Great depression & financial crisis

Friday, April 7, 2023

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Group 4 _ Section C

Anand Kumar 12P127

Bhoomi Ashwin 12P131

Chirayu Gandhi 12P135

Rakshit Sharma 12P160

Saurabh Saxena 12P167

Soumyajit Sengupta 12P171

Great Depression, 1929 v/s Financial Crisis, 2008


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Background

Causes/Triggers

Impact

Recovery Steps

Recovery

Comparison • Differences• Similarities

Agenda


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Great Depression, 1929


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Severe economic depression which preceded World War II

Started in the US on October 29th , 1929 with the fall of US stock market

Impacted the major European and Asian economies of the world

Lasted till early 1940’s – longest, most widespread and deepest depression of 20th century

Background


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Major Causes

Great Depression

High Tariff Barriers

Stock Market crash

Over ProductionInequality

Monetary Policy


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Farm: The production rose to very high level to meet the demand

during WW-I but the consumption dropped in 1902’s

The prices of the agricultural land and crops fell and the average annual income of farmers dropped to $273

30% of Americans were dependent on farming

Industry: Factories were producing products at a higher rate but the

wages of workers were not increasing in the same proportion

Consumers were buying less than the and their was overproduction

Over Production


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Monetary contraction, the consequence of poor policy-making by the American Federal Reserve System and continued crisis in the banking system responsible for Great Depression

The Federal Reserve, by not acting, allowed the money supply to shrink by one-third, transforming a normal recession into the Great Depression

Led to the closure of more than 11000 banks and increased conservatism in remaining banks in extending credit

Monetary Policy


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The American stock markets were the most visible symbol of prosperous American economy in 1920’s

Stock prices rose steadily in 1920’s and in 1929 Dow peaked at its highest level of 381 points

The industries were not performing well and in the stock market there were 2 major problems: Speculation Margin

On October 29th, 1929 the stock market plummeted leading to a loss of $30 billion

Stock Market crash


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Nation’s wealth grew steadily in 1920’s but it was not distributed evenly

The income rose to 75% for the top 1% and for the remaining it was only 9%

80% of Americans had no savings at all

70% of families had annual earning < $2500

Inequality: Unequal distribution of Wealth


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During initial stages of Great Depression, the USA's main goal emerged to protect American jobs and farmers from foreign competition

So, the Smoot-Hawley Tariff Act was enacted in 1930

But it led to the worsening of depression by reducing international trade and causing retaliatory tariffs in other countries

High Trade Barrier


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There are various approaches for explaining the cause of the first downturn in 1929: Demand-driven

KeynesianBreakdown of international tradeDebt deflation

Monetarist Inequality Productivity shock Austrian School New classical approach

Different views of the causes


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Keynesian: Lower aggregate expenditures in the economy contributed to a massive

decline in income and to employment that was well below the average To keep people fully employed, governments have to run deficits when

the economy is slowing

Debt deflation: Predominant factor leading to the Great Depression was over-

indebtedness and deflation Margin requirements were only 10% - People took the loan to invest in

stock market, but when the market crashed they were unable to repay these loans – leading to default

Breakdown of international trade: American Smoot-Hawley Tariff Act responsible for worsening the

situation of the crisis American exports declined from about $5.2 billion in 1929 to $1.7

billion in 1933

Demand Driven


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Monetary contraction, the consequence of poor policy-making by the American Federal Reserve System and continued crisis in the banking system responsible for Great Depression

The Federal Reserve, by not acting, allowed the money supply to shrink by one-third, transforming a normal recession into the Great Depression

The Federal Reserve Act limited the amount of credit the Federal Reserve could issue

Monetarist


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Root Cause: Global over-investment in heavy industry capacity compared to wages and earnings from independent businesses

Solution: Redistribute purchasing power, maintain the industrial base, but re-inflate prices and wages to force as much of the inflationary increase in purchasing power into consumer spending

Inequality


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The first three decades of 20th century witnessed rapid growth in productivity and production capacity

According to this school of thought “The Great Depression” was a result of these long term trends

Productivity shock


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Austrian School: The key cause of the Depression was the expansion of the money

supply in the 1920s that led to an unsustainable credit-driven boom

This inflation of the money supply that led to an unsustainable boom in both asset prices by the late 1920’s and led to economic contraction

