Americans binge on credit in a mania of speculation and consumption until the debt-fueled bubble bursts. Wall Street has a meltdown, the mania turns to hysteria, and the economy goes haywire.
That scenario spawned the Great Depression - and it's painfully clear that similar factors are in play today.
Now the question on everyone's mind is: Will it happen again?
From late-night comics to financial pundits, there are plenty of people predicting a new era of breadlines and Hoovervilles. In fact, according to a poll this month, about 60 percent of Americans think we could suffer another depression soon.
To be sure, the calamitous events of recent weeks - a deepening credit crunch, bank failures and hasty mergers, financial titans crumbling, the stock market tumbling, the government stumbling for solutions - evoke an alarming sense of deja vu.
But at the same time, most people's day-to-day reality is nothing like that during the Great Depression, when millions of families were thrust into poverty.
Despite screaming headlines about financial chaos, "for the average person, it hasn't had an impact," said Gregg Easterbrook, a Brookings Institution fellow in government and economic studies. "Goods and services are plentiful; the price of gas is falling; ATMs are working. People are not losing jobs left and right."
The current situation is a financial panic, not an economic collapse, Easterbrook said.
There is no doubt that damage to the financial sector has been profound, with the demise of major Wall Street institutions and gut-wrenching plunges in the stock market. But that has not hurt Main Street to the extent it did in the Great Depression.
"The mess in the financial system is probably a lot worse than it was in the 1930s," said Gary Richardson, an associate professor of economics at UC Irvine and a research fellow at the National Bureau of Economic Research. "But the problems in the financial system have not been transmitted to the rest of the economy to anywhere near the same extent. That's the comforting thing that the public should take out of this."
Economists can readily tick off numerous parallels between today's economic climate and that of the late 1920s. But many of them immediately bring up important ways in which this time is different.
"That was a period of rising economic inequality; this is a period of rising economic inequality," said David Moss, professor of economic history at Harvard Business School. "That was a time of exuberance in financial markets; this is a time of exuberance in financial markets. (Both times) there was a big rise in consumer debt and leverage in general. That was a time when installment credit was taking off. People were buying all sorts of items - automobiles, radios. There were a lot of consumer purchases on installment credit. There was a lot more reliance on debt, including buying stock on margin."
But he and others also enumerated many critical differences today.
One of the biggest is the very fact that the Great Depression already happened and has been intensely studied - including by Federal Reserve Chairman Ben Bernanke.
"We have learned from history," said Gregory Clark, chairman of the economics department at UC Davis. "The people running the Federal Reserve and Treasury are acutely aware of that possibility (of another depression). Politicians all know about the Great Depression, and because of that previous experience are willing to (let go of) worry that we're just awarding bankers" with rescue plans.
Some of the other distinctions are in magnitude - certainly, unemployment and foreclosures are rising today, but they're mere fractions of Great Depression-era levels. Other distinctions are in our current system, which has built in many more safeguards, both social and financial, many of them legacies of the Depression itself. Others are in the health of our overall economy - it may be battered, but it has more underlying resilience and diversity than that of the 1920s and '30s, economists say.
Here is a rundown of some key distinctions:
Unemployment: Joblessness hit a five-year high in September - but that high is 6.1 percent, drastically different than the 24.9 percent peak reached in 1933. While economists think unemployment will continue to rise, they predict a range of 7 to 8 percent.
The "jobless recovery" after the last recession may be a saving grace now, according to Mark Riepe, senior vice president of the Schwab Center for Financial Research. "Because firms didn't over-hire during the recent expansion, there are fewer jobs to cut during this downturn," he wrote in a newsletter last week. "We expect this should prevent the unemployment rate from getting out of control."
Exacerbating the situation in the 1930s, few women worked, so if the "man of the house" was unemployed, there likely was no income. Conversely, today, because many households have two incomes, losing one income is difficult but not necessarily as devastating.
Many of today's jobless workers can collect unemployment insurance, a federal program that grew out of the 1930s experience.
