The Great Depression and The Great Recession are two important downfalls in economic fluctuation in two completely different time periods. The 1930s (The time period The Great Depression) and the late 2000s (The time period of the Great Recession) are very different, but problems within the Federal government provided a parallel between the two. What goes up must come down and The Recession and Depression are two prime examples. The roaring 20s skyrocketed the economy and immediately fell into the Great Depression. The finally striving economy of the early 2000s fell into the Great Recession soon after. Although these are two different time periods, certain events connect and differentiate the two.
The Great Depression did not start with the Stock Market Crash in October of 1929. Although there was correlation between the Crash and the start of the Great Depression, this was not the direct cause. The underlying economic conditions around 1930 were not the best. Economic uncertainty was a main cause of the Great Depression. Credit and installment buying arose around 1929 as consumption of new consumer products. This was good for the American industry, but was actually very unsustainable for those involved financially. The banks were trying to make more money by taking people’s money and investing, when things started going south, Americans wanted the money back that the banks no longer had due to investments. “American farms had expanded enormously during World War I to provide food for all those soldiers… the expansion led many farmers to mechanize their operations…”(Green 12) and undergo large debts.
Between overproduction and low prices, many of these farms were soon out of business which left those who invested in a sticky situation. Many signs of economic weakness appeared throughout the years leading up to the time period of the Great Depression. The growth of car manufacturing slowed due to overproduction, and the over-speculation of the stock market that began around 1927 and lasted well into the Great Depression. Loans from commercial baking began being taken for stock market and real estate investments. The stock market crash and the Depression were not the same thing.
Many Americans lost money during the Stock Market Crash, however, what really made The Great Depression The Great Depression was the severe unemployment and the hardship that followed. Although big banks and corporations were investing in stock, they utilized borrowed money from brokers, or “margin buying”. Through all of these events that seemed to have tanked the Economy, there was a similar underlying cause to everything; The weak banking system. The Federal Reserve system was established in 1913, but the vast majority of American banks were privately owned institutions that relied on their own money. If a bank did not have enough money on reserve, the bank would fail. 1930 is known for bank failures, the credit system froze up. This led to deflation where less money was circulating.
The failure to predict or forecast the fall of the economy is what hurt the most. There was no preparation and the money people had in the banks was the only reassurance they had. During the time period of The Great Depression, the unemployment rate was at a jaw dropping 25 percent dropping the GDP an additional 35 percent. The people who were lucky enough to maintain wealth during the Great Depression were extremely wealthy, and those who were less fortunate were completely poor. There was no longer a distinguishable middle man or middle class. On top of everything, political policy seemed to creep up from behind as the U.S still had war debts from World War I that needed to be paid.
The United States places tariffs on imported goods. When the world needed trade the most, trade was at a valley. The United States was buzzing and began to overproduce items due to the fluctuation exports, when things began to get a little more expensive, business between foreign countries began to stop and the United States was left with too much good and not enough consumer. Due to the severe loss of income, the government was forced to spend millions of dollars on relief programs. “At the same time the government increased relief spending, it also contributed to the crisis by laying off employees and making cuts to health care, education and other social programs.”(Higgins 2) Looking from the outside in, The Great Depression seems as though it could have been predicted/ prevented. Things were going so good, they were destined to go bad. Luckily, there is a flip side to that, and what is bad enough can only get better.
The Great Recession (December 2007 – June 2009) or the “subprime mortgage crisis” is described as “a decline in per-capita world gross domestic product (GDP)”(Roberts 2). From the start of the Recession in 2007 to the end of the Recession in June 2009, GDP declined by 4.3 percent and unemployment approached 10 percent. In this case, increased unemployment leads to less growth and a drop in consumer spending. Consequently, businesses lay off workers because they can no longer afford to pay them. “8.7 million jobs… lost”(policy priorities 2) between the start and end of the Recession.
Investors looking for low risk, high return investments began to spend money on the U.S housing market. They predicted they could get a better return from home owner paid mortgages than they could on U.S treasury bonds. Investors began to buy mortgage back securities where financial institutions would purchase thousands of mortgages, bundle them as one, and sell shares of stock to the money hungry investors. Investors forecasted that since the housing market was skyrocketing, it would continue to do so until they were satisfied with their return on investment. Credit ratings agencies were also giving the investors reassurance. Due to the crazy boom in the purchase of mortgage back securities, lenders began to drop credit standards in order to create more and more bundles for purchase.
People with low income and poor credit were now being granted Subprime mortgages. It got to a point where a few institutions began utilizing predatory lending practices where they would not verify income and offer outrageous adjustable rate mortgages which the subprime mortgage buyers could afford at first, but soon grew out of a proportion they could afford. Although this was actively occurring, investors maintained their trust in the credit agencies and continued to invest more and more money into these lenders.
