April 18, 2008 / 4:59 AM / 9 years ago

Experts see Depression parallels in U.S. crisis

<p>A family is seen during a Depression-era photo. Events surrounding the U.S. housing crash in many ways resemble the Great Depression, including strings of failed bailout plans and a reliance on voluntary compliance, policy experts said on Thursday.USDA/Handout</p>

Annandale-on-Hudson, New York (Reuters) - Events surrounding the U.S. housing crash in many ways resemble the Great Depression, including strings of failed bailout plans and a reliance on voluntary compliance, policy experts said on Thursday.

A panel of speakers at Bard College's Levy Economics Institute, in Annandale-on-Hudson in upstate New York, offered a series of proposals for grappling with the crisis. Among them was the creation of an institution like the Depression-era's Home Loan Corporation to put a floor under the mortgage market.

"There is some stuff that does have that eerie 1932 feel," said Thomas Ferguson, a professor of political science at the University of Massachusetts, Boston, citing regulators' "infinite confidence in moral suasion."

The experts agreed that the housing boom contained the seeds of its own demise, creating the illusion that prices could rise indefinitely and leading to reckless risk-taking.

"One of the things that makes bubbles hard to control is that so many people are making money off them while they last," said Alex Pollock, a fellow at the American Enterprise Institute who spent 35 years in the banking sector.

Minsky Moment

The yearly conference is held in honor of Hyman Minsky, an economist who argued that periods of financial stability provide the perfect breeding ground for crisis, as investors' ability to gauge risk is impaired by the prospect of consistently lofty returns.

UMass' Ferguson maintained, however, that the current approach of employing all of the Federal Reserve's monetary ammunition to cushion the market's fall was doomed to failure, and would hurt competition in the banking sector.

"They're going to stand around the trough with machine guns," he said of the banks. "They're not going to kill each other, just keep taking from the taxpayer."

The Fed has cut interest rates aggressively since the official start of the credit crisis last August, slashing its target for interbank lending by 3 percentage points to 2.25 percent. In addition, it has pumped hundreds of billions of dollars into the banking system and begun accepting shadier assets as collateral in an effort to get financial institutions to begin lending again.

But observers like former Fed Chairman Paul Volcker have said the central bank is pushing the boundaries of its legal authority by giving money to investment banks over which it has no regulatory authority.

Walker Todd, a fellow at the American Institute for Economic Research, said Volcker's skepticism was justified.

"Overnight, without public debate, the Fed gave out half of its balance sheet to the primary dealer community," said Todd. "They have crossed the line."

A Tale of Two Crises

Todd went on to say that the housing crisis was really a two-for-one phenomenon: a speculative bubble in coastal areas and places like Nevada and Arizona, and a case of essentially fraudulent lending gone bad in the rest of the country.

He pointed to instances where mortgage lenders in places like his home state of Ohio swindled homeowners out of fixed-rate mortgages and pushed them into risky variable-cost ones by enticing them with lower monthly payments.

"They were even advertised as fixed-rate mortgage loans," in some cases, Todd said. "The Fed let them get away with that."

He and other panelists seemed in general agreement that the crisis required swift government action, but they all said it was crucial to put the right person or institution in charge.

The U.S. central bank, they said, did not exactly have a flattering track record.

"The Fed has been a big cheerleader for these things," said Jane D'Arista, a financial analyst at the Financial Markets Center. "Nothing that came down the pike seemed the least bit troublesome to them."

Editing by Leslie Adler

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