Banks: Federal deposit insurance - another legacy of the New Deal - has made all the difference in the world to the banking sector. Fifteen banks have failed this year, some of them triggering bank runs reminiscent of the Great Depression. But deposits at all those banks were insured up to $100,000 (recently raised to $250,000). When banks went under in the 1930s - and about 10,000 out of 25,000 banks went belly-up during the Depression - people lost every penny.
The bank failures and bank panics in the early 1930s had grave consequences for the overall economy. Bank lending virtually stopped, paralyzing business expansion. The nation's money supply fell 33 percent from 1929 to 1933 as consumers hoarded cash and banks increased their reserves to guard against runs. That in turn led to rampant deflation, with aggregate prices falling 22 percent from 1929 through 1933.
"When prices fall, debtors have a real hard time paying back their debts, because the debts are growing," said Richardson of UC Irvine. "That prevented a lot of people from paying back loans." (A similar situation can be seen today in the many "underwater" homes, with borrowers owing more than their home is worth.)
Consumer spending, the bulwark of the economy, ground to a halt after the 1929 stock market crash and bank failures. "What turned a recession into the Great Depression was a drop in consumer spending that we cannot explain through income or wealth effects," said Martha Olney, an economics professor at UC Berkeley.
Housing: America had a housing boom in the 1920s, fed by lax lending standards, an increase in loan-to-value ratios and more use of high-interest secondary loans, according to a report by David Wheelock, vice president and economist at the Federal Reserve Bank of St. Louis.
Real estate speculation was widespread. Most home loans were balloon notes of five years or less; borrowers would refinance them at maturity, but when housing prices started to fall, refinancing became impossible and they ended up losing their homes.
That all sounds grimly familiar.
But, again, the consequences were far more drastic then. By early 1932, about half of all urban houses with an outstanding mortgage were behind on payments, according to Wheelock. Between 1931 and 1935, at least 1 out of every 20 nonfarm homes was lost to foreclosure - and that was despite many states imposing a moratorium on foreclosures.
By contrast, today's foreclosure problem has been largely confined to subprime mortgages, which represent 14 percent of all outstanding first mortgages. While foreclosures have started to spread to "near-prime mortgages," which represent another 8 to 10 percent of the market, that contagion has been relatively minor to date. Also, it's noteworthy that one-third of all homeowners own their residence free and clear.
At the end of the second quarter this year, 6.41 percent of all residential mortgage loans were delinquent, up from 5.12 percent a year ago, according to the Mortgage Bankers Association. One out of every 416 households, or about 0.24 percent of all homes, were somewhere in the foreclosure process, according to RealtyTrac.com (over half of homes in the process end up being repossessed).
Monetary policy: The United States was on the gold standard in the 1930s, which constrained the Federal Reserve from lowering interest rates; in fact it actually raised interest rates before and during the Great Depression, which many economists blame for exacerbating the situation.
Today's Fed "is not shackled by trying to defend an exchange rate, so there is a great deal of flexibility," said Alan Taylor, an economics professor at UC Davis.
The current Fed has consistently been willing to slash interest rates to help liquidity, as well as taking a range of other aggressive steps in recent weeks. "Obviously, history will be the judge, but my basic feeling is positive" about the Fed's actions, said Laurence Ball, an economics professor at Johns Hopkins. "Some things might end up costing the government money, but it's prudent to be activist. The possible costs of action are moderate compared to the possible costs of inaction. I'd rather risk having the government waste a few hundred million here or there than have another Great Depression."
International trade: The government famously (or infamously) enacted the protectionist Smoot-Hawley tariff in the 1930s, aiming to stop imports in their tracks. But it simultaneously choked off exports, a Pyrrhic victory at best.
Today, exports continue to bolster the economy. U.S. exports have risen 15 percent since December, "providing an important outlet for U.S. industries seeking to offset weak domestic demand," Schwab Center's Riepe wrote.
Fiscal policy: Today's tax structure, while not entirely progressive, has more automatic stabilizers than that of the 1930s. "When income fell in the Great Depression, after-tax income and expenditures fell a lot too," Taylor said. "Today our fiscal policy reduces taxes as incomes fall, and expenditures tend to rise as incomes fall through social policies. The impact of a dollar decline in GDP is offset by some automatic government spending increases and tax decreases."
