Financial Crisis Comparison to Depression and Other Crises

Wall street
Steven Puetzer/Getty Images

Every financial crisis seems to be the worst in history when it occurs. The global financial system is becoming more connected, giving each new financial crisis the potential to be worse than any other. The best way to understand the impact of a financial crisis on the world's economy is to compare the worst crises in history. 

Financial Crisis of 2008

At first, it seemed that the financial crisis of 2008 was similar to the Savings and Loan Crisis of 1987, except that it was caused by a pricing problem, not fraud.

 

It turns out that the mortgage company Ameriquest spent $20 million lobbying legislatures in Georgia, New Jersey and other states. It sought to relax laws that protected borrowers from taking on mortgages they couldn't afford. Ameriquest has been sued for mortgage fraud.

Ameriquest was not alone. Several banks, including Citigroup, Countrywide, and even the Mortgage Bankers Association were also involved in lobbying efforts. (Source: WSJ Online, Lender Lobbying Blitz Abetted Subprime Mortgage Mess, 12/31/07)

If fraud and possibly illegal lobbying of government officials have occurred, then the crisis was caused by more than a pricing problem, which would have been easily solvable. 

Fraud means that mortgage companies were more than just greedy or even negligent, they were downright unethical. That could be one reason why the subprime mortgage crisis spread as far into the economy as the Savings and Loan Crisis.

During the financial crisis of 2008, the Federal Government pumped trillions into the economy to keep the banking system from collapsing.

That included the $700 billion bailout package approved by Congress in 2008, the nearly $200 billion the Federal Reserve used to bail out Bear Stearns and AIG, and the $150 billion that the Treasury Department spent to take over Fannie Mae and Freddie Mac.

Long-Term Capital Management Crisis

In 1997, one of the world's largest hedge funds almost collapsed. It had invested in foreign currencies. They plummeted when investors panicked and switched assets to Treasury bonds. LTCM had $126 billion in these assets. Banks bailed it out after Federal Reserve Chairman Alan Greenspan twisted their arms.

Savings and Loan Crisis

In the Savings and Loan Crisis five U.S. Senators, known as the Keating Five, were investigated by the Senate Ethics Committee for improper conduct. They had accepted $1.5 million in campaign contributions from Charles Keating, head of the Lincoln Savings and Loan Association. They had also put pressure on the Federal Home Loan Banking Board, who was investigating possible criminal activities at Lincoln.

In the late 1980s, more than 1,000 banks failed as a result of the Savings and Loan Crisis. The total cost to resolve the crisis was $153 billion, a mere drop in the bucket compared to the 2008 crisis. Of this, the taxpayer was only on the hook for $124 billion. Rather than taking ownership in banks, the funds were used to close them, pay the FDIC insurance and pay other debts. Of this, the taxpayer cost was $124 billion.

Great Depression of 1929

Over the four days of the stock market crash of 1929, the stock market dropped 25%.

During that time, a record $30 billion in market value was lost. That's worth $396 billion today.

In the next ten months, 744 banks failed. As depositors ran to take out their savings, more banks failed. There was no FDIC to bail out deposits. In just three years, $140 billion was lost ($2.3 trillion today).

The stock market crash and banks failures weren't the worst things about the Depression. The Federal Reserve raised interest rates, trying to defend the gold standard. Gold prices soared as investors fled the stock market and depositors traded cash for its value in gold.

By raising interest rates, the Fed slowed the economy. As a result, businesses closed. Unemployment rose to 25%, wages dropped 42%, and GDP was cut in half. It took ten years and the start of World War II before the economy got back on its feet.