Government responses to the Great Depression and 2008 financial crisis

Great Depression of 1929 vs. The 2008 Global Economic Crisis

For many people, the Great Depression of 1929 and the 2008 Global Economic Crisis are synonymous with: greed along with vast excesses that came to a sudden halt. As both events, would signal how the government's response to financial related calamites would shape economic growth going forward. In the case of the United States, the policy decisions that were taken at the beginning and during both crisis, would determine the overall events of the economic implosion. As the Great Depression would highlight how various polices would make the economic situation worse. Evidence of this can be seen by looking no further than the collapse in economic activity that occurred in country between 1929 and 1933. As the unemployment rate would rise from 3.4% (in 1929) to 24.9% (in 1933). At the same time, real GDP would decline by 27% in four years. (Tucker, 2008, pg. 422) This is significant, because the extent of the contraction and the policy decisions made; would have an impact on how the U.S. Government responded to the economic implosion of 2008. To fully understand how these events would affect policymakers requires comparing the government's response to: the Great Depression and the 2008 Global Economic Crisis. This will be accomplished by examining: the underlying causes of each event, the responses and how it would impact the economy. Together, these various elements will provide the greatest insights as to how the actions taken by the government would shape both events.

Causes of the Great Depression

To fully understand the Great Depression requires going back to World War I. This is when the world economy would undergo a severe transformation. As the war and its lasting effects, would create a shift in the economic power base. For many European countries, they would begin to experience a decline in economic strength. As the winners of the war (the U.S., Great Britain along with France) would impose severe penalties and reparations on those nations, that were believed to have started the different events (Germany). At the same time, the United States was undergoing a tremendous amount of economic growth from the war. Where, it would create a shift in manufacturing and in the automation of agriculture. This is significant, because it shows how the war would set the stage for the tremendous amounts of economic growth throughout the 1920's (the Roaring 20's). However, by 1929 the economy in the United States was beginning to overheat, as stock prices were at an all time high and the nation's manufacturing activity would slowly begin to flatten out in August 1929. Despite this ominous sign the stock market continued to head even higher, fueled by rampant optimism. Once October 1929 arrived, the stock remained at these lofty levels (as the crash would come on the 29th). This is when the different actions taken by the government would make the effects of the Great Depression worse. (Temin, 1999, pp. 41 -- 89)

As a result, three different events would contribute to the severity of the Depression to include: the stock market crash / the Hawley Smoot Tariff, the banking crisis and the collapse in commodities prices. Together these different events would spread the Great Depression around the world.

The stock market crash and the Hawley Smoot Tariff would play an equally important part in spreading the effects of the Great Depression. What happened was the stock market crash of 1929 would provide an initial shock to the economy. Where, it would attack the wealth of many different individuals. This is because, the initial declines market sparked tremendous waves of selling that would cause a panic. At which point, the averages would continue to see consistent declines on a regular basis. As the stock market, would take out key levels of support easily. This would impact the liquidity positions, of many individuals and their personal net worth. The reason why, is because a larger number of people and financial institutions (i.e. banks, brokerage firms along with insurance companies) were investing a significant amounts of money into the market. As prices continued to head lower, this would have ripple effect on consumer spending. Where, the banks were facing a liquidity crisis because they did not have enough cash in reserve (as this money was invested in the stock and through various loans). Once their stock positions declined, this would have ripple effects on business loans. At which point, many companies began to lay people off and a downward spiral of economic activity would take place from 1929 to 1933. (Temin, 1999, pp. 41 -- 89)

As the Great Depression, was beginning to have an adverse effect on jobs, the federal government began a new initiative of raising tariffs. This was in an effort to: protect manufacturing and prevent the economy for seeing any more increases in the unemployment rate (the Hawley Smoot Tariff). However, the effects would be devastating, as the high tariffs would result in retaliatory measures from trading partners. At which point, global trading would slow down significantly, resulting in an even more pronounced down turn. (Temin, 1999, pp. 41 -- 89)

The above two events would have an impact on the banking sector, as the stock market would force many banks to face the possibility of bankruptcy. Where, they did not have enough money, to satisfy the demands of depositors. This caused fear to spread about the liquidity of the entire system. At which point, runs would become common at a number of banks around the country. This led to even further declines in economic activity, as the banks were not lending money and businesses could not finance the operations of a number of different activities. As many different large and small companies would disappear (due to the fact that they could not obtain financing). (Temin, 1999, pp. 41 -- 89)

The implosion in commodities prices were from a lack of demand from businesses, as consumer spending had slowed to a halt. This would force many manufacturers, to cut back on their use of different raw materials in the production of various goods. At which point, commodities prices would decline, leading to a cycle of crippling deflation. (Temin, 1999, pp. 41 -- 89)

