Seeing Shades of the 1930s

On Tuesday and Wednesday, Federal reserve chairman Ben Bernanke, a scholar of the epic financial meltdown of the Great Depression, and Treasury Secretary Henry Paulson, a survivor of more recent Wall Street crises, told Congress of their latest efforts to rescue the financial sector. If Fed chairman Alan Greenspan, Clinton Treasury Secretary Robert Rubin and his deputy Lawrence Summers were known as the Committee to Save the World during the financial crises of the 1990s, today's duo may go down as the Committee to Save Wall Street From Itself. For the past several months, the Fed and the Treasury Department have pulled all-nighters dealing with three-alarm fires, from the demise of Bear Stearns in March to the rising concerns over the mortgage giants Fannie Mae and Freddie Mac.

Fannie and Freddie play a huge role in the mortgage business by lending cash and guaranteeing loans made by others. But with the spread of the mortgage crises their stocks have plummeted in recent weeks, and questions have been raised as to whether the government would do what it implied it would all along when it established the two government sponsored organizations: stand behind their debt. Bernanke and Paulson gave an emphatic "yes," as they described to occasionally hostile Congress members their plans to allow Fannie and Freddie to borrow money from the Federal Reserve, and to empower the Treasury Department to buy (and buoy) the companies' stock and stand behind their $5.2 trillion in debt. The prospective moves, along with some slightly better-than-expected earnings reports from banks last week, calmed the markets. The price for this desperately needed action is likely to be more regulation and oversight. Will the crisis inspire a fundamental restructuring of the vital, symbiotic relationship between Washington and Wall Street, as happened during the New Deal? Or will these responses prove a temporary blip, as when the government bailed out the savings and loan industry in the late 1980s? In short, is this 1933 or 1989?

It certainly seems a bit more like 1933, and not just because CNN, the modern-day equivalent of newsreels, has been filled with pictures of people queuing outside failed banks. Rather, as happened 75 years ago, Wall Street—after two terms of a business-friendly Republican president—self-immolated on a pyre of greed, incompetence and excessive optimism. The troubles thought to be contained to a particular sector (stocks then, subprime mortgages now) spread throughout the entire financial system. And with confidence shattered, the federal government stepped in with unprecedented efforts. "This is a much broader extension of government assuming risk in the financial system than we saw in the 1980s," said Bill Seidman, the former chairman of the Resolution Trust Corp., the federally created liquidator of all those failed S&Ls.

The New Deal left behind plenty of important landmarks, from the Appalachian Trail to Hoover Dam. But its financial infrastructure has proved just as important. The Banking Act of 1933 created the Federal Deposit Insurance Corporation and forced member banks to submit to regulation. The Securities and Exchange Act (1934) brought forth a body to oversee the nation's stock exchanges. Later in the decade, Fannie Mae was established to revive the dormant mortgage market. "It was a wholesale restructuring of the financial system," said New York University historian Richard Sylla.

The efforts—strenuously opposed at the time by the supine financial sector—worked. "Only with the New Deal's rehabilitation of the financial system in 1933–1935 did the economy begin its slow emergence from the Great Depression," as Bernanke wrote in "Essays on the Great Depression." The art deco complex of backstops, insurance, oversight, disclosure and regulation proved to be remarkably durable: in 75 years, the FDIC hasn't lost a penny of depositors' money.

Of course, New Deal-era financial dams occasionally broke. In the 1980s, the Federal Savings and Loan Insurance Corporation (born 1934), which provided deposit insurance to S&Ls, was overwhelmed when the deregulated thrift industry imploded. The ensuing bailout—taxpayers made insured depositors whole—cost $120 billion. But while surviving thrifts entered the FDIC system, NYU's Sylla notes "there was no major reform." The Resolution Trust Corp. folded in 1995, a few years before the Depression-era prohibitions against investment banks owning commercial banks, known as the Glass-Steagall Act, were wiped away.