- While no two financial and economic crises have been exactly alike, most share certain characteristics: Political and monetary policy errors, loss of investor confidence, and rising risk aversion. But past crises also ultimately ushered in a new age of economic growth and prosperity of varying length — hopefully with many lessons learned.
- Even in the absence of a severe crisis, uncertainties are ever-present. Investor moods regularly vacillate between fear and greed, and financial markets can exhibit heightened volatility for extended periods of time.
- No matter the economic or market environment, it’s important that investors focus on their personal investment goals — in the context of a time horizon that’s most appropriate to their circumstances — adhering to a well-designed asset allocation strategy, and employing a rebalancing discipline to capitalize on market volatility.
U.S. economic and financial crises have been a recurring reality throughout history, pervading the U.S. economy since it was formed nearly 250 years ago. Each new crisis tends to invite comparisons to past recessions — especially the Great Depression that began in 1929, but also the malaise of the 1970s and early 1980s and the global financial crisis of 2008 to 2009.
While no two periods of severe turbulence have been exactly alike, varying widely in size, scope, cause and length, they do tend to share common characteristics:
- Political and monetary policy errors
- Loss of confidence in the banking and financial sector
- Rising investor risk aversion
They also ultimately ushered in new ages of economic growth and prosperity of varying lengths, offering lessons to be learned.
The Great Depression: 1929 to 1939
The Great Depression is the ultimate benchmark for financial and economic crises, primarily because of its depth and duration. Officially beginning in 1929 following the infamously devastating stock-market crash, it spanned a total of nine years and involved two deep recessions (one from 1929 to 1933 and another from 1937 to 1938). As economist Robert Margo has put it, “The Great Depression is to economics what the Big Bang is to physics…and it continues to haunt successive generations of economists.” 1
While its causes are still hotly debated, there’s fairly widespread agreement that an initially mild recession prior to the 1929 stock-market crash was exacerbated by subsequent policy errors, including a global tariff and trade war as well as tightening measures by the Federal Reserve (Fed) and Bank of France (BoF). Exhibit 1 depicts the sharp downturn and long recovery in U.S. trade.
The policy moves of the Fed and BoF threatened to push worldwide prices of goods and services to a level not seen since before the start of World War I in 1914, causing massive deflation. History offered a warning against taking such actions: The Bank of England enacted similar measures around 1920, then changed course as they threatened to throw the world into depression. But new generations of leadership at the Fed and BoF overlooked that lesson. By the mid-1930s most countries abandoned the so-called gold standard (which established an international benchmark for the value of gold and other currencies) in order to provide their economies with some relief from deflation.
As the Depression era unfolded, unemployment soared well into double digits across much of the world, productive capacity was idled, and deflation (which causes nominal revenues and income to fall while debt-servicing costs typically remain fixed) triggered recurrent financial and banking crises. As a result, creditors eventually became insolvent, banks’ assets (loans) started to go bad, and depositors all at once tried to pull their money out of failing banks. The number of bank failures that occurred during the Great Depression remains a staggering figure to this day. The situation became so dire that people largely abandoned check writing, and most transactions were executed with cash or via bartering.
All three catalysts typically responsible for financial and economic turbulence were clearly at work:
- Political and monetary policy errors: The hands-off approach of President Herbert Hoover’s administration at the Great Depression’s onset in 1929 is perhaps the most distinguishing feature of the historic crisis. Since then, the U.S. government and Fed have taken much more active roles in mitigating periods of turbulence.
- Loss of confidence in the banking and financial sector: More than 9,800 banks failed from 1929 through 1934 because of so-called bank runs, which is when bank customers try to withdraw more money than the bank can provide. For comparison: Less than 500 banks failed during a comparable six-year period that began in 2008 and included the most acute phase of the global financial crisis, according to the Federal Deposit Insurance Corp (FDIC). Banks runs, common during the Depression, are all but a thing of the past—primarily due to the backstop provided by the FDIC, which was created at depths of the Great Depression in 1933.
