Download The Next Great Depression? Not Likely

Modern History:
What the Economic Past Can Tell Us
About the Future
Price Fishback
University of Arizona
Copyright, Price Fishback, 11/12/2014
1
Shameless Plug for Readership
2
Spectacular Meltdown Fall 2008
• in the Financial Sector in 2007-2008
– Stock Market Halved in Value
– Wall Street Investment Banks are gone or are now
Commercial Banks
– Large slug of toxic assets on books of financial
institutions
• Towers of MBSs, CDOs, CDSs built on mortgages, with
houses as collateral
Copyright, Price Fishback, April 26, 2012.
3
Constant References to
the Great Depression
• Worst Financial Crisis Since the Great
Depression
– Bernanke now calls it worst ever
• Intensity focused in such a short period
• Size of financial institutions in danger
• Difficulties for large firms to get commercial paper
• Worst Downturn since the Depression?
Copyright, Price Fishback, April 26, 2012.
4
Unemployment Rate, 1947-2014
Compare 2007-14 to Early 1980s: lower peak but longer recovery
Long periods between recessions 3 of 5 longest recoveries in U.S. history
5
Unemployment Rates, 2001-2014 and 1922-1940
30
25
20
15
20s & 30s
10
2000s
5
0
0
2
4
6
8
10
2001-2014
12
1922-1940
Copyright, Price Fishback, April 26, 2012.
14
16
18
20
19
Employment Rate, 1948-2014
MUCH SCARIER
In Modern Era
7
Disability Insurance Payments under SSA
Copyright, Price Fishback, 11/12/14
8
Ratio of Employment to Total Population, 2001-2014, and 1922-1940
50.0
48.0
2000s
46.0
44.0
42.0
40.0
38.0
36.0
20s & 30s
34.0
32.0
30.0
0
2
4
6
8
10
2001-2014
12
14
16
18
20
1922-1940
Copyright, Price Fishback, April 26, 2012.
9
Real GDP Per Capita, 1947-2013
Copyright, Price Fishback, April 26, 2012.
10
Shortfall in Real GDP Per Capita Relative to Peak,
2001-2014 and 1923-1940
15.0
10.0
5.0
0.0
0
2
4
6
8
10
2000s12
14
16
18
20
-5.0
-10.0
-15.0
20s & 30s
-20.0
-25.0
-30.0
-35.0
2001-2013
1922-1940
Copyright, Price Fishback, April 26, 2012.
11
1932 and 1933 GDP Output Loss Equivalent to
Shutting Down Production West of Mississippi
Equivalent Loss for 2008,
Washington State
Copyright, Price Fishback, April 26, 2012.
12
25.0
CPI Inflation Rate, 1901-2013
Nasty
Inflation
Late 70s,
Early 80s
20.0
15.0
10.0
5.0
0.0
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
2000
2010
-5.0
-10.0
-15.0
Terrible
Deflation
in 1930s
Hurts Borrowers
Copyright, Price Fishback, April 26, 2012.
13
Compare to late 1970s early 1980s
Civilian Unemployment Rate, Inflation, and Misery Index, 19652006
Huge Success
25.0
Inflation rate around 3 percent
Misery Index
Percent
20.0
15.0
Unemployment Rate
10.0
5.0
0.0
1960
Inflation Rate
1965
1970
1975
1980
1985
Year
1990
Copyright, Price Fishback, April 26, 2012.
1995
2000
2005
2010
14
Was Stock Drop Similar?
11/07 to 2/09
www.bigcharts.com
Copyright, Price Fishback, April 26, 2012.
15
1920-1940
301.7
http://stockcharts.com/charts/historical/djia1900.html
Rise is even
Bigger than it
Looks because
Of the log scale
41.2
Copyright, Price Fishback, April 26, 2012.
