Rock-a-bye, trader on the tip top
When the Board meets, the market will rock.
When the rate rises, quotations will fall.
And down will come trader,
margins and all.
The Wall Street Journal
March 29, 1929
As American finance is being twisted and reshaped almost hourly, many worry that we’re in for an encore of the galvanic upheavals of 80 years ago. Is this a gruesome economic Groundhog Day?
There are important parallels but also major differences. The America of 1929 was energy self-sufficient. It was a muscular industrial society that imported few necessities. A businessman would have been hard pressed to get a foreign-manufactured safety pin into the country. We owed no foreign nation money; they owed us. We were at peace. The size of the military establishment was about right for a nation that did not believe in pre-emptive war and had no enemies.
We had a new president who, at least on paper, was ideally prepared for the economic holocaust. Herbert Hoover was the only president to distinguish himself as a businessman. In 1907, he started his own company, opening offices in New York, London, San Francisco, and Russia. By 1913, he had some 175,000 employees and was running mining operations around the world. Generations before the term “global economy” was coined, Hoover was practicing it.
By the standards of his time, Hoover was an interventionist, not inclined to remain inert while calamities rained down, although many in both parties thought differently 80 years ago. Secretary of the Treasury Andrew Mellon’s recipe for dealing with the Depression was “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” Ultimately, Hoover liquidated Mellon by making him ambassador to the United Kingdom.
Mellon was of the short, sharp retraction school, which believes an unhampered liquidation of the financially weak blows debt out of the economy fast and enables a quick recovery. The Mellon hypothesis still has adherents, but the politics are too awful for an administration to contemplate since this approach risks throwing 20 million people out of work in months if not weeks.
The 1929 crisis was a stock-market disaster. The 2008 crisis is a bond-market disaster. Yet they have important elements in common. Through much of the 1920s, the Federal Reserve made easy credit available to the nation’s banks, which lent money to masses of people to buy stocks on margin. As long as the stock was worth more than the loan to buy it, all was well. The more people got into the market, the higher the prices of stocks went and the easier it was to use the stocks they had borrowed money to buy as collateral to borrow more money to buy more stocks that they did not pay for. Stock prices rose for so long that people came to believe that in the new, modern economy of the 1920s, prices could only go one way. Substitute the word “house” for the word “stock,” and you see what the great grandchildren of 1929 did in the 2000s.
When the price of stocks purchased with borrowed money fell to a point where they were worth less than the loan, buyers had to come up with the money to make up the difference. If they couldn’t, the stockbroker from whom they had gotten the loan took the stock and sold it. The same happened with mortgages and the bonds or collateralized debt obligations (CDO’s) into which the mortgages were packed. Today, purchasers have to put down 50 percent of the price of a stock they buy on margin, but the investment banks that bought CDO’s were putting up as little as 0.3 percent and borrowing the rest.
Thus the underlying mechanics of disaster in 2008 are similar to those of 1929. But there are differences. In 1929, there were no derivatives, those complex deals or arcane side bets that multiply potential losses of billions into trillions. We can thank computers for them. Without electronic computation and record keeping, trading and tracking at such speed and in such volume could not be done. Devilish tricks go back to the days of Daniel Drew (1797-1879), reputed inventor of stock watering, but without modern toys even Ole Dan’l, who went to jail and died bankrupt for the sheer gall of his business crimes, could not have pulled off the tricks we first saw with Enron.
What people in 1929 did with stock, Americans did in the last decade with real estate, but since Wall Street institutions financed the real estate bubble with bonds they were foolish enough to keep rather than fob off on suckers, the effect on the stock market has been about as dismal as 80 years ago.
With J.P. Morgan’s heroics during the panic of 1907 as a model, the big financiers of 1929 attempted a similar act of “organized support” to gin up the market. In a moment that retains a place in Wall Street lore, New York Stock Exchange president Richard Whitney went to the trading floor to place an order for 25,000 shares of the United States Steel Corporation at $205, $10 higher than it had fallen. Whitney then did the same for shares in other major companies. The market ralliedbut not for long.