- Rising investor risk aversion: The Dow Jones Industrial Average (DJIA), the price-weighted average of 30 large U.S.-based stocks, plummeted by 91% from 1929 to 1932 — reflecting plunging investor confidence and rising risk aversion. (It’s worth noting, however, that this followed an incredible eight-year surge in stock prices, during which the Dow rose nearly 500%).
The Great Inflation: 1965 to early 1980s
Between the Great Depression and the Global Financial Crisis of 2007-2009, the two longest U.S. recessions each lasted 16 months — the first from November 1973 through March 1975 and the second spanning July 1981 through November 1982. In both periods, high inflation accompanied steep and volatile unemployment and interest-rate levels — contributing to uncertainty among policymakers and a general malaise in financial markets. Before entering recession in the 1970s, the stock market had already exhibited significant volatility for nearly a decade (since 1965); it remained range-bound for almost 10 more years until finally springing back to life after the early-1980s recession. This macroeconomic era is known as the Great Inflation.
The early 1970s were arguably one of the bleakest periods for Americans during the second half of the 20th century. Mired in the Vietnam War, which had already spanned more than 10 years, the nation endured a confluence of several crises. In 1973, the Bretton Woods international monetary system that was forged in the wake of World War II collapsed. In 1974, the Watergate scandal ultimately brought down U.S. President Richard Nixon.
Meanwhile, a full-scale energy crisis began to grip our nation in 1973. Not only did oil prices quadruple in the wake of Saudi Arabia’s emergence as the world’s swing producer and marginal price setter of crude oil in its role as the effective leader of the Organization of the Petroleum Exporting Countries (OPEC), but there was also a shortage in oil supply. Long lines were common at gas stations, gasoline was rationed, and the U.S. government made matters worse by putting price controls in place.
During this period, Baby Boomers across many developed economies began entering their household formation years en masse, propelling household and consumer credit into a four-decade expansion.
- Markets: During the bear market of 1973 to 1974, the DJIA lost 45% of its value in less than 23 months.
- Inflation: Inflation began to soar in 1973; after averaging about 3.3% annually for 10 years, it hit 6.2% in 1973, 11% in 1974, and 9.1% in 1975. This was a somewhat new and frightening concept to many Americans. The U.S. had not experienced rising inflation to this extent since the post-war years of 1946 to 1948 (Exhibit 2 on the following page).
- Labor market: In November of 1973, the unemployment rate stood at a rather benign 4.8%. One year later, in November 1974, unemployment increased to 6.6%. The rate continued to rise until hitting 9% in May 1975 (two months following the end of that recession), before slowly falling below 8% by January 1976.
All of these factors presented a quadruple whammy to 1970s America: High unemployment, rising prices, an energy crisis, and turmoil at the highest levels of our government.
By late 1979, unemployment had fallen below 6% once again — but then crept back upward during a short recession that began in January and ended in July of 1980. Inflation hit a 33-year high, having jumped from 7.6% in 1978 to 11.3% in 1979, before ultimately reaching 13.5% in 1980. But this was not a typical case of inflation. This was “stagflation,” when high inflation and economic stagnation occur simultaneously, and it began in the wake of the energy crisis of 1979.
Although not as severe as the 1973 energy crisis, the 1979 version came amid major tensions in the Middle East, including a revolution in Iran, a war between Iran and Iraq, and the taking of American hostages in Iran.
As the U.S. economy worsened, unemployment breached the 8% mark by late 1981 and hit 10.8% by November of 1982. In fact, from September 1982 until June 1983, there were 10 consecutive months of 10%+ unemployment — including 7 months after the recession “officially” ended in November, 1982.
- Banking: The 1980-to-1982 period was also marked by a banking crisis. Following a wave of deregulation, banks were able to lend money more broadly beginning in 1980. As the economy worsened and defaults mounted, banks began to fail at alarming rates. Meanwhile, the savings and loans (S&L) industry was also suffering at the hands of the worsening economy, leading to hundreds of failed S&L institutions.
