In 1928, an election year, discussion of the national economy was a popular topic of conversation. At the time, such discussion was limited to print media, with very little news on the fairly new invention of the radio. There was no television, Internet or email to aide in the dissemination of news stories.
By 1929, new president Herbert Hoover was relishing in a vibrant economy, despite problems with Prohibition. Among those problems was the elimination of taxes collected by states and communities on the sale of alcoholic beverages, including beer.
Only seven months after taking office, Hoover was shaken by the news that the NYSE had a catastrophic loss. Though this triggered the Depression Era, it did not directly cause it.
As businesses, large and small collapsed in subsequent weeks, huge layoffs and spiking unemployment reduced the volume of deposits held in America’s banks. Fearing the collapse of banks, which were much more local than national or regional then, people would, on the basis of usually untrue rumors, rush to the bank to remove their funds, believing that banks held the money on account. These rushes could rarely be covered by the bank because the money on deposit was actually loaned to others for mortgages, business loans and so on. Banks would shut their doors and usually, never open them again.
Unable to get their money, Americans became depressed. Unemployed, often starving, many who had previously been successful found themselves begging on street corners, wearing tattered clothes and struggling every day to find food. Crime rose, with organized crime becoming a sancturary for those who would work for them. Prohibition, previously an annoyance, became a boon to criminals who found ways to produce or import liquor for underground sales. Between 1930 and 1933, the nation’s crime rate more than tripled.
This was the era of bathtub gin. Where alcoholic concoctions made from anything that could be found were produced and bottled, any place the could be made out of the eyes of the law. From stills hidden in Appalachian farms, to gin made in homes in the outer boroughs of New York City or suburbs of Boston, Philadelpha, Chicago and so on. An underground economy had been created to replace that which previously existed in the mainstream. In the entire time Prohibition existed, alcoholic beverage consumption only dropped by 10 percent. Though the income from taxes normally collected by states had dropped to zero. Compounding this was the increased cost to local municipalities and states of police actions to curb the rising crime rate.
While entire economies were created in the underground world, the public continued suffering. Bad weather in the American heartland hurt crops and killed thousands. Supplies of corn, wheat, beef, pork and chickens were cut and the nation was, by 1932, starving. At a time when ten cents could by a meal, the term “Brother, can you spare a dime?” became a popular phrase.
In 1932, Franklin Roosevelt was elected on a platform of “A New Deal”. Despite sound economic policies and extensive efforts to revive and secure the nation’s economy, the public remained depressed. Even the repeal of Prohibition didn’t solve the problems. People remained ‘jittery’ about their future, if they survived the crisis at all.
In the first few months of Roosevelt’s administration, his government created the Federal Deposit Insurance Corporation, to insure the deposits of Americans in remaining banks, giving the public a sense of security for their money. The Securities and Exchange Commission was also created, to regulate and monitor securities fraud and companies trading on the markets, as well as those individuals who sold securities. These steps restored faith in the public, but the damage had been done. More than three years of serious depression are not going to be forgotten, nor cured quickly.
In fact, the only true cure for the Depression of the 1930’s was World War II, with massive Federal spending on munitions and defense.
Though America is not in the same conditions we were in back in ’29, like 1928, the public is being bombarded with repetitions of how bad things are in the public discourse known as Presidential Elections. Each election cycle, this serves to put the public in a nervous state, a condition sought by politicians, who claim they can resolve the problems that cause your anxieties.
In recent years, several banks and mortgage companies had changed their business model hoping to increase sales by outsourcing their mortgage sales to brokers who were not subject to the same regulations. Brokers, seeking commissions developed the sub-prime market, where they would represent a mortgage candidate to the bank and help someone without the resources to obtain a mortgage. No thought was given to the mortgagee’s ability to pay and soon, they found themselves unable to meet their obligations. Adding to this, a new product called a 5/1 ARM was sold as the solution… people would be able to have a low interest rate locked in for 5 years before it would rise.
