History May Not Repeat, But It Does Rhyme*

Transcription

1 History May Not Repeat, But It Does Rhyme* Looking at the 2000s through a 1930s Lens *Mark Twain Mark D. Vaughan American University / Economics 639

2 Disclaimer The views expressed in this presentation and throughout this class are mine alone and do not represent official positions of the: National Credit Union Administration Don t look for a hidden political agenda either! Ghost of Career Past 2-25

3 Everything Old is New Again! 3-25

4 Partisan Distortion Everything Old is New Again Chicago Tribune April 21,

5 Great Depression vs. Great Recession Interesting Similarities Both preceded by good economic times : Annual real GNP growth = 4.4% (2 mild recessions) : 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: Installment credit 2000s: Mortgage/credit-card lending driven by credit-scoring/securitization 5-25

6 Great Depression vs. Great Recession Interesting Similarities Both preceded by asset bubbles. 1920s: Florida real estate (mid 1920s); stock market (late 1920s) 1990s-2000s: Tech stocks (late 1990s); housing (mid 2000s) Both started in U.S., then spread around the world. 1930s: Via gold standard : Via exposure to U.S. housing (toxic MBSs); Euro Both featured high-profile failure perceived as trigger. December 1930: September 2008: Bank of United States Lehman Brothers Both featured banker/financier bashing. 1930s: Andrew Mellon, Pecora Commission : Backlash over bonuses 6-25

7 Great Recession* Length: Industrial production: Rise in unemployment: Consumer prices: 18 months* 14.9%* 5.7 percentage points 1.5%* From May 2007 to October 2009 (peak) Bank failures: 501 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 Worst since World War II! 7-25

8 Great Contraction* Length: Industrial production: 43 months* 51.7%* Rise in unemployment: 19.3 percentage points 1929 average to 1932 average Consumer prices: 27.2%* Bank failures: 9,000 37% of U.S. banks in December 1929 Stock prices (DJIA): 89.2% From market peak (9/3/29) to trough (7/8/32) * Indicator measured from cyclical peak in August 1929 to cyclical trough in March Great Recession not close! 8-25

9 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. - Groundhog Day 16.0 Trends in Industrial Production August December 1942 Index of Industrial Production (Seasonally Adjusted, 2007 = 100) Pre-1929 Trend Line, Industrial Production Minor Tick = Recession 4.0 Industrial Production 2.0 Data Sources Federal Reserve Bank of St. Louis (FRED) National Bureau of Economic Research 0.0 Aug-24 Aug-26 Aug-28 Aug-30 Aug-32 Aug-34 Aug-36 Aug-38 Aug-40 Aug-42 Minor Tick = 1 Year Industrial production (and Real GDP) did not return to pre-1929 trend until

10 Great Depression vs. Great Recession Comparing Default Spreads to Gauge Intensity Minor Tick = 25 basis points Default Spreads and the Business Cycle Yields on Moody's Seasoned Corporate Bonds (Baa - AAA) January July 2014 (Monthly Averages of Daily Data) Peak (May 1932) = 5.64% Baa Yield minus AAA Yield (%) Data Sources Federal Reserve Bank of St. Louis (FRED) National Bureau of Economic Research Peak (December 2008) = 3.38% 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 Mean ( ) = 1.19% Recession Mean ( ) = 1.68% Median ( ) = 0.95% Recession Median ( ) = 1.34% Minor Tick = 2.5 Years Default-spread peaked in Great Recession at 0.6 times the Great Depression peak

11 Great Depression vs. Great Recession Comparing Unemployment Rates to Gauge Intensity 25.0% Joblessness during the Great Depression Bureau of Labor Statistics (BLS) Unemployment Rates, 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 20.0% 20.6% 20.1% 19.0% Minor Tick = 1 Percentage Point 15.0% 10.0% 5.0% 3.2% 8.7% 3.2% 15.9% 8.7% 15.3% 16.0% 14.2% 9.9% Peak Post-WWII Unemployment, November/December, 1982 = 10.8% Data Sources Darby, JPE (1976) Federal Reserve Bank of St. Louis (FRED) 0.0% % 14.3% 9.1% 12.5% 11.3% 17.2% 9.5% 14.6% 6.0% 9.9% 3.1% 4.7% 1.8% Minor Tick = 2.5 Years 1.9% Unemployment rate exceeded Great Recession peak (10.1%) for better part of 9 years

12 What Caused the Great Depression? Phase I The Great Contraction ( ) 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 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

13 What Caused the Great Depression? Phase I The Great Contraction ( ) Trends in Real and Nominal Discount Rate August 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) Recession Real (Ex Post) Discount Rate Nominal Discount Rate Percent, Minor Tick = 100 Basis Points Aug-24 Aug-26 Aug-28 Aug-30 Aug-32 Aug-34 Aug-36 Aug-38 Aug-40 Aug Data Sources Federal Reserve Bank of St. Louis (FRED) National Bureau of Economic Research Minor Tick = 1 Year Fed tightens money explicitly and implicitly! 13-25

14 What Caused the Great Depression? Phase I The Great Contraction ( ) Declines in Interest-Sensitive Spending/Real Output Great Contraction vs. Great Contraction (Benchmark) Percentage Change from Prior Year REAL SPENDING CATEGORY Consumer Durable Goods -17.2% -13.6% -24.0% -2.6% -5.2% -3.7% Producer Durable Goods (Plant and Equipment) -17.6% -34.5% -40.1% -9.9% 0.3% -17.1% Residential Housing -39.2% -16.4% -47.2% -18.3% -24.0% -22.9% Gross Domestic Product -8.6% -6.5% -13.1% -1.3% 0.0% -2.6% Percentage Point Contribution to Change in Real GDP from Prior Year REAL SPENDING CATEGORY Consumer Durable Goods -1.6% -1.1% -1.9% -0.2% -0.4% -0.3% Producer Durable Goods (Plant and Equipment) -1.9% -3.3% -2.8% -0.5% 0.0% -2.0% Residential Housing -1.5% -0.4% -1.1% -0.2% -1.1% -0.7% Note: Percentage changes based on 2005 chained dollars; data obtained from Bureau of Economic Analysis, U.S. Department of Commerce 14-25

