The Panic of '08: Cause or Effect of the Recession?

The financial panics of last September and October will always be part of the story of this recession, just as bank failures are always part of the Great Depression story. But recent research questions the claim that the financial panics themselves contributed to their contemporaneous and severe employment downturns.

In his academic research, Ben S. Bernanke blamed part of the Great Depression of the 1930s on banking panics. And this time last year (at the height of the panic in the commercial-paper market) he was telling President Bush that if “we don’t act boldly, Mr. President, we could be in a depression greater than the Great Depression.” A lot of taxpayer money was spent based on this theory.

Some recent research supports an alternative view: that those financial panics did not cause depressions, but are merely symptoms of deeper economic forces.

The U.C.L.A. economics professor Lee Ohanian’s recent paper has looked at monthly data from the 1930s and finds that bank failures came well after manufacturing establishments had sharply dropped their work hours. Moreover, the banks failing during the initial panics were known to be weak. Whatever brought those weak 1930s banks down had already hit the manufacturing sector hard.

The timing was different in this recession — the largest employment drops seemed to come immediately after the financial panic — but a recent paper by Ravi Jagannathan, Mudit Kapoor and Ernst Schaumburg of Northwestern argues that the coincidence is just as misleading. They argue that the changing global economy — with more employment of residents in developing countries like China — created a glut of savings in those countries, and was destined to reduce employment in developed countries regardless of whether there had been a financial panic.

The foreclosure crisis is not fully behind us, and the time may come again when it looks like “banks are in trouble.” When that time comes, will taxpayers still believe Mr. Bernanke’s theory that they are better off financing bailouts than letting a bank panic run its course?

Comments

[chap08:]

James, I don't mean to be rude, but to be honest, your view on the banks is complacent and short sighted.

I agree with you on the auto industry, but that is fundamentally different to the banks. In a capitalist society, banks play a unique role. They are not like autos, consumer goods, construction or anything else. In all those other industries, a big player can go down and the others get stronger. It doesn't work like that in banking. If we let GM go, other auto makers get stronger. If we'd just let the banking crisis unfold, most banks in the US and around the world would be bust. What would happen then? Would we carry on our lives as if GM had gone? No, the whole economy would follow them down. There would be no "vortex of growth", there would be a vortex of hell and lots of excellent businesses would fail.

I agree with you on TBTF, but there are ways of achieving that which don't imperil the lives and livelihoods of all Americans and citizens of the world.


On Oct 23 08:18 AM JAMES CARLINI wrote:

> The Panic of '08 was the culmination of several different factors
> and not one specific event or industry segment.
>
> There was a significant rise in foreclosures starting in 2005-2006
> that few seemed to recognize or maybe they just ignored it. It kept
> building as more people lost jobs or had to take a job paying a lot
> less money (underemployment - which is NOT tracked)
>
> By '08 it was hard to ignore, and the "experts" on CNBC who initially
> said, "Don't worry about the subprime rate mortgage crisis it won't
> effect the other 98% of the people paying their mortgages" were whistling
> a much different tune.
>
> People in several industry segments have been losing jobs to offshoring,
> outsourcing and the influx of a lot of cheap skilled labor being
> brought into the country. This job erosion started in 2000-2001
> and continued especially in the IT industry as well as others.<br/>
>
> I don't see any articles that discuss this impact which has led to
> the underemployment of thousands of skilled people and in turn, diminished
> their buying power which has definitely affected consumer spending.
> Someone going from $90K-$100K to $32K-$36K is not going to be buying
> any big ticket items. Those that tried to maintain their lifestyle
> by maxing out credit cards thinking that the setback was temporary
> have found out they are in a more long-term (and maybe permanent)
> loss of wages. So, they cannot get out from under (more credit card
> defaults as well as foreclosures)
>
> We bailed out the auto industry to save industrial-age jobs yet there
> was no rush to save high-skilled IT jobs where people had cutting-edge
> skills.
>
> As for bailing out failing companies, my take is this:
>
> "Too-big-to-fail" bailouts dilute the concept of capitalism.
>
> Letting an institution fail will create a vortex of growth in competitors
> and the market eventually takes care of itself.
>
> Keeping the weak organization on life support weakens the total market
> because then the next organization that starts falling has no incentive
> to correct itself, they will just wait for their bailout - AND their
> undeserved bonus checks.

