GREAT DEPRESSION REDUX?

Here's the second part of a very interesting two-part essay explaining some of the economic factors behind the current recession and how it compares to the archetypal 1930s experience. James Livingston makes the argument that the real cause of the housing bubble is the excess capital released by the Bush tax cuts that poured into the real estate market. The results, as they say, may surprise you:

So the current crisis does bear a strong resemblance to the Great Depression, if only because its “underlying cause” is a recent redistribution of income toward profits, away from wages and consumption (of which more in a moment), and because all the unprecedented assistance offered to the banking system since the sale of Bear Stearns and the bankruptcy of Lehman Brothers in September—AIG, Fannie Mae, Freddie Mac, the bail-out package, the equity stake initiative, etc.—has not helped thaw the credit freeze. The markets have responded accordingly.

... the historical record of the 1930s and the slow motion crash of the stock market in recent weeks would suggest that Friedman’s theoretical answer to our question lacks explanatory adequacy—and that Paulson and Bernanke’s practical program, which follows the Friedman line, has not restored, and cannot restore, investor confidence. The effective freeze of interbank lending which, contrary to recent news reports, was already an alarming index as early as September 2007, would suggest the same thing. (“The system has just completely frozen up—everyone is hoarding,” says one bank treasurer. “The published [London interbank overnight] rates are a fiction.” [Financial Times 9/5/07, p. 23]).

Moreover, a severe recession now waits on the other side of “recapitalization,” mainly because consumer confidence, spending, and borrowing have been compromised or diminished, if not destroyed, by the credit freeze and the stock market crash: “Discretionary spending is drying up as Americans grapple with higher food and energy prices, depressed home values and diminished retirement accounts.” (Wall Street Journal 10/9/08, p. 1.)

...George Bush’s tax cuts produced a new tidal wave of surplus capital with no place to go except into real estate, where the boom in lending against assets that kept appreciating allowed the “securitization” of mortgages—that is, the conversion of consumer debt into promising investment vehicles.

...The responsible fiscal policy for the foreseeable future is, then, to raise taxes on the wealthy and to make net contributions to consumer expenditures out of federal deficits if necessary.

I recommend you read the whole thing, as I've butchered the argument in editing the excerpt here. But the key take-away is that you cannot ignore income inequality and the drop in real wages in the last eight years, as Robert Reich notes here, because they helped create the conditions for this crisis alongside deregulation.

--Tim Fernholz

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