Unfortunately, people would miss payments and the banks would raise rates. If they did complete the five year at the fixed rate, the subsequent increase was often huge, causing massive personal bankruptcies and forcing banks to charge off billions of dollars in bad loans.
As the news of the sub-prime mortgage mess became public, real estate values, which had been on the rise for years, suddenly dropped. In some cases by more than 20 percent in a year Now in reality, this is simply a market correction of the over-inflated values placed on property because of the real estate boom, which was in turn prompted by banks selling more mortgages than they should to underqualified people.
As real estate values dropped, bank foreclosed properties were not selling, compounding the banks inability to recover losses.
This crisis is going to have serious ripple effects, only now becoming evident. Just as in the ’20’s with the loss of revenue to states and municipalities over Prohibition, local governments are now seeing dramatic lowering of real estate tax revenues. First, from appeals because the tax assessment is based on a higher value than the property is currently worth, and secondarily, from the increased numbers of bankruptcies as more and more people default on their property and fail to pay taxes.
People who are successful in business and pledged their homes or other real estate as collateral are discovering, slowly, that banks are getting nervous about the value of the pleged property today, as compared to the loan originaiton date.
Small businesses are failing at a higher rate, particularly restaurants, construction companies, home building and hardware stores, and home related services. As these fail, banks are forced to take large charge offs. The total we expect to discover for 2007 could be between $35 and 45 Billion (yes, with a “B”). Combined with billions charged off from bad mortgages and our banks are in serious trouble.
A STORM IS COMING
Normally, the cure to economic crises is war. This prompts government to dump large volumes of money into the economy to supply the military. In times past, with the draft, the unemployed would find themselves in the military, fed, clothed and out of their economic crisis.
We’re already in two simultaneous wars. There is no more draft and we have an all volunteer military.
The preseidents of Venezuela and Iran, two of the largest oil producers are working in unison to drive the price of oil high, recently reaching $100 a barrel for the first time. Normally, spikes in oil prices occur in summer, but this one is happening in the dead of winter, prompting us to believe that oil could reach $150 to $200 a barrel by summer. This factor alone could trigger an economic depression, though in our consideration of such a dramatic statement, we’ve considered other factors.
Being a political year, it is possible that Al-Qaeda could attempt another dramatic terrorist attack, here or abroad, to upset elections. We saw them do so in Spain in 2004, attacking a train. Attempts to bring about the collapse of the Blair government in Britain with terrorist attacks were thrwarted, fortunately.
We’re also seeing problems with decreased spending by state and municipal governments caused by reduced revenues. Budgets will be curtailed, taxes raised and services eliminated or reduced. This happened already in 2007 in New Jersey, with a budget crisis that forced an increase in sales tax by a full percent and prompted local municipalities to attempt to raise real estate and other local taxes.
Decreases not only in new home building, but in repairs and renovations are also causing us to believe depression may be looming. As people fail to care for their properties as they did, values will further decrease leading to a longer term devaluation than a short term market correction.
The price of gold recently hit an all-time high and is expected to reach close to $1000 an ounce this year. Gold is a leading indicator of the value of our currency, even though the dollar is no longer pegged to the price of gold. It is seen as a secure investment for those seeking to protect assets in case of inflation or continued devaluation of the dollar.
And finally, there’s politics to consider. We’ve just been through the Iowa Caucuses, and New Hampshire, a more telling indicator, we feel, is three days hence. As the political season heats up, and we reach summer, we’ll be seeing more and more nervousness in the American public as discussion of the economy puts everyone on the edge of their seats. Keeping in mind that a standard political technique to garner votes is to create fear then try to allay it by presenting a policy to solve your problems, we feel the election season will be a significant factor in whether the nation slips from the current recession, now in slow motion since June of 2007, to a state of economic depression.
While there’s nothing to fear at this point, one should consider protecting your assets by balancing portfolios. Keeping the elections this year in mind, we believe the phrase “It’s the Economy, Stupid!” will have new meaning and importance in ’08.