Oct 23 08:54 AM

[socrateaz:]

When that time comes. What do you expect? The fixes put on the various money exchangers fixed the underlying problems? And you really think this president will listen to what people say, other than to appear to appease the worst problems? This leader is scarey to me. He reminds me of the professors I saw in college that told you how things were. And I tended to believe them. When I got away from that enviornment and things did not add up, I then realized their truths were really their beliefs and I was being taught a lot of religion along with some facts. I believe Obamanomics is more religion than science. Sometimes it is hard to tell. But when the basis seems to be more toward convincing others of your view than stating the facts from both sides, then there is high probabillity you are being fed beliefs.

Oct 23 08:59 AM

[enigmaman:]

Crisis management was all this was and still is, the Fed could not see the trees for the forest and if they did they refused to believe what they saw was real, its denial led to world wide economic, nobody wanted to be a party pooper so they let things spiral out of control. yes we have had a rally but not because our economy is on sound footing, despite the great earnings from AAPL, AMZN and the likes they are the exception and not the rule, and there success does very little to help solve the underlying problems found in our economy. The Fed bailed out the big banks, the good old boy crowd, some are now making oodles of money, more then ever before, some are bigger then ever but none are doing anything with there success to support broad economic growth, except to say the big amounts of money we earn in bonuses make it back into the economy through purchase of expensive toys and such, for real! Going forward we face serious problems on the horizon, massive CRE defaults, potentially 8 million more home foreclosures in the next four years, higher taxes in 2010, income, cap & trade, health care, Admin who said yesterday " they dont expect to see anymore job creation from the stimulus spending and see 10% unemployment through 2010 and beyond" My friends what they are telling us is "it is what it is" and they will fight a different fight because they have given up on stopping what is inevitable, but in the meantime they will do what they can to "legislate us into a box" its what they do, and do more of when they have no real solutions, they pass more laws

Oct 23 10:09 AM

[Tony Petroski:]

Professor Mulligan is back on his game.

He is doing the research, but common sense says that depressions aren't caused by bank problems (although runs on paper currency can be stemmed quickly by government action).

Banks aren't lending now, because those animal spirits don't want money right now.

Oct 23 10:13 AM

[Dave Wrixon:]

They are not insolvent because Bernanke will give them all the cash they need. However, if the assets on the their balance sheet where set a market then they would have a negative net worth. Fair value is subjective, but if it were done by an objective third party the outcome would still be Negative Net Worth. For any normal company that would mean insolvency, but Too Big to Fail puts you in a whole different category, especially if your cronies have control of the purse strings.


On Oct 23 07:00 AM bbro wrote:

>
> The banks are not insolvent....unprofitable yes but not insolvent....two
> different things....
>
> On Oct 23 06:41 AM Michael Clark wrote:

Oct 23 10:44 AM

[Dave Wrixon:]

They weren't lending before they were rescued and they aren't lending now. Why would their demise affect anyone outside their own little magic circle?


On Oct 23 08:54 AM chap08 wrote:

> James, I don't mean to be rude, but to be honest, your view on the
> banks is complacent and short sighted.
>
> I agree with you on the auto industry, but that is fundamentally
> different to the banks. In a capitalist society, banks play a unique
> role. They are not like autos, consumer goods, construction or anything
> else. In all those other industries, a big player can go down and
> the others get stronger. It doesn't work like that in banking. If
> we let GM go, other auto makers get stronger. If we'd just let the
> banking crisis unfold, most banks in the US and around the world
> would be bust. What would happen then? Would we carry on our lives
> as if GM had gone? No, the whole economy would follow them down.
> There would be no "vortex of growth", there would be a vortex of
> hell and lots of excellent businesses would fail.
>
> I agree with you on TBTF, but there are ways of achieving that which
> don't imperil the lives and livelihoods of all Americans and citizens
> of the world.

Oct 23 10:46 AM

[bbro:]

Even if say BAC marketed everything to market..they have enough
capital ,loan reserves and preprovision earnings to survive and then
suddenly you would ridiculous earnings swings...in this case very huge positive ones....and check your data none of these banks
are insolvent.....the term is being thrown around way too loosely....


On Oct 23 10:44 AM Dave Wrixon wrote:

> They are not insolvent because Bernanke will give them all the cash
> they need. However, if the assets on the their balance sheet where
> set a market then they would have a negative net worth. Fair value
> is subjective, but if it were done by an objective third party the
> outcome would still be Negative Net Worth. For any normal company
> that would mean insolvency, but Too Big to Fail puts you in a whole
> different category, especially if your cronies have control of the
> purse strings.

