19 May, 2005

Depression on my mind

What's fun about subscribing to the Wall Street Journal while studying American economic history is the feeling of utter dread it leaves in the stomach.

Lately, the dread comes from watching a series of seemingly insignificant and unrelated policy decisions that add up to the dismantling of the economic safety net that has existed since Roosevelt's election in 1932. By economic safety net, I don't mean the social safety net for the poor -- Clinton made short work of that. I mean the systems that have kept unemployment in check, kept the poor and middle class on a gradually improving quality of life (or at least of possessions), and prevented mass starvation even in periods of economic dislocation.

To understand what I mean, think for a second about what caused the Great Depression. In short, it was a set of positive feedback loops that ran out of control:

Excessive debt (rich folks): People bought stocks "on margin," meaning that they used borrowed money. There was no federal regulation of who could receive a margin loan. When stocks began to drop in late 1929, lenders, worried that their collateral was becoming useless, made "margin calls." That meant they required borrowers to pay back loans at once. The borrowers had to sell their stocks to pay back their loans. This further crashed the market, which caused more margin calls.

Too-rigid debt (moderate income and poor folks): Repo law was strict back then. Economist Christina Romer has convincingly shown that consumers had to cut back on spending in order to keep up their car and furniture payments. If they missed a payment, they could lose their entire sunk cost in the big purchase. So it was better to cut back on food and clothes than to lose all the money they'd put into the new car (along with the car).

A related item was that debtors had no recourse to bankruptcy protection. So any debt had to be paid in full or privately renegotiated; the courts didn't help out.

Consumer jitters: Consumers could have kept spending after the stock market went down -- most consumers didn't own any stock and had no reason to be concerned. Well, almost no reason. They were worried they'd be laid off, so they cut back at once on durable goods. That led to layoffs in the big manufacturing sector, which led to more jitters and more cutbacks.

Lack of financial insurance: Bank deposits were uninsured, so depositors were right to worry if a bank was in trouble. They did best to rush in and withdraw their full savings, rather than risk getting back cents on the dollar from a crashed-out bank.

Ideological macroeconomic policy: Herbert Hoover preferred to maintain balanced budgets as the economy crashed. As incomes and spending declined, taxes declined, so government spending declined -- exacerbating the layoffs and the overall reduction in aggregate demand.

Another ideological decision was to restrict margin borrowing by raising interest rates, rather than through regulation. Federal regulation of the stock market was for commies. Interest rates were ok to use for macroeconomic adjustments. The problem was, higher interest led to a decrease in corporate investment once the downturn got going. The Depression was the only time in US history when the nation's capital stock lost value -- it was better for rich guys to keep their money in a T-bill than to invest in their productive machinery.

Inefficient information: The old ticker system was slow. When it started to run behind in the stock market panics, that caused more panic selling, which caused it to run further behind.

Uncushioned structural adjustment: Structural adjustment is part of the deal when an economy goes from agriculture to manufacturing to information and services. But it can be rougher or easier. Without unemployment insurance, job training, public job centers, or Craigslist, structural adjustment was much more difficult in as the nation left its agricultural past in the dust. The lack of aid meant that displaced persons were less able to get going in their new urban environments, burdening society rather than offering their productive talents.


Everything's been fixed.

We have Chapter 7 bankruptcy protection and protection from vicious repo contracts. Consumers have learned that they can survive slowdowns and even reduce the pain of an economic cycle by pulling out the credit card and maintaining consumption. We have deposit insurance on banks and S&Ls. American politicians all understand that balanced budgets are nice but that stopping a recession is more important. The SEC was formed in 1932; its rules restrict margin trading to people who can afford to lose their (stock) shirts. Stock market information is now instantaneous everywhere. You can get it on your frickin wristwatch. Structural adjustment has been cushioned by vocational ed, community colleges, unemployment insurance, job retraining, and of course Craigslist.

But. But now, Chapter 7 has been gutted. Consumer credit is over $2.1 trillion and debt service takes up a higher portion of American household income (13%) than it has in the 25 years records have been kept. There's no deposit insurance on 401(k)s, IRAs, and other stock investments. The only Keynsian government spending to be had is in military hardware (not even paychecks, which are being indirectly cut), which by some lefty analyses has less of a positive effect on the economy than spending on, say, schoolteachers or clean water systems.* While margin trading in stocks remains limited, the equivalent in real estate is booming. Yesterday the Wall St Journal wrote that 2/3 of new mortgages are either "interest-only" or adjustable-rate or both. With such mortgages, a person who had to stretch to buy the home could easily end up owing more than s/he can get by selling the home, and payments can (with rising interest rates) easily get too big to handle. Now the Feds are threatening to crack down on these risky vehicles, probably sometime next year. (Watch for people to rake in a bunch of really dumb investments just before the new rules kick in.) But even with better rules, information in the real estate market remains diffuse and slow. There is no central auction site where home prices are compared; homes are not easily comparable in any case. A bust, if it happens, will be revealed month-by-month at best, potentially contributing to panic. Structural adjustment has gotten tougher lately as the feds have backed off on unemployment insurance and state and local governments have had to raise prices for vocational ed and community college.

In short, we might be primed for a 1929-style set of panics, displacements, and impoverishments -- and that's all without talking about oil.

Have a nice day!**

*It depends on how much of the money goes to pay for unrenewable resources vs. how much goes to labor, and how much is a true cost vs. how much is an investment in the future. For that latter number, you have to ask whether a nearly useless umbrella against ICBMs is an investment; some say it is while some of us use our brains.

**As a punk rocker, I should be cheering all these changes. Instead, I see them and think about the photographs of Dorothea Lange.

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