johnnymk

http://www.bellinghamherald.com/602/story/939371.html

JOHN STARK - THE BELLINGHAM HERALD

BELLINGHAM - Nobel Prize-winning economist Vernon Smith draws some disturbing parallels between the events that led up to the Great Depression of the 1930s and the severe economic slump of today.

Smith, professor of economics and law at Chapman University, won his Nobel in 2002. He spoke Friday, June 5, before a standing-room-only crowd in Fraser Hall at Western Washington University.

Most people think of the Great Depression as originating in the stock market crash of 1929. But Smith's research indicates that the 1929 crash was itself the result of an earlier collapse in the boom housing market during the Roaring '20s.


He argued that stock market crashes in themselves are not enough to drag the whole economy under: The collapse of the dot.com stock bubble of the 1990s, painful though it was, did not lead to wider economic collapse.

But in the 1920s, and again in the first few years of the 21st century, there was a rapid expansion in housing construction, and a rapid increase in household debt as more people borrowed more money to get their own homes. In both periods, housing construction and investment collapsed even more rapidly once the phenomenon peaked, Smith's data showed. Only then - in both cases - did stock prices fall off a cliff as concerns about the financial system began to mount.

When a questioner asked Smith if more economic shocks are still to come, Smith was far from reassuring.

"We've got a lot of this stuff coming due yet," he said. "We still have shoes to drop out there."

Examples: Large numbers of adjustable-rate mortgages will reset at higher rates in the next couple of years, putting more households at risk of foreclosure and piling more losses on mortgage lenders. And sharp drops in consumer spending have yet to play themselves out in the commercial real estate markets. Increasing numbers of commercial loans to retailers are likely to go sour in the months ahead.

"That has yet to hit the banking sector," Smith said.

The housing boom and bust that touched off the economic chain reaction was at least partly due to federal policies that made it easier for people to borrow money to buy homes. Politicians from both parties pushed those policies because they were popular, Smith said.

Once the boom got rolling, everyone invested on the assumption that house prices could only go up, Smith said. That includes the home buyer, the mortgage lender, the buyer of mortgage-backed bonds and the companies that insured repayment on those bonds. Nobody involved had the cash reserves to withstand the inevitable drop in home prices when it finally came.

Now, Smith said, federal officials are still feeling their way through an economic crisis unlike anything in their lifetimes.

He praised the expertise of Federal Reserve Chairman Ben Bernanke but added that expertise may not be enough.

"Probably no one is better-fitted than Bernanke," Smith said. "But 'knowing that' and 'knowing how' are not the same. ... Knowing about art does not make a painter."

InfiniteNothing

The article mentioned that many adjustable were adjusting up in the next couple years. Can anyone explain why this would be when the prime rate is pretty much at an all time low. Isn't the prime rate a typical underlying rate?

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zippyjuan

The rate adjustment time of course depends on the terms of the loan- some had five year fixed before adjusting- and how much can depend on what index they are tied to (there are three main ones- the LIBOR index (which is the overnight rate in London), the 11th District Cost of Funds (inter bank lending rates) and the prime rate. The majority of the subprime loans have already adjusted by now but the more dangerous types of loans (so called Liars Loans or Alt A loans) are now starting to roll over. Some of these had "pick a payment" clause where you could decide to pay no interest, interest only, or interest plus principal. Unless you did principal plus interest, what you owed did not go down and in the case of no interest could have even gone up. Then when the loan adjusts, you are amortized not at 30 years but at 25 (or 30 minus whatever the grace period was) so while the indexes for adjustable loans are down, the balance and amortization periods on these loans will cause the payments to be higher.


Historical chart of the indexes:

http://www.moneycafe.com/library/compare.htm

As for comparisons to the Great Depression, the responces have not been the same. In the 1930's, the money supply was contracted and credit tightened while today money has been added into the system. It will not be the same as the Great Depression. There are countless different factors today vs then. Some people keep trying to link the two events (and they do have some similarities but also large differences) but they are not the same.

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