The Great Depression and the Financial Recession of 2008 - Essay Sample

Introduction

The United States has encountered a fair share of recessions in its 242 years of existence but none of them come close to the Great Depression of 1929-1941 and the Great Recession of 2007-2009 in terms of the financial ruins they left behind (Folson). The two enormous recessions significantly devastated the US economy and subsequently the world economy. Due to their magnitude, economists argue that it is hard to point out one fault for their occurrence and hence attribute several factors and events that together caused the explosion of the bubble. In this view, this paper presents the causes, effects, and policy responses of the Great Depression of 1929 and the Financial Crisis of 2008.

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The crash of the stock market in October 1929 is taunted as the major cause of the Great Depression (Folson). The crash started on October 24, 1929 (popularly known as the Black Thursday) when the Dow Jones Industrial Average fell by 11%. That decline caused the investors to panic and immediately started to offload their shares at an alarming rate. The panic was exacerbated by the fact that the Dow Jones had been on a free fall in the past two months hence the investors interpreted the Black Thursday as an indicator for the worst to come. Panic amongst investors continued the next week and the Dow fell further on October 28 by 13% gaining its name the Black Monday. More panic set in the following day (Black Tuesday) and nothing could stop the rapid rate that investors offloaded their shares in the New York Stock Exchange. Data shows that more than $30billion worth of shares vanished in just two days (Black Monday and Tuesday), a decline that would continue for the next three years. Confidence in the stock market was destroyed, banks seen as unreliable, and investors opted for gold (Eigner & Umlauft, 6-9).

Income inequality also contributed to the Great Depression (Eigner & Umlauft, 7-12). In 1928, the top 1% accounted for about 20% of the country's total income. Although the early 1920s were marked by high employment rates, the wages did not increase at the same rate that corporate earnings increased. That meant that many consumers could not afford the products made by industries and the low spending contributed to the decline of stock prices (Eigner & Umlauft, 7-12). In addition, the Smoot-Hawley Tariff Act of 1930 had its fair share of exacerbating the mess (U.S. History). The legislation was aimed at protecting the American farmers from foreign competition but instead caused more harm than good. The tariffs imposed on foreign products were retaliated against which in turn resulted in the decline of trade volume between countries for several years. The unintended consequences of the legislation are taunted to be responsible for the depression to last for many years.

On the other hand, the primary cause of the 2008 financial crisis was deregulation of the financial sector (Financial Crisis Inquiry Commission, 413-445). The repeal of several legislations such as the Gramm-Leach-Billey Act and the Commodity Futures Modernization Act permitted the banks to invest in derivatives and the exclusion of these derivatives together with credit default swaps from regulations. Also, the Community Reinvestment Act pushed the banks to invest in subprime areas and offer subprime mortgages. The mortgages were then sold as derivatives and required an investor to have a home loan as collateral (mortgage-backed securities). Given that the two were directly correlated, the growth in demand for derivatives, in turn, created an insatiable demand for mortgages. Between 2000 and early 2006, the house prices were skyrocketing and demand was high. However, the population is constant and there is only so many houses and mortgages that one can sell. This was noted in mid-2006 when the housing prices started to decline. In the beginning, the realtors welcomed this phenomenon and were hopeful that the overextended housing market would soon go back to normal levels. Unfortunately, the realtors did not know that many of the homeowners had an unsatisfactory credit rating and did not qualify for the home loans. That led to high default rates and a decline in value of the derivatives. Majority of the mortgage-backed securities were owned by pension funds, hedge funds, mutual funds, and other financial institutions globally. Given that the banks had sub-divided the mortgage securities into tranches, it was impossible to determine their value accurately. With the decline in the value of the derivatives, the insurance company that was supposed to insulate these investments did not have sufficient cash flow hence could not honor all the swaps. As a result, the financial institutions had to absorb the losses and this caused panic and the banks stopped lending to each other. That mistrust raised the interbank borrowing costs and lack of liquidity which was the primary cause of the 2008-09 financial recession (Financial Crisis Inquiry Commission, 413-445).

Despite occurring eight decades apart, both the Great Depression and the 2008 financial crisis had almost typical effects. Among the most rampant and far-reaching implications were the sharp increase in unemployment rates, collapse of financial institutions, and many people rendered homeless (Eigner & Umlauft, 12-40). Given that wages were low before the depression of 1929, the collapse of major companies and mistrust of the banking sector resulted in low savings and high unemployment rates. The Dust Bowl drought that lasted for ten years together with the decline of prices for agricultural produce exacerbated the financial situation of the population. The high employment rates forced many farmers to move in search of jobs and with no jobs available, they became homeless giving rise to more than 6,000 shanty towns called the Hoovervilles in the 1930s (Albers & Uebele, 10-95).

Those that remained employed had their wages dropped by 40% between 1929 and 1933. Consequently, the number of children sent to orphanages increased by 50% (Eigner & Umlauft, 6-26). In the early 1920s, the unemployment rate was about 3.2%. By 1930, it had increased to 8.7% and would continue to increase to 15.9% in 1931 and 24.9% in 1933 (U.S. History). In addition, about 50% of all the banks in the US collapsed during the Great Depression. That was about 9000 banks and the depositors lost about $140billion. Further, 90% of the value of the stock market was wiped out between 1929 and 1932, and it would only recover after 25 years (Folson).

In the same way, the 2008 financial crisis resulted in the decline of the value of the stock market by more than 50%. In addition, the financial sector incurred heavy losses. According to the International Monetary Fund, the big US and European banks incurred losses of more than $1 trillion from toxic assets between January 2007 to September 2009 (Financial Crisis Inquiry Commission, 120-200). These losses had increased to $2.8 trillion by the end of 2010. These huge losses led to the collapse of major banks like the IndyMac Bank, the Lehman Brothers, Citigroup, and Merril Lynch (Financial Crisis Inquiry Commission, 120-200). Further, the 2008 financial crisis resulted in the decline in production by 6% in 2009 and an increase in the unemployment rate to 10.1% by 2009, the highest record since 1983. In addition, the wealth of 63% of all American households decreased and since the white households recovered faster than the black households, the racial wealth gap widened.

In response to the 1929 Great Depression, President Roosevelt's administration implemented several policies that were dubbed "the New Deal." The first New Deal was economy-oriented and designed to financially strengthen the farmers. Also, the Emergency Bank Act was passed to bring stability into the financial sector while the Emergency Farm Mortgage Act together with the Agricultural Adjustment Act was enacted to insulate the farmers, their produce, and the farms. In 1935, the Second New Deal was implemented and unlike the first one, this one was focused on the unemployed, the poor, and the struggling farmers (U.S. History).

On the other hand, the response towards the 2008 financial crisis was somewhat different from the Great Depression. Firstly, unlike in the Great Depression where the Federal Reserve refused to increase the money supply, the Treasury quickly swung into action and increased the money supply in an attempt to prevent a deflationary spiral. Further, the Federal government implemented enormous fiscal stimulus packages whereby there was increased borrowing and expenditure to compensate for the decline in the private sector. The United States implemented two major stimulus program between 2008 and 2009 totaling $1 trillion. The packages also bailed out large banks that were on the verge of collapse. In Europe, the European Union passed Basel III regulations that were aimed to control fraudulent behavior of banks. In the US, several legislations were enacted including the American Recovery and Reinvestment Act of 2009, the Fraud Enforcement and Recovery Act of 2009, and Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Appelbaum).

Conclusion

In conclusion, the Great Depression of 1929 and the Financial Crisis of 2008 are considered as the most devastating in the history of the US financial sector. The Great Depression was primarily caused by the crash of the stock market in October 1929 while the 2008 financial crisis was caused by deregulation of the banking sector. Both crises resulted in the collapse of the banking sector, high unemployment rates, and low economic growth. In both cases, the federal government responded with policies to remedy the situation but the delay to react quickly during the Great Depression is considered the main reason for the extended period it lasted.

Works Cited

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Appelbaum, Binyamin. "Slow Response to Housing Crisis Now Weighs on Obama." Breaking News, World News & Multimedia - The New York Times, 19 Aug. 2012, www.nytimes.com/2012/08/20/business/economy/slow-response-to-housing-crisis-now-weighs-on-obama.html. Accessed 10 Apr. 2019.

Burton W. Folsom. "Comparing the Great Depression to the Great Recession." Home - Foundation for Economic Education, 20 May 2010, fee.org/articles/comparing-the-great-depression-to-the-great-recession/. Accessed 10 Apr. 2019.

Eigner, Peter, and Thomas S. Umlauft. "The Great Depression (s) of 1929-1933 and 2007-2009? Parallels, Differences and Policy Lessons." Parallels, Differences and Policy Lessons (July 1, 2015). Hungarian Academy of Science MTA-ELTE Crisis History Working Paper 2 (2015). Pp 4-49.

Financial Crisis Inquiry Commission. The financial crisis inquiry report: The final report of the National Commission on the causes of the financial and economic crisis in the United States including dissenting views. Cosimo, Inc., 2011. Pp 50-470.

U.S. History. "The Great Depression." US History, 2018, www.ushistory.org/Us/48.asp. Accessed 10 Apr. 2019.