Oct 23 10:51 AM

[JAMES CARLINI:]

chap08

Read my comment again. Where do I even mention banks?????

I don't mean to be rude but maybe you should sharpen up your basic reading comprehension skills before you question someone else's perspective.

As to your defense of banks and trying to say that no one would come in and take their place, let's take a look at that since you mentioned it. I seriously doubt that. In fact, that's a laugh.

Many banks did NOT take TARP money and there would be a feeding frenzy on those that made some bad decisions. The winners may not have been US Banks but other banks would definitely step in and grab up the marketshare.

Evidently, you favor rewarding failure. I don't. You don't improve any organization if you don't get rid of those executives who made some bad decisions. AND, you definitely should not reward their mistakes.

Go back and read some books on leadership. Start with Patton.
The banking industry like any other industry should purge those executives that have exemplifed the Peter Principle.

Oct 23 11:03 AM

[chap08:]

Give me a break James. You spoke about "Too-big-to-fail bailouts" and "undeserved bonus checks". If you REALLY didn't mean banks then you were, at best, misleading.

As for you saying that I "favor rewarding failure", what the f**k gives you that idea? Certainly nothing that I wrote. As I said above, the stock and bond holders should have been wiped out. I would also agree with getting rid of the executives. But, the key point is that you do it in a way that doesn't damage the rest of the economy. "Letting a bank panic run its course" would fail to do that.


On Oct 23 11:03 AM JAMES CARLINI wrote:

> chap08
>
> Read my comment again. Where do I even mention banks?????
>
> I don't mean to be rude but maybe you should sharpen up your basic
> reading comprehension skills before you question someone else's perspective.
>
>
> As to your defense of banks and trying to say that no one would come
> in and take their place, let's take a look at that since you mentioned
> it. I seriously doubt that. In fact, that's a laugh.
>
> Many banks did NOT take TARP money and there would be a feeding frenzy
> on those that made some bad decisions. The winners may not have
> been US Banks but other banks would definitely step in and grab up
> the marketshare.
>
> Evidently, you favor rewarding failure. I don't. You don't improve
> any organization if you don't get rid of those executives who made
> some bad decisions. AND, you definitely should not reward their mistakes.
>
>
> Go back and read some books on leadership. Start with Patton.<br/>The
> banking industry like any other industry should purge those executives
> that have exemplifed the Peter Principle.

Oct 23 11:46 AM

[chap08:]

Dave, clearly banks were lending (a little too much if I remember) and despite what you say, are continuing to lend. I'm happy that they're not lending as much and I am happier still that they're still lending.

I don't know if you have ever run a business. Probably if you had, you wouldn't have asked what you did. Banks provide essential working capital for many businesses. Without it, they would go under. This isn't about businesses being uneconomic, it's about cash flow. Equally, every day, they roll over thousands of longer term loans. If these loans were not rolled over, again, the businesses would fold. Let's not get started on what they do to support international trade, transaction processing etc. I know, as a business owner, how important the bank is.

You also have to consider the impact if a large group of them had been allowed to collapse simultaneously. The result would have been a sudden freeze in economic activity. What would you do if your bank suddenly disappeared? What would businesses do? M and V would suddenly contract. The result would be a deep depression in which, not just bad businesses, but good ones fail. That's not good for anyone.


On Oct 23 10:46 AM Dave Wrixon wrote:

> They weren't lending before they were rescued and they aren't lending
> now. Why would their demise affect anyone outside their own little
> magic circle?

Oct 23 12:12 PM

[Dave Wrixon:]

There is a difference between new credit and existing credit.

Bank failure does not mean existing credit goes away, it doesn't it just changes title.

Rolling over loans is inevitable even under current conditions. Not rolling over loans would simply in most cases mean that the banks would have to take a total loss straight onto their balance sheets. As we have seen, there is no way in hell they will do that even if borrowers has absconded.


