FEATURE | SUMMER 2010 EFFECT
The Great Depression to the Great Recession: Lessons Learned or Forgotten?
Bad things happen to good people. Save for a rainy day. A penny saved is a penny earned. Neither a borrower nor a lender be. Use it up, wear it out, make it do, or do without.
The lessons that older generations learned in the Great Depression are coming back to their children and grandchildren living through the current Great Recession. Not everyone is going to plant a vegetable garden in the back yard or save string, but some of the big picture lessons have relevance for both businesses and individuals. Those include insights on debt, work, safety nets, and regulation.
Lesson one: debt
“Debt is the ultimate bomb that can create downturns like we had,” says Tony Hallada, a principal with LarsonAllen Financial. Debt runs through the Great Recession like a tidal wave, engulfing individuals, small and large businesses, and ultimately national economies around the world.
Family and individual debt stories are easiest to understand. I sat down with Nancy in a coffee shop in Minnesota, to hear her story of debt and disaster. (Nancy is not her real name.)
“The shame is huge,” she says. “I’ve never been interviewed for a story before and not wanted to use my name.” That’s a thread that runs through many personal stories.
Nancy and her husband, both professionals, have lost their home and savings over the past three years, and now are going through bankruptcy.
“We’re keeping this from our kids,” she says. “We’re just telling the kids we’re giving the house back to the bank because the payments are too much.” She’s keeping it from her mother and other family members, too.
A few years ago, Nancy and her husband looked at a modest house, just a few blocks from their children’s school. Home values were still rising steadily. This was not their first home, and they were not naive homebuyers.
Real estate was once a surefire investment. As my father told me decades ago, “Land is the one thing they aren’t making any more of.” For too many people, that suggested homes and land were safe bets to keep going up and up and up in value.
Despite their 700+ credit score, Countrywide offered them only a subprime mortgage, because Nancy’s husband was between jobs. They decided to take the mortgage and buy the house. When Joe settled into a new job, they planned to refinance, escaping the balloon clause and knocking the too-high $2,400 mortgage payments down to an affordable $800–900 per month.
The new job came quickly, but, says Nancy bitterly, “Countrywide wouldn’t do anything. We sent the documents, and then they said they didn’t have the documents, so they couldn’t talk about refinancing. We sent the documents repeatedly. You could never talk to the same person twice. Sometimes, even if we had the name of a specific person, they wouldn’t let us talk to them.”
By 2007, with the bottom falling out of the housing market, Nancy and her husband were underwater. They owed more on their mortgage than the house was now worth. Struggling to make high house payments, they stopped paying credit cards, student loans, and taxes. Bill collectors started calling them. In mid-2009, with the Great Recession in full swing across the country, Nancy lost her job. Foreclosure followed, with a sheriff’s sale in November 2009, a week before Nancy’s birthday.
Nancy says they’ll be okay. Her husband’s job is secure, they have health insurance, they have a roof over their heads and enough to eat.
“We weren’t sold a bill of goods by anyone,” Nancy says. “We drank the same Kool-Aid everyone drank—believing that housing values would stay stable.”
What lessons has she learned from the recession?
“Play it safe,” Nancy says, without hesitation. “I’ll never count on property values again. ... The economy has driven our lives. ... I’m forever changed.”
Nancy probably isn’t the only one changed. Credit card debt looms large for many people, with senior citizens and recent college grads carrying especially high levels. A recent Sallie Mae study showed college students increasingly using credit cards to pay for tuition and college expenses, raising their level of credit card debt, and using more credit cards. More than 80 percent of undergraduates have at least one credit card, and half have more than four. Their median balance increased from $946 in 2004 to $1,645 in 2008. According to MSNBC, “Graduates leave school with 41 percent more credit card debt than four years ago, with one in five owing at least $7,000.” That’s in addition to student loan balances, which are also rising.
“The Plastic Safety Net,” a study by Demos, a non-partisan think tank, found that, “During the height of the housing bubble, from 2001 to 2006, homeowners cashed out $1.2 trillion (2006 dollars) in home equity and households accumulated nearly $900 billion in credit card debt.” During this time the cost of living jumped 27 percent and family income was stagnant or declining.
Older Americans—those 65 and up—saw a 26 percent increase in credit card debt from 2005 to 2008, attributed in part to the recession’s reduction in the value of retirement savings.
Credit card delinquency rates jumped by 11 percent in the first quarter of 2009. Bankruptcy filings for the year ending September 30, 2009, were 34 percent higher than in the same time frame in 2008.
While homes are the largest asset, and mortgages are the largest liability for most families, businesses struggle with other kinds of debt.
“Business owners also did some illogical risk assessment with their companies and had a false sense of control,” reflects Jean Wolfe, a senior wealth advisor at LarsonAllen Financial. “At the end of the day, we can only control certain things—what we spend, what we invest in business, what we expense—but we cannot control the bigger picture, the worst recession of a lifetime, the inability to secure credit.” Wolfe insists, “Debt is not evil. It just needs to be framed and used appropriately.”
Businesses, small and large, that were conservative in their use of credit, met the recession in much better shape than those that were highly leveraged.
When banks start behaving in a squirrelly way, you know you may not have a credit line.
—Trish Karter, CEO, Dancing Deer Baking Company
“The old style of knowing your customer went away a few years ago, when banks like Bank of America decided to do all their business lending on a formula basis so they didn’t have to know the customer,” explains Trish Karter, CEO of Dancing Deer Baking Company in Massachusetts. “It was all just standard metrics. You had to pass through the screener—they decided it would be more efficient that way.”
As the recession unfolded, lending metrics changed. Many businesses found unexpected credit problems, and banks tightened up on long-time customers, increasing interest rates, canceling or restricting lines of credit, even when all accounts remained current.
Karter says her impression is that “most businesses had some kind of hiccup with their banks” as the recession unfolded. “When banks start behaving in a squirrelly way, you know you may not have a credit line.” Her mid-size company got through the time, answering all of the questions raised by the bank and getting approval to continue, but ultimately decided to change banks. They needed to feel more secure in their banking relationship, rather than facing the uncomfortable uncertainty they felt as their old bank scrutinized their business.
Lesson two: work
Young people coming of age during this recession see fewer opportunities available.
“Normally, teens can get jobs because they’ll take lower wages,” explains a high school senior in Minnesota, who has worked steadily throughout school. “Now everybody is taking low wages, so you can’t get a job.”
If you do get one, his friend adds, the company may close. Insecurity about the future is widespread among teens, who wonder how they can get a foot on the employment ladder as they watch their parents worry about holding onto their positions.
They are right to worry, according to the Center for Labor Market Studies at Northeastern University. During the first year of the recession (approximately October/November 2007–October/November 2008), the age cohort of people under 30 accounted for 70 percent of the net job losses. In contrast, employment rose by 1.094 million among people over the age of 55.
One positive consequence of the discouraging job market is record high college enrollment among new high school grads. After all, if you can’t find employment, college is a good place to try to wait out the recession, acquiring or upgrading skills that might make you more employable in the future. Laid-off workers and returning vets join the new high school grads filling college classrooms. Two-year colleges have seen the biggest gains in enrollment.
Returning to school makes sense. In October/November 2008, among 16–24 year olds, high school dropouts had an employment rate of only 45 percent, while college degree holders were employed at a rate of 88 percent.
But employment doesn’t necessarily mean great jobs. In early 2009, fewer than half of college grads under the age of 25 were employed in positions that required a college degree. From the other end of the spectrum, many older workers are delaying retirement plans. Those who have pension plans or retirement accounts watched their nest eggs crack as the stock market crashed. That’s a big part of the reason for increased employment in the 55+ age group.
Wolfe says older people are managing the recession better. “The 70- and 80-year-olds don’t like it,” she says, “but they put it into perspective. The 40-year-olds have been more challenged because they’ve never had this happen to them.”
As for lessons for younger adults, Wolfe says, “When I was in high school and college in the early 1980s, we had the same level of unemployment as today. I looked for any job. I left the state to go to Joliet, Illinois, as a bill collector—with a college degree. It paid very little, but I was employed. I had a job. Some of these 25–30 year olds I want to slap upside the head and say, ‘Nobody told you that you could walk out of college into a job making $50,000 and buy a house in your 20s. Be happy if you can pay your bills and make a rent payment.’”
Lesson three: the safety net is full of holes
Deep in the winter of 2009–2010, food shelves and homeless shelters across the country reported they were running out of resources to serve the rising numbers of hungry
and homeless people. Nationwide, 18.5 percent of households reported not having enough money
to buy sufficient food during the fourth quarter of 2009. For families with children, the number was even higher—25 percent. Food shelves in northern Texas reported an 80 percent increase in requests for help since 2006. In Massachusetts, one person in ten used a food shelf, food kitchen, or homeless shelter, a 23 percent increase from 2006 to 2009. Wisconsin saw a 40 percent increase in use over the same time period.
Health care coverage is another growing hole in the safety net. Newly unemployed workers can continue health care coverage (if they had it) through the COBRA program, but premiums sometimes eat up almost the entire unemployment insurance check. A federal subsidy helped some workers for a time, but the number of uninsured people continues to grow.
Many families are relying on credit cards to pay medical expenses. According to the Demos survey, “In 2008, more than one-half of indebted lower- and middle-income households (52 percent) cited medical expenses as contributing to their credit card debt.” In addition, medical debt remained the most commonly cited reason for declaring bankruptcy.
Businesses, too, found themselves unable to continue to pay for health insurance, as insurance and health care costs continued to rise. A 2010 survey of 180 businesses in Minnesota and Wisconsin showed that health care costs posed the most common obstacle to business expansion.
With the economy shedding more than eight million jobs during the first two years of the recession, millions of workers faced the prospect of running out of unemployment insurance eligibility long before finding a new job. The average time needed to find a new job continued to rise throughout 2009 and into 2010. With the duration of unemployment compensation generally pegged at 26 weeks, emergency federal extensions were renewed and renewed again. Those extensions, however, did not cover all states or all workers.
During the Great Depression of the 1930s, government jobs programs, such as the Works Progress Administration (WPA) and Civilian Conservation Corps (CCC), put people to work. David Riemer, the director of policy and planning for community advocates of Milwaukee, Wisconsin, thinks we need similar programs today.
Riemer points to the gap between available jobs and workers seeking them, a gap that has been growing steadily larger since mid-2007, as shown by the graph below.
Source: Community Advocates Public Policy Institute
More than seven people are seeking work for every one job available. That number of job seekers, high as it is, includes only people actively looking for work, not those who have given up searching. The number of jobs, low as it is, includes not only full-time, but also part-time and temporary jobs.
Riemer argues that incentives and tax credits to businesses are an inefficient way to foster job creation. “The most efficient way is to use the money to create transitional employment,” he says.
“Part of the lesson we need to learn is to go back to the Great Depression and realize that part of the solution that made sense in the 1930s still makes sense today,” he says. “During the Great Depression, the WPA and CCC actually did things. They carried out a whole bunch of projects, some of which have produced lasting benefit. We need to reinvent the WPA—I don’t see any other way to do it. The other way is to massively expand unemployment insurance—but you’re not getting any work for that.”
Lesson four: the fox is still in the henhouse
From the beginning of the Great Recession, the government has bailed out big banks, financial institutions, and even automobile companies because they are “too big to fail.”
Not only are they too big to fail—they’re too big to regulate.
After the 1929 stock market crash and the ensuing Great Depression, the government established the Securities and Exchange Commission (SEC) to regulate the stock market, the Federal Deposit Insurance Corporation (FDIC) to insure bank deposits and regulate the banking industry, and the Glass-Steagall Act to separate commercial banks and investment banking.
The FDIC and the Federal Savings and Loan Insurance Corporation (FSLIC) are products of the lessons learned in the 1930s. They insure savings and monitor the soundness of banks and savings and loan institutions. That protects the little guys, or the comparatively little guys. While deposits in federally insured institutions were once protected up to $2,500, they’re now insured up to $250,000 per depositor per bank.
The regulatory reforms of the 1930s targeted the big guys, the bankers, and Wall Street. The Glass-Steagall Act protected depositors from speculative investing practices. It also gave oversight and regulatory authority to the Federal Reserve Board. The SEC got the power to regulate stock and bond trading, to regulate stock exchanges, and to set requirements for fair disclosure to investors.
Federal deposit insurance has remained, but the regulatory reforms that grew out of lessons learned in the Great Depression, including the Glass-Steagall Act, were gutted in the 1990s. Government regulations have been eased or eliminated, not only on financial institutions but also on airlines, telephone services, broadcasters, and more.
Financial institutions and investors (or speculators) gleefully took advantage of their new freedom, inventing an eye-popping variety of new financial instruments and derivatives that escaped all regulation and oversight, such as credit default swaps (CDSs) and collateralized debt obligations (CDOs).
“Certain kinds of banks got to take more and more and more risk,” says Karter. “That was crazy. They got to palm it off to other people. The result is that the old fashioned basic business of banking is paying the price.”
If the country learned anything from the Great Recession, it is that regulation needs to come back. All kinds of financial instruments, all kinds of derivatives, need regulatory oversight.
Moreover, the too-big-to-fail institutions need to be cut down to size. Massachusetts Institute of Technology (MIT) economics professor Simon Johnson cogently summarized the issue: “Weakening the big banks and their bosses should not be seen as an unfortunate side effect of beneficial medicine. It is exactly what we need to do under these circumstances. Unless and until these banks’ economic and political influence declines, we are stuck with too many people who know exactly what they can get away with because their organizations are ‘too big to fail.’
“Having some of these banks go out of business or be broken up as part of a comprehensive system reboot (with asset revaluations at market prices and a complete recapitalization program) will help return the credit system to normal.”
Significant re-regulation may not happen. This session of Congress has shown little inclination to take decisive action. But Hallada predicts passage of the Volcker plan as a form of “Glass-Steagall light,” imposing some regulation but allowing banks to do more than they could before the 1999 Glass-Steagall repeal.
Hallada says regulators need to “get their arms around the credit default swap market, where they write insurance on debt. No one really understands what is there. We need to get regulation around this.” Still, he acknowledges, “There’s discussion, but I haven’t seen any legislation yet.”
The biggest lessons from the Great Recession echo the lessons that earlier generations learned in the Great Depression. They are not all that complicated: People need jobs. Don’t spend more than you have, and don’t borrow more than you can repay. Save for a rainy day. Take care of each other, watching out for the young and the old. Maintain a safety net for those who are vulnerable. Regulate banks—they have our money. Don’t let anybody get too big to fail. The tough part is not knowing what we should do, but doing it.
Those lessons were forgotten or abandoned, especially during the decade preceding today’s recession. Individuals incurred more debt than they could afford, counting on an ever-expanding economy and rising incomes. Financial institutions, freed from regulation and oversight, grew bigger and took greater risks. Perhaps we thought we were too modern to learn from our grandparents. The Great Recession should disabuse us of this bit of presumption.
Mary Turck is a freelance writer, who also edits the online Twin Cities Daily Planet
Contact Mary at email@example.com