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Op-Ed: The Second Great Depression?


Unnerving parallels between now and then.

When this bubble collapsed, a lesson should have been learned. Instead, Alan Greenspan lowered interest rates to 1% and encouraged everyone to take out an Adjustable Rate Mortgage. The speculation in real estate reached phenomenal heights by 2005; the downside of that speculation is now only half finished. Stabilization of housing prices is at least another year -- and another 20% to the downside -- away.

That would still leave prices high on a historical basis. Home prices did not fall on a national level during the Great Depression.

Excess speculation by a small group of wealthy investors

The administrations of Warren Harding and Calvin Coolidge are considered the most corrupt in American history. Coolidge declared that "the business of America [was] business," and his was a laissez-faire, anti-regulation government.

The top tax rate was lowered to 25% in 1925, the lowest in any decade since. Exports boomed due to the low value of the dollar versus the British pound. Wall Street speculators were a ruling elite in a society in which only 1.5 million out of 120 million people invested in the stock market at all.

Ben Strong, attempting to help Britain, reduced rates in 1927. This ignited a speculative frenzy in 1928 and 1929. Margin loans increased from $3.5 billion in 1927 to $8.5 billion in 1929. Stock prices rose 40% between May 1928 and September 1929, while daily trading rose from 2 million shares to 5 million shares per day. The market reached a peak of 381, with a P/E ratio of 23 based on normalized earnings, on September 3, 1929.

Greenspan's excessively low rates caused a speculative frenzy in stocks, then housing. The Bush administration's belief that free markets can regulate themselves led financial institutions to take ridiculous risks and acquire massive amounts of debt. Despite 2 ongoing wars and growing budget deficits, the Bush administration decreased taxes on the wealthy.

The dollar declined dramatically over the last 8 years, resulting in increased exports. The PE ratio of the market reached an astronomical 38 in 2000, before crashing below 20 by 2003. Currently, the P/E ratio (25) exceeds that prior to the crash in 1929.

In the last few months, how many times have we heard Hank Paulson, John Thain, and other Wall Street cheerleaders tell us the banking system is safe and sound? Ben Bernanke has reduced interest rates dramatically, pumped money into the banking system, and taken bad assets onto the Fed balance sheet. So far, this doesn't appear to be working. The market has declined 30% from the peak, but is overvalued on a historical basis with profits about to plunge during the coming downturn.
No positions in stocks mentioned.

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