From Crash to Meltdown in 80 Years

It's was 80 years ago this week that the Crash of 1929 [1] kicked off the Great Depression.

Not quite 79 years later, the fall of Lehman Brothers [2] on September 15, 2008, sent the stock market into a meltdown [3] precipitated by the crises of such Wall Street Giants as Bear Stears and AIG, among others.

Comparisons between now and then are, of course, inevitable.

Last year, I interviewed economist and author Robert Kuttner [4], who had this to say about the similarities between 1929 and 2008.

TERRANCE HEATH: In his column about the 79th anniversary of the 1929 Wall Street Crash [5], Professor Maury Klein [6]asked, "Is it 1929 all over again?" Is it?

ROBERT KUTTNER: Yes, this is 1929 all over again. For the same reasons. The crash of 1929 was caused by too much speculation, with too much borrowed money, with too many conflicts of interest and too little transparency. And in the 1930's the New Deal mostly repaired that by much tighter regulation of banks, much stricter supervision of conflict of interest, much greater controls on leverage and much grater disclosure for investors.

But it fixed the problem for the known universe of financial institutions, and after the '70s all kinds of new exotic financial instruments were invented. And because deregulation came back into fashion, and the right wing really took over the conversation as well as government regulators did not keep up with the new instruments that Wall Street invented. And so all the same kinds of uses crept back in, and it took about 20 years until the house of cards was so high and so rickety that you then had the same kind of crash.

TH: When did the rolling back of those New Deal measures start?

RK: Well, it's interesting; it happened in fits and starts. Some of it was deliberate and some of it was simply people taking advantage of other things that had happened. For instance, in the period between 1971 and 1973 the Nixon administration dismantled dismantled one of the main pillars of Bretton Woods from 1944 [7], which had created a regime of fixed exchange rates and along the way prevented a great deal of international speculation in currencies

So, after the 1970s little by little you had a whole category of speculation that had been prohibited by the ground rules obtained in the '50s and '60s, namely a lot of currently speculation. You had the so-called eurodollar market of dollars that existed in Europe that are not really regulated by anybody.

Then in the '70s also you had Wall Street taking something that had been the monopoly of Fannie Mae back when Fannie Mae was a public institution and part of the government, namely the securitization of mortgage, and privatizing it, and having lower standards than Fannie Mae did.

Again this was OK from the first decade or so but then when securitized mortgages rendezvoused with subprime and subprime rendezvoused with contracts written against the risk of bonds going bad, the whole house of cards just goes higher and higher and because in the '80s and the '90s Democrats fingerprints were on this, too. Regulators were not really interested in keeping up with these new risk products that Wall Street invented.

So, then in 1999, the capstone of this is the repeal of the Glass-Steagall Act. [8] One other aspect of this was Greenspan's failure to enforce the Home Ownership Equity Protection Act of 1994, [9] which, had Greenspan enforced it, subprime never would have happened, because that legislation required anybody who made mortgage loans to use sound underwriting standards. And you had Democrats and Republicans preventing the Commodity Futures Trading Commission from regulating many categories of derivatives.

So it was in the air, the idea that whatever Wall Street invents is by definition efficient, by definition virtuous, by definition self-regulating, and little by little a whole parallel banking system gets created that is beyond the scope of what the regulators can monitor.

Of course, there are countless takes on what happened then, what's happening now, and the similarities (and/or differences) between the two. The New York Times published this timeline [10] of what led up to the Meltdown of 2008, and I put together this surprisingly popular timeline about a year ago.

This week, PBS is running a special series [13] about the 1920's — the decade that preceded the crash — and the Great Depression of the 1930s [14]. Check the schedule of upcoming broadcasts for the next chance to watch it.

Last year, the History Channel ran "Crash: The Next Great Depression?" [15] impressed me as the one of the best explanations on the similarities and differences between 1929 and today. Perhaps that's because, besides a bit of lip service paid to conservatives New Deal Denialism [16], it pretty much echoed what progressives have said about the causes of the current crisis.

Finally, there's nothing like an anniversary to get people started on their versions of what happened then and what should be happening now. One one hand, the run the gamut from blaming bubbles [17] to pinning it on everything from excessive regulation to civil rights laws [18].

I'm no economist, but I tend to agree with the assessment that some important pieces of today's puzzle are income disparity, wage disparity, and their role in creating credit bubbles.

