The next Great Depression

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Depression Dynamic Takes Hold as Markets, Banks Revisit 1930s


By Rich Miller

March 9 (Bloomberg) -- The U.S. economy’s vital signs may not confirm a diagnosis of depression. The symptoms increasingly point to one.

As in the Great Depression, world trade is collapsing, wealth is evaporating and the banking system is broken. Deflation is a growing threat as companies slash production, pay and prices. And leaders worldwide are having difficulty making headway in halting the self-perpetuating decline.

“We are tracking 1929-1930,” says Barry Eichengreen, a professor of economics and political science at the University of California, Berkeley.

The result: This contraction may leave a lasting imprint on the economy and society, just as the Depression did. In the wake of the devastation of the 1930s, Americans swore off stocks, husbanded their own resources and looked to the government for help. Now, another generation might draw some of the same lessons from the deepest economic collapse of their lifetime.

“This is going to scar the collective psyche,” says Mark Zandi, chief economist at Moody’s Economy.com in West Chester, Pennsylvania. “People will become much more conservative in borrowing, lending and investing.”

There’s no official definition of what qualifies as a depression. In the 1930s, the unemployment rate rose to 25 percent and the economy shrank by more than a quarter.

No economist forecasts a return to the breadlines and shantytowns of that era, even as the economy gets closer to some of the metrics academics cite as constituting a depression, if not a “great” one.

Little Likelihood

Nobel Prize-winning economist Robert Barro defines a depression as a 10 percent fall in per-capita gross domestic product and consumption. The Harvard University professor sees roughly a 30 percent chance of that occurring now.

The economy contracted at a 6.2 percent annual rate in the last quarter of 2008 and will shrink at a 7 percent rate in the first three months of 2009, projects Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc. in New York.

Bradford DeLong, a former Treasury official who is now a professor at Berkeley, says a depression is a two-year period with unemployment at 10 percent or above. He says that’s possible, though not likely. The jobless rate rose to 8.1 percent in February, a 25-year high.

Some industries are already in a depression, led by housing, where the decline accelerated in recent months as the credit crisis intensified. During the last four years, residential investment is down by 37 percent. That compares with an 80 percent drop in spending on home building from 1929 to 1932.

‘Most Difficult’

“The past five months have been among the most difficult in U.S. economic history,” Robert Toll, chief executive of Horsham, Pennsylvania-based Toll Brothers Inc., said Feb. 11, after the largest U.S. luxury homebuilder reported a 51 percent sales drop.

In the auto industry, U.S. sales have fallen 55 percent from their July 2005 peak. Production of cars and trucks plunged in January to an annual rate of 3.9 million, the lowest since the Federal Reserve began keeping records in 1967, and 67 percent below the January 2005 level.

Things are so bad that auditors have questioned the ability of General Motors Corp., the biggest U.S. automaker, to continue as a going concern.

U.S. motor vehicle output slumped 75 percent from 1929 to 1932, according to statistics in the book “American Automobile Workers 1900-1933,” by Joyce Shaw Peterson.

‘Automotive Depression’

“We are in an automotive depression,” said Efraim Levy, an equity analyst for Standard & Poor’s in New York.

The financial-services industry has also been decimated. Since the crisis began in the middle of 2007, institutions worldwide have racked up $1.2 trillion in credit losses and writedowns. Announced job cuts have topped 280,000.

“You’ve had a major disruption of the financial system, just like the 1930s,” says Mark Gertler, a New York University professor who collaborated on research about the Depression with Fed Chairman Ben S. Bernanke. In the 30s, more than 10,000 banks went bust.

That disruption is making it hard for Bernanke and his fellow policy makers to get much traction in their efforts to stop the economic decline. Strapped with losses, banks are hoarding capital rather than lending.

This type of breakdown happens only two or three times a century and can lead to a “downward vortex” in which weaknesses in the economy and the financial industry feed on each other and are difficult to break, Lawrence Summers, director of the White House’s National Economic Council, said Feb. 26. “It’s the kind of vicious cycle Franklin Roosevelt talked about,” he told a forum in Arlington, Virginia.

Collapse of Jobs Market

Particularly worrying, says Stanford University professor Robert Hall, is the collapse of the jobs market. Over the past four months, payrolls have plunged 2.6 million.

Summers has also voiced concern about a return of deflation, which wreaked havoc on the economy during the Great Depression. As wages fell back then, workers had a harder time paying their debts, aggravating the banking industry’s woes.

In an echo of those troubles, GM, FedEx Corp. and casino company Wynn Resorts Ltd. are among businesses slashing pay for more than 100,000 workers as they cut costs to counter declining demand.

There are other echoes. Since hitting a peak in October 2007, the Dow Jones Industrial Average has fallen 54 percent. Over a similar length of time -- from 1929 to 1931 -- the average fell 55 percent. It ultimately dropped 89 percent from its 1929 high before beginning to recover in mid-1932.

Stock Market Free-Fall

Combined with collapsing house prices, the free-fall in the stock market will destroy $23 trillion worth of U.S. wealth, reckons Lawrence Lindsey, a former senior White House official who now heads his own consulting company in Arlington, Virginia.

Like the Great Depression, the current economic decline is global. The International Monetary Fund says this will be the first time since World War II that the U.S. and other industrial nations will suffer a simultaneous decline in their economies.

Worldwide trade is falling fast as the credit crunch curbs financing for exporters and importers. The volume of merchandise trade plunged at an annual rate of 22 percent in the fourth quarter from the third, according to the CPB Netherlands Bureau for Economic Policy Analysis. The peak-to-trough decline from 1929 to 1932 was 35 percent, as countries slapped big tariffs on imports.

“We’re in a depression, and we need policy makers to make the right decisions to ensure that it does not become great,” says Kevin H. O’Rourke, a professor at Trinity College in Dublin, who has studied the trade issue.

Quicker Response

Government officials, especially in the U.S., are moving more rapidly to tackle the turmoil than their counterparts did during the early years of the Great Depression. Bernanke has cut the benchmark interest rate to as low as zero, while President Barack Obama won congressional approval of a $787 billion stimulus package.

Massachusetts Institute of Technology professor Peter Temin says the trouble is that the economy seems to be collapsing faster than policy makers are reacting. “They’ve only done enough to cushion the downturn,” says Temin, author of the book “Lessons from the Great Depression.”

That leaves the U.S. -- and the rest of the world economy - -in danger of being mired in an extended period of little or no growth, much like that which afflicted Japan during the 1990s. Eichengreen says such an outcome would be equivalent to a depression.

Enduring Marks

Whatever it’s called, the economy’s continuing deterioration will likely leave enduring marks. U.S. households are already rebuilding savings in response to the crisis. The savings rate rose to 5 percent in January, the highest in almost 14 years.

“They’re buying what they need, and they’re being very smart about how they spend their money,” Myron Ullman, chief executive officer of Plano, Texas-based J.C. Penney Co., said on Feb. 20, after the third largest U.S. department-store chain forecast its first quarterly loss in almost five years.

In a Feb. 27 memo, “The Return of the Frugal Consumer,” Goldman Sachs economist Andrew Tilton projected a savings rate exceeding 8 percent by the end of 2010.

Americans may also turn more conservative about where they keep their money. Merrill Lynch & Co. says U.S. bonds owned by individuals likely will account for 2 percent of households’ financial assets by 2013, up from 0.2 percent now.

“We’re in the midst of a massive economic and financial crisis,” former Fed Chairman Paul Volcker said at a Columbia University conference on Feb. 20. “We’re going to hear reverberations about this for a long time.”

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China May Press G-20 to Guard Its U.S. Assets, Researcher Says

By Li Yanping

March 24 (Bloomberg) -- China’s leaders may press at the Group of 20 summit for specific steps to protect its more than $1 trillion of dollar assets as U.S. fiscal policies risk sparking a “currency war,” a senior Chinese researcher said.

The dollar weakened after the Federal Reserve said March 18 it would buy as much as $300 billion of Treasuries and the U.S. this week outlined plans to buy as much as $1 trillion of illiquid bank assets.

U.S. purchases of Treasuries are “irresponsible” because they may weaken the dollar, Li Xiangyang, of the government- backed Chinese Academy of Social Sciences, told a forum in Beijing today. “Chinese leaders are likely to articulate their concern to their U.S. counterparts strongly and ask for specific measures.”


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Mayo Says Bank Loan Losses Will Exceed Great Depression Levels

By Nick Baker

April 6 (Bloomberg) -- Mike Mayo, who left Deutsche Bank AG to join Calyon Securities, assigned an “underweight” rating to banks on expectations that loan losses will exceed levels from the Great Depression.

“While certain mortgage problems are farther along, other areas are likely to accelerate, reflecting a rolling recession by asset class,” Mayo wrote in a report today. “New government actions might not help as much as expected, especially given that loans have been marked down to only 98 cents on the dollar, on average.”

Mayo gave "sell" ratings to BB&T Corp., Fifth Third Bancorp, KeyCorp, SunTrust Banks Inc. and U.S. Bancorp, while "underperform" ratings were assigned to Bank of America Corp., Citigroup Inc., Comerica Inc., JPMorgan Chase & Co., PNC Financial Services Group Inc. and Wells Fargo & Co.

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Default Count Rises to Highest Since Great Depression

By John Glover

April 7 (Bloomberg) -- Thirty-five companies defaulted in March, the highest number in a single month since the Great Depression, according to Moody’s Investors Service.

The rate at which speculative-grade corporate borrowers worldwide failed to meet their obligations rose to 7 percent from 4.1 percent at the end of last year, Moody’s said in a report today. So far this year, 79 companies rated by Moody’s have defaulted, the New York-based ratings firm said.

Almost $1.3 trillion of losses and writedowns at financial institutions worldwide, combined with the deepest economic slowdown since World War II, have weakened companies’ finances, reducing their ability to pay debt. The global default rate will peak at 14.6 percent in the final quarter of this year, Moody’s predicted, lower than last month’s 15.3 percent forecast.

“There was a triangle of leverage between companies, banks and investors that was higher than at any time in history,” said Gary Jenkins, a strategist at Evolution Securities Ltd. in London. “It’s clear the default rate is going to be significant.”

In the U.S., the default rate at the end of the first quarter was 7.4 percent, up from 4.5 percent at the end of 2008, and in Europe it jumped to 4.8 percent from 2 percent.

European defaults are expected to peak at 21 percent in the fourth quarter, down from the 22.5 percent the ratings firm’s model calculated last month.

Defaults “will remain at an elevated rate,” the report said. The forecast for the peak rate has been reduced “in the last couple of months as high-yield bond spreads have declined moderately,” according to Moody’s.

In the leveraged loan market, 24 issuers rated by Moody’s defaulted in the first quarter of this year, all in North America, up from 11 a year earlier, according to the report. The rate was 4.5 percent, up from 3.5 percent at the end of the previous quarter and 1.5 percent a year ago, according to Moody’s.

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U.S. Economy: Leading Index Shows Recovery Many Months Away

By Bob Willis

April 20 (Bloomberg) -- The index of U.S. leading economic indicators fell more than forecast in March, signaling what may be the longest recession in the postwar era will extend into the second half of the year.

The Conference Board’s gauge, which points to the direction of the economy over the next three to six months, fell 0.3 percent after a 0.2 percent drop in February. The gauge hasn’t risen since June.

Rising unemployment and tight credit mean recent gains in consumer spending, the biggest part of the economy, will probably not be sustained. Stocks dropped as a report by Bank of America Corp. raised concern Americans will keep falling behind on loan payments.

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The recession that began in December 2007 already matches the longest since 1933, and the 6.3 percent decline in fourth- quarter GDP was the biggest since 1982. The downturn has cost 5.1 million jobs and economists surveyed by Bloomberg forecast the unemployment rate will rise to 9.5 percent by the end of the year.

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Global Crisis ‘Vastly Worse’ Than 1930s, Taleb Says

By Shiyin Chen and Netty Ismail

May 7 (Bloomberg) -- The current global crisis is “vastly worse” than the 1930s as financial systems and economies worldwide have become more interdependent, “Black Swan” author Nassim Nicholas Taleb said.

The global economy is heading into a “big deflation,” though the risks of inflation are increasing as governments print more money, Taleb said at a conference in Singapore today. Gold and copper may “rally massively” as a result, he added.

“The gravity of the situation is vastly worse than the thirties,” Taleb said. “Navigating the world is much harder than in the 1930s.”

The International Monetary Fund last month cut its world economic growth forecasts and said the global recession will be deeper and the recovery slower than previously predicted as financial markets take longer to stabilize. The world economy will contract 1.3 percent this year, the IMF said.

“This is the most difficult period of humanity that we’re going through today because governments have no control,” Taleb told the conference organized by Bank of America-Merrill Lynch. “They had in the 1930s. Today they have no control.”

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