The Great Financial Crisis of 2007-2009 is widely regarded as the worst of its kind in postwar history, with economists claiming that it is only equal to the Great Depression in terms of magnitude and duration. The fear of this aspect has necessitated the need to make parallels between the two series. However, as all margins and metrics are considered, the 1929-1933 recession had a more serious impact on all but one, the financial market, than the current crisis. The parallels in the rapid rise of real estate prices, the flawed financial sector, and notable inequalities have remained the key connections between the 1930s Greta Depression and the 2007 financial crisis.
Background of Both Crises
The Great Depression has since been reported as the deepest and long-lasting crisis in the Western industrialized world based on the associated economic downtown that it epitomized. The case of the United States followed the crashing of the stock market in October 1929 where the Wall Street was sent into a panic leading to many investors losing out. Consumer spending later dropped and there were not many investments with the industrial output falling significantly. Other notable trends included the high unemployment rates and when the Depression reached its nadir in 1933, an estimated half of the world banks failed though president Franklin D. Roosevelt tried to lessen the effects. It was, however, not until 1939 that the American Industry improved following the start of the Second World War with further improvement following the passage of the Social Security Act that served to safeguard for the unemployed, the disabled and the aged.
Meanwhile, the 2007-2009 financial crises is believed to have begun in the summer of 2006 with many agreeing that it traces its roots to the U.S. housing market. The announcement by the public government-sponsored enterprise Federal Home Loan Mortgage Corporation, also known as Freddie Mac that it was no longer in a position to purchase the high-risk mortgages, and the realization that the leading mortgage lender New Century Financial Corporation was filed for bankruptcy . The effect was followed by a number of other high-profile companies being declared bankrupt with IndyMac, Fannie Mae and Freddie Mac, Lehman Brothers, and AIG all facing liquidity crises. One key factor that has been inferred to have caused the 2007 economic downturn is advancement of information technology that resulted in financial motivation by banks. The effect is argued to have made it easier for banks to device tradable securities, which made commercial banks to be intertwined with the shadow banking systems and the financial markets. It is imperative, however, to draw the comparisons between the two generation crises, which can act as a solid basis for preventing future economic setbacks across the globe.
Parallels between Both Crises
One of the similarities when relating the Great Depression to the latest Financial Crisis is that in both cases, there was a flawed financial sector design. In both instances, a fragile banking system that is inherently ill-designed is believed to have played a significant factor in the causation and intensification of economic turmoil. In 1929, the eruption of the Great Depression the US had been the dominant economic powerhouse comparing of many unit banks that meant that banks would operate without branching networks and related office networks (Eigner and Umlauft 4). The prevalence of unit banking is believed to have rendered the US banking system fragile and vulnerable to the great depression. Meanwhile, in the 2007 case, it is reported that the increased generosity in support of the failing banks has been attributed to have made more financial institutions vulnerable. Regarded as the laissez-faire phenomena, Eigner and Umlauft believe that the propensity of governments and the central banks led to more bankruptcy that jeopardized the US economy, in a doctrine described as the too-big-to-fail (TBTF). In both cases therefore, it is noted that the characteristic feature of a flawed financial sector design contributed to the banking sector becoming vulnerable.
Real estate bubbles and a rise in debts have also been described as a parallel between the 1929-1933 and the 2007-2009 banking crises that shook the world. The accumulation of private debt in both cases became manifested in the form of an accumulation of mortgage debt following the rise in house prices. Eigner and Umlauft note that in the 1920s Florida underwent a massive real estate boom that was indicated by the value of housing permits. The effect was not specific to Florida as Miami and Manhattan also recorded increased in real house prices between 1922 and 1926. The population was thus responsive and was willing to buy into the booming real estate prices, which resulted in mortgage financing and repayment problems and a stifling credit supply. The end was an erosion in the lensing standards. Comparatively, in the 2007 scenario, it is reported that house prices almost doubled the 1920s case, which led to an erosion of lending terms. In the latest crisis, there was an associated rise in unconventional terms that was manifested by interest-only and low or no-doc that increased from 0 to 37.80 percent and 28.5 to 50.70 percent respectively between 2001 and 2005 . It is inferred that by every measure the real estate securities ended up being toxic as in the 1930s and ceased to be traded after 1929 and 2007.
The last feature that is worth highlighting as a notable parallel between the past and the present financial crises is the rise in inequality measured by the share of total income. Through the use of a model, it is described that inequality led to bubbles that were associated with sharp increase in wealth inequalities and a consequent rise in debt-to-income proportions. The lower and the middle-income populations were the most affected as investors used their increased income to acquire assets. The effect led to loans to workers and the growing increase in credit intermediation resulted in workers striving to compensate their declining incomes, resulting in a critical income inequality . With the growing consumption to inequality and rising debt-to-income ratios, the effect was more financial rigidity hat eventually culminated in a financial crisis.
Course of Action for the Present
The suggested solution to the recent crisis that economist believe would save the global economy from undergoing outcomes similar to those noted in the Great Depression involve the idea of bail out. Defined as the act of offering fix boost to bankrupt and failing businesses, the idea has since been described in different dimensions. One of the suggested solutions involves the injection of funds in exchange for an equity stake through the use of cash and other instruments (Honohan 8). The alternative approach entails protecting the senior creditors while diluting the other less developed shareholders with the degree of dilution being dependent on the price of equity . An alternative solution involves opting not to provide cash to the threatened business but instead a guarantee of creditors through the government. Usually, guarantees have necessitated the issuance of a premium payment that is met by the covered banks. In case the guarantee shows a profit following the guarantee process, it is likely to have also benefited the creditors and the shareholders at a go. The last plausible way of overcoming the threat of the Great Depression through bail out would involve targeting the creditors through the government’s acquisition of problems assets at an above-average market prince. The strategy is comparable to the German bank Hypo RE in 2009 where the Hypo Real Estate was targeted by the German Government.
In summary, it is noted that the Great Depression that occurred in the 1920s is comparable to the Financial Crisis that featured in 2007. The three commonalities that exist are described in the consideration of the flawed financial systems, the bubbling of real estate princes, and a characteristic increase in inequality. While the causing factors differed, the outcomes of the three effects resulted in major economic challenges across the globe which have formed a pivotal point for learning lessons. To prevent the chance of a similar crisis to the one in the 1929-1933 era, it is recommended that the government should be involved in both cash and credit bailing out of vulnerable companies and financial institutions.
A&E Television Networks, LLC. “The Great Depression.” History.com (2017): n. pag. Web.
Eigner, Peter, and Thomas Umlauft. “The Great Depressions of the 1929-1933 and the 2007-2009. Parallels, Differences and Policy Lessons.” University of Vienna (2014): n. pag. Web.
Honohan, Patrick. “Management and Resolution of Banking Crises: Lessons from Recent European Experience.” Peterson Institutte for International Economics (2017): n. pag. Web.
Thakor, Anjan V. “The Financial Crisis of 2007–2009: Why Did It Happen and What Did We Learn?” Review of Corporate Finance Studies (2015): n. pag. Web.