After yesterday's bailout fiasco and stock market drop, what can we
expect going forward? And how can we prevent another Great Depression?
Learning from 1929
ONE THING THAT PEOPLE often forget is that the stock market crash of
1929 did not turn into the Great Depression overnight. The
unemployment rate was still only 8.7 percent in 1930. GDP lost 6.4
percent in 1931, but the bottom fell out only in 1932, when GDP
plunged by 13 percent. So it took three years for the damage to the
stock market to ravage the banking sector, and eventually for the air
to come out of the real economy. In the meantime, government did far
The basic cause of the great crash of '29 was very similar to what we
are experiencing today: too much speculation with too many exotic
financial creations, using too much borrowed money.
Supposedly, 1929 could not happen again because of "what we learned."
We learned that in a financial panic, the Federal Reserve needs to
pour in heaps of "liquidity" -- money -- as the Fed failed to do after
October 1929. One of the world's reigning experts on the Fed's
failures of the early 1930s is one Ben Bernanke, and he certainly
hasn't been stingy with the Fed's billions.
But the other lesson was the one "we" forgot -- not to let banks and
other financial institutions turn themselves into casinos. It is
helpful, in the spirit of Tonto's historic interrogatory to the Lone
Ranger -- "What you mean, we?" -- to unpack that "we." The "we" who
forgot the lessons included first and foremost Republican ideology --
deregulate everything and let markets run wild; secondly Bush
administration regulatory officials who disdained even the regulations
on the books; and third, the Wall Street Democrats who were
de-regulation's willing enablers.
In some respects, the challenge today is more arduous than in 1929
because the financial products of this era are even more baroque; the
economy is more internationalized, with the U.S. far more dependent on
foreign capital; and there is also different sequencing of events. In
1929, the crash began in the stock market, but only in 1932 did banks
begin collapsing (and the biggest banks never went down). This time,
the crash began in the banking sector, and is only now triggering a
stock market collapse.
That said, there is still time to prevent a crash from turning into a
full-blown depression. Although the economy is on the edge of an
abyss, there is one key political difference that bodes well for the
timing. The crash of 1929 began in the first year of the Hoover
Administration, and for three years Hoover dithered. The crash of 2008
occurred at the tail end of an exhausted Bush administration (and an
exhausted free-market ideology. We only have to make it from October
to January for a serious recovery strategy to commence. With some luck
and leadership, we can telescope the process of reversing the damage
from more than four years in the 1930s to just a few months in early
But we do need to prevent the economy from falling off a cliff in the
next four months. And in the near term, there is a dire leadership
vacuum compounded by an ideological panic on the part of the
Republicans. Not surprisingly, Bush's influence is nil. Treasury
Secretary Hank Paulson, as the ultimate investment banker, proved the
worst possible emissary for his own proposed deal. All he lacked was
the top hat. Nancy Pelosi and Barney Frank were willing to provide
troops for a Wall Street-oriented deal that they didn't much like, but
not to bear sole responsibility.
And House Republicans at last experienced the accumulated
contradictions of their worldview. The reigning ideology of the past
three decades has been turned on its head. Disdain government and give
Wall Street everything it wants. The right has tried to paper over how
that ideology harms Main Street with the use of tax cuts as
all-purpose balm. But this week, the ideology ran out of gas. House
Republicans were left as the party of "no" -- in the apt words of
conservative New York Times columnist David Brooks, as "nihilists."
Nothing in their ideological kit bag could fix what was broken, but
they responded viscerally to their constituents' disgust for the
Paulson deal by voting it down.
Democrats will shortly become stewards not just of a temporary bailout
but of a long term recovery strategy. They might as well begin by
pointing us on the right path. That includes direct refinancing for
homeowners, direct government involvement in the management of failing
financial institutions that are recapitalized by government money,
through something like the Reconstruction Finance Corporations of the
Roosevelt era; and a transfer tax on stock and bond transactions, both
to raise needed revenue and to damp down the kind of speculation that
led to the meltdown. Then Congress can begin the task of regulating
the financial system properly. The basic concept is that any financial
enterprise capable of taking down the system requires the tight
government supervision that in the recent past has been limited to
This is Democratic ideology, if you drill down, just like financial
regulation. But lately, that set of core convictions has gotten rusty.
It needs to be reclaimed, and fast. Too many Democrats are still
thinking small. Barack Obama has just put out a statement urging
Congress to act on the bailout -- and his one new idea proposes that
the FDIC insurance limit be increased to $250,000 per bank. But of all
the things that are broken, this isn't one. Anybody with more than
$100,000 in savings -- the present insurance limit per bank -- knows
to put the money in more than one bank.
One other reversal of recent conventional wisdom will be required.
Government will need to rely on substantial public spending to pull
the wider economy out of the hole. Most of that can be raised by
surtaxes on the wealthy and by transaction taxes on speculation, but
it will also require a temporary increase in public deficits. Raise
enough revenue to cover about $700 billion of financial
recapitalization in year one, and in years two through eight use the
proceeds for public works, infrastructure, good jobs, universal health
coverage, expanded pre-kindergarten and child care.
In my book, Obama's Challenge, which went to press in late July, I put
the necessary number for increased annual public spending at $600
billion. At the time, it felt like I might be over-reaching. If
anything I was low.
So far, the financial collapse has been an ideological windfall for
Democrats. Republicans appear to be flailing. Democrats seem steadier.
But on January 20, their windfall will become their hurricane -- one
that Democrats can use to soar or to crash. And they do not have much
time to get this right.
Robert Kuttner is co-founder and co-editor of The American Prospect