New classical approach: Initial severe decline but rapid recovery in productivity, relatively

little change in the capital stock, and a prolonged depression in the labor force

focuses on the decline in productivity that caused the initial decline in output and a prolonged recovery due to policies that affected the labor market

Other Views


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Effect on the major Economies of the World and US


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United States

Great Britain France Germany

Industrial production –46% –23% –24% –41%

Wholesale prices –32% –33% –34% –29%

Foreign trade –70% –60% –54% –61%

Unemployment +607% +129% +214% +232%

ImpactChange in Economic Indicators from 1929-1932


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In March 1933, the country was virtually leaderless The banking system had collapsed. He provided dynamic leadership in a time of crisis

Series of economic programs enacted in the USA

between 1933 and 1936

3R’s - Relief, Recovery and Reforms

Relief for the unemployed and poor

Recovery of the economy to normal levels

Reform of the financial system to prevent a repeat depression

Recovery StepsNew Deal


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Specialists and experts, mostly college professors, idea men

New Economists: government spending,

deficit spending and public works, government should prime economic pump

Roosevelt Cabinet: included conservatives, liberals, Democrats, Republicans, inflationists, anti-inflationists -- often conflicting, compromising, blending ideas

Sources of New Deal Ideas


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Primary Aim of this Deal was to Achieve Economic Recovery

Philosophy: economic nationalism and economic scarcity (i.e., raise prices by creating the illusion of scarcity)

Objectives: higher prices for agriculture and business

Beneficiaries: big business and agricultural business

First New Deal (1933-1934)


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National Recovery Act (NRA)

Purpose: recovery of industry Created a partnership of business,

labor, and government to attack the depression with such measures as price controls, high wages, and codes of fair competition

Federal Emergency Relief Admin (FERA)

Purpose: relief Gave money to states and municipalities so they could distribute money, clothing, and food to the unemployed


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First Agricultural Adjustment Act (AAA)

Purpose: the recovery of agriculturePaid farmers who agreed to

reduce production of basic crops such as cotton, wheat, tobacco, hogs, and corn

Money came from a tax on processors such as flour millers and meat packers who passed the cost on to the consumer


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Civilian Conservation Corp (CCC)

Purpose: relief

Gave outdoor work to unemployed men between the ages of 17 and 29

They received $30 per month, but $22 went back to the family


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Primary aim: permanent reform

Philosophy: international economic cooperation and economic abundance

Objectives: increased purchasing power and social security for public

Beneficiaries: small farmers and labor

Second New Deal (1934-1941)


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Purpose: reformGave money to states for

aid to dependent children, established unemployment insurance through payroll deduction, set up old-age pensions for retirees.

Purpose: reformPut restraints on employers and

set up a National Labor Relations Board to protect the rights of organized labor to bargain collectively with employers.

Social Security Act

National Labor Relations Act


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Purpose: recovery for agriculturePaid farmers for conservation

practices, but only if they restricted production of staple crops.

Purpose: recovery and reformUsed federal funds to tear down

slums and construct better housing.

Second Agricultural Adjustment Act

U.S. Housing Authority


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Physical Rehabilitation of Country Attacked soil erosion Built dams and planted trees to prevent floods Reclaimed the grasslands of the Great Plains Developed water power resources Encouraged regional reconstruction projects

like the TVA and Columbia River project

Established the principle that government has responsibility for the health, welfare, and security, as well as the protection and education of its citizens

Embraced social security, public health, housing Entered the domain of agriculture and labor

Human Rehabilitation


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The Depression ended when the U.S. entered World War II in December 1941

Massive war spending doubled the GNP Military Keynesianism brought Full Employment

Military Keynesianism: the position that the government should increase military spending in order to increase economic growth.

The mobilization of manpower following the outbreak of war in 1939 ended unemployment

Spending on the New Deal was far smaller than spending on the war effort, which passed 40% of GNP in 1944

Massive war spending doubled economic growth rates, either masking the effects of the Depression or essentially ending the Depression

Businessmen ignored the mounting national debt and heavy new taxes, redoubling their efforts for greater output to take advantage of generous government contracts.

