History lessons for financial crisis: Act fast, act globally

A global financial crisis of the current magnitude is unique. But two historic events offer lessons for a way out, say economists.

First, move with alacrity. During the Great Depression a protracted delay in aiding banks proved fatal – a lesson Britain and now, this week, the United States have taken on. Second, coordinate globally. The Bretton Woods agreement near the end of World War II became an effective tool for reworking a shattered world economy. Calls for a second Bretton Woods are now being sounded by such figures as Britain's Prime Minster Gordon Brown, French President Nicolas Sarkozy, and World Bank president Robert Zoellick.

Central to European leaders discussions Wednesday and Thursday in Brussels is this motto: A global crisis requires a global solution. The subtext is that much tougher regulation is required. As Mr. Brown put it Monday, "Sometimes it takes a crisis for people to agree that what is obvious and should have been done years ago can no longer be postponed. We must create a new international financial architecture for the global age."

The storied 1944 Bretton Woods conference – where some 700 delegates from 44 nations gathered at a hotel in New Hampshire – was a bold move to create the first negotiated monetary system among industrial states. The World Bank and the 185-nation International Monetary Fund emerged from that pact. The IMF has become a major source of loans for developing nations in financial trouble.

The legacy of Bretton Woods, said Mr. Zoellick in a speech this week, was that the crisis of a ravaged world created a commitment to remake institutions, to "turn the problems of an era into an opportunity."

In the past week, European nations have begun to coordinate their responses to the crisis, after initially being unwilling, or unable, to do so. The two-day meeting in Brussels, ending Thursday, is intended to solidify new measures in the wake of bank failures and credit crises from Iceland to Germany that brought near panic.

"Mechanisms for cross-border cooperation in Europe exist but they are incomplete," argued Mr. Mandelson, who joined Brown's Cabinet this week. "Internationally, the problem is even more acute...." he says, since coordinating systems are "outdated," with huge stakeholders like China not tied firmly enough into the economic order. "It is 64 years since the Bretton Woods conference put in place the basic machinery.... It is time for a Bretton Woods for this century," he wrote on Oct. 3 in The Guardian, a British newspaper.

The specter of another Great Depression of the 1920s and '30s has been raised by the speed and scope of this financial crisis. But such fears have been mitigated, for some, because Federal Reserve Chairman Ben Bernanke is himself a student of the Great Depression. He has taken the opposite approach to the Fed's cautionary policy of the '30s, when the Fed tried to slow the economy, increased interest rates, and allowed some 9,