On Oct 23 12:12 PM chap08 wrote:

> Dave, clearly banks were lending (a little too much if I remember)
> and despite what you say, are continuing to lend. I'm happy that
> they're not lending as much and I am happier still that they're still
> lending.
>
> I don't know if you have ever run a business. Probably if you had,
> you wouldn't have asked what you did. Banks provide essential working
> capital for many businesses. Without it, they would go under. This
> isn't about businesses being uneconomic, it's about cash flow. Equally,
> every day, they roll over thousands of longer term loans. If these
> loans were not rolled over, again, the businesses would fold. Let's
> not get started on what they do to support international trade, transaction
> processing etc. I know, as a business owner, how important the bank
> is.
>
> You also have to consider the impact if a large group of them had
> been allowed to collapse simultaneously. The result would have been
> a sudden freeze in economic activity. What would you do if your bank
> suddenly disappeared? What would businesses do? M and V would suddenly
> contract. The result would be a deep depression in which, not just
> bad businesses, but good ones fail. That's not good for anyone.<br/>

Oct 23 12:30 PM

[chap08:]

Bank failure certainly does mean that existing credit goes away. You seem to be only thinking about real estate loans. What about that working capital I was talking about? What about the 5 year business loan that has reached the end of its term? There's no write down involved, it's rolled over or it's paid back. If it's not paid back, the business is broken up.

You seem to assume that another bank will just step in. That's a bad assumption. If one bank goes down fine, no problem. But, last year, it's no exaggeration to say that the majority of the world's banking system could have disappeared in one go. Who's going to step in? Where does the capital come from?


On Oct 23 12:30 PM Dave Wrixon wrote:

> There is a difference between new credit and existing credit.
>
> Bank failure does not mean existing credit goes away, it doesn't
> it just changes title.
>
> Rolling over loans is inevitable even under current conditions. Not
> rolling over loans would simply in most cases mean that the banks
> would have to take a total loss straight onto their balance sheets.
> As we have seen, there is no way in hell they will do that even if
> borrowers has absconded.

Oct 23 12:57 PM

[Tom E.:]

I think the author is correct, the panic was the result of chickens coming home to roost in the jobs and income area.

Job and income growth has been lagging this decade. The reason unemployment was low was because many people dropped out and were living off of home equity and debt. Now those people are trying to re-enter the labor force.

We have a massive oversupply of labor due to globalization. A glut of labor in developed countries can be deadly to capitalism and trade.

Oct 23 01:06 PM

[thiazole:]

To give an example to what you are saying, farmers must borrow a significant amount of money in the spring in order to plant. They insure their crops against yield and are therefore guarenteed enough money to pay off the loan when they harvest. Their actual profit is pretty low; often only $20 thousand for a single farmer, so they could never afford to plant again without the loan. Many businesses are run this way with cycles that can last weeks or an entire year.


On Oct 23 12:12 PM chap08 wrote:

> Dave, clearly banks were lending (a little too much if I remember)
> and despite what you say, are continuing to lend. I'm happy that
> they're not lending as much and I am happier still that they're still
> lending.
>
> I don't know if you have ever run a business. Probably if you had,
> you wouldn't have asked what you did. Banks provide essential working
> capital for many businesses. Without it, they would go under. This
> isn't about businesses being uneconomic, it's about cash flow. Equally,
> every day, they roll over thousands of longer term loans. If these
> loans were not rolled over, again, the businesses would fold. Let's
> not get started on what they do to support international trade, transaction
> processing etc. I know, as a business owner, how important the bank
> is.
>
> You also have to consider the impact if a large group of them had
> been allowed to collapse simultaneously. The result would have been
> a sudden freeze in economic activity. What would you do if your bank
> suddenly disappeared? What would businesses do? M and V would suddenly
> contract. The result would be a deep depression in which, not just
> bad businesses, but good ones fail. That's not good for anyone.<br/>

Oct 23 05:01 PM

[chap08:]

Yes, good example and makes the point that the more seasonal the business, the critical this is.


On Oct 23 05:01 PM thiazole wrote:

> To give an example to what you are saying, farmers must borrow a
> significant amount of money in the spring in order to plant. They
> insure their crops against yield and are therefore guarenteed enough
> money to pay off the loan when they harvest. Their actual profit
> is pretty low; often only $20 thousand for a single farmer, so they
> could never afford to plant again without the loan. Many businesses
> are run this way with cycles that can last weeks or an entire year.
>

Oct 23 06:20 PM

[perceptions...:]

Following is a perspective on historical consumer levels and current trends and the authors take on the debt/markets situation.
www.sitkapacific.com/f... pital_Management_Septembe r_2009_Client_Letter.pdf
==================
This perspective suggests that the US economy is continuing thru a deleveraging process, which may take many years.

In addition, it provides a chart on the Employment to Population Ratio (EMRATIO) and the Debt to Disposeable Income Ratio (TDSP), which provides some useful insights.

