gold rather than losing it.
As importantly, they now had other instruments with which to address the unemployment
problem. Cutting the currency loose from gold freed up monetary policy. Without a gold parity
to defend, interest rates could be cut, and central banks No longer bound by the gold standard
rules could act as lenders of last resort. They now possessed other tools with which to
ameliorate the Depression. These worked, as shown in Figure 3. As a result, governments were
not forced to resort to trade protection.
Figure 3. Change in industrial production, by country group
This relationship is quite general, as we show in Figure 4. It also carries over to non-tariff
barriers to trade such as exchange controls and import quotas.
Figure 4. Exchange rate depreciation and the change in import tariffs, 1929-1935
This finding has important implications for policy makers responding to the Great
Recession of 2009. The message for today would appear to be “to avoid protectionism,
stimulate.” But how? In the 1930s, stimulus meant monetary stimulus. The case for fiscal
stimulus was neither well understood nor generally accepted. Monetary stimulus benefited the
initiating country but had a negative impact on its trading partners, as shown by Eichengreen
and Sachs (1985). The positive impact on its neighbours of the faster growth induced by the
shift to “cheap money” was dominated by the negative impact of the tendency for its currency
to depreciate when it cut interest rates. Thus, stimulus in one country increased the pressure
for its neighbours to respond in protectionist fashion.
Today the problem is different because the policy instruments are different. In addition
to monetary stimulus, countries are applying fiscal stimulus to counter the Great Recession.
Fiscal stimulus in one country benefits its neighbours as well. The direct impact through faster
growth and more import demand is positive, while the indirect impact via upward pressure on
world interest rates that crowd out investment at home and abroad is negligible under current
conditions. When a country applies fiscal stimulus, other countries are able to export more to
it, so they have no reason to respond in a protectionist fashion.
The problem, to the contrary, is that the country applying the stimulus worries that
benefits will spill out to its free-riding neighbours. Fiscal stimulus is not costless – it means
incurring public debt that will have to be serviced by the children and grandchildren of the
citizens of the country initiating the policy. Insofar as more spending includes more spending on
imports, there is the temptation for that country to resort to “Buy America” provisions and
their foreign equivalents. The protectionist danger is still there, in other words but, insofar as
the policy response to this slump is fiscal rather than just monetary, it is the active country, not
the passive one, that is subject to the temptation.
But if the details of the problem are different, the solution is the same. Now, as in the
1930s, countries need to coordinate their fiscal and monetary measures. If some do and some
don’t, the trade policy consequences could again be most unfortunate.
Bernanke: Federal Reserve Caused Great Depression
David Kupelian, World Net Daily
March, 19, 2008
Despite the varied theories espoused by many establishment economists, it was none
other than the Federal Reserve that caused the Great Depression and the horrific suffering,
deprivation and dislocation America and the world experienced in its wake. At least, that’s the
clearly stated view of current Fed Chairman Ben Bernanke.
The worldwide economic downturn called the Great Depression, which persisted from
1929 until about 1939, was the longest and worst depression ever experienced by the
industrialized Western world. While originating in the U.S., it ended up causing drastic declines
in output, severe unemployment, and acute deflation in virtually every country on earth.
According to the Encyclopedia Britannica, “the Great Depression ranks second only to the Civil
War as the gravest crisis in American history.”
What exactly caused this economic tsunami that devastated the U.S. and much of the
world?
In “A Monetary History of the United States,” Nobel Prize-winning economist Milton
Friedman along with coauthor Anna J. Schwartz lay the mega-catastrophe of the Great
Depression squarely at the feet of the Federal Reserve.
Here’s how Friedman summed up his views on the Fed and the Depression in an Oct. 1, 2000,
interview with PBS:
PBS: You’ve written that what really caused the Depression was mistakes by the government.
Looking back now, what in your view was the actual cause?
Friedman: Well, we have to distinguish between the recession of 1929, the early stages, and
the conversion of that recession into a major catastrophe.
The recession was an ordinary business cycle. We had repeated recessions over hundreds of
years, but what converted [this one] into a major depression was bad monetary policy.
The Federal Reserve System had been established to prevent what actually happened. It
was set up to avoid a situation in which you would have to close down banks, in which you
would have a banking crisis. And yet, under the Federal Reserve System, you had the worst
banking crisis in the history of the United States. There’s no other example I can think of, of a
government measure which produced so clearly the opposite of the results that were intended.
And what happened is that [the Federal Reserve] followed policies which led to a
decline in the quantity of money by a third. For every $100 in paper money, in deposits, in cash,
in currency, in existence in 1929, by the time you got to 1933 there was only about $65, $66
left. And that extraordinary collapse in the banking system, with about a third of the banks
failing from beginning to end, with millions of people having their savings essentially washed
out, that decline was utterly unnecessary.
At all times, the Federal Reserve had the power and the knowledge to have stopped
that. And there were people at the time who were all the time urging them to do that. So it
was, in my opinion, clearly a mistake of policy that led to the Great Depression.
Although economists have pontificated over the decades about this or that cause of the
Great Depression, even the current Fed chairman Ben S. Bernanke, agrees with Friedman’s
assessment that the Fed caused the Great Depression.
