Do Politicians Learn Anything From History?- 2 : “The 2007/8 Crash- A Case of Déjà-Vu?” – ECONOMICS HISTORY

The causation of the 2007 recession is well documented by academics. However, in order to discuss whether or not politicians did in fact learn the lessons of history from the 1929 Crash, it is important to analyse to what extent the two crashes were similar. Therefore, without going into too much detail, I shall quickly evaluate the causation, effects, and response to the 2007 Financial Crash.

Throughout the late 90s and early 2000s, the American housing market has been booming, exponentially growing in value from year to year, fuelled by cheap mortgages and help to buy schemes. As we have discussed before, this unsustainable growth creates a climate of overvaluation, resulting in the creation of a housing bubble. Therefore, as soon as the housing market crashed and subprime loans expired; households were unable to pay back expensive mortgages, meaning that huge established banks (such as Leheman Brothers) went bust. Consumer and investor confidence evaporated, which combined with the bank’s lack of credit, resulted in a credit crunch. The consequent contraction of the US economy had economic repercussions across the world, which stimulated the “global financial crisis.”

Wall Street

The initial impact of the crash first hit America. Stock wealth in the U.S fell by $7.4 trillion from July 2008 to March 2009. Within 18 months, unemployment grew by 4.5% (5.5 million), as labour demand is derived from RNO. American households lost an average of $5800 in 2008 as a result of the crash and loss of income.

In terms of response, Obama initiated expansionary fiscal policy. Namely his controversial “Jobs Bill”, which included a $62 billion injection for a Pathways Back to Work Program for expanding opportunities for low-income youth and adults, in order to reduce the recessive nature of increased unemployment. The Federal Reserve were able to counteract the issue of major financial institutions collapsing with the assistance of bailouts (preventing a complete liquidity crisis), but were unable to prevent the stock market from plummeting.

From this analysis, we can begin to identify similarities between both crises in terms of their causation, effects, and response, which I will do in my next article on economics history.  This will ultimately allow us to the question as to whether or not the two crises are comparable, and therefore to what extent politicians were able to learn from the past to avoid / reduce the effects of economic crashes.

Do Politicians Learn Anything From History?- 1 : “The Great Depression vs 2008 Crash” – ECONOMICS HISTORY

Could politicians have looked to the past to predict the 2008 Financial Crash?

Philosopher George Santayana famously quipped that “Those who cannot learn from history are doomed to repeat it.” In many ways, this is a motto adopted by politicians and investors alike world wide. If an institution is about to invest in capital or start a new scheme, surely it makes sense to look to the past and gain foresight through reflection.  Often, politicians can learn a great deal from the mistakes made by their predecessors, and act to not repeat them. Here, I will try to draw parallels between the causes of the Great Depression of 1929, and the causes of the Financial Crash of 2008, and therefore answer the question as to whether or not politicians did indeed learn from the past.

The Great Depression of the 1930s began on the 24th October 1929, when the American Stock Market crashed. However, this collapse did not come from nowhere; rather it was the inevitable consequence of decreased market regulation, investor over speculation, and overconfidence within the stock market. During the 1920s, wartime technologies (such as the radio and hoover) were seen as necessities rather than luxuries, hence increased output resulted in short run economic growth within America. This translated to the increase in value of share prices, averaging an increase of 20% per year in the 1920s. Banks were eager to lend out credit to potential investors because as long as the money was invested in the Dow Jones, investors would see their asset prices rocket, and therefore encourage investors and consumers alike to borrow even more credit from banks (40% of bank loans during the 20s were used to fund investment). This level of borrowing to fund investment meant that stock prices soon became overvalued, as investors would pump money into shares, which would in turn increase their value, and therefore encourage even more people to invest in these blue-chip stocks (ie General Motors). As credit was near limitless due to the lax monetary policy of the Federal Reserve, this process was able to repeat, leading to the creation of a stock market “bubble”.

Indeed, this bubble was able to develop due to the “Buy on the margin” scheme, which meant that that investors would only have to pay upfront 10-20% of a transaction in order to buy the shares, as the rest could be borrowed from a broker. This meant that only a small amount of “real” credit was used in stock transactions, meaning that for the first time the stock markets became accessible to the general public, rather than just the extremely wealthy. This in turn made the effects of the crash more widely encompassing.

Indeed, the growing bubble was further fuelled by a lack of government regulation within stock markets. Republican Presidents Warren Harding, Calvin Coolidge, and Herbert Hoover were great believers in Laissez-Faire economics, (the belief the Adam Smith’s invisible hand behind market forces will ultimately result in the optimum allocation of resources, and any government interference prevents this action). However, this interpretation of the Austrian School of Economics allowed for the forming of monopolies, as wealth inequality reached record levels. The reduced levels of regulation allowed for the stock markets to go unmonitored, allowing small elite firms such as JP Morgan to control vast amounts of the stock exchange, and manipulate share prices.

However by October 1929, investors began to realise the expanding difference between share price and actual share value. It became clear that stocks had become overvalued, hence, on October 24th 1929, share prices began to fall. Immediately, investors and the general public alike rushed to sell their stocks, resulting in 16,410,310 shares being sold on Black Thursday, to the tune of $40 billion, a fall of 12%.

The Dow Jones continued to decrease in value for another 3 years. Labour demand is derived from RNO, hence as output shrunk unemployment grew to 25%. The decrease in demand for labour meant that workers lost their bargaining power, so wages fell by 42%, which lead to a regressive decrease in living standards, hence inequality grew (show in the creation of “Hooverville” slums for the unemployed).

Black Thursday Newspaper
London Herald Friday 25th October – The effects of the Crash were felt worldwide.

Therefore, the Great Depression came from a culmination of overconfidence, the public’s newly found hobby of investment in shares, and a seemingly endless supply of credit from banks and brokers alike. These ultimately fuelled the bubble that would eventually collapse to cripple the worldwide economy (international trade fell by 65%). In my next blog on ECONOMIC HISTORY, I will analyse the causation of the 2008 Financial Crisis, and then draw parallels between the two events, to conclusively decide whether or not the politicians of 2008 did learn the lessons of history.