15 What Caused the Great Depression? Phase I The Great Contraction ( ) Policy Mistakes Mortal Sins Fed did not inject liquidity necessary to stop bank panics ( ). 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 Certainly unhelpful, but not as bad as once thought! 15-25

16 What Caused the Great Depression? Phase II The Great Lingering ( ) 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 ( ) Licensing banks to re-open (1933) / Creating FDIC (1934) IRONY: Key New Deal policies hurt; by the way policies helped! 16-25

17 What Caused the Great Depression? Phase II The Great Lingering ( ) What delayed recovery? Another Policy Mistake: Doubling of reserve requirements ( ) 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 by hording liquidity / avoiding credit risk

18 Bankers Have Long Memories (I) Took Years to Stop Hoarding Liquidity Cash/Assets (%) Minor Tick = 2.5% 40.0% Cash/Assets (1940) = 37.2% 35.0% Investments/Loans (1945) =384.2% Trends in Bank Liquidity All U.S. Commercial Banks, (Year-end Balance-Sheet Data) Recession Cash & Due / Total Assets Investments / Total Loans Investments/Loans (%) Minor Tick = 25.0% 400.0% 350.0% 30.0% 300.0% 25.0% Cash/Assets (1934) = 24.1% 20.0% 250.0% 200.0% 15.0% Cash/Assets (2013) = 11.9% 150.0% 10.0% Investments/Loans (1934) =124.3% 100.0% 5.0% DATA SOURCES FDIC, Historical Statistics on Banking National Bureau of Economic Research 0.0% Cash-to-assets ratio did not fall below 1934 level until Investment-to-loans ratio did not fall below 1934 level until Investments/Loans (2013) =37.6% 50.0% 0.0% Minor Tick = 2 Years 18-25

19 Bankers Have Long Memories (II) Took Years to Get Comfortable with Credit Risk Minor Tick = 25 basis points 3.75% Cyclical and Secular Trends in Asset Quality Aggregate Charge-Off Rate (Net Charge-Offs / Total Loans) All U.S. Commercial Banks, (December Balance-Sheet Figures) Net Charge-Offs (Loans & Leases) / Total Loans & Leases (%) 3.25% 2.75% 2.25% 1.75% 1.25% 0.75% 1934 = 3.42% Recession Net Charge-Off Rate DATA SOURCES FDIC, Historical Statistics on Banking National Bureau of Economic Research 1975 = 0.55% 1991 = 1.60% 2002 = 1.07% 2010 = 2.69% 2013 = 0.68% 0.25% 2006 = 0.39% % Minor Tick = 2 Years 19-25

20 What Ended the Great Depression? Accidentally Expansionary Monetary Policy Apart from recession, growth was impressive. Average annual real GDP growth, = 9.0% Average annual real GDP growth, = 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 ( ) = 13.1% [ average = 6.6%] Average annual growth, M2 ( ) = 9.2% [ average = 5.5%] 20-25

21 Great Depression vs. Great Recession Key Differences Dodging the Bullet! Presidential transition was smooth, cooperative. GD: GR: Election in November; inauguration in March; banking system collapses as FDR rebuffed Hoover. Election in November; inauguration in January; Obama and Bush administrations worked together. Wealth of data / economic expertise was available. GD: GR: Few real-time numbers to guide policy, no grasp of modern macroeconomics / money multiplier. Fed headed by foremost economic student of Great Depression (Ben Bernanke). Federal government responded with stimulus (?) GD: Federal deficit as a percentage of GDP, average = 1.3% GR: Federal deficit as a percentage of GDP, 2009 = 8.9% Focus on banking. GD: Plight of small, non-member banks ignored (some large banks, too) ignored until 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 GR: Wide-open discount window / multiple liquidity facilities stabilized financial system; between December 2007 and June 2009, M2 rose 12.5%

22 Fed Provided Ample Liquidity Minor Tick = $100 Billion $2,000.0 $1,800.0 EXCESS RESERVES OF DEPOSITORY INSTITUTIONS* January 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 $200.0 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 August 2008 = $2.3 billion September 2001 (9/11) = $24.8 billion $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 *Depository institutions subject to Federal Reserve reserve requirements. Minor Tick = 3 Years Average excess reserves since advent of financial crisis exceed 500 times pre-crisis average

23 And Yet The Economy Remains Sluggish Why? Real GDP Per Capita Business-Cycle Peak Quarter = STRENGTH OF RECOVERIES Great Recession vs. Average for Previous Post-WWII Recessions NOTES - Real GDP per capita is only 2.6% above 2007 business-cycle peak. - Real GDP per capita is 11.4% below average of previous post- WWII recoveries. - if current recovery matched average of previous post-wwii recoveries, per capita income would be $6,547 higher and 15.2 more Americans would be working Business-Cycle Peak Great Recession Average for Previous Post-WWII Recessions Data Source FRED, Federal Reserve Bank of St. Louis Quarters Since Business-Cycle Peak 23-25

24 Who is closest to the truth? Heraclitus (535 BC 475 BC): You can never step in the same river twice. George Santayana ( ): Those who cannot remember the past are condemned to repeat it

25 Any Good News? 2013 This is a great time to be an economist! 25-25

26 Questions over History May Not Repeat, But It Does Rhyme: Lessons from the 1930s for the 2000s? Mark D. Vaughan American University / Economics 639