Econ: The Panic of 1873; A more accurate model than the Great Depression
I found this article very enlightening.
In fact, the current economic woes look a lot like what my 96-year-old grandmother still calls "the real Great Depression." She pinched pennies in the 1930s, but she says that times were not nearly so bad as the depression her grandparents went through. That crash came in 1873 and lasted more than four years. It looks much more like our current crisis.
The more I read, the more it sounded true.
The echoes of the past in the current problems with residential mortgages trouble me. Loans after about 2001 were issued to first-time homebuyers who signed up for adjustable rate mortgages 1 they could likely never pay off, even in the best of times. Real-estate speculators, hoping to flip properties, overextended themselves, assuming that home prices would keep climbing. Those debts were wrapped in complex securities that mortgage companies and other entrepreneurial banks then sold to other banks; concerned about the stability of those securities, banks then bought a kind of insurance policy called a credit-derivative swap 2 , which risk managers imagined would protect their investments. More than two million foreclosure filings - default notices, auction-sale notices, and bank repossessions - were reported in 2007. By then trillions of dollars were already invested in this credit-derivative market. Were those new financial instruments resilient enough to cover all the risk? (Answer: no.) As in 1873, a complex financial pyramid rested on a pinhead. Banks are hoarding cash. Banks that hoard cash do not make short-term loans. Businesses large and small now face a potential dearth of short-term credit to buy raw materials, ship their products, and keep goods on shelves.
This looks a lot like what really happened but The Great Depression, of 1929, didn’t have anything like it.
If there are lessons from 1873, they are different from those of 1929. Most important, when banks fall on Wall Street, they stop all the traffic on Main Street - for a very long time. The protracted reconstruction of banks in the United States and Europe created widespread unemployment.
Bernanke is putting in place mechanisms to accelerate the re-inflation of a bank’s capital assets. Those did not exist, in 1873. Likewise, we have better communications and coordination than we had back then. However, this is still Superman trying to dodge a kryptonite bullet. Superman may not be able to dodge it completely.
Footnotes:
Originally posted on The Slamlander:
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