The End of The Great Depression


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Financial Crisis, 2008


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Worst financial crisis since the Great Depression of the 1930s

Global economic decline which began in August, 2007 after BNP Paribas terminated withdrawals to hedge funds citing a liquidity crunch in the UK. This was the liquidity crisis which marked the beginning of the Financial Crisis.

It took a sharp downturn in September, 2008 Resulted in the threat of total collapse of large financial

institutions, bailouts of banks by national governments and stock market crashes

Resulted in prolonged unemployment, decline in consumer wealth and caused the global recession of 2008-2012 and also contributed to the European Sovereign Debt Crisis

Background-Financial Crisis, 2008


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Sub-Prime Lending

The term “sub-prime” refers to those borrowers who neither have the assets, nor a reliable income source, hence, have greater chances of loan default

Bankers and the middlemen got carried away to the extent that special financial products were created to cloak the sub-prime loans with respectability

Causes/Triggers


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Growth of the Housing Bubble From 1997 to 2006, the price of the typical American

house increased by 124% Resulted in many homeowners refinancing their homes

at lower interest rates or financing consumer spending by taking out second mortgages secured by the price appreciation

By September 2008, average U.S. housing prices had declined by over 20% from their mid-2006 peak

As prices declined, borrowers with adjustable-rate mortgages could not refinance to avoid the higher payments associated with rising interest rates and began to default

Causes(Continued)


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Easy Credit Conditions Lower interest rates encouraged borrowing(Between 2000

to 2003, the Federal Reserve lowered the federal funds rate target from 6.5% to 1.0%)

downward pressure on interest rates was created by the high and rising U.S. current account deficit, which peaked along with the housing bubble in 2006

Weak and Fraudulent Underwriting Practices loans not meeting an issuer's minimal underwriting

standards were subsequently securitized and sold to investors

Causes(Continued)


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Predatory Lending Practice of unscrupulous lenders, enticing borrowers to enter

into "unsafe" or "unsound" secured loans for inappropriate purposes

ExampleAdvertisement stated that 1% interest would be charged but

the consumer would be put into an adjustable rate mortgage (ARM) in which the interest charged would be greater than the amount of interest paid. This created negative amortization, which the credit consumer might not notice until long after the loan transaction had been consummated

Deregulation Regulatory framework did not keep pace with financial innovation

Causes(Continued)


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Over-Leveraging/Increased Debt Burden Financial institutions were over burdened with debt,

increasing their appetite for risky investments and reducing their resilience in case of losses.

Incorrect Risk Pricing Risk Pricing refers to the incremental

compensation required by investors for taking on additional risk, which may be measured by interest rates or fees

Lack of transparency about banks' risk exposures prevented markets from correctly pricing risk before the crisis

Causes(Continued)


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Financial Innovation/Complexity Development of financial products designed to achieve

particular client objectives, such as offsetting a particular risk exposure (such as the default of a borrower) or to assist with obtaining financing

ExamplesAdjustable-rate mortgage(ARM)Bundling of subprime mortgages into mortgage-

backed securities (MBS) Collateralized debt obligations (CDO) for sale to

investors, a type of securitizationForm of credit insurance called credit default swaps

(CDS)

Causes(Continued)


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Boom & Bust of Shadow Banking The riskiest, worst performing mortgages were funded through

the "shadow banking system“ Competition from the shadow banking system pressured the

more traditional institutions to lower their own underwriting standards and originate riskier loans

Run on the shadow banking system was the "core of what happened" to cause the crisis

These entities became critical to the credit markets underpinning the financial system, but were not subject to the same regulatory controls

Further, these entities were vulnerable because of maturity mismatch of short term borrowings and long term investments

Causes(Continued)


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Commodities Boom Rapid increases in a number of commodity prices

followed the collapse in the housing bubble The price of oil nearly tripled from $50 to $147 from

early 2007 to 2008, before plunging as the financial crisis began to take hold in late 2008

An increase in oil prices tends to divert a larger share of consumer spending into gasoline, which creates downward pressure on economic growth in oil importing countries, as wealth flows to oil-producing states

Causes-Continued


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Global Economy contracted by 3% in 20092nd quarter,2008: Greece, Estonia, Latvia, New Zealand, Ireland3rd quarter,2008: Japan, Sweden, Hong Kong, Singapore, Italy,

Turkey and Germany(fifteen nations in the EU went into recession)

