“Economic and Political Consequences of Financial Crises”

Richard Sylla, New York University

International Conference: “Financial Development of the State: history, theory and policy”

Moscow, 28.10.10

Financial Crises: the best and worst things about them

• The worst thing about a financial crisis is that it happens, and interrupts normal economic growth and development.

• The best thing about a financial crisis is that it goes away, and the economy gets back to normal growth and development.

• During a crisis, most people remember the first point, and they forget the second one.

Economic consequences of crises• Obviously, when a major financial crisis occurs,

growth slows and even becomes negative for a time.

• But for how long? Today in the USA there is talk of a recovery taking a decade, and that we must get used to a “new normal” of slow growth and high unemployment.

• Was this true of past financial crises? I decided to investigate most of the major ones in the history of the USA, comparing growth in the periods before and after the crises.

The panic of 1792: Wall Street’s first crash

• GDP data only begin with 1790, so a five-before and five-after comparison is not possible.

• 1790-1792, real output grew 6.68%/year, and real output per person grew 3.53%/year

• 1792-1797, the comparable figures are 6.47%/year and 3.33%/year.

• There was little to no lasting economic effect of this well-handled crisis, so well-handled that most people have never heard of it.

The panic of 1819

• During 1813-1818, real output, Q, grew 2.17% per year, and real output per capita (Q/N) grew -0.66% per year.

• From 1820 to 1825, the five years after the panic year, Q grew 4.62%/year, and Q/N grew 1.64%/year.

• Conclusion: Economic performance was better after the panic of 1819 than before it.

The panic(s) of 1837-1842

• Complicated because these years were ones of protracted financial crises, bank failures and state debt defaults and repudiations. The years of real crisis were 1837, 1839, and 1842.

• I decided to look at both 1839 and 1840 as mid-points of this protracted crisis, and see what happened to Q and Q/N during the five years before and after those mid-points.

1837-1842 (ctd.)

• 1839 as mid-point• 1833-1838, Q is

2.99%/yr., and Q/N is 0.12%/yr.

• 1840-1845, Q is 4.47%/yr. and Q/N is 1.57%/yr.

• After the panic was better than before it.

• 1840 as mid-point• 1834-1839, Q is

3.17%/yr., and Q/N is 0.35%/yr.

• 1841-1846, Q is 5.65%/yr. and Q/N is 2.67%/yr.

• Ditto

The panic of 1857

• 1851-1856, Q is 6.23%/yr. and Q/N is 2.72%/yr.

• 1858-1863, Q is 5.95%/yr. and Q/N is 3.62%/yr.

• For the third time, post-panic is better than pre-panic

The panic of 1873

• 1867-1872: Q grows 4.53%/yr. and Q/N grows 1.86%/yr.

• 1874-1879: Q grows 4.69%.yr. and Q/N grows 2.55%/yr.

• Ditto, for the fourth time of four

The panic of 1893

• 1887-1892: Q, 4.88%/yr.; Q/N, 2.71%/yr.

• 1894-1899: Q, 6.26%/yr.; Q/N, 4.53%/yr.

• After again better than before. (This is getting monotonous.)

The panic of 1907

• 1901-1906: Q, 3.87%; Q/N, 1.88%

• 1908-1913: Q, 4.02%; Q/N, 2.13%

• Same story—a new century did not seem to usher in a new pattern.

The panic(s) of 1929-1933(Shades of 1837-1842: protracted)

• 1929• 1923-1928: Q is 2.80%,

Q/N is 1.29%• 1930-1935: Q, -0.63%,

Q/N, -1.29%

• Finally, after is worse than before. Or is it?

• 1931• 1925-1930: Q, 1.06%,

Q/N, -0.17%• 1932-1937, Q, 7.21%,

Q/N, 6.53%

• A mixed message from the Great Depression era.

Late 1980s crises: crash of ‘87, S&L and banking crises

• This conforms more to the expected pattern: slower growth after a crisis, than to the usual historical pattern of faster growth after a crisis

• It doesn’t matter whether one chooses 1987, 1988, 1989, or 1990 as the crisis year, growth was somewhat (not a lot) higher in the previous five years (“morning in America”) than in the subsequent five years.

Late 1980s crises

• Federal Reserve’s powers to oversee and regulate the entire financial system are expanded

• Since this crisis was one of the few in US history to lead to slower growth, a political effect was George H. W. Bush’s failure in 1992 to be re-elected. W. J. Clinton, helped by the mantra, “It’s the economy, stupid”, defeats Bush

The crisis of 2008

• 2002-2007, Q is 2.79%, and Q/N is 1.84%

• 2009-2014, ??????

Verdict

• The verdict based on historical evidence concerning major panics and financial crises in the USA, while not unanimous, is that crises do go away and quite often (not quite always) the five-year period after a crisis shows more growth than the five-year period leading up to it.

• The economic effects of crises are fleeting.• What about the political effects?

Panic of 1792 and politics

• Solidified the two-party system that was just emerging

• Jefferson and Madison’s Republicans lined up to oppose Hamilton’s Federalists and their financial modernization policies

• Jefferson personally disliked all banks, but many Republicans were pro-banking

• Republicans “compromised” by directing their antipathy towards the Bank of the United States, which they would end in 1811

Panic of 1819

• In 1816 Congress authorized a second Bank of the United States

• The new BUS was blamed for causing the 1819 panic

• Jackson and his Democratic party used this antipathy to gain power and end the second BUS as a central bank in 1832

• For eight decades until 1913-14, the USA would have no central bank and more frequent financial crises

Crises of 1837-1842

• The crises energized the Loco-Foco radical democratic splinter party that was against ALL banks and paper money

• Anti-bank sentiment led to the “Independent” Treasury, which was an attempt to sever all ties of the federal government to banks

• Some US states tried to ban banking entirely within their borders

Panic of 1857

• The crisis disproportionately affected the northern states as compared with southern states

• It energized the southern secessionists to pursue their goal of seceding to preserve slavery, which they did in 1861

• A Civil War, the deadliest war in US history, followed, lasting until 1865

Panic of 1873

• Crisis led to the formation of the Greenback Party, an anti-banking, anti-hard money political party that favored inflation

• The Greenback Party fielded presidential candidates in 1876, 1880, and 1884

• Never obtaining more that 3-4% of the national vote, the party faded after 1884, but many of its adherents would later join the Populist movement

Panic of 1893

• The crisis energized the Populist movement and led the Democrats to adopt its goal of ending the gold standard and fostering inflation

• The Democrats dumped their president, Grover Cleveland, an advocate of the gold standard, in 1896, and nominated William Jennings Bryan, an advocate of free coinage of silver, after his “Cross of Gold” speech

• What should be the monetary base of the USA became the ‘hot’ issue of the 1896 elections, in which Republican William McKinley defeated Bryan

• The Wizard of Oz treats this allegorically

Panic of 1907

• The important political effect was the Aldrich-Vreeland Act of 1908, which authorized the Treasury and national banks to make emergency currency issues in crises as well as a National Monetary Commission (NMC) to recommend financial reforms to prevent crises

• The NMC’s work led to the establishment of the Federal Reserve System as the USA’s third central bank in 1913-14

Crises of 1929-1933• Resulted in a host of New Deal financial reforms from 1933 to 1940• Banking: deposit insurance, regulation of interest rates, separation of

commercial and investment banking• Central banking: Federal Reserve’s powers are enhanced and centralized• Securities markets: SEC established to regulate securities issues and

oversee securities exchanges and markets; investment companies and mutual funds become subject to federal regulation

• Crisis leads to radical movements: On the left, pro-Soviet, pro-communist movements. On the right, “America First” and pro-fascist, pro-Nazi movements. These last long after the 1930s crisis ends.

Our current crisis

• Congress enacted comprehensive financial reform legislation (Dodd-Frank) in 2010, but its effects are still not very apparent and many provisions are to be phased in slowly

• The “Tea Party” movement arose in 2009, and reminds us of such earlier post-crisis political movements as the Loco-Focos, the Greenbackers, and the Populists

• Elections of November 2 should be interesting

Political Economy

• The political effects of financial crises appear to be greater—and certainly more interesting—than the economic effects, which after a few years become pretty much ‘ho hum’

• Is this pattern of US financial history unique? Or is it fairly common across countries with modern financial systems?