16
Peaks and Troughs in S&P 500 Stock Index
1957-2011
Date
Months
Date of
Date of
Prior Peak
Trough
Peak Value
7/15/1957 10/22/1957
49.13
12/12/1961 6/26/1962
72.64
2/9/1966 10/7/1966
94.06
11/29/1968 5/26/1970 108.37
1/11/1973 10/3/1974 120.24
9/21/1976
3/6/1978 107.83
11/28/1980 8/12/1982 140.52
8/25/1987 12/14/1987 336.77
7/17/1998 10/8/1998 1186.75
3/14/2000 10/9/2002 1527.46
10/9/2007
3/9/2009 1565.15
Trough
Value
38.98
52.32
73.20
69.29
62.28
86.90
102.42
223.92
959.44
776.76
676.53
Percent
Drop
-20.7
-28.0
-22.2
-36.1
-48.2
-19.4
-27.1
-33.5
-19.2
-49.1
-56.8
Copyright, Price Fishback, April 26, 2012.
Reached to Reach
Peak
Next
Again
Peak
9/16/1958
11
9/3/1963
15
5/4/1967
7
4/15/1972
23
7/17/1980
79
8/15/1979
17
11/3/1982
3
7/26/1989
20
11/23/1998 1.5
5/30/2007
43
3/28/2013
48
17
Credit Unions: Real Assets and Real Loans, 1927-1940
700
600
Depression Success Story
500
400
Only Financial Sector I Have Found
That Did Not Drop Like a Stone
Between 1929 and 1933
300
200
100
0
1928
1929
1930
1931
1932
1933
1934
Real Assets
1935
1936
1937
1938
1939
1940
Real Loans
Copyright, Price Fishback, April 26, 2012.
18
Bank Failures and Fed Response
in 1930s
• Bank Failures
• 1920-1929 Average of 630 banks a year failed
– Small unit banks lost about 0.7 % of deposits
• 1930-1933 Lost 7,200 banks
• Much bigger banks,
• Major bank runs.
• FED Response
• Ineffective discount rate cut--due to deflation
• Waited until 1932 for large purchase of bonds
Copyright, Price Fishback, April 26, 2012.
19
Comparison
• During Great Depression, It took the Federal
Reserve
– 3 years
– a rise in unemployment to over 20 percent
– and a decline in annual output of 25 percent
– before the emergency moves were made?
• Fed Chair Bernanke is a Student of the
Depression.
• What have he, Paulson, and Geithner Done?
Copyright, Price Fishback, April 26, 2012.
20
Bernanke Policy, 2008
FED and Treasury have taken ownership stakes
in banks and AIG
Guarantees on Bear Stearns and in many other
places.
This happened all before the unemployment
rate made it to 7 percent.
Copyright, Price Fishback, April 26, 2012.
21
Fed Policy Since 2008. Keep Federal Funds Rate at 0 bound,
Quantitative Easings.
Copyright, Price Fishback, April 26, 2012.
22
Pre-Crisis Fed Policy
Long-Term Govt. Securities
Short-term Govt. Securities
http://greshams-law.com/2012/02/13/charting-the-federal-reserves-assets-from-1915-to-2012/#1915to1925
Copyright, Price Fishback, April 26, 2012.
23
Where is the Inflation?
•
•
•
•
•
•
IS IT
lack of borrowers seeking loans?
OR
Are Bankers sitting on the money?
Regulators sitting on bankers?
Still have plenty of toxic assets, because
mortgage crises take a long time to unwind
• Is Fed Just Propping up Toxic assets?
Copyright, Price Fishback, April 26, 2012.
24
Fiscal Policy Since World War II
Federal Government Revenues (diamonds), outlays (squares), Deficit
(triangle), Percentage of GDP, 1947-2012
30
25
20
15
10
5
0
-5
-10
-15
1945
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
Revenues
Outlays
Deficit
Side Note: New Deal
was
not
Keynesian
nor was WWII
Copyright,
Price
Fishback,
April 26, 2012.
2005
2010
2015
25
Federal Debt Held by the Public as Share of GDP, 1970-2012
80
70
60
50
40
30
20
10
0
1965
1970
1975
1980
1985
1990
1995
Copyright, Price Fishback, April 26, 2012.
2000
2005
2010
2015
26
Fiscal Multipliers
• Pre 1970s– Samuelson Text – 2 or 3.
– Federal Deficit of $1, Real GDP up 2 or 3.
• Backlash from Friedman. Crowding out of
Private Investment and Employment.