4th quarter,2008: United States, Switzerland, Spain and TaiwanUkraine went into Depression in 2008 at -20% GDP growthChina and India experienced a slowdown

Countries Impacted


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Real GDP decreased by 6% y-o-y in 2008-09 Domestic demand decreased at record pace-2.6% q-o-q Inflation rose to 5.6% in 2008 from 4% in 2007 Capital investment declined y-o-y at levels unprecedented

since the post war levels of 1957-58 Unemployment rate increased to 10.1% in early 2009, from

5% in early 2008 Average work hours per week declined to 33 hours, lowest

since 1964

Scale of Impact-USA


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Housing Prices declined by 20% in 2009 Aviation sector gravely impacted: 4 airlines closed down in

a week’s span Wealth decreased by over 25% for all Americans combined

63% of ALL Americans had a decrease in net worth 77% of the RICHEST Americans had a decrease in net worth 50% of the POOREST Americans had a decrease in net worth

Stock Market DOW JONES Industrial Average declined to 6600 in 2009 from a high

of 14000 in 2007(a fall of more than 50% in 18 months) S&P 500 declined by 45% in 2008 from its 2007 high

Scale of Impact-USA(Continued)


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Numerous financial institutions went under or were bailed out, the most prominent among them being: New Century Financial(Largest Sub-Prime Lender) Bear Sterns(consequently acquired by JPMC after it lost $15billion in 2

days) Citibank($18.1billion write-down in its sub-prime mortgage exposure) Merrill Lynch($14.1billion write-down, acquired by BoA for $50billion) Freddie Mac & Fannie Mae(Largest bailout in history after the US

Government took over) Lehman Brothers(filed for bankruptcy in 2008 after share prices

decreased by 85% and acquisition talks with BoA failed) AIG(Losses due to $11billion of CDS portfolios, US Government took

over with a stake of 80% after loaning it $85billion)



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Median Income declined to $49,445 in 2010 from a high of $52,823 in 2007 leading to an increase in the BPL families in USA

National Income Pie Upper Class: 29% in 1969 to 46% in 2010 Middle Class: 61% in 1969 to 45% in 2010 Lower Class: 10% in 1969 to 9% in 2010


29%

61%

10%

Income-1969

Upper ClassMiddle ClassLower Class 46%

45%

9%

Income-2010

Upper ClassMiddle ClassLower Class

Median Income47000

48000

49000

50000

51000

52000

53000

5400052823

4944520072010


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Stock prices CRASHED worldwide leading to eroding of investor wealth and confidence

Run on Financial Institutions leading to their bankruptcy

Led to the Political and Economic Instability of the European Union

European Sovereign Debt Crisis is still an issue

Countries like Jamaica, Estonia, Latvia which relied heavily on foreign investment suffered when credit inflow dried up and their debt levels rose to unprecedented levels

Impact on Developed & Developing Nations


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Iceland faced both stagflation and depression which led to national bankruptcy and ultimately the fall of the government in 2009

Countries like Japan, which were dependant on exports to US and UK also suffered due to decreased demand for its goods

Countries like India and China, however were insulated from the worst effects of the crisis, primarily due to high domestic demand and lower cost manufactured goods exports respectively

Composition of world financial holdings has shifted away from equity investments like stocks and toward government debt

Impact on Developed & Developing Nations


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Government announced a package consisting of tax breaks and government backed refinancing to help homeowners avoid foreclosures in August, 2007

US Federal Reserve resorted to an expansionary monetary policy by cutting interest rates in 2007 from 5.25% to 4.75% and further to 4.5% and injected $41billion in the banking system

US Treasury announced a $50billion package to insure investments in a bid to stop a potential run on money-market mutual funds

Temporary exemptions allowing financial groups to share funds more easily among its members

Recovery Steps-USAMonetary Steps


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Termination of short-selling of financial stocks

Tightened rules on sub-prime lending

Announced a $150billion stimulus package and interest rates were cut to 3.5% after the stock market crashed on Jan 21, 2008 which was further reduced to 3% in Feb, 2008

$700billion package to buyout toxic loans of banks in 2009 and finally interest rates were reduced to 0.25% following which they lost the most important regulatory tool

Recovery Steps-USAMonetary Steps(Continued)


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USA proposed a regulatory plan in which the Federal Reserve was given more powers as a market regulator. The Plan proposed the following:

Fed Reserve allowed to examine the books of any financial institution

Organization would be set up which will oversee and regulate all the banks

Another body will regulate business conduct, consumer protection and investor protection.

