ECONOMIC CRISIS: Depression rerun?

In recent days, you’ve heard —- a lot —- how the current financial crisis is the worst since the Great Depression.

It may be. Much less clear is whether it will turn into anything actually like the Depression, when over three years the economy shrunk by nearly half and unemployment reached 24 percent.

Current economic measures are still far cheerier than that. There are other reassuring differences as well.

As the Depression began, the nation had virtually no safety net for the needy and no regulation of banks. Government officials then were reluctant to rescue distressed players in the market.

Yet to some historians, today’s storyline has familiar themes.

“It is a very similar process to the Great Depression, because what you have is people not spending enough money,” said historian Bryant Simon of Temple University, director of American studies.

Debt-ridden consumers and troubled banks are toxic to a consumption-driven economy, he said.

“It is not as severe as it was,” Simon said. “But if the banks are not going to lend money, you can’t get the economy back in gear. What you have is people not spending enough money.”

The United States has struggled through periodic and painful downturns during its history, every time bouncing back.

But the Great Depression was so deep and broad that it sparked dramatic action to change the rules of the market.

Some of those changes —- such as deposit insurance —- make another Depression much less likely, many experts agree.

The current credit crunch may test the theory.

The late economist Hyman Minsky said capitalist systems tend to “constantly leverage up with more debt,” noted former Fed economist Tim Yeager, who was one of Minsky’s students and is now a finance professor at the University of Arkansas.

“Credit becomes weaker, loans become worse and worse and risk grows,” Yeager said. “It is like a Ponzi scheme.”

He hears echoes in today’s financial headlines.

“That is a good explanation of what happened this time. It’s a good explanation of what happened in the Great Depression.”

In popular memory, the stock market crash in the fall of 1929 triggered the Depression, although many experts say the crash was more symptom than spark.

Again this fall, the market has gyrated unnervingly.

“That is what everybody is looking at and that is about where the similarities end right now,” said Tom Smith, finance professor at Emory’s Goizueta Business School.

Even with the similarities, the stock market has a long way to go to match the Great Depression’s collapse. The Dow, an index of big company stocks, has lost roughly 40 percent in a year. In October 1929, stocks lost 40 percent in a month and would go on to lose almost 90 percent in three years.

Banks were a focus then as now, but for different reasons, Smith said.

“The 1930s was a failure of the banking system. What we had this time was a failure of banking practices.”

Those practices included creation of innovative securities meant to dilute the risk of bad loans. Instead, they spread financial poison around the world when the housing market stalled, as many of the securities were backed by mortgages.

Another difference: During the Depression, loans came mostly from small, virtually unregulated community banks. Government did not insure deposits, and banks could invest them any way they wanted.

As a sliding world economy ensnared the United States, millions of Americans saw their incomes drop. Passage of the Smoot-Hawley tariff exacerbated the problem by chilling trade. Many —- especially in rural America —- couldn’t make debt payments.

The need to get money often accelerated to a frenzied run on banks, which could not keep enough cash on hand to satisfy all depositors at once.

During the first 10 months of 1930, 744 banks failed, said Roger Cominsky, a Buffalo-based partner in Hiscock & Barclay’s Financial Institutions & Lending practice. By the end of the decade, 9,000 had gone under —- nearly one in three.

In contrast, the community banks of the 21st century are relatively strong. But they do less of the nation’s lending. Instead, the economy depends on a handful of huge banks and other financial institutions.

Both eras came after economic “bubbles” that inflated many Americans’ wealth, at least on paper. In the ’20s it was stocks, and in this decade housing.

In both cases ownership was propelled by easy credit, easy terms and rules meant to encourage buyers to stretch beyond their ability to pay.

With stocks, it was “margin” buying —- investors needed just a fraction of the price to make a purchase. A broker could issue a “call” that required the buyer to come up with more cash, but that was easy if prices had gone up. With homes it was a combination of public policy that encouraged easier credit, along with lending and investing practices that fueled the binge. Consumers used refinancings or equity loans to fund other big purchases.

For both stocks and homes, the game could go on as long as prices kept rising.

During the early years of the Depression, about 40 percent of bank loans were secured with stocks, said Brian Olasov, managing director at McKenna Long & Aldridge, who consults with banks and has done extensive research on banking crises.

“Now, about six-tenths of bank portfolios are real estate-related.”

Despite similarities, most experts don’t think the 2008 crisis will lead to a full replay of the Depression.

But Yeager, the former Fed economist, said the worst may still be to come.

“There is a big storm brewing.”

 A TALE OF TWO ERAS
So far, the pain of the 2008 market crisis is milder than in 1929 —- and far milder than it was by 1932.
......................Fall 1929 ......Fall 1932 ......Fall 2008
Dow loss..............44% ............88% ............15% (so far)
Unemployment..........3.2%............24% ............6.1%
Bank failures, 
 ..year to date ......About 1,000 ....N/A ............15
Size of U.S. economy..$103.6 billion..$58.7 billion ..$14.3 trillion
Sources: Bureau of Labor Statistics, Econ Review, Federal Deposit Insurance Corp., Bureau of Economic Analysis