Safety nets: A raft of New Deal programs is already in place to protect consumers and safeguard the system. Deposit insurance, unemployment insurance and Social Security all directly target consumers. Other institutions, like the Securities and Exchange Commission, regulate the stock market to protect investors.
All of this is not to say that happy days are here again. Most economists agree that we're already in a recession, one that probably started last December and could last up to another year. But a recession - two or more quarters of declines in growth - is a far cry from a depression.
While the exact hallmark of a depression isn't clear-cut, it's often defined as an annual drop in gross domestic product of 10 percent or more.
By that yardstick, a depression is not in the cards. GDP is expected to be in positive territory this year and next, according to forecasters polled by the National Association for Business Economics, who predict 1.8 percent growth this year and 1.6 percent in 2009.
"If a recession is really bad and long, we call it a depression," Taylor said. "A recession if something you remember 10 years later. A depression is something you remember 100 years later."
Economic indicators: then, now
GDP
-- A classic definition of a depression is an annual decline in gross domestic product of 10 percent or more.
-- Gross national product fell 50 percent from 1929 to 1933.
-- These days, GDP is still in positive territory, expected to climb 1.8 percent this year and 1.6 percent in 2009.
Consumer debt
-- In the 1920s, outstanding consumer debt (excluding mortgage debt) was 6.7 percent of household income. In the 1930s, it rose to 9.6 percent.
-- In 2006, consumer debt (again excluding mortgage debt) was 25.1 percent of household income.
Jobs
-- In 1929, the unemployment rate was 3.2 percent. It rose to 8.7 percent in 1930, 15.9 percent in 1931 and 23.6 percent in 1932, peaking at 24.9 percent in 1933. "Underemployment" was significant; about one-third of employed people were able to get only part-time work. Wages fell 42 percent for those who still had jobs.
-- In September, the unemployment rate hit a five-year high of 6.1 percent, up from 4.7 percent a year ago. Many economists think it could reach 7 or even 8 percent, but don't expect double digits. Underemployment is also prevalent; as of September, 6.1 million workers were working part-time because their hours had been cut back or they could not find full-time work.
Homes
-- Homeownership reached 49 percent in 1929, but fell to less than 44 percent by 1944.
-- By early 1932, about half of all urban houses with an outstanding mortgage were behind on payments. More than 1 out of every 100 homes was lost to foreclosure every year from 1931 to 1935.
-- Homeownership today is at a record high of 68 percent, fueled by the easy credit of the housing boom.
-- In June, 6.41 percent of all residential mortgage loans were delinquent. In September, 1 out of every 416 households (or 0.24 percent of homes) was in the foreclosure process. (Slightly more than half of all houses that enter the foreclosure process end up being repossessed.)
Sources: "Buy Now, Pay Later: Advertising, Credit, and Consumer Durables in the 1920s," by Martha Olney; "The Federal Response to Home Mortgage Distress: Lessons from the Great Depression," by David C. Wheelock; "An Empire of Wealth," by John Steele Gordon; "America's Greatest Depression 1929-1941," by Lester V. Chandler; Mortgage Bankers Association; National Association for Business Economics; RealtyTrac.com
Stock market: then and now
Ownership
-- In 1929, less than 5 percent of U.S. families owned stock.
-- In 2004 (the most recent year for which broad data are available), slightly more than 50 percent of U.S. families owned stock, either directly or indirectly (i.e., through retirement accounts).
Dow Jones average
-- The Dow Jones industrial average fell 89 percent from 1929 to 1932.
-- The average has fallen 37 percent from its peak of 14,280 on Oct. 5, 2007, to Friday's close at 8,979.
Author Carolyn Said
US EXPORT COUNCIL PROVIDES ASSISTANCE TO US COMPANIES SEEKING ACCESS TO HIGH GROWTH MARKETS OVERSEAS. http://usexportcouncil.com/
