Vernon Smith: "We're witnessing the second great consumer debt crash"

Matt Welch | April 6, 2009

Fascinating, numbers-rich piece in today's Wall Street Journal by economists Vernon L. Smith and Steven Gjerstad, that begins by trying to figure out why the 2000 dot-com collapse and the 2006 housing bubble implosion affected the economy so differently, and ends with a new theory about the Great Depression (not to mention the Great Whatever It Is We're Experiencing Now): It's the consumer debt, stupid. Fast forward to the conclusion:

The events of the past 10 years have an eerie similarity to the period leading up to the Great Depression. Total mortgage debt outstanding increased from $9.35 billion in 1920 to $29.44 billion in 1929. In 1920, residential mortgage debt was 10.2% of household wealth; by 1929, it was 27.2% of household wealth.

Bank earnings reached a record $729 million in 1929. Yet bank exposures to real estate were substantial; as the decline in real estate prices accelerated, foreclosures wiped out banks by the thousands. Had the mounting difficulties of the banks and the final collapse of the banking system in the "Bank Holiday" in March 1933 been caused by contraction of the money supply, as Milton Friedman and Anna Schwartz argued, then the massive injections of liquidity over the past 18 months should have averted the collapse of the financial market during this current crisis.

The causes of the Great Depression need more study, but the claims that losses on stock-market speculation and a monetary contraction caused the decline of the banking system both seem inadequate. It appears that both the Great Depression and the current crisis had their origins in excessive consumer debt -- especially mortgage debt -- that was transmitted into the financial sector during a sharp downturn. [...]

The hypothesis we propose is that a financial crisis that originates in consumer debt, especially consumer debt concentrated at the low end of the wealth and income distribution, can be transmitted quickly and forcefully into the financial system. It appears that we're witnessing the second great consumer debt crash, the end of a massive consumption binge.

Whole thing, chock full o' detail, here. Nick Gillespie and Michael Lynch interviewed Vernon Smith for Reason in 2002.

Comments

|4.6.09 @ 8:21AM|#

Great Whatever It Is We're Experiencing Now

Let's call it the Great Denial.

Good post. Good article.

The Average Voter|4.6.09 @ 8:31AM|#

So does that mean we get a rebate check this year?

|4.6.09 @ 8:36AM|#

Great Whatever It Is We're Experiencing Now

It's called the Great Change. Or, the Great Hope and Change.

Warty|4.6.09 @ 8:41AM|#

Great Whatever It Is We're Experiencing Now

The Great WTF Mate?

jtuf|4.6.09 @ 8:50AM|#

The suggestion that excessive mortgage debt primes the economy for a collapse is interesting. If true, it is yet one more reason to end the tax break for the interest on home mortgages.

Other Matt|4.6.09 @ 8:54AM|#

Very good article.

it is yet one more reason to end the tax break for the interest on home mortgages.

Let's go all the way to a flat tax.

Bronwyn|4.6.09 @ 8:56AM|#

The Great Fuck You, American Express.

Dirty, rotten, insulting bastards.

Bronwyn|4.6.09 @ 8:57AM|#

Great article... sorry, didn't mean to let my bitter overflow there. Pardon me while I bottle it back up.

Other Matt|4.6.09 @ 9:00AM|#

sorry, didn't mean to let my bitter overflow there

That's ok, when it comes to AMEX, as far as I'm concerned you're among friends.

Just wanna know|4.6.09 @ 9:03AM|#

What's wrong with Amex? Not a challenge; an inquiry from one who admits to being uninformed.

|4.6.09 @ 9:07AM|#

Great. I guess this means we need to hope for a war that devastates all our economic competitors. It worked before.

|4.6.09 @ 9:13AM|#

What I took out of the excepts was that loaning money to people that don't qualify for those loans is a bad idea. And until they were forced to they didn't loan them the money. Good thing Barney Frank is on top of this crisis then......

Jerry|4.6.09 @ 9:14AM|#

I'd call it the Great Redefinement.

High Every Body|4.6.09 @ 9:17AM|#

Good thing Barney Frank is on top of this crisis then again

Mark|4.6.09 @ 9:21AM|#

I'm surprised -- in the 80s, when I was in grade school, this is what they taught us the Great Depression was all about. They focused on installment buying, not mortgages, but it was all about consumer debt. Is this a new theory, or a rediscovered theory?

Cabeza De Vaca|4.6.09 @ 9:28AM|#

"I'm surprised -- in the 80s, when I was in grade school, this is what they taught us the Great Depression was all about. They focused on installment buying, not mortgages, but it was all about consumer debt. Is this a new theory, or a rediscovered theory?"

This is what my grandfather always said caused the great depression. So maybe it is just a rediscovered theory.

dhex|4.6.09 @ 10:35AM|#

that had been the narrative i got in grade school as well.

|4.6.09 @ 10:52AM|#

If true, it is yet one more reason to end the tax break for the interest on home mortgages.

Revenue neutral (combined with a cut in the top marginal rates), I would agree.

As part of a flat tax, I would agree even more.

Bronwyn|4.6.09 @ 11:09AM|#

Just wanna know...

I can't speak for everyone, but I hate Amex because, after 20 (hubby) and 10 (me) years of perfect credit history with the company, we both got Saturday morning phone calls telling us we were no longer allowed to use our cards with them.

Actually, they did that with two of our three accounts. On my Blue card, they just emailed a notification that my limit had been lowered to (shock!) just a few dollars above the balance.

When pressed to tell us when, exactly, we'd ever been late with a payment, they had to reply "never". Have we ever been delinquent? "Never." Have we always paid more than the minimum? "Always."

But yet you still choose to insult us like this?

"Don't take it personally."

Pardon the fuck outta me, but this is about as personal as it gets. Close my accounts immediately.

So now I've got no credit whatsoever. Just a mortgage.

So yeah. Fuck you, AmEx. My wish is for everyone with an AmEx card to cancel it. I won't advocate defaulting (although the devil in me says "do it!") because that's tantamount to theft. But I do advocate giving them the finger and taking your business elsewhere.

/rant over
//bitter bottled

Blow Wind Blow|4.6.09 @ 11:56AM|#

This is what we get for giving people access to credit in lieu of pay raises.

T|4.6.09 @ 12:15PM|#

If true, it is yet one more reason to end the tax break for the interest on home mortgages.

Gahhh. Don't do that. I already pay enough in taxes. If it weren't for that and charitable deductions, I'd get really hosed.

ChrisO|4.6.09 @ 12:37PM|#

Once a consumer debt bubble has crashed, all "massive injections of liquidity" do is attempt to reinflate the bubble. Without underlying productivity gain to support such hyper-inflated spending, that's a terrible idea.

If the tax code needs to be modified, then maybe it should be rebalanced to favor saving rather than consuming. Increased savings would seemingly do more to put the financial industry on a good footing than yet more funny money would.

robc|4.6.09 @ 1:27PM|#

ChrisO,

Lets see, what form of taxation would best encourage saving? I know, a consumption tax.

Of course, I cant support the Fair Tax or equivalent unless it includes a repeal of the 16th amendment. Otherwise, we will get both.

|4.6.09 @ 1:34PM|#

I'd be happy to have both. Let them tax the economy until it breaks for good. At this point, it's the only way this crap is going to be seen for what it is. Things have too much momentum now to turn back - it'll be better sooner if it gets worse sooner.

|4.6.09 @ 1:38PM|#

If the tax code needs to be modified, then maybe it should be rebalanced to favor saving rather than consuming. Increased savings would seemingly do more to put the financial industry on a good footing than yet more funny money would.

the tax code already favors saving via tax deductions for 401k's, IRA's etc. It doesn't favor consuming - if anything with state sales tax, consumption is more heavily taxed. Increased savings rates could help shore up banks balance sheets, but no more so than "funny money" loans from the government - they are identical from the banks perspective.

Craig|4.6.09 @ 1:54PM|#

Let's go all the way to a flat tax.

Let's go all the way to no tax slavery at all, and find voluntary means for people to pay for services currently provided by the government, to the extent there really is a consumer demand for them.

T|4.6.09 @ 1:59PM|#

Let's go all the way to no tax slavery at all, and find voluntary means for people to pay for services currently provided by the government, to the extent there really is a consumer demand for them.

Hush with your crazy talk, son. Don't you know adults are talking about their improbable tax schemes?

Other Matt|4.6.09 @ 2:08PM|#

So yeah. Fuck you, AmEx.

My problem stems from about 15 yrs ago. I contested a charge, but I was in the throes of moving (leaving the military) and divorce, so my address changed a number of times. Fuckers put me as a "paid collection" though it 1) never went to collection and 2) I was right. It's the only thing that I have ever had to register a statement on my report, I had documents proving them wrong, they just didn't care to make it right.

Fuck them. I'm glad to see they're up to their same standard shit even though it's 15 yrs later.

Other Matt|4.6.09 @ 2:09PM|#

Let's go all the way to no tax slavery at all, and find voluntary means for people to pay for services currently provided by the government, to the extent there really is a consumer demand for them.

That would cause a mess with all the exploding skulls from the obamanites. At least with a flat tax, there is still a tax, so they can keep talking about "just a lil bit"

Amex Sucks?|4.6.09 @ 3:12PM|#

I'm not sure if Amex is screwing with me, too. Last year someone stole my identity, opening a couple of bogus store credit cards. As a result Amex lowered my limit. So far, so good; I can see why they'd do that.

After spending months clearing up the ID theft, I call them to ask if they can reinstate my former credit limit. They tell me I have to wait a year before they'll consider it. Is that standard procedure for credit card companies, or are they being dicks?

T|4.6.09 @ 3:18PM|#

Is that standard procedure for credit card companies, or are they being dicks?

It's AMEX. They're being dicks. If you have a choice with AMEX, always go with that as your first option.

Bronwyn|4.6.09 @ 3:42PM|#

Second that: Dicks.

What weird is that, just a few years ago they were pleased as punch to honor my request for a lower interest rate. I got them to do it twice in two years.

They've made boucoups bucks from me and my husband, and we've enjoyed some great rewards. We thought we had a good relationship, until they showed just how much we really meant to them.

It's left us bitter, like after a dirty breakup.

ChrisO|4.6.09 @ 5:24PM|#

the tax code already favors saving via tax deductions for 401k's, IRA's etc. It doesn't favor consuming - if anything with state sales tax, consumption is more heavily taxed. Increased savings rates could help shore up banks balance sheets, but no more so than "funny money" loans from the government - they are identical from the banks perspective.

You're probably right about the latter. I was thinking more systemically, rather than just in regard to the banks alone. As a society, we simply cannot go on as we have been, regardless of whether the funny money comes from sovereign wealth funds or is printed out of thin air by the feds. At some point, we have to produce something of value.

As to taxes, they are levied heavily on both the consumption and production sides. Getting rid of the federal income and capital gains taxes and replacing them with a sales tax (or with nothing at all in my libertarian paradise) would seemingly be the better course.