A brief history of financial panics

Today was what passes for a good day on Wall Street — the Dow Jones industrial average only went down 1.49%. And just in time to help us put this crazy week into perspective, UC Berkeley economist Brad DeLong has posted a lecture on the history of financial panics (web-link, iTunes), part of his current course on American Economic History (website, iTunes).

(Two listener’s tips: 1) Don’t pay any attention to the title of the lecture. It really is about financial panics, and not about the New Deal. 2) You can skip the first 16 minutes, which do not directly deal with the main topic.)

In the lecture, DeLong goes back to the late 18th century to explain how an early financial panic played out in England, and then he relates how the Bank of England developed the tools to deal with such panics during the course of the 19th century. But the main event is his discussion of the Great Depression, and what parallels can be drawn to our present predicament.

DeLong says that both the Great Depression and the current financial panic had their source in a “catastrophic failure of risk management.” During the 1920s, banks got into the business of giving out high interest loans for the purpose of buying risky stocks. And of course in the current crisis, lenders handed out too much money for risky real estate loans.

It seems that economists are not in agreement as to whether the Great Depression was simply a very large regular recession, or if it was a different animal entirely. And so, DeLong says,

Right now we have another financial crisis rolling forward that appears to be as great as the Great Depression in terms of its financial impetus and if in fact the Federal Reserve and the Treasury are able to stop it from becoming a serious, serious depression, then we’ll have a big data point that says that yes, the same tools we can use to cure ordinary recessions and small depressions work on a financial shock the size of the Great Depression. If not, and we end up in another great or near great depression in the next two or three years, we’re going to have to rethink and say that yes, there are garden-variety financial crises and business cycles, but also there are these extraordinarily outsize things that truly are different animals.

If you’re looking for more insight into the current crisis, check out DeLong’s blog, and especially the downloadable booklet put together this week by a group of leading economists, who offer suggestions for defusing the crisis.

Also, listen to The Financial Crisis: Where Do We Go from Here? a panel discussion from the University Channel featuring NYU economist Nouriel Roubini.

Related posts:
Podcasts to help you understand the economic crisis

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