Can We Avoid a Deep Depression? Lessons From 1929-1933

The crash of 1929 gave rise to a decade of hardship and despair. Is history repeating itself? Will the 2008 crash turn into another Great Depression? Or, will 2009 bring once a once in a lifetime opportunity for recovery? Have we leaned from the mistakes made in 1929-1933 or did we repeat those mistakes in 2008?

The beginning or the era of deregulation began in 1981 with Ronald Reagan who said, "I put a freeze on pending regulations and set up a task force under Vice President Bush to review regulations with an eye toward getting rid of as many as possible."

Despite setbacks such as the 1987 Savings and Loan collapses and the junk bond scandals of Michael Milken and Ivan Boesky President Clinton continued to press Congress for more deregulation as did Alan Greenspan as Federal Reserve Chairman.

In the early 2000’s the Republicans in Congress pushed massive deregulation of financial markets. Senator Phil Gramm is the influential Republican chairman of the Senate Banking Committee and in 2008 was McCain’s economic advisor.

Gramm opened a June 21, 2000 hearing with a call for "regulatory relief." And said, "I think we would do well to remember the Lincoln adage that to ask a society to live under old and outmoded laws -- and I think you could say the same about regulation -- is like asking a man to wear the same clothes he wore when he was a boy." That was actually not Lincoln, but Thomas Jefferson.

"But Gramm was also wrong about deregulation which contributed to the huge bust on Wall Street in 2008. When capitalism becomes unfettered you can see the consequences," said Andy Serwer, Editor of Fortune Magazine.

In 2005 Democrats in Congress tried to pass a bill to restrict subprime lending but it was opposed by Republicans led by House Majority Leader Tom DeLay as well as some other Democrats.

The Republicans have a long history of opposing regulation believing that the market was self-correcting and you needed to have a free flow of capital as well as tax cuts for the richest. This goes back to Ronald Reagan’s "supply side economics," where benefits would "trickle down." George Bush Sr. in 1980 correctly called it "voodoo economics"

We were in an era of market based economics as well as the now proven failure of "trickle down economics" where helping the wealthy in theory trickles down to the poor and middle class.

Especially in the last 8 years, this idea has resulted in a massive shifting of wealth to the already most wealthy at the expense of the majority of Americans. The million dollar bonuses flourished on Wall Street while Main Street suffers the most from the economic collapse.

In 1929 on "black Tuesday" the market dropped about 20% in one-day which created a liquidity crisis. Between 1929 and 1932 the stock market lost 90% of its value.

One lesson learned from the 1929 crash is that the government has to react quickly. President Hebert Hoover’s Treasury Secretary in 1929 was former banker Andrew Mellon who announced that the Federal Reserve would simply stand by while the market worked itself out and by letting the free market work it was a way of promoting economic growth. This was a disastrous decision in retrospect which resulted in the crash and the Great Depression as well as just like today a widening gap between the rich and the poor.

In the 1920’s there was no SEC and virtually no regulation of Wall Street at all. Brokers made their own rules which led to corruption. Big money was made and tax cuts on capital gains and the wealthy allowed the rich to hold on to more of their money.

Today U.S. individual tax rates have dropped to historic lows – among the lowest in the world while at the same time we are not paying for the war in Iraq, we are building up huge financial deficits and ignoring the crisis coming to pay for Social Security, Medicare and needed health care reform.

In the 1990’s and 2000’s executive pay skyrocket with CEO’s typically making $10 million or more plus private jets and other perks. But the middle class didn’t see much of this prosperity and relied on borrowing on increasing home values and credit card debt.

In 2008 the party ended like in 1929. In the 1920’s the bubble that burst wasn’t a housing bubble like today but a stock bubble far greater than the technology stock bubble we had in 2000-2001.

In the 1920’s excessive speculation drove stock prices far beyond any relationship to the value of the companies. Today we are almost in a reverse stock market bubble with fear driving values far below what most consider the real value of many companies. Today we are in the bust of the housing bubble with about 25% of homeowners with mortgages that are more than their home is now worth after so many foreclosures have driven down prices.

What started as a subprime mortgage crisis is now a crisis for even prime mortgage borrowers with loss of jobs and spiraling down home values. Even those with perfect credit may not be able to refinance since their homes have lost so much value vs. existing debt.

2008 vs. 1929 Similarities and Differences

In both crashes consumer credit dried up for both business and consumers. After 1929 credit froze solid and people could not get money from their banks which ran out of cash and there was no FDIC to insure bank deposits. Panic followed as many lost their life savings not just in the market collapse but lost all their savings in banks. 785 banks closed the first year. By 1932 five thousand banks had gone broke.

By 1933 20 million or 25% of the workforce was unemployed and another 25% worked for reduced hours or reduced pay. There were no food stamps and no unemployment insurance, just bread lines and millions of previously middle class or well off families now in poverty and homeless. This lasted a decade resulting in broken families and suicide rates the highest in U.S. history.

Today we have about the same 20 million unemployed if you count those that have given up and are not included in the official unemployment numbers. But it is only about 10% of the larger workforce today

In the run up to the Great Depression President Hoover’s administration was slow to react believing the economy would correct itself. All the major political figures assured everyone in ways similar to President Bush in early 2008 that the fundamentals of the economy were strong.

In 2008 the government was trying to avert a financial collapse. The Bush Administration decided it could not allow major financial institutions to fail. This was not the case in 1929.

After the 1929 crash Hoover’s failed attempts to fix it made him very unpopular. Many mistakes were made. The government made a series of disastrous policy moves. The Fed kept money tight and increased interest rates. In 1932 they tried to balance the budget by raising taxes up to a 79% top rate, resulting in what had been a rapidly declining economy to fall off a cliff. Then a $2.5 billion bailout of the financial system was too little too late and in 1933 the economy hit bottom.

Federal Reserve Chief Ben Bernanke has extensively studied the Great Depression. In late September 2008 he urged swift action by Congress to pass the $700 billion TARP plan. By late 2008 the Fed moved very aggressively and very quickly to fill the gap left by the Treasury when it abandonment of the purpose of the TARP. The Bush administration acted primarily to help banks and financial institutions. But the actions failed to "trickle down" or help the foreclosure crisis and job losses plummeted.

By the fall of 1932 the nation was convinced it needed a new leader. FDR offered his country a "New Deal" offering bold solutions for the economy. By 1935 large jobs programs were created to improve the infrastructure of the nation and get people back to work.