The U.S. government responded to the S&L crisis by creating the Resolution Trust Corporation (RTC), which ensured that failed institutions were unwound in an orderly fashion. The RTC exemplifies the increased willingness of governments to intervene in financial crises following the Depression era. That is not to say, however, that post-Depression policy approaches have necessarily been flawless. Some may argue that these more recent crisis-era policy decisions have actually fostered a proclivity for deregulation and excessive risk-taking, as there have been many similar financial
crises around the world in the last 40 years.
- Government intervention: The Fed played a huge role in the early 1980s’ economic crisis. In an effort to halt rampant inflation, Chairman Paul Volcker raised the fed-funds rate to as high as 20% in 1980—taking the country into recession, for all intents and purposes, in order to tame inflation.
- Markets: The DJIA fell from its peak by 24% during the 1981-to-1982 recession,
before recovering substantially beginning in mid-1982 to start of the great bull
market of the 1980s.
The Global Financial Crisis: 2007 to 2009
Perhaps the darkest economic period since the 1930s began in 2007, when a housing and credit crisis started to push the U.S. economy into recession and financial markets subsequently plummeted around the world. The most acute phase of the Global Financial Crisis lasted from 2008 to 2009. At this time, concerns about the fragility of the global banking system grew to a fever pitch amid a near-total freeze of credit markets.
Several years before the onset of the Global Financial Crisis, its origins began in the U.S. mortgage market. Loose bank-lending standards helped households gorge on credit, and, shortly after home prices peaked in 2006, mortgage-payment delinquencies began to rise. The global banking network for trading in U.S. mortgage-related securities and other credit instruments became the channel by which financial institutions around the world were hit with losses triggered by rising defaults on U.S. loans.
Major global banks were caught short of liquidity on a combination of growing losses, an unwillingness to trade, uncertainty about how to value mortgage-related securities after the market evaporated, and scarce credit. This forced a raft of bankruptcies, acquisitions and restructurings — with varying degrees of government support—which affected many of the largest financial institutions in the country.
Households were forced to start deleveraging (that is, attempt to reduce their debt) after over-borrowing during the housing boom and as sharper lending restrictions made it harder for banks to issue new loans. Total U.S. consumer credit contracted for two consecutive years beginning in July 2008.
The damaging after-effects lasted for many years and spread far beyond banks and consumer finances. The U.S. unemployment rate doubled from 5.0% in December 2007 at the start of the recession to a peak of 10.0% in October 2009, and then took until September 2015 to return to 5.0%.
Oil prices skyrocketed: The West-Texas Intermediate spot price hit an all-time high of $145 per barrel in July 2008 — just as the seriousness of the strain on the financial system was becoming apparent. This period of concern about inflation gave way to fear of deflation, as the oil price collapsed to $30 per barrel before the end of 2008 amid a sharp economic slowdown.
Globally, advanced economies — particularly those of the U.S. and Europe — suffered outright contractions (Exhibit 4). Many emerging-market economies saw their high pre-crisis growth rates diminish. In fact, overall global growth took an extended hit in the post-crisis era: World gross domestic product in the four years after 2009 averaged 3.2%, a full percentage point lower than that of the four years preceding 2008.
- Banking: More banks failed in the 1980s and early 1990s than during the Global Financial Crisis. However, the banks that failed during the latter period were much larger in terms of assets. Exhibit 5 illustrates this difference in concentration.
Major banks were disproportionately exposed to mortgage-related securities of questionable value. Mortgage delinquency rates at the top 100 U.S. banks (by assets) spiked from about 2% in 2006 to more than 12% in 2010; but they only climbed to about 4.5% out among other U.S. banks despite starting at similar levels.
- Government intervention: During the depths of the Global Financial Crisis, most government involvement was aimed at increasing the provision of liquidity to the banking system. In early 2008, the Fed and U.S. Treasury Department began establishing a series of lending facilities (that is, financial assistance programs meant to help financial institutions seeking capital) in an effort to soften the fallout from liquidity shortages.
Additionally, beginning in late 2008, the Fed’s quantitative easing program (QE) and the Treasury Department’s Troubled Asset Relief Program (TARP) were used to conduct outright asset purchases and lasted for several years. With QE, the Fed’s balance sheet increased from less than $1 trillion in the first half of 2008 to $4.5 trillion in 2015 as it primarily purchased mortgage-backed securities and U.S. Treasurys. As for TARP funds, more than $400 billion were used beginning in late 2008 — primarily to purchase ownership stakes in financial institutions, automakers and illiquid assets — through late 2009, when the Treasury Department began to sell off these holdings until finishing in 2014.