In particular, I would suggest the PARTICIPATION RATE (EMRATIO) will continue to fall for some time yet.

This arises from a mixture of the GFC causing layoffs in the US employment market, as well as employers NOT HIRING due to the state of the economy AND the cummulative effects of increasing RETIREMENTS in the Baby Boomer generation.

The combination of higher Debts, higher savings rates and less total jobs, means there is less real disposable income circulating in the US economy.

The net effects of these issues, plus Peak Oil, other Baby Boomer effects (Social security & Health costs) & Climate Change, means that THIS TIME IS DIFFERENT!

Oct 23 06:40 PM

[perceptions...:]

Let's try that link again?

www.sitkapacific.com/f...

Oct 23 06:41 PM

[bob adamson:]

chap08 -

Thank you. You are quite right.

Further, the article and some of the other posts fail to recall the freeze in both inter-bank lending and commercial and consumer lending generally that was rapidly taking hold last fall when the investment banking crisis was in full swing. The ensuing recession in the general economy would have been much deeper and longer if that freeze had been allowed to really become established and that freeze was directly related to the banking crisis. It was a near thing as it was and only the massive government intervention by the US and the other G8 prevented chaos from ensuing.

Sure, the downturn and general anxiety were building throughout 2007 and 2008 before the September/October 2008 crisis point and there may not have been a week by week correlation between the pace of the emerging crisis in the investment banking sector and the pace of the emerging recession. However, that does not negate the argument that the general economic situation would not have got much worse very fast if the governments and central banks had not intervened decisively when they did. In fact, a measure of the success of that intervention is the fact that the recession, perhaps the worst since WW II though it might be, began to abate rather than deepen.

bob adamson

On Oct 23 07:19 AM chap08 wrote:

> Err, hello. Neither of these papers say that bank failures are irrelevant
> to depression. You are completely distorting their arguments.
>
> If you wanted the 2008 bank panic to run its course, then I have
> no hesitation in calling you an idiot. Could the bailout have been
> handled better? 100% yes. Does that mean it shouldn't have happened
> at all? 100% no. There is no reason why bank stock and bond holders
> should not have been wiped out - they should have been. We should
> now be getting ready to IPO a reorganized Goldman et al (after separating
> out investment banking) with the receipts coming back to the tax
> payer. But to let the "bank panic run its course" would have simply
> been idiotic. You clearly have no concept of the real world human
> suffering and waste that would have resulted. Creative destruction?
> More like total destruction.

Oct 23 11:58 PM

[ebworthen:]

A crap sandwich with rye and mayonnaise is still a crap sandwich.

The housing bubble and subsequent collapse was engineered.

CDS's, politicians buying votes with cheap mortgages and pork, home equity lines of credit out the wazoo, and accommodative FED and politicians and..Voilà! A debt bubble led by housing.

This is not rocket science.

This theft of the common citizen to benefit the bankers and politicians was engineered, some complicit, some simply with their hand out, some delusional and truly believing they were "helping the little people".

Nevertheless, it wasn't an accident, and the bubble building now is either a well honed machine or a desperate contraption of duct tape, hair pins, and fishing line to keep the calliope spinning.

Oct 28 12:32 AM

[ebworthen:]

We could put your perspective in a time machine to Fall 1930 and it would sound just as good then too.


On Oct 23 11:58 PM bob adamson wrote:

> chap08 -
>
> Thank you. You are quite right.
>
> Further, the article and some of the other posts fail to recall the
> freeze in both inter-bank lending and commercial and consumer lending
> generally that was rapidly taking hold last fall when the investment
> banking crisis was in full swing. The ensuing recession in the general
> economy would have been much deeper and longer if that freeze had
> been allowed to really become established and that freeze was directly
> related to the banking crisis. It was a near thing as it was and
> only the massive government intervention by the US and the other
> G8 prevented chaos from ensuing.
>
> Sure, the downturn and general anxiety were building throughout 2007
> and 2008 before the September/October 2008 crisis point and there
> may not have been a week by week correlation between the pace of
> the emerging crisis in the investment banking sector and the pace
> of the emerging recession. However, that does not negate the argument
> that the general economic situation would not have got much worse
> very fast if the governments and central banks had not intervened
> decisively when they did. In fact, a measure of the success of that
> intervention is the fact that the recession, perhaps the worst since
> WW II though it might be, began to abate rather than deepen.
>
> bob adamson
>
> On Oct 23 07:19 AM chap08 wrote:

Oct 28 12:34 AM