Mark Vaughan Washington University in St. Louis Federal Reserve Bank of Richmond FFIEC Community Financial Institutions Lending Forum William Siedman Center – Arlington, VA April 14, 2009 History Does not Repeat, But It Does Rhyme* Looking at the 2000s through a 1930s Lens *Mark Twain
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Mark Vaughan Washington University in St. Louis Federal Reserve Bank of Richmond
History Does not Repeat, But It Does Rhyme* Looking at the 2000s through a 1930s Lens *Mark Twain. Mark Vaughan Washington University in St. Louis Federal Reserve Bank of Richmond FFIEC Community Financial Institutions Lending Forum William Siedman Center – Arlington, VA April 14, 2009. - PowerPoint PPT Presentation
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Mark VaughanWashington University in St. Louis
Federal Reserve Bank of Richmond
FFIEC Community Financial Institutions Lending ForumWilliam Siedman Center – Arlington, VA
April 14, 2009
History Does not Repeat, But It Does Rhyme*
Looking at the 2000s through a 1930s Lens*Mark Twain
Vaughan – FFIEC4/14/09 2 - 20
Disclaimer
The views expressed are mine alone and do not represent official positions of the:Federal Reserve Bank of Richmond Board of Governors Federal Reserve System
Vaughan – FFIEC4/14/09 3 - 20
Outline
• What caused the Great Contraction (1930-33)?
• What caused the Great Recession (2007 - present)?
• How do the Great Contraction/Great Recession differ?
• How are the Great Contraction/Great Recession alike?
• What are the public policy implications?
• What does all this mean to community banks/examiners?
Vaughan – FFIEC4/14/09 4 - 20
Great Recession
December 2007 to Present (16 months):• Real output (GDP): ↓0.8% (December 2008)
• Consumer prices: ↑0.6% (February 2009)
• Unemployment: ↑4.9% to 8.5% (March 2009)
• Bank failures: 39 (0.5% of U.S. banks, 2007)
• Money supply (M2): ↑11.1% (February 2009)
• Stock prices (DJIA): ↓42.0% (Peak to April 1, 2009)
Shaping up to be worst since WWII!
Vaughan – FFIEC4/14/09 5 - 20
Great Contraction
August 1929 to March 1933 (43 months):
• Real output (GNP): ↓30.5%
• Consumer prices: ↓24.4%
• Unemployment: ↑3.2% to 24.9%
• Bank failures: 9,000 (30% of U.S. banks, 2007)
• Money supply (M2): ↓35.2%
• Stock prices (DJIA): ↓86.5%
“Great Recession” still not close!
Vaughan – FFIEC4/14/09 6 - 20
Great Recession vs. Great ContractionComparing Default Spreads to Gauge Intensity
Vaughan – FFIEC4/14/09 7 - 20
What Caused the Great Contraction?
Consensus of Economists
• 1928: Fed tightened money to “pop” stock market bubble.
• Fall 1930 - Spring 1933: Four panics led to massive currency withdrawals from banking system/massive hording of liquidity by banks (induced collapse of money supply).
• “Amplifying” Policy Mistakes:– Fed did not inject liquidity necessary to stem panics.– Hoover “jawboned” businesses to maintain wages (late 1929).– Hoover championed Smoot-Hawley tariff (mid-1930).– Hoover raised income taxes (1932).
Vaughan – FFIEC4/14/09 8 - 20
What Did Depression Linger?
Consensus of Economists• New Deal policies were counterproductive.
– Tax increases (excise, income, corporate, Social Security) discouraged work, savings, and investment.
– Attacks on “economic royalism” created regime uncertainty.
• Federal Reserve doubled reserve requirements (1936-37)
– Misunderstood high level of excess reserves in banking system.
– Money supply (M2) dropped 3.7%.
• Restarting banking/financial system took time.
– Bankers horded liquidity.
– Bankers avoided credit risk.
Vaughan – FFIEC4/14/09 9 - 20
Bankers Have Long Memories (I)Took Years to Stop Hoarding Liquidity
Vaughan – FFIEC4/14/09 10 - 20
Bankers Have Long Memories (II) Took Years to Get Comfortable with Credit Risk
Vaughan – FFIEC4/14/09 11 - 20
What Caused the Great Recession?
Possible Suspects
• Tight money?– Raised Fed funds target from 1.0% (2004) to 5.25% (2006).
• Collapse of housing/stock markets?– From December 2007 to December 2008, net worth of U.S. households/nonprofit
organizations tumbled $11.2 trillion (17.9%).
• Spike in oil prices?– Oil prices rose nearly 2.5 times from January 2007 to June 2008.
• Collapse of credit flows?– Banks/other financial firms sold $152 billion in ABS in 2007, down from $906 billion
in 2006. In 2009, only $16 billion sold so far.
• Decline in labor supply?– Mortgage forgiveness, IRS leniency, etc. depend on income – Interesting, but probably much less important than other factor
Vaughan – FFIEC4/14/09 12 - 20
Great Contraction and Great RecessionInteresting Similarities
• Both preceded by robust economic times.– 1921-29: Annual real GNP growth = 5.2% (2 mild recessions)
– 1982-2007: Annual real GDP growth = 3.2% (2 mild recessions)
• Both preceded by innovations in consumer finance.– 1920s: Installment credit
– 2000s: Mortgages/credit cards driven by credit-scoring/securitization
• Both preceded by innovations in banking.– 1920s: Banks ramped up real-estate lending/investment banking.
– 1990s-2000s: Banks ramped up real-estate lending/securitization.
• Both preceded by era of banking consolidation.– 1921-29: Number of banks, ↓ 29,788 to 24,026 (-19.3%)
– 1982-2007: Number of banks, ↓ 14,451 to 7,283 (-49.6%)
Vaughan – FFIEC4/14/09 13 - 20
Great Contraction and Great Recession:Similarities?
• Both started in U.S. and transmitted around the world.– 1930-33: via Gold standard
– 2008: via Exposure to U.S. housing markets (toxic MBSs).
• Both preceded by era in which Fed highly regarded.
• Both preceded by housing boom.
• Both preceded by stock market “bubble.”
• Both featured high-profile failure perceived as “trigger.”– Bank of United States (December 1930)
– Lehman Brothers (September 2008)
• Both featured “scapegoating.”– 1930s: Andrew Mellon, Sam Insull, Pecora Commission
– 2009: AIG bonuses
Vaughan – FFIEC4/14/09 14 - 20
Great Contraction and Great RecessionKey Differences