The Fed also lowered its benchmark fed funds rate in 2008 to a range between zero and 0.25%, where it remained until the end of 2015 in order to help encourage credit-market activity.
In terms of more direct fiscal stimulus, the American Recovery and Reinvestment Act (known as the Recovery Act) was implemented at the beginning of then-President Barack Obama’s first term and provided about $800 billion in relief. Tax cuts — the Recovery Act’s largest allocation — totaled about $300 billion alone; state aid for Medicaid represented another $90 billion. Work-related programs, including extended unemployment insurance and infrastructure projects, were allocated about $70 billion and $60 billion, respectively.
All of this activity represented an explicit effort by the U.S. government to avoid the inadequate interventions of past leadership, which had only served to prolong the Great Depression and other periods of significant economic hardship.
The immediate aftermath of the Global Financial Crisis was marked by fears that governments globally would go too far in their efforts to stimulate their economies — stoking hyper-inflation and increasing their national debts along the way. With the benefit of hindsight, we can see that such concerns about sharp inflation increases were unfounded. Furthermore, calls to restrain government spending likely only served to repeat the mistake of premature austerity that caused a “recession within a depression” from 1937 to 1938.
- Markets: The S&P 500 Index declined by 57% from October 2007 to March 2009. This was its second-largest selloff since 19282, after the 83% plummet from 1930 to 1932. In reality, the bear market that accompanied the Global Financial Crisis was nearly identical in size to the 55% selloff that took place during the 1937-to-1938 recession.
In terms of intensity, the spiking volatility and sickening market plunges of autumn 2008 ranked among the most severe in the recorded history of U.S. stocks. This period gave us three of the top-10 one-day losses since 1928, reminiscent of Depression-era volatility. October 2008 also gave us two of the top-10 one-day gains since 1928 (11.58% on October 13 and 10.79% on October 28 of 2008).
We’re often warned about the perils of adopting the sentiment that “this time it’s different.”
But we do believe that each major economic crisis is unique, even if it shares features with other crises. Each presents a distinct set of challenges that combine to create difficult economic and political circumstances, market volatility — and subsequent investor fear and uncertainty.
Common characteristics of crises include:
- Ever-present political and financial uncertainties
- Investors vacillating between fear and greed, bouncing between risk-on and risk-off
- Stock markets moving in a volatile manner for an extended period of time
During challenging and turbulent market environments, we believe it is important for investors to:
- Stay focused on a time horizon appropriate to their circumstances.
- Adhere to a well-designed asset-allocation strategy, adjusting it as circumstances change.
- Maintain a sound rebalancing discipline that can take advantage of market volatility.
1 “Employment and Unemployment in the 1930s.” Margo, Robert A. Journal of Economic Perspectivse, Vol. 7, Num. 2, Spring 1993, Pgs. 41-59.
2 The earliest available data, which includes the S&P 90 Index, the predecessor to the S&P 500 Index
- Federal Deposit Insurance Corporation
- Federal Reserve
- U.S. Bureau of Economic Analysis
- U.S. Bureau of Labor Statistics
- U.S. Department of the Treasury
Glossary of Financial Terms
West-Texas Intermediate crude-oil spot price: The West-Texas Intermediate crude-oil spot price refers to the futures contracts that track the traded price of a prominent grade of U.S.-produced crude oil. It is one of the most widely followed oil-price benchmarks in the world.
S&P 500 Index: The S&P 500 Index is a market-capitalization weighted index that consists of 500 publicly traded large U.S. companies that are considered representative of the broad U.S. stock market.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice and is intended for educational purposes only.
There are risks involved with investing, including loss of principal. Diversification may not protect against market risk.
Index returns are for illustrative purposes only and do not represent actual fund performance. Index returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.
Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company. Neither SEI nor its subsidiaries is affiliated with your financial advisor.