Is today's economic crisis another Great Depression?

By John Waggoner, USA TODAY
Failed banks. Panicked markets. Rising unemployment. For students of history, or people of a certain age, it all has an all-too-familiar ring. Is this another Great Depression? Not yet.
By any measure, our current economic suffering pales in comparison with what the nation endured from 1929 through 1939. Still, most economists are predicting a long, difficult period ahead. Could it eventually become a depression? It's possible — but not likely.

The Great Depression left a mark on the world that remains today, nearly 80 years after it began. It re-created our banking system, molded our securities laws, and left scars on the nation's psyche that have faded only modestly with the decades. During the Depression, savers watched their money evaporate in bank failures, because deposits weren't insured. Bankers became so unpopular that bank robbers, such as Bonnie and Clyde, became folk heroes.

By the depths of the Depression, 25% of the population was out of work. The Dow Jones industrial average had fallen 89%. The entire banking system was shut for four days by presidential order. Home and farm foreclosures soared. Homeless people created vast shantytowns, called "Hoovervilles," outside most major cities.

The word "depression" became so terrifying that economists stopped using it to describe a business slump. "It was an active choice of words," says Peter Bernstein, the celebrated economist, now 89. The Roosevelt administration judged the word too terrifying for the public to hear, Bernstein says. And for people who lived through the Depression, it was terrifying, indeed. "It was a killer," Bernstein says.

Mitchel Namy, 96, recalls how his family fared. "My father was very successful in the wholesale dry-goods business," Namy recalls. "He lost the business, our home and a valuable 26-acre tract of land in suburban Pittsburgh."

Our economic woes dwindle in comparison. As of the end of June, the latest data available, the nation's gross domestic product was still growing at a respectable 2.8% rate. In the third quarter, it fell at an annual 0.3% rate. Unemployment in September was 6.1%. "We're a long way from the D-word," says David Wyss, chief economist for Standard & Poor's. "It's a recession."

And, in fact, it's not even officially a recession. The National Bureau of Economic Research, the official arbiter of when recessions begin and end, has yet to declare the end of the most recent economic recovery. Even the shorthand version of recession — two consecutive quarters of shrinking gross domestic product — hasn't happened yet.

How today's situation sounds similar

Few people deny, however, that the current economic climate bears disturbing similarities to the start of the Great Depression:

•Big declines in the stock market reduced people's wealth and decreased spending, notes Timothy Canova, associate dean of international economic law at the Chapman University School of Law. The Dow didn't fall steadily: It plunged 47% from its high of 381 in September 1929 through November 1929 and then started a famous "sucker's rally" in the spring of 1930 before plunging to 41 in July 1932.

The Dow fell 42% from its Oct. 9, 2007, high to its Oct. 27, 2008, low, roughly equal to the market's initial tumble in 1929. Far more of the population owns stocks now than in 1929, however: For many people, stock mutual funds are the cornerstone of their retirement savings. In 2006, the latest data available, two-thirds of all 401(k) plans were invested in stocks, a percentage little-changed in the previous 11 years, according to the Investment Company Institute, the funds' trade group.

•The banking system was crippled by bad loans and speculation. In 1929, the bad loans were made to stock speculators; most recently, the bad loans were made to homeowners and investors in mortgage-backed securities.

Banks stopped lending in 1929 to avoid further losses, which slowed the economy even further. By the mid-1930s, more than 5,000 banks had collapsed. Today, banks have also slowed lending to avoid losses, and the credit markets have nearly ground to a halt.

But there are some big differences today that make a repeat of the Great Depression unlikely. The biggest: massive intervention by the world's central banks. "The Federal Reserve has been very aggressive in its role as lender of last resort," says Paul Kasriel, chief economist for Northern Trust. "That's why the Fed was created — not to prevent recessions, but to prevent the implosion of the financial system."

In 1929 and 1930, the Fed actually raised interest rates, draining liquidity from the system, deciding that it was best to stamp out speculation. Although economists still debate the exact causes of the Great Depression, the Fed's moves are often considered one of the prime reasons the economy tumbled so hard.

In addition, President Herbert Hoover raised taxes in 1930 in an effort to balance the budget. At the same time, Congress passed the protectionist Smoot-Hawley Tariff Act, which raised the fees charged on imported goods, setting off a trade war. Exports fell as other countries retaliated against the tariffs, crippling the nation's manufacturing.

In contrast, the government this time has been active in trying to prevent an economic meltdown, precisely because officials worried about another Great Depression. Explaining why President Bush backed the bailout, spokeswoman Dana Perino said: "It was when Ben Bernanke and Treasury Secretary Henry Paulson came to him and said we could be facing something worse than the Great Depression if we don't act, that the president realized that he had to put aside his instincts and focus on what he could do as president of the United States to help save this economy — not to help save Wall Street, not to help save any individual economy, but to help individual Americans all across the country of all economic stripes." The $700 billion bailout bill, and the fiscal stimulus checks that went out early this year, although controversial, show that the government is willing to intervene in the financial system to keep it afloat.

The Fed has cut interest rates nine times since the credit crisis began in September 2007. In addition, the Fed has created several credit facilities, which allow troubled financial institutions to exchange assets that they couldn't sell otherwise for ultrasafe Treasury securities. (The institutions must eventually take back their illiquid assets and return the Treasury securities.)

Have we done enough for prevention?

Despite the Fed's activist role — and the role of central banks around the world — some still worry that further financial calamity is possible. Chapman University's Canova says that $700 billion pales in comparison with what the country spent to get the economy out of the Depression in the 1930s, particularly if you include the massive spending for World War II. "If one lesson of the Great Depression is that the Federal Reserve must be ready to expand the money supply, another lesson is that monetary expansion alone will not renew a growth path for the economy," Canova says.

Another worry: In 1929, stocks were the most overvalued asset. This time, the U.S. had more than one bubble entering the current crisis, says Mark Kiesel, executive vice president at Pimco, and that means that unwinding it all could be more painful and protracted than many think. "We entered this slowdown with massive overvaluation in all assets: commodities, stocks, mortgages and real estate," Kiesel says. Unwinding all those bubbles will lead to a far weaker economy than many experts expect, he says.

And, he says, the worst has yet to come. Unemployment typically lags behind earnings slowdowns: He expects unemployment to rise to as high as 8% in the next year or so. Many experts note that real unemployment may be much higher than the official figure of 6% because those numbers don't include those who have stopped looking for work.

Also, Kiesel says, home prices, which have swooned as much as 25% or more in some areas, still have another 10% to 15% to go.

Finally, the big question is how long it will take for consumers to feel confident enough to start spending again. Unlike the economy of the 1930s, which was largely based on manufacturing and agriculture, the U.S. today is primarily a consumer and service economy. Until consumer confidence rises, spending is likely to stay weak. And that, Kiesel says, won't happen until corporations and consumers pay down their debts. "We had companies with weak balance sheets selling to consumers who were leveraged up, too," he says. The whole process could take years, Kiesel says. "It won't be a depression, but it won't feel good."