Causes of the 2008 Global Economic Crisis

The causes of the 2008 Global Economic crisis began with deregulation and globalization. What happened was, deregulation was taking place in response to various calls from politicians, who felt that government had become too intrusive, in the matters concerning the economy. Where, many analysts and economists believed that if various regulations were reduced they could be able to compete more competitively. The reason why is because this pressure was increasing, due to the fact that the globalization (the reeducation of trade barriers) were making many businesses more competitive. In the financial world this was troubling, because some of the different laws from the New Deal (the Glass Steagall Act) would limit the size and the activities of: banks, brokerage firms as well as insurance companies. The Glass Steagall Act was: a law that forbid various financial institutions from becoming involved in each other's business activities. The idea was that by limiting the size and activities of these industries, you can control their risks and possible exposure to the economy (in the event of a financial collapse). As the economy began to grow, various financial institutions would begin to call for the dismantling of the Glass Steagall Act. (Stareny, 2010, pp. 47 -- 48) Once the law was repealed in the late 1990's this would cause the size and scope of financial institutions to increase dramatically. At the same time, various hedge funds would begin to explode. They would trade in host of different instruments. This is important, because it shows how the innovations in the financial world would set the stage for various trading activities. (Baru, 2009, pp. 3 -- 38)

Then, the Federal Reserve was dramatically lowering interest rates in the aftermath of the September 11th. This was in response to the terrorist attacks and the lingering dot com bubble that was hanging over the economy. Over the course of time, this would lower interest rates to such a point, that many banks and other financial institutions were offering easy terms (on a host of different lending products). This would cause many consumers and businesses take out a significant amount of debt. At the same time, mortgage rates and the reduction in lending standards at various financial institutions (through deregulation) would make these products widely available. In many cases, the traditional standards of qualifying for various loans were often waved. As the belief was that the high amounts of debt would translate into increased income, from the interest of the different loans. All of these: consumer, business, residential and commercial loans were packed into what is known as tranche. This is where, they will take different mortgages and bundle them together (offering a higher interest rate). At which point, they would be sold to large financial institutions, banks, brokerage firms, hedge funds and individual investors around the world. Once interest rates began to increase and the economy started to slow, this would cause many people who owed money to different financial institutions to default on their loans. This would have ripple effects on the credit markets, as no one could be able to trade these loans. This is because there was no way to accurately value them. As the economy began to slow and the value of real estate declined even more, the price of would become difficult to determine. This would affect the liquidity of businesses and financial institutions. As they did not have access to the credit market (because they are frozen) and they were holding assets they could not sell. Once the various loans began to default this would have a ripple effect on large insurance companies that had underwritten the debt and were financially liable. When put these different elements together, it would mean that institutions such as: Lehman Brothers would become insolvent overnight. (Kolb, 2010, pp. 77 -- 86)

Government Responses

In response to what was taking place, the government would engage in massive bailout programs. Where, they would pump billions of dollars into various financial institutions and the credit markets. The idea was that by having the government serve as the lender of last resort, it would help to provide stability to many businesses. This is important, because it would give them the financing for various operations that support their daily activities. During the early stages of the crisis, this would play a major role in preventing the situation from spiraling out of control. (Bonnick, 2010, pp. 61 -- 68)

At the same time, the government would engage in various actions to relieve the different burdens on home owners (through the Home Affordable Modification Program) and consumers (i.e. Cash for Clunkers). These different programs were important, because they would allow various loans to be modified for home owners, so that they could reduce their mortgage payments (avoiding possible foreclosure). The Cash for Clunkers program would allow the consumers to trade in their expensive SUV's for fuel efficient cars. This would help to support the auto industry (through increased sales) and it would reduce the debt / expenses of consumers (by allowing them to purchase more affordable vehicles). (Bonnick, 2010, pp. 61 -- 68)

When you step back and analyze the government's response to both economic events, it is clear that the lack of response during the early part of the Great Depression would make the economic situation worse. Then, when the government did respond, the actions were often taken were half hearted or contradictory to other parts of their strategy. This would basically negate any kind of support they were trying to provide. At which point, the economy would fall into a more pronounced economic contraction. Once Roosevelt became President, the government would begin to provide social services (through massive amounts of spending) and addressing the causes of the depression (through increased regulation). This is different from the government's response during the 2008 Global Economic Crisis. Where, they would provide massive amounts of liquidity and loans to various businesses as well as consumers. This would help to mitigate the effects of the crisis, as it would prevent the economy from falling into a similar downward spiral that was experienced during the Great Depression.

Clearly, the response by the federal government during the Great Depression and the 2008 Global Economic Crisis would have an impact on future economic growth. The reason why, is because when the economy enters these kinds of situations, added amounts of liquidity are required to maintain the stability of the system. In the Great Depression this did not take place, as the lack of a response from the government would allow the situation to become worse. Then, once a response did take place, it would have no effect on preventing the runaway economic implosion. It was not until the government would address the fundamental issues facing the financial system and provide stability to key industries; that their actions would help to mitigate these effects. Evidence of this can be seen by looking no further than various regulations that protect the economy and the financial system from one institution becoming too big. However, as deregulation and globalization would have an impact on these views. This would create a similar situation as to what occurred in 1929 (only this time it was 2007). The difference was that the federal government responded to the situation early, preventing the downward spiral in economic activity that was taking shape in 2008. This is significant, because one could argue that the actions taken during a financial crisis will determine if the underlying effects will become worse. As a result, it is obvious that the government bailouts were necessary, in protecting the economy from facing a similar situation as to what occurred from 1929 -- 1933.