At a Nov. 8, 2002, conference to honor Friedman’s 90th birthday, Bernanke, then a
Federal Reserve governor, gave a speech at Friedman’s old home base, the University of
Chicago. Here’s a bit of what Bernanke, the man who now runs the Fed – and thus, one of the
most powerful people in the world – had to say that day:
I can think of no greater honor than being invited to speak on the occasion of Milton
Friedman’s ninetieth birthday. Among economic scholars, Friedman has no peer. …
Today I’d like to honor Milton Friedman by talking about one of his greatest
contributions to economics, made in close collaboration with his distinguished coauthor, Anna
J. Schwartz. This achievement is nothing less than to provide what has become the leading and
most persuasive explanation of the worst economic disaster in American history, the onset of
the Great Depression – or, as Friedman and Schwartz dubbed it, the Great Contraction of 192933.
… As everyone here knows, in their “Monetary History” Friedman and Schwartz made
the case that the economic collapse of 1929-33 was the product of the nation’s monetary
mechanism gone wrong. Contradicting the received wisdom at the time that they wrote, which
held that money was a passive player in the events of the 1930s, Friedman and Schwartz
argued that “the contraction is in fact a tragic testimonial to the importance of monetary
forces.”
After citing how Friedman and Schwartz documented the Fed’s continual contraction of
the money supply during the Depression and its aftermath – and the subsequent abandonment
of the gold standard by many nations in order to stop the devastating monetary contraction –
Bernanke adds:
Before the creation of the Federal Reserve, Friedman and Schwartz noted, bank panics
were typically handled by banks themselves – for example, through urban consortiums of
private banks called clearinghouses. If a run on one or more banks in a city began, the
clearinghouse might declare a suspension of payments, meaning that, temporarily, deposits
would not be convertible into cash. Larger, stronger banks would then take the lead, first, in
determining that the banks under attack were in fact fundamentally solvent, and second, in
lending cash to those banks that needed to meet withdrawals. Though not an entirely
satisfactory solution – the suspension of payments for several weeks was a significant hardship
for the public – the system of suspension of payments usually prevented local banking panics
from spreading or persisting. Large, solvent banks had an incentive to participate in curing
panics because they knew that an unchecked panic might ultimately threaten their own
deposits.
It was in large part to improve the management of banking panics that the Federal
Reserve was created in 1913. However, as Friedman and Schwartz discuss in some detail, in the
early 1930s the Federal Reserve did not serve that function. The problem within the Fed was
largely doctrinal: Fed officials appeared to subscribe to Treasury Secretary Andrew Mellon’s
infamous ‘liquidationist’ thesis, that weeding out “weak” banks was a harsh but necessary
prerequisite to the recovery of the banking system. Moreover, most of the failing banks were
small banks (as opposed to what we would now call money-center banks) and not members of
the Federal Reserve System. Thus the Fed saw no particular need to try to stem the panics. At
the same time, the large banks – which would have intervened before the founding of the Fed –
felt that protecting their smaller brethren was no longer their responsibility. Indeed, since the
large banks felt confident that the Fed would protect them if necessary, the weeding out of
small competitors was a positive good, from their point of view.
In short, according to Friedman and Schwartz, because of institutional changes and
misguided doctrines, the banking panics of the Great Contraction were much more severe and
widespread than would have normally occurred during a downturn. …
Let me end my talk by abusing slightly my status as an official representative of the
Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re
right, we did it. We’re very sorry. But thanks to you, we won’t do it again.
Best wishes for your next ninety years.
Today, the entire Western financial world holds its breath every time the Fed chairman
speaks, so influential are the central bank’s decisions on markets, interest rates and the
economy in general. Yet the Fed, supposedly created to smooth out business cycles and
prevent disruptive economic downswings like the Great Depression, has actually done the
opposite.
Article
Financial Crisis Was
Avoidable, Inquiry
Finds- Sewell Chan
What Caused the
Financial Crisis?
Experts Point to
Government Policy,
Not Greedy BankersRichard W. Rahn
Everyman’s Financial
Meltdown- Ron
Chernow
The Protectionist
Temptation: Lessons
From the Great
Depression for
Today- Barry
Eichengreen and
Douglas Irwin
Federal Reserve
Caused Great
Depression- David
Kupelian
What hypothesis, or
hypotheses, does the
article suggest is the
cause of the financial
crisis?
What data does the article
give in support of the
hypothesis/hypotheses?
Does the article
disprove any of the
other hypotheses? If
so, how? Does it
modify any
hypotheses?
Compare and Contrast the Causes of the Great Depression and the 2008 Recession
Great Depression Causes
Similarities
2008 Recession Causes
Bibliography
Chan, S. (2011, January 25). Financial crisis was avoidable, inquiry finds. The New York Times.
Retrieved from
http://www.nytimes.com/2011/01/26/business/economy/26inquiry.html
Chernow, R. (2009, October 23). Everyman’s financial meltdown. The New York Times.
Retrieved from
http://www.nytimes.com/2009/10/23/opinion/23chernow.html?pagewanted=all
Eichengreen, B. & Irwin, D. (2009, March 17). The protectionist temptation: Lessons from the
great depression for today. VoxEU.org Retrieved from
http://voxeu.org/article/protectionist-temptation-lessons-great-depression-today
Kupelian, D. (2008, March 19). Bernanke: Federal reserve caused great depression. World Net
Daily. Retrieved from http://www.wnd.com/2008/03/59405/
Rahn, R. W. (2010, November 15). What caused the financial crisis? Expert points to
government policy, not greedy bankers. Washington Times. Retrieved from
http://www.washingtontimes.com/news/2010/nov/15/what-caused-the-financialcrisis/