As we mark the 80th anniversary of the 1929 stock market crash, dubbed “Black Tuesday,” many public officials are breathing a sigh of relief. The collapse of Lehman Brothers last September sparked a panic that nearly brought down the global financial system and triggered fears of a second Great Depression.
Fortunately, policy makers gleaned important lessons from the events that began eight decades ago. Fiscal policy reacted quickly to stimulate the economy. The Federal Reserve Board, headed by an academic expert on the 1930s, reduced interest rates dramatically and used novel strategies to counteract the near-disappearance of private credit. And rather than pursuing a beggar-thy-neighbor strategy, the world’s leading economic powers coordinated their responses—not perfectly, but well enough.
It is one thing to manage a crisis so as to avert disaster; quite another to remedy the ills that produced the crisis. After 1933, we adopted a host of financial reforms, including the Securities and Exchange Commission, the Federal Deposit Insurance Corporation and the separation of commercial banking from investment banking. A second wave of innovation at the end of World War II helped coordinate international exchange rates and fostered a more open international trade regime.
Over the past few decades, however, some of this regulatory architecture was dismantled, and economic changes rendered much of the rest obsolete. When major imbalances developed earlier this decade, we were poorly equipped to take preemptive action. The question before us now is whether we and other nations can learn the appropriate lessons from our economic near-death experience and usher in a new era of institutional reform.
The early signs are mixed at best. Interest group resistance has already watered down the bold reforms that the Obama administration and some congressional leaders have proposed. The recent flap over huge bonuses for Wall Street executives suggests a disturbingly rapid reversion to business as usual. If mass unemployment, millions of housing foreclosures, the loss of trillions of dollars in household assets, and the bankruptcy or forced merger of major financial institutions are not enough to jar the system out of its complacency, one wonders what would.
Some economists believe that booms, busts and bubbles are not avoidable excesses but rather inhere in the DNA of market economies. In the long run, they may turn out to be right. In the here and now, however, our political system has a duty to act against the obvious abuses that crept into the mortgage industry and securitization markets. It wouldn’t hurt if households spent less, saved more and paid down debt—at least until their balance sheets stabilize. If we can’t wholly avoid market-driven excess, at least we can mitigate its effects. The alternative to serious, sometimes painful reform is another—perhaps even worse—crisis down the road.