The Current Economy:From an EconomicHistorian’s Perspective
Price FishbackUniversity of Arizona
1Copyright, Price Fishback, April 26, 2012.
Spectacular Meltdown Last Fall
• 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
2Copyright, Price Fishback, April 26, 2012.
Constant References to the Great Depression
• Worst Financial Crisis Since the Great Depression
• Worst Downturn since the Depression– Still Questionable
• Here is Why This is Not the Next Great Depression
3Copyright, Price Fishback, April 26, 2012.
Modern Unemployment Rates
• Since December 2007• Unemployment Rate has risen from 4.9 to
around 9.7 percent in July• Before Thinking About the Great Depression
Consider the Late 1970s and Early 1980s
4Copyright, Price Fishback, April 26, 2012.
Fed Chair Volker Wrings InflationOut of System
5Copyright, Price Fishback, April 26, 2012.
The Great Depression
6Copyright, Price Fishback, April 26, 2012.
7Copyright, Price Fishback, April 26, 2012.
8Copyright, Price Fishback, April 26, 2012.
9Copyright, Price Fishback, April 26, 2012.
1932 and 1933 GDP Output Loss Equivalent toShutting Down Production West of Mississippi
10Copyright, Price Fishback, April 26, 2012.
11Copyright, Price Fishback, April 26, 2012.
12Copyright, Price Fishback, April 26, 2012.
Civilian Unemployment Rate, Inflation, and Misery Index, 1965-2006
0.0
5.0
10.0
15.0
20.0
25.0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010Year
Perc
ent
Misery Index
Inflation Rate
Unemployment Rate
Huge Success
Inflation rate around 3 percent
13
Compare to late 1970s early 1980s
Copyright, Price Fishback, April 26, 2012.
Is Stock Drop Similar?
• November 2007 through February 2009 Cut in Half.– Has Recovered to 90% of peak
• Stock Market Dropped by Half between October 1929 and October 1930 – 12 months
• Unlike Today– In the 1930s, Market Dropped to 11% of the 1929 peak
in the middle of 1932.– Corporate Profits were negative for U.S – Net Investment negative
14Copyright, Price Fishback, April 26, 2012.
15
Dow Jones Ind. Avg. Past 10 Years
www.bigcharts.com Copyright, Price Fishback, April 26, 2012.
16
http://stockcharts.com/charts/historical/djia1900.html
1920-1940
Rise is evenBigger than itLooks becauseOf the log scale
Copyright, Price Fishback, April 26, 2012.
Date of Prior Peak
Date of Trough Peak Value
Trough Value
Percent Drop
Date Reached
Peak Again
Months to Reach
Next Peak
7/15/1957 10/22/1957 49.13 38.98 -20.7 9/16/1958 11
12/12/1961 6/26/1962 72.64 52.32 -28.0 9/3/1963 15
2/9/1966 10/7/1966 94.06 73.20 -22.2 5/4/1967 7
11/29/1968 5/26/1970 108.37 69.29 -36.1 4/15/1972 23
1/11/1973 10/3/1974 120.24 62.28 -48.2 7/17/1980 79
9/21/1976 3/6/1978 107.83 86.90 -19.4 8/15/1979 17
11/28/1980 8/12/1982 140.52 102.42 -27.1 11/3/1982 3
8/25/1987 12/14/1987 336.77 223.92 -33.5 7/26/1989 20
7/17/1998 10/8/1998 1186.75 959.44 -19.211/23/199
8 1.5
3/14/2000 10/9/2002 1527.46 776.76 -49.1 5/30/2007 43
10/9/2007 3/9/2009 1565.15 676.53 -56.8 Now 1400
Peaks and Troughs in S&P 500 Stock Index 1957-2011
17Copyright, Price Fishback, April 26, 2012.
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
18Copyright, Price Fishback, April 26, 2012.
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?
19Copyright, Price Fishback, April 26, 2012.
Bernanke Policy
A federal funds rate near zeroFED has Flooded the System with Cash
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.
20Copyright, Price Fishback, April 26, 2012.
Experimentation?
• Uncertainty Delays Long-Run Decisions• 1929 Crash and current Crash strong negative
effect on • Purchases of autos, houses, other consumer durables• Investments in new plant and equipment
• Serious problems with Constant Policy Change in 1930s– Higgs, Shlaes
21Copyright, Price Fishback, April 26, 2012.
Source: Federal Reserve Board
Federal Reserve Assets (Uses of Funds)$ billions
-
200
400
600
800
1,000
1,200
1,400
1,600
1,800
2,000
2,200
2,400
Dec-07 Feb-08 Apr-08 J un-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 J un-09
Agency & MBS
Lending to Nonbanks Credit Mkts
Short-term Lending to Financials
Misc.
Treasuries
INFLATION WORRIES FLOOD OF FED ASSETS
22Copyright, Price Fishback, April 26, 2012.
Auto Bailout Today/RFC Railroad Bailouts in 1930s
• RFC gave loans to some RRs, while some went into bankruptcy
• Guess which ones spent more on maintenance and improvements in capital stock
23Copyright, Price Fishback, April 26, 2012.
Challenges for the Future
• Search for Security • Gigantic Budget Deficit• Will the Stimulus Work?• Controlling Inflation• Social Security and Medicare• Health Care Issues
24Copyright, Price Fishback, April 26, 2012.
Side Note: New Deal was not Keynesian nor was WWII 25Copyright, Price Fishback, April 26, 2012.
26Copyright, Price Fishback, April 26, 2012.
Keynesian Deficit 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 1.5
• 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.
27Copyright, Price Fishback, April 26, 2012.
New Deal Multiplier
• Fishback-Kachanovskaya Study of State Income and Net Federal Spending in 1933-1939
• Expect the largest multiplier in the Great Depression because unemployment over 14%
• Do Not Find a Robust Number• Range is 0.03 to 1.76 depending on
assumptions (all are reasonable).
28Copyright, Price Fishback, April 26, 2012.
Social Security Worries
• Pay-as-you-Go System– Current Tax Revenues Fund Soc. Sec. pensions– Have also been funding other govt. programs– With Soc. Sec. Tax collections, deficit much bigger.– Same True of Medicare collections
29Copyright, Price Fishback, April 26, 2012.
Iron Law of Pay-Gotax rate = Benefit Rate/Wage Rate * Recipients/Working Pop.
• Currently tax rate is = .12• Benefit Rate/Wage Rate is 0.4• Recipients/Working Population is 0.28• Still an annual surplus.
– t = .12 > 0.4 * 0.28
• 2030 Recipients/Working Population is 0.4– Current tax rate = .12 Less than (0.4) * (0.4) = 0.16
30Copyright, Price Fishback, April 26, 2012.
Solutions
• tax rate = Benefit Rate/Wage Rate * Recipients/Working Pop.
• Solutions – Raise tax rate to 0.16 (8% worker/ 8% employer)
• History of doing this (original 1%/1% now 5.5%/5.5%)
– Lower Benefit Rate • Done in 1970s
– Lower number of Recipients by raising retirement age• Rise from 65 to 67.• Lowers lifetime benefits
– Raise Working Population• Increase immigration
31Copyright, Price Fishback, April 26, 2012.
Medicare Problem
• People even more worried about the Medicare problem because of the great uncertainty about containing health costs
32Copyright, Price Fishback, April 26, 2012.
Does the Rest of the World Spend More on Social Welfare
• Social Welfare Spending– Health, unemployment, poverty relief, disability
pay, retirement, etc.
• Comparison to the Nordic Countries– Third Way
• Different Philosophies – Nordic Universal– U.S. Safety Net
33Copyright, Price Fishback, April 26, 2012.
34Copyright, Price Fishback, April 26, 2012.
USA
35Copyright, Price Fishback, April 26, 2012.
USA
36Copyright, Price Fishback, April 26, 2012.
USA
37Copyright, Price Fishback, April 26, 2012.
38Copyright, Price Fishback, April 26, 2012.
10th Percentile
90th Percentile
Finland 9,300 27,100
Sweden 9,300 27,600
United States 9,500 51,300
Estimate of Income per Equivalent Person in Households at the 10th Percentile and the 90th Percentile in 2000 U.S. Dollars, PPP
39Copyright, Price Fishback, April 26, 2012.
Problem for U.S. Arises in the Average for the HHs in Bottom 10 %
• U.S. average is $5,800 in 2005• Nordic Average is $8,000 in Finland to $12,000
in Norway.
40Copyright, Price Fishback, April 26, 2012.
Holes in the Safety Net
• Surprisingly large share of eligible not getting benefits– Why? – Is it lousy information flow from government?– Is it difficult barriers to eligibility?– Is it choice by eligible not to collect?
41Copyright, Price Fishback, April 26, 2012.
The Health Safety Net
– Personal Insurance – Employer-Based Insurance
• No taxes on health insurance
– Medicare for the Elderly– Medicaid for the Poor– Child Health Insurance Program (CHIP) for the Near
Poor– Direct Payment for Health Services– Hospital and Doctor Charity Care– Emergency Room
42Copyright, Price Fishback, April 26, 2012.
Facts About Health Care
• U.S. spent 15.8% of GDP on Health Care• Other countries• French spent 11, Swiss spent 10.8, Ger. 10.5• UK 8.5, Sweden 9.1, Finland 8.3• U.S. PUBLIC expenditures on Health Care were
7.1 % of GDP (45% of the 15.8% figure) – We spend almost as much on poor and elderly as
rest of world spends on
43Copyright, Price Fishback, April 26, 2012.
Ratio of Health Care Expenditures by AgeGroup Relate to ages 50-64 in 2002
US Spends a Lot for Elderly
Hagist and Kotlikoff, “Who’s Going Broke”, 2005
44Copyright, Price Fishback, April 26, 2012.
Who Are the Uninsured?
• Employment Policy Institute Study by June O’Neill and Dave O’Neill of Baruch College
• 47 million (16% of pop) uninsured by anybody• Elderly almost all covered by medicare• Children access at 200% of federal poverty line in AZ
• Focus on 18-64 38 million uninsured– Roughly 16 million have incomes > 2.5 times
poverty line – Described as voluntarily uninsured
http://www.epionline.org/studies/oneill_06-2009.pdf 45Copyright, Price Fishback, April 26, 2012.
Look at “Involuntary Uninsured”
• 21.6 million with less than 2.5 times poverty level are uninsured.
• Of those– 55 percent in households with no kids– 42.4 % White, 34.7% Hispanic, 16.6% black– 51.7 % 18-34, 22% 35-44– 38 % did not work in prior year– 58 % family income less than $20,000.– Less Educated
46Copyright, Price Fishback, April 26, 2012.
State Variation in 2006
• States with highest percentage of uninsured among people with incomes < 2.5 fed pov. Line
• NM 20, TX 18.4, OK 18.3, MS 18.3, AR 17.7• LA 16.4, AZ 15.9, FL 15.8 AL 15.3
• States with lowest %• MN 6.6, VT 5.6, HA 6.9, CT 5.9, MA 6.4
47Copyright, Price Fishback, April 26, 2012.
Effects on Probability of Having Insurance Holding All Else Constant
– Rise in health premium of $1000 • lowers the probability of insurance by 32% for
unmarrieds with no children• Lowers probability by only 2.7 % for marrieds with
children
– Hispanics • with children 10 % less likely than white non-Hispanics
to have insurance• without children 13 percent less likely
48Copyright, Price Fishback, April 26, 2012.
Fundamentals of Insurance
• Insurance works best when pool known risks that are similar and independent of each other
• Mutual arrangement of everyone in room.• If risks not known, works less well
49Copyright, Price Fishback, April 26, 2012.
Insurance Problems
• Adverse selection• End up with large share of high risks• Moral Hazard More protection allows people
to take more risks
50Copyright, Price Fishback, April 26, 2012.
Reforms
• Development of Universal Coverage in Other countries very Path Dependent
• Britain National Health care came out of WWII shift to National Hospital
• Netherlands employer private-insurer based.
51Copyright, Price Fishback, April 26, 2012.
Problems
• 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
52Copyright, Price Fishback, April 26, 2012.
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
53Copyright, Price Fishback, April 26, 2012.
54
Housing Prices More than Doubled in Major Markets, 2000 to 2006. Have fallen back to 150% of 2000 peak
Copyright, Price Fishback, April 26, 2012.
55WSJ 11/12/08
Copyright, Price Fishback, April 26, 2012.
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
56Copyright, Price Fishback, April 26, 2012.
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
57Copyright, Price Fishback, April 26, 2012.
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
•
58Copyright, Price Fishback, April 26, 2012.
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
59Copyright, Price Fishback, April 26, 2012.
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
60Copyright, Price Fishback, April 26, 2012.
How Did We Get There?
• 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
61Copyright, Price Fishback, April 26, 2012.
Was the Problem Deregulation?
• NO.• Nearly all of this occurred in Regulated
Markets.• Fannie and Freddie heavily regulated
• did they control the regulator?
• Credit Default Swaps and CDOs were never regulated– Calls for CDSs and CDOs to be traded on
exchanges might be good idea62Copyright, Price Fishback, April 26, 2012.
Was the Problem Deregulation?
• Repeal of Glass Steagall divided between investment banks and banks?
• Did more to save situation than make it worse.
63Copyright, Price Fishback, April 26, 2012.