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More than a Recession

Competing visions of how the economy should be organized.

12:00 AM, Oct 31, 2008 • By IRWIN M. STELZER
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November was much celebrated by investors in 1954. On the 23rd of that month the Dow Jones average of shares of industrial companies for the first time closed above the level it had reached at its peak on Sept. 3, 1929. Are we in for another 25-year wait before share prices match their October 9, 2007 peaks? Only a brave man or a fool would attempt to predict the course of share prices, which have been gyrating at a rate that would be the pride of any belly dancer. And it would take an even braver and more foolhardy one to predict with confidence that the situation in which we find ourselves, unpleasant and dangerous as it is, is not going to reach levels last seen in the depression of the 1930s (actually there were two, separated by a period of growth). So here goes.

A bit of history. In the 1930s the U.S. economy shrank by 30 percent, the unemployment rate rose from 3 percent to 25 percent, and prices fell at an annual rate of 10 percent during the early part of the decade. Since World War II we have lived through ten expansions, averaging four years in length, and ten recessions, with an average length of one year. The two longest recessions (1969/1970 and 1973/1974) lasted for five quarters. And recorded declines were modest by the standards of the Great Depression. Which should provide a bit of comfort to those who are worrying that recessions typically collapse into a 1930s style depression.

That is not to say that the current recession is a mirror image of those we have experienced since WWII. It has many similarities to those setbacks, of course. Unemployment is rising, consumer confidence is fading, output is shrinking (although not as yet at an alarming rate), many investors are getting burned, some firms are being driven to the wall by declines in demand for their products, and a closing of credit markets.

Sigmund Freud is alleged to have said, "Sometimes a cigar is only a cigar." And sometimes a recession is only a recession, with the consequences described above. The one in which we are stuck is different from those we have seen since World War II. The seizing up of credit markets, the ubiquity of bad IOUs on the books of financial institutions, the massive indebtedness of consumers, the rattling of the banks' credit bowls at the doors of the Treasury and the Federal Reserve Board--a clamor made louder by auto companies, and insurance companies, construction companies, and U.S. subsidiaries of foreign banks--are relatively new features. Yes, we have had bailouts in the past--most notably of Chrysler during the Carter years, and Long Term Capital in the early days of Alan Greenspan's tenure as chairman of the Fed--but we did not see the government buying shares in banks, or guaranteeing money funds, or opening the Fed "window" to collateral that, to put it politely, is not of the highest quality.

But note a common thread: All of these moves are generally correct policy responses to what some call the worst financial crisis ever, a veritable "tsunami". In the Depression the Fed got it wrong, and tightened when it should have been loosening credit. In the Depression, the government almost got it wrong. Franklin Roosevelt thought part of the solution was a cut in spending to balance the budget, and so promised to do just that. Fortunately, that was a promise that he quite wisely decided not to keep, even before John Maynard Keynes provided the theoretical basis for deficit spending in a recession.

Now, after some stumbles, the most important being Treasury Hank Paulson's decisions to let Lehman Brothers go down (he says he had no choice, since Lehman had no decent collateral he and the Fed could have accepted in return for bailout cash) the authorities are getting it right.

Ben Bernanke, a keen student of the Great Depression, learned from his predecessors' mistakes, and even added some innovative loosening measures to a series of rate cuts, culminating in this week's reduction to 1 percent. The recapitalization of the banks is underway on a huge scale, putting them in a position to begin lending again. The extension of government deposit guarantees calmed the panic that threatened to create queues at the withdrawal windows of the world's banks. Measures to improve banks' willingness to lend to each other seem to be taking hold, although that problem is proving the most resistant to government measures. There are tentative signs that the steps taken to thaw the frozen commercial paper market are working, so that businesses can cover short-term cash needs. All is not yet well in credit markets, and more shocks are in store, but the trajectory seems rather more encouraging than it was a few short weeks ago.