Wage stagnation has forced workers to look for other ways to maintain the same standard of living. Easy credit provided that opportunity, but not without severe damage to the family balance sheet. When the credit bubble burst and housing prices began to drop, millions of people were wiped out, stuck in homes with negative equity and zero savings.

Stagnant wages, shrinking personal savings, and record household debt, have created conditions similar to those in the Great Depression. The symptoms have been masked by the trillions in monetary and fiscal stimulus, and by the cheery talk in the media. But people are poorer and they are acting like it. Author and economist James K. Galbraith explains why this may be a problem in the future:

"The oddest thing about the Geithner program is its failure to act as though the financial crisis is a true crisis—an integrated, long-term economic threat—rather than merely a couple of related but temporary problems, one in banking and the other in jobs. In banking, the dominant metaphor is of plumbing: there is a blockage to be cleared. Take a plunger to the toxic assets, it is said, and credit conditions will return to normal. This, then, will make the recession essentially normal, validating the stimulus package. Solve these two problems, and the crisis will end. That’s the thinking.

But the plumbing metaphor is misleading. Credit is not a flow. It is not something that can be forced downstream by clearing a pipe. Credit is a contract. It requires a borrower as well as a lender, a customer as well as a bank. And the borrower must meet two conditions. One is creditworthiness, meaning a secure income and, usually, a house with equity in it. Asset prices therefore matter. With a chronic oversupply of houses, prices fall, collateral disappears, and even if borrowers are willing they can’t qualify for loans. The other requirement is a willingness to borrow, motivated by what Keynes called the "animal spirits" of entrepreneurial enthusiasm. In a slump, such optimism is scarce. Even if people have collateral, they want the security of cash. And it is precisely because they want cash that they will not deplete their reserves by plunking down a payment on a new car.

In the past year I've heard the need for consumers to start spending [19] and banks to start lending [20] (something they're doing less of [21], despite the bailout) if there's to be an economic recovery. What I haven't heard addressed much is just how this combination leads to anything but another bubble bursting if people borrow more and spend more (as is supposedly needed to get the recovery going), but aren't earning any more — unless the idea is for people to spend more, borrow more, and accept a lower standard of living. Permanently.

We know that Wall Street is doing quite well. Record profits [22] and huge bonuses [23] are back, even as unemployment is soaring, foreclosure reach record numbers, and the rest of America waits [24] for the recovery to start.

What does all this mean for the economy as a whole? It raises the fundamental question of where demand will come from to get us out of this hole. If so many Americans are losing their jobs and wages, you have to wonder who will be returning to the malls.

That same Bank of America Merrill Lynch report notes cheerfully that 42 percent of consumer spending before the meltdown came from the top-earning 10 percent of Americans (not too surprising given that the top 10 percent was raking in half of total earnings) and the top 10 percent continues to do relatively well. So, says Bank of America Merrill, we can rely on the spending of the top 10 percent to get the economy moving again. Indeed, they conclude, Congress and the White House should be careful not to raise taxes on the top 10 percent, lest the consuming ardor of these most privileged members of our society be dampened.

This logic is morally and economically indefensible. If we've learned anything from the Great Recession-Mini Depression of the last 18 months, it's that the skewing of income and wealth to the top has made our economy far less stable. When the majority of middle-class and poor Americans are either losing their jobs or feel threatened by job loss, and when those who still have jobs are experiencing flat or declining wages, there's simply no way to get the economy back on track. The track we were on -- featuring stagnant median wages, widening inequality, and job insecurity -- got us into this mess in the first place.

I tend to agree with Nomi Prins [25], who knows something about Wall Street.

Eighty years ago today, the stock market took a dive of more than 11 percent, a move that is considered the start of the Great Depression. The crash, like our own, was a wakeup call for change, says Nomi Prins—but Obama isn’t heeding the lessons of FDR and changing the banking landscape.

President Obama would do well to heed the notion of being true to Main Street economic conditions, rather than risk losing the next election by overlooking them and considering the rising markets and stabilizing banks as a sign of general strength.

Call it a dying cat bounce, but we should heed the lessons of Black Tuesday. That stock market dive, 80 years ago Thursday, was a wakeup call for change. Yet today, bank regulation is dialed back to pre-Black Tuesday conditions, as the economy for real people is similarly faltering. If we don’t make lasting changes to the banking landscape now, we will see more pain—not in 80 years, but in the next couple.

If there's no recovery for the real economy, there's no recovery. Just another bubble, and a bigger mess when it inevitably bursts.