The present secretary of the Treasury, Henry Paulson, also tried to put together “organized support” to drive up the swooning stock prices of financial companies choking on worthless CDO’s. But would-be supporters were either broke or terrified of buying bonds everybody was calling “toxic waste.”
From this point, 1929 and 2008 begin to diverge. After the organized support attempted by Whitney failed, there was nothing to do but ride out a hurricane of wealth destructionunless the government attempted what the private sector had failed to do. Nothing of the sort had been done before, and although Hoover was a forward thinker, having the government prop up private business was a huge gulp for a man who in his weaker moments blamed the crash on John J. Raskob, a DuPont and General Motors finance executive. A bee got into Hoover’s bonnet that Raskob, a Democrat, was the center of a short sellers’ conspiracy. A similar bee has been buzzing into our heads, with the result being that short selling of the stock of more than 800 companies has been forbidden by the Securities and Exchange Commission.
Hoover, who had the optimism of a successful businessman, was waylaid with spasms of magical thinking. In the summer of 1930, he told a delegation of clergymen asking him to expand public works for the unemployed, “You have come 60 days too late. The Depression is over.” But he eventually agreed to a shot at a bailout through the new Reconstruction Finance Corporation, which lent to banks, railroads, and insurance companies. It was not enough money and came too late, though had it been more and sooner, the results may not have been better.
Hoover’s slowness may have resulted in part from his having assumed office in March, a few months before disaster struck in October. He had almost four years before he had to run again. The crisis of 2008 arrived in the middle of a campaign. It’s impossible not to believe that someone in the White House or the Treasury said something like, “Either we save AIG or McCain loses.”
Paulson and Fed chair Ben Bernanke were probably also hurried into action by their knowledge of the huge foreign investments in American financial companies and government bonds. A new drop in the value of the dollar or in their investments might cause the oil Arabs, the Chinese, and many others to stop lending the U.S. money. Moreover, foreign financial institutions, which are demanding that they be included in any rescue program, pose a grisly choice for the administration: accede to foreign demands and face furious reaction just before the election or decline and risk cracking America’s economic position in the world, possibly turning it into the new Argentina. Hoover had no such nightmarish alternatives.
Bernanke, who has written a book called Essays on the Great Depression, ought to be prepared, if anyone is, to take on this crisis. Yet the America of 1929 and that of 2008 are so unlike as to be almost different countries. At this writing, Bernanke has not been successful in doing the first thing that the Federal Reserve Board is tasked withkeeping the financial system liquid. That is, making sure there is enough money available that commerce and industry do not starve for lack of affordable capital. Though Bernanke has tried, businesses and individuals are growing parched.
In the intellectual realm, the Hoover-Roosevelt administrations had organized opposition from Marxists and socialists. These small but clangorous political parties offered an ongoing, systematic critique of what the government was doing. Today, the disagreements aren’t over basics and don’t arise from a different premise and different analysis.
The last contrast between now and then concerns the American people themselves. One may wonder if the men and women whose images were recorded by Walker Evans’s camera are to be found in 21st-century America. The greed and stupidity quotient is doubtless the same, but the Americans of 1929 were a grittier bunch. They were more self reliant, if only because they did not live in a service economy. They were closer to the land and made do with far less. They were thinner, bonier people who did not live as long and worked harder.
Phil Gramm, the former Texas senator, economist, and McCain adviser, got in trouble for saying of contemporary Americans, “We’ve sort of become a nation of whiners. You just hear this constant whining, complaining…” There is a grain of truth in that. If the hard times do come, they will be harder for us.
Nicholas von Hoffman is a former columnist for the Washington Post and Point-Counterpoint commentator for CBS’s “60 Minutes.” He is the author of many books, including, most recently, Hoax.
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