• Majority of Economists these Days would put
multiplier between 0.5 and 1,.0
• Christina Romer, Chair of Presidents CEA and Mark
Zandi at Moodys.com around 1.5
• Robert Barro at Harvard around 0.8, long run zero.
Copyright, Price Fishback, April 26, 2012.
27
How Did we Get the Great
Recession?
• Problems stem from Asset Value Problems.
• Large Share of Troubled Assets Based on
Mortgages
– Assets because flow of payments
• House itself is collateral
– Backed by the value of the House
Copyright, Price Fishback, April 26, 2012.
28
Housing Problems
• Problems stem from Asset Value Problems.
• Large Share of Trouble Assets Based on
Mortgages
– Assets because flow of payments
• House itself is collateral
– Backed by the value of the House
Copyright, Price Fishback, April 26, 2012.
29
Housing Prices More than Doubled in Major Markets
, 2000 to 2006. Have fallen back to 150% of 2000 peak
Case-Shiller Housing Price Index, 10 Cities Through June 2009
250.00
200.00
150.00
100.00
50.00
0.00
March 1986 December 1988
September 1991 June 1994
March 1997 December 1999
September 2002 May 2005 February 2008
Copyright, Price Fishback, April 26, 2012.
30
WSJ
11/12/08
Copyright, Price Fishback, April 26, 2012.
31
Key Assets Involved
• All were attempts to Spread Risk and Minimize
it.
– Mortgage Backed Securities (MBS)
• Just like a stock fund
• Own a whole group of mortgages
– Collateralized Debt Obligation (CDO)
• Fund made up of MBSs
– Credit Default Swaps (CDS)
• Insurance on the CDOs
Copyright, Price Fishback, April 26, 2012.
32
AIG Credit Default Swap
• Goldman owns a CDO and pays insurance
premium to AIG to cover CDO
• If bunch of mortgages default and MBS and
CDO fall sharply in value, AIG pays Goldman
and takes over CDO
Copyright, Price Fishback, April 26, 2012.
33
Posting Collateral for CDS
• The Big Risk that AIG never Expected with
respect to Credit Default Swap
• If AIG’s market value falls, CDS requires that
they post collateral to prove that they can
cover the CDS.
– AIG was so big, no one ever thought that they
would ever have to post collateral
•
Copyright, Price Fishback, April 26, 2012.
34
The Perfect Storm
• Plenty of Blame to Go Around
• Stock Bust early 2000s led People to Invest in
Housing as Asset
• Greenspan interest cuts than rises
• Increase in Federal Government pressures on
Freddie Mac and Fannie Mae to purchase
subprime loans
– subprimes from 5 to 20 percent of market
Copyright, Price Fishback, April 26, 2012.
35
Perfect Storm (cont.)
• Change in lending standards
• Ratings Agencies Overly Optimistic
• Accounting Rules for Regulatory Purposes
– Shifts in Valuing Assets
• Move from Book Value to Mark to Market
Copyright, Price Fishback, April 26, 2012.
36
Was the Problem Deregulation?
• Not Necessarily.
• Nearly all of this occurred in Regulated
Markets.
• Why Didn’t work?
• Success/Failure of Regulations is really a case-by-case
situation
• Fannie and Freddie regulated
• did they control the regulator?
• Biggest worry here is that they now dominate housing
market and they were big part of problem
Copyright, Price Fishback, April 26, 2012.
37
Was the Problem Deregulation?
• Repeal of Glass Steagall divided between
investment banks and banks?
– Did more to save situation than make it worse.
• Credit Default Swaps and CDOs were never
regulated
– Calls for CDSs and CDOs to be traded on
exchanges might be good idea
Copyright, Price Fishback, April 26, 2012.
38
Housing Problems of the 1930s
• Nominal Home Values Fell an average of 40-50
percent between 1927-1929 and 1933
• Sharp Jump in Foreclosures in early 1930s
• Home Ownership Decline by 4-5 percentage
points
• Tremendous Deflation
– Increased value of dollars owed by 30%
Copyright, Price Fishback, April 26, 2012.
39
Why Did Building and Loans Delay
Closure for So Long?
• Problems begin in 1931, 1932, 1933
• Why Didn’t the B&Ls close until after 1935
• Mutual nature of B&L
– Borrowers and nonborrowers are owners
– 2/3 vote to close
– Was not until after 1935 that most B&Ls reached a point
where borrowers accounted for less than 1/3 of owners
– Counteractive gains and losses
• Stay open, borrower gain, less probability of losing house
• Close, nonborrowers gain, investment can switch to better
alternative after taking loss
New Deal Solution:
Home Owners Loan Corporation
• HOLC designed to help homeowners who
were in trouble with mortgage “through no
fault of their own.”
• HOLC bought 1 million troubled nonfarm loans
from mortgage lenders (1.8 million
applications)
– 10 % nonfarm homeowners
– 3 % of all households
• Refinanced the loans with new terms.
41
HOLC Major Features
• Bought Loan from Lender at Close to Full Value
– Principal, back interest and taxes, renovations
• Refinanced that Value for Borrowers
– No break on what was owed lender
– Lengthened loan
– Subsidized interest rate of 5 %, (low-risk private at 6-7
%)
• Waited 1.5-2.5 years before Foreclosing
• Ex Post lost only 2 percent based on government
accounting.
– True Size of Subsidy Ex Ante more like 20-30%
42
Effects on Housing Markets
• Two independent studies of county data find
similar effects in smaller counties (2700 with
under 50k people)
• Kept home values from falling much further
– Estimated Probably stopped an added 15% decline
• Kept home ownership rate from falling any
further
– Probably stopped another 10% decline in number
of home owners
43
HAMP vs. HOLC
• HOLC bought loans, HAMP not purchase but
some subsidy
• HAMP asking for more of a haircut, attracting
relatively fewer lenders.
• Neither provided much in principal reductions
to borrowers (HAMP small program)
• HOLC much more generous servicer of loans,
HAMP not really involved there
44
Other Connections
• New Deal created Federal Housing Administration
(FHA) and Fannie Mae
– FHA insured mortgages
– Fannie created market for mortgages
• Modern times
– Fannie and Freddie significant contributor to housing Crisis
– Still a major player
– Fed has bought up huge amount of Mortgage-Backed
Securities as part of Qes
• How much of that was purchasing toxic assets from banks to prop
up their balance sheets
• To what extent has Fed and bank regulators slowed lending by
regulatory limites because of this policy
Generally Optimistic
• Long Run per capita income Growth 1.6
percent per year for 170 years
• 3 out of last 4 years at that rate
• Although this is slow recovery
• Constant innovations coming all of the time
– Particularly in health care
– Fracking revolution; alternative energy, slowing pollution.
– Knowledge exploding in many areas we can’t see
• Expect rest of the world will start growing
again reasonably soon.
Copyright, Price Fishback, April 26, 2012.
46
Challenges of Policy Uncertainty
•
•
•
•
Contributed to Depression
Only partially written financial reforms
Worries about getting out of QE
Social Insurance issues
– Social Security, Medicare, New Health Care, Public Pensions
– Funded as pay-go or poorly funded; increased bills coming
• War, biggest disaster for all involved
• Resolving school quality issues
• Freddie, Fannie and Housing markets
Copyright, Price Fishback, April 26, 2012.
47
Shameless Plug for Readership
48
Copyright, Price Fishback, April 26, 2012.
49
Copyright, Price Fishback, April 26, 2012.
50
Inequality
Copyright, Price Fishback, April 26, 2012.
51
Meyer and Sullian 2012
Real Wages for Hourly Manufacturing Workers and Unskilled Workers,
1982-1984 Dollars, 1901-2013
14
12
10
8
6
4
2
0
1900
1910
1920
1930
1940
1950
Real cost unskilled
1960
1970
1980
1990
2000
2010
Real hourly Mfg. Wage
Copyright, Price Fishback, April 26, 2012.
55
Total Federal Debt as Percentage of GDP
100
90
80
70
60
50
40
30
20
10
0
1945
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
Federal Debt as Percentage of GDP
Copyright, Price Fishback, April 26, 2012.
56