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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