Ed FirmageThe Gathering Storm
“The year 1929 reached almost the end of its third quarter under the promise and appearance of increased prosperity, particularly in the United States. Extraordinary optimism sustained an orgy of speculation. Books were written to prove that economic crisis was a phase which expanding business organization and science had at last mastered. “We are apparently finished and done with economic cycles as we have known them,” said the President of the New York Stock Exchange in September. But in October a sudden and violent tempest swept over Wall Street. The intervention of the most powerful agencies failed to stem the tide of panic sales. A group of leading banks constituted a milliard-dollar pool to maintain and stabilize the market. All was vain.
“The whole wealth so swiftly gathered in the paper values of previous years vanished. The prosperity of millions of American homes had grown upon a gigantic structure of inflated credit, now suddenly proved phantom. Apart from the nationwide speculation in shares which even the most famous banks had encouraged by easy loans, a vast system of purchase by installment of houses, furniture, cars, and numberless kinds of household conveniences and indulgences had gown up. All now fell together. The mighty production plants were thrown into confusion and paralysis. But yesterday there had been the urgent question of parking the motor-cars in which thousands of artisans and craftsmen were beginning to travel to their daily work. To-day the grievous pangs of falling wages and rising unemployment afflicted the whole community, engaged till this moment in the most active creation of all kinds of desirable articles for the enjoyment of millions. The American banking system was far less concentrated and solidly based than the British. Twenty thousand local banks suspended payment. The means of exchange of goods and services between man and man was smitten to the ground, and the crash on Wall Street reverberated in modest and rich households alike.
“It should not however be supposed that the fair vision of far greater wealth and comfort ever more widely shared which had entranced the people of the United States had nothing behind it but delusion and market frenzy. Never before had such immense quantities of goods of all kinds been produced, shared, and exchanged in any society. There is in fact no limit to the benefits which human beings may bestow upon one another by the highest exertion of their diligence and skill. This splendid manifestation had been shattered and cast down by vain imaginative processes and greed of gain which far outstripped the great achievements itself. In the wake of the collapse of the stock market came during the years 1929 and 1932 an unrelenting fall in prices and consequent cuts in production causing widespread unemployment. ” Winston Churchill, The Gathering Storm, pp. 31-32, Houghton Mifflin, 1945.
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Submitted by Ed Firmage, Samuel D. Thurman Professor of Law, emeritus, University of Utah College of Law.
October 4th, 2008 at 7:56 am
Thanks, Ed, for posting this. I posted the following comment elsewhere that may help explain the current crisis.
In the deregulated financial and securities markets, new financial instruments like CDO’s, collateralized debt obligations were invented. A CDO is a debt security collateralized by a variety of debt obligations including bonds and loans of different maturities and credit quality. CDO’s originated in the 1990’s when financial institutions began moving debts off their balance sheets. I recommend the book Liar’s Poker: Rising Through the Wreckage on Wall Street for background.
Risk was spread, and supposedly reduced, by the use of derivatives. Derivatives are financial instruments whose values depend on the value of other underlying financial instruments. This includes default credit swaps (CDS’s). The CDS market exploded over the past decade to more than $45 trillion in mid-2007. This is roughly twice the size of the U.S. stock market. This is credit gone wild. This was a gigantic credit feeding frenzy. It includes credit cards and all sorts of loans as well as mortgages. What began as a potentially dangerous idea became an extremely dangerous bubble, and the regulators were asleep at the switch for a decade. Even as recently as a few months ago, we were repeatedly assured that the fundamentals were sound. But the fundamentals were not sound. Things had gotten out of hand, and no one still knows, no one can yet put their arms around, how bad things are. Is $700 billion enough? No one knows. That is the scary part.
These instruments are so complicated and so hard to value that people’s eye glaze over when you talk about them. There is even a market for the market for CDO’s of CDO’s (CDO squared). Who can determine was a CDO squared is worth?
Foreign banks and sovereign wealth funds figured the fundamentals of the world’s largest economy (the good old USA) were sound and bought a fair amount of our new fangled financial instruments. We can’t default of them now without bringing down the world economy.
With such complicated instruments and unregulated markets, bad investments got spread around the world like so much toxic waste, and no one can yet figure out how toxic they are because they are so complicated. If a bad loan, however, had stayed with the originating bank, then it would be relatively easy to value and the loss would be limited to the originating institution. Moreover, the bank or the other lending institution would have had a much greater incentive not to originate risky loans. You probably have received in the mail solicitations for credit cards. You probably have seen TV programs offering wealth with no money down. You probably have seen internet ads for mortgages. Now we know where all that ended up. We just can’t figure out how bad it is, how much is good debt and how much is bad.
Ironically, the current mortgage system was rebuilt after the Savings and Loan meltdown, which was caused by the deregulation of the system that was built after the meltdown of the Great Depression.
October 4th, 2008 at 4:32 pm
Thank you for the poignant reminder. Along these same lines, something clicked in my mind as I listened to Elder D. Todd Christofferson’s talk in LDS General Conference today. I summed it up on Simple Utah Mormon Politics in the article “A Healthy Society Does Not Have Obscene Levels of Income Inequality“. It begins thusly:
Hopefully the current economic “collapse” will be “small” enough that we can learn this great lesson before it’s too late.
October 4th, 2008 at 5:49 pm
Frank,
Shout it from the roof tops, “Instances have occurred in American history where socialists and atheists cared for their neighbors in a much better way than many Christians ever thought of doing.”
I would say those instances were actually notices as in someone noticed. But ‘Socialist and atheists’ is almost redundant.
Since there is no God, ‘we’ become the higher being. You, me and our neighbors ultimately dependent upon one another in the absence of a god.
October 5th, 2008 at 2:14 pm
I respect your opinion that there is no God, but I disagree with it. But regardless of whether there is a God, I agree with you that “you, me and our neighbors ultimately dependent upon one another.”
Instances have occurred where socialists and atheists have helped their neighbors, but they don’t hold a monopoly on service and good deeds. Whether atheist-socialist or Christian or any other religious or moral philosophy, we should stand up for ‘the forgotten man’ and against the usurpation of freedom by government or other powers. This the conscience of every good person will compel them to do.
October 5th, 2008 at 6:16 pm
Frank, Amen again I say.