Gary Gorton, Toomas Laarits, and Tyler Muir write,
At the start of the Great Depression there were no nationwide bank runs and banks did not avail themselves of the discount window. Yet, output dropped substantially: industrial production fell over 20%. As a consequence, 1930 is viewed as a puzzle. For example, Romer (1988) writes: ”The primary mystery surrounding the Great Depression is why output fell so drastically in late 1929 and all of 1930” (p. 5).2 And Bernanke (1983) does not include 1930 in his study of the effects of bank failures on output: ”it should be stated at the outset that my theory does not offer a complete explanation of the Great Depression (for example, nothing is said about 1929-1930)” (p. 258).
In this paper show that a large part of the output drop in 1930 can be explained by bank actions: the reduction in loans and purchase of safe assets. We argue that banks realized the severity of economic conditions and, in effect, ran on themselves.
I want to note this paper for future reference. But I’m not saying I buy it. I mean, the reason that output dropped so sharply is that the banks ran on themselves, and the reason that the banks ran on themselves is that they realized that output was dropping so sharply?
I suspect they are missing something. They conclude:
The first year of the Great Depression appears to be an anomaly. Industrial output dropped by over 20% but there were no immediate signs of banking troubles evident during prior crises. In this paper we show that the banks’ decision to significantly cut back on lending and invest instead in safe assets contributed to the drop in output. Consistent with the results of Boyd et al. (2009), we find large declines in loan growth preceding the start of the crisis.
Industrial output dropping by 20%??? Why?
Over-investment in prior years? over-borrowing based on using over-prices stock shares up thru ’29? This paper doesn’t address that much.
But it is important to get the order right, plus also some implications. If 1930 had a drop of 20%, “better production planning” would have had much less in 1929 so the next year’s drop would be smaller drop. Perhaps like 2006 house building?
Now I’d like to see month-by-month loan amounts by the banks from ’29 thru the crash and thru ’30. What I recall was that the ’29 stock crash made banks stop lending and it was the crash which made firms to start letting workers go, with no new investment, new jobs. At the same time, the agro mechanization continued, replacing farm workers with machines, so there was also new ex-farm workers looking for jobs that weren’t yet being created.
Were there applications for loans that the banks weren’t supplying?
Where’s the simple summary that economists can agree on? The failure to agree on the Great Depression narrative condemns economics to be a non-science, no matter how much math is used.
If the failure to reach consensus on the cause of a particular event renders a discipline a non-science, then there are no sciences.
We argue that banks realized the severity of economic conditions and, in effect, ran on themselves.
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Yes, I had your commentin mind before i READ IT.
Pages 7 and 8 suggest that there are significant variations among industries and states. I’d guess disaggregation would provide more useful information.
Every dip shows up in accounts. Like if a meteor hit LA, many economists will blame the banks because the books suddenly fouled.
When Milt did his study, did he ever ask anyone, at the time, why did you suddenly stop? Did he look at the flow of goods past and try to find out which goods stopped first? Every single bit of data is available, all real goods flow was collected over the period, I actually saw the data once, which goods did what. Not a single economists ever has actually looked at the data.
Exactly which data are you referring to, and where are they located?
Another endless debate is what caused the blue bar to appear on our Fred charts. Everyone has a opinion what caused the blue bar, housing, regulations, banking or something else.
I have a clue. The blue bar was placed on our Fred charts by a small number of humans in the BLS, go ask them how they managed to get the blue bar where it is. They are as accurate as we got, we all go by their blue bar and likely a five or six step algorithm placed the blue bar.
I notice Mish does that, he skips the horrid debates, and he will actually e mail the government bean counter in chart, talk to the actually human who makes that stat. and get exactly what happened. And Mish gets the answer, a non economists, an engineer.
Have you read Scott Sumner’s Depression book?
It seems like Benjamin Strong’s death in Oct. 1928 is a causal element.
Why did it take a year for his death to have an effect? I haven’t read Sumner’s book even though I have it.
First, the Fed tightened to pop the stock market bubble. Higher rates and lower asset prices could trigger lower spending.
Second, has everyone forgotten about the huge tariff hike of 1930?
Third, it all sounds like a multiple equilibrium model driven by expectation shocks. A change in bank willingness to lend might be self-justifying.
This isn’t hard. Using a simple equity valuation measure which is highly correlated with future returns (I recommend John hussmans margin-adjusted CAPE), marks 1929 as one of the highest points of overvaluation in US history. When risk assets are expensive it is only a matter of time until there is a flight to safety. This is classic late-cycle behavior:returns on cash have increased while forward returns on risk assets have compressed. This is inherently unstable.
The better question is why do risk assets over and under react to such a high degree.
Why do risky assets go up too much, then down fast?
Why, after Greenspan’s Dec 97 “irrational exuberance” speech about the internet, did so many investors keep pumping money into those stocks, until the post Y2k bust starting on March 11, 2000? a) everybody knew that some dot com companies would be huge, b) many thought “this time is different”, c) from ’95, all those who invested were getting higher valuations, and those, like Buffett, who failed to invest, failed to get high returns.
Read Buffett’s 1999 investment letter.
He didn’t understand the business model, he didn’t invest, he didn’t get the big gains over the 5 years; he didn’t lose in the bust.
When “all” the other investors are making big returns in any class, including MBS (in the housing boom), it’s hard for any investor to not invest.
No good equity valuation in the dot com bubble. No good equity valuation in the MBS / CDO financing more house buying bubble. (Dr. Mike Burry “knew” it would collapse — he was reading the fine print of the big legal documents.)
Yes, i know “why” this happens. But economists completely discount the notion that we all act in predictable, irrational ways. If you look at over/under-valuation of risk assets it closely follows consumer confidence. It’s pretty easy really and explains most of our “unexplained” bank-runs, crises, etc.
So why don’t we correlate 1930 with 2007 in which investors and average citizens throughout the year (into 1931 and 2008) had their Wile E Coyote moment at different intervals. And wasn’t that a big piece of The Big Short in which even as foreclosures increasing and home sales decreasing the industry only called this a blip and assumed good times would continue? (And wasn’t there a push for Fannie and Freddie in 2008 to lower credit standards to buy the mortgages that other banks had already realized was a bad investment?) The reality was the stock market crash happened in 1929 but the low point was not until 1933 and how many headlines for the NYT had the economy was already turning around? The reality was not that the stock market crashed in Oct. 1929 and massive banks run happened in January 1930.
The system had a level of deflation to create a lot of bad loans that depositers would start sniffing as lost investments. (And think how much slower information moved in 1930.)
Based on a recently revealed story from the last downturn, I think what happened was a drop in productivity led to a bank run.
The recent story is this: A retired FT writer revealed that on the eve of the downturn, he went to his local and discovered Wall Street workers taking steps to protect their cash. The bank was accommodating them with special products and offered to do the same for the writer. He didn’t report the incident because he didn’t want to cause a panic. He did take advantage of the offer. What he failed to realize is that the panic had already begun, the average chumps just didn’t know it yet.
The same is likely to have happened in ’29-’30. Productivity started to slow. Banks became aware of this through their clients and started to shore up against loses.