As investors, traders and bankers remained linear with an increase in the amount of money being invested in the housing market, the price of homes in the U.S was increasing just as much. Due to the low interest rates and higher housing prices, the mortgage back securities were being portrayed as even better investments.
Unfortunately for those who invested any kind of money, the now low credit, untrustworthy borrowers could no longer afford their mortgage payments. Borrowers began to default which put many houses back on the market with no buyers because seemingly no one could afford their home! Supply was extremely high and demand was extremely low so the prices of houses began to tank. Due to the decrease in value, some borrowers were now stuck with mortgage payments that was now a total of much more than their houses were worth at the time of the Recession. Because of this, many borrowers were no longer making payments dropping both themselves and the lenders into a hole deeper than imaginable or predictable before hand. Big financial institutions stopped buying subprime mortgages meaning subprime lenders were being glued to bad loans.
By 2007 some of the biggest lenders of these loans had already declared bankruptcy. Unregulated over the counter derivatives such as credit default swaps were sold as insurance in case of default of mortgage back securities. Institutions such as AIG sold countless insurance policies without any kind of actual insurance to back them up. Everyone involved financially was connected through a big string with never ending ties of liability, assets and risk factors meaning when things started falling apart, they fell apart for the entire financial system at once. The stock market crashed once again as the U.S economy found itself in the middle of a disastrous recession.
The federal reserve almost immediately surfaced and offered to make emergency loans to banks to keep them from collapsing. The troubled assets relief program or “TARP” spent 250 billion dollars to bail out the disaster bound banks and later helped AIG, home owners and auto makers. Congress in 2009, also provided nearly 800 billion dollars to the economy through tax cuts and new spending.
In 2009 the Dodd-Frank Act “enabled the federal government to assume control of banks deemed to be on the brink of financial collapse and… implemented various consumer protections designed to safeguard investments and prevent predatory lending.”(History 10). Between Moral Hazard and Perverse incentives, the seemingly great concept of investing in the consistently rising housing market based off of a simple economic model ended up not being so great after all. Sometimes if things seem too good to be true, it is because they are. Do not count your chickens before they hatch.
To be realistic, what goes up can only come down and what is down can only come up. When reviewing economic models of both of these time periods one can notice a constant fluctuation in the economy. In both time periods, the economy was doing abnormally well which means it was destined to do abnormally bad soon after. A decline in consumer spending, an increase in unemployment and sever strain on financial institutions cause the Great Depression and Great Recession to almost mirror one another. History indeed repeats itself.
In the 1930s, the time period of the Great Depression, Keynesian economics accompanied by the new deal began to doctor the economy, after the first huge decline, back into stability. This did things such as help the actual people of the failing economy, but also create long-standing government institutions to prevent similar catastrophes from reoccurring. During the Obama administration, the time period of the 2007 recession, a similar approach was made. In reflection of Keynesian economics, the American Recovery and reinvestment act of 2009 were established to revive the American economy once again. In both cases, due to the unemployment rates and drop in GDP, many people were put out of jobs leading to much civil unrest in the economy of both time periods.
The banking system received backlash in both instances. This came with an increased crime rate, and much protest from the uninformed or ignorant American citizens involved in the exchange. The gap in incomes between the extremely wealthy and extremely poor fueled a lot of the protests. Although there was a huge gap between the 30% unemployment rate of the Great Depression and the 10% unemployment rate of the Great Recession, the confidence in the government dragged to a stoop in both situations. It was not only the corporations and federal government who seemed to drive the depression and recession, but the entire capitalist system that, to the people, had been proven wrong for the second time.
In consequence of the Great Depression, the only thing the economy and government could think to do was fix things and get them running smooth again. After the Recession in the late 2000s, the economy began brainstorming and inventing ways to improve and ensure the economy is not to collapse a third time. A weak, unstable banking system was to an extent a great cause of both of these historical time periods. By stabilizing our banking systems and making financial moves more transparent, financial crises such as these can be prevented. The government did indeed kick in at a good timing in both events with ways to slow the declines. Both instances could have been much worse, but due to quick action of authority, the catastrophes were prevented from escalating any further.
Business had to make the right decisions and pull the right cards in order to maintain or, depending on the situation, retain stabilization financially. Forecasting in both situations can be improved, however the forecasting of what would effectively stop the declines was predicted well. Through managerial incentive structures, these corporations during both time periods had an insight that something was destined to go wrong, and unfortunately for the banks, lenders, investors and borrowers, it did.
History repeats itself, from wars and conflicts to declines and recessions, it is easy to look over past mistakes and make them again. Modern acts and laws have been established to prevent situations like the recession and depression from happening again, however, these are not a 100 percent risk free guarantee. Based on the economic model of the economyToday, It is only a matter of time before we experience another huge collapse in the U.S economy, maybe this time America will learn from its inaccurate forecasting and be a little more prepared.