Because the notion of an active monetary policy to combat the business cycle was so novel and the knowledge of how the economy worked so primitive, debates among the various factions within the Fed became highly confused and at time even incomprehensible.
-Liaquat Ahamed, pp. 365
This week marks the one year anniversary of the fall of Lehman Brothers, the starting point of our current economic recession. This is a fitting time to read Liaquat Ahamed’s book “Lords of Finance: The Bankers Who Broke the World.” Ahamed focuses on the events, but more importantly the individual financial leaders of the US, England, France, and Germany, that shaped the Crash of 1929 and the international Great Depression of the 1930s. The similarities between the state of American finances which Ahamed describes and what we have been experiencing for the last few years was shocking to me. I couldn’t help but wonder, did we learn anything from 1929?
There are many parallels between the two eras. The booms of the US stock market in both the 1920s and mid-2000s were based on speculative bubbles. The bubbles Ahamed describes were tangled up in the 1925 Florida land grab and the stock market boom associated with advances in industrialization, mainly the US automobile industry. The housing market and the tech boom led to today’s bubbles. In both situations, after the bubbles burst the American public found itself deeper in debt as price levels fell and the real value of loans owed increased. Indeed, President Obama’s speech to the financial leaders of Wall Street on Monday describing the “risk without regard for consequences” they took could have been taken from Ahamed’s analysis on the expansion of brokerage firms throughout the US.
Infighting and a lack of action characterized the Federal Reserve Bank of New York which Benjamin Strong headed during the 1920s. Though everyone seemed to have a different view of the scope of the problem, most acknowledged its existence. Still, little was done to prevent the economic catastrophes of the era. The US Congress could not get around the central divide of who should be held responsible for the speculation and how it could be reined back in. It seemed “a reenactment of an old morality play that had divided the republic since its founding – between those, like Hamilton, who believed that great wealth was the reward for taking risks and those, like Jefferson, who believed that prosperity should be the reward for hard work and thrift.” (Ahamed, pp. 317) The responsibility to take care of the economy fell squarely on the Fed. But bureaucratic controls and less than qualified Board members led to a “paralysis of the Fed” and actions were taken too little too late. (pp. 368)
At least one lesson was learned from the mistakes of our economic forefathers. The Fed acted much more quickly to the signs of economic depression, injecting billions of dollars of liquid assets into the banking system. Only two days after Lehman Brothers declared bankruptcy, the Fed approved controversial loans to AIG in an attempt to curb the effects of the closures. Though the full consequences of the measures taken by the Fed and other government agencies are yet to be seen their quick actions are a direct reflection of the lessons learned by the “wait and see” policies of the mid-1920s.
While we may have learned our lesson on the governmental level, we have not learned our lesson on the psychological level. Ahamed describes how people choose to believe in stock prices and speculation which have no anchor in reality, this is the psychological aspect of the market place. This sort of thinking led to the bubbles of the 1920s and the 2000s. It is more difficult to learn the personal lessons which cause bubbles and ultimately recessions. By exploring book’s like Ahamed’s which focus on the history of past booms and busts, we can be more aware of similar situations in the present. We are not the first to think that prices would always go up and the good times would stay good forever. Rather than thinking that we are finally the exception to the rule, we can be more conscious of the dangers of buying in to bubbles and make an effort to combat wild speculation. Moving forward we should try to combine the institutional lessons with the personal psychological lessons so that we can avoid these bubbles and crashes.