A commission would be created to establish stricter criteria for firms involved in the mortgage market.

Securities and Exchange Commission, which regulates companies with publicly traded shares, would be merged with the Commodities Futures Trading Commission, which oversees commodities trading

Recovery Steps-USARegulatory Steps


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Rating Agencies were also reformed and agreements with S&P, Moody’s, Fitch was announced which included:

fee reforms

disclosure reforms

loan originator reforms

due diligence reforms

credit agency independence

representatives and warranties reforms

Increased regulations on shadow banking systems and derivatives

Recovery Steps-USARegulatory Steps(Continued)


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China cut its interest rate in 2008, for the first time since 2002. It announced a $586billion stimulus package in November,2009.

Indonesia cut its repo rate overnight in 2008 to 10.25% from 12.25%

Bank of Japan pumped in $29.3billion on Sep 21, 2008; Reserve Bank of Australia injected $3.45billion on the same day

RBI injected $1.3billion in February,2008, the most in a month ever

European Central Bank injected €95billion into the European Banking System in 2007. Central Banks across the world injected €300billion to prevent a credit market seizure

Household tax rebates were introduced in Europe

European Commission announced a €200billion stimulus package for the EU at the country level in 2009

Recovery Steps: RoW


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India cut its repo rate from 9% to 4.75% in 2008-09 and announced a $60billion stimulus package to boost the economy along-with duty cuts in 2009

UK Government announced a 500billion bank rescue package in ₤2009

Basel III norms were implemented which increased capital ratios, limits on leverage, narrow definition of capital (to exclude subordinated debt), limit counter-party risk and new liquidity requirements

G-20 set up to validate the feasibility and conduct discussions among the world’s major economies to find ways to counter the crisis

Pledged to fight against all forms of protectionism

Pledged to maintain trade and foreign investments

Pledged to stimulate demand and employment

Pledged to provide more liquidity and recapitalization of the banking system

Recovery Steps: RoW-Continued


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By mid-2012, Iceland recovered and is regarded as one of Europe's recovery success stories largely as a result of a currency devaluation that has effectively reduced wages by 50%, making exports more competitive

In the United States, jobs paying between $14 and $21 per hour made up about 60% those lost during the recession, but such mid-wage jobs have comprised only about 27% of jobs gained during the recovery through mid-2012. In contrast, lower-paying jobs constituted about 58% of the jobs regained

Unemployment Rates have decreased to 8% from 10% in 2008-09 Anemic recovery that has yet to pull per capita annual real GDP

back to the level of 2008

Time Period of Recovery


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Limited deleveraging of household and government sectors has occurred in the last 5 years

U.S. housing prices are still falling in many areas and credit to small and medium- size businesses is restrained

GNP has increased by 5.5% in the period from 2009-2011 following a fall of 5.6% from 2007 to 2009

Low aggregate demand, uncertainty and government policies are causes for slow speed of recovery

Time Period of Recovery(Continued)

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Great Depression

Stock Market crash was of greater magnitude(90% decline in 33 months)

GNP contracted by 30% Lasted for 3.5 years(1929-1933)

Money Supply decreased Unemployment Rate=25% Debt at 300% of GDP 40% of Banks failed Regulated Federal Reserve Oversupply of Cars and Radios WW2 helped the economy Recovery took 8 years(1933-

1941)

Stock Market did not crash as much(40% decline in 18 months)

GNP contracted by 5.6% Lasted for 1.5 years(Dec,07-

Jun,09) Money Supply increased Unemployment Rate=10% Debt at 350% of GDP Very few Banks failed Deregulated Federal Reserve Oversupply of Houses No engine of recovery like

WW2 Full recovery not in sight yet

Differences

Financial Crisis


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Exorbitant rise in asset prices in period prior to event

Cheap credit available

Inadequate regulation

Caused by massive debt

Low aggregate demand due to insufficient stimulus by monetary and fiscal policy(cited by Krugman,2010)

High unemployment rates

Continued uncertainty about economic policy(cited by Pirong-Becker,2011)

Similarities


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Thank You!

Great depression & financial crisis

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