Robert Samuelson gives the credit for averting Depression 2.0 to the government:
That these huge declines [ed. freezing of the credit markets, drop in the stock market, fall in consumption] didn’t lead to depression mainly reflects, as Romer argues, countervailing government actions. Private markets for goods, services, labor and securities do mostly self-correct; but panic, driven by the acute fear of the unknown, feeds on itself and disarms these stabilizing tendencies. In this situation, only government can protect the economy as a whole, because most individuals and companies are involved in the self-defeating behavior of self-protection.
Government’s failure to perform this role in the early 1930s transformed recession into depression. That changed when newly inaugurated Franklin Roosevelt closed all banks on March 5, 1933. Many were already shut, having suffered massive withdrawals by terrified depositors who feared their funds would be lost. Yet when banks reopened in mid-month, Americans redeposited most of that money. The reason was not just Roosevelt’s first calming fireside chat (“It is safer to keep your money in a reopened bank than under the mattress”), argues a study by economist William Silber of New York University. FDR’s pledge was credible because the Federal Reserve was authorized to supply currency to any reopened bank equal to 100 percent of its deposits.
Something analogous happened over the past year. Scholars will debate which interventions — the Federal Reserve propping up a failing credit system, the Troubled Assets Relief Program, Obama’s “stimulus” plan and bank “stress test” — counted most. Regardless, they all aimed to reassure people that the free fall would stop and thereby curb the fear perpetuating the free fall. Confidence had to be restored so the economy’s normal recovery mechanisms could operate. This seems to have happened. By last month, the consumer confidence index had rebounded to 53.1. Housing prices had stopped falling. By the Case-Shiller index, they’ve increased for three months.
That’s only fair since the federal government and its affiliated agencies (like the Federal Reserve) were largely responsible for the conditions that created the problems to begin with.
Just for a moment let’s consider the critical factors leading to the sharp economic decline starting in 2007. As a hipshot guess I’d suggest the following:
- Changes in banking law over the last thirty years allowing branch banking, adjustable rate mortgages, allowing banks to get into securities, etc.
- Extending credit to the uncreditworthy, growth in unsecured credit.
- Inadequate regulation of banks in part due to regulatory capture.
- Chinese de facto peg of the yuan to the dollar causes asset inflation.
- Fed’s keeping interest rates too low too long abets asset inflation.
- Worldwide savings glut.
- Panic
The only one of those that has abated to any degree at all is the panic. I don’t think we’ve addressed the causes of the downturn which means it will either persist or return (depending on whether you think the recession is over or not).
Is it realistic to continue to refer to government and business as two separate entities when it comes to banking, securities, etc… Hasn’t the line been so thoroughly blurred that the two act more as somewhat disjointed corporate cousins more like Time and Warner or Fox and HarperCollins?
Don’t forget the credit rating agencies. The government not only requires institutional investors to use their ratings, but the government also allowed those agencies to collect fees from the firms they were rating. I think things would have been a lot different if trillions in institutional investor money had not gone into AAA – rated CDO’s.
Michael:
Yes, it’s a problem. I have my own preferred approaches for changing that but none of them have the slightest hope of happening.
Andy:
I’d lump that in with “regulatory failure”. Not only did the government allow the credit rating agencies to collect fees from the firms they were rating but it required that those credit rating agencies be used to rate the firms. I think that’s an enormous problem.
Sooo….banks are still lending to the un-credit worthy? I thought banks weren’t lending at all, now after they’ve stood on the brink of the abyss they are doing the very same thing they did earlier?
Zombie banks anyone?
Maybe we should have killed the zombies (remove the head or damage the brain) and kept the good ones.
And regulatory capture can’t be right. Why that is right out of the Public Choice/Chicago School/libertarian play book. What are you some sort of Niskanen/Stigler sycophant or something?
[/sarcasm]
Michael,
Yes, Dave covered that with the part about regulatory capture.
1), is pretty much just deregulation. This was all stuff the banks wanted.
2) Agreed, driven by the banks as they were making big money off of it.
3)Big issue. I see this raised more often as an issue at places like Baseline Scenario rather than by people Kling TBH.
4) Agreed.
5) Agreed.
6)US personal debt reached record levels.
7) Agreed.
I would also include the shadow banking system and its lack of transparency. The mortgages going under was bad. The financial instruments which amplified that made it a crisis. Finally, any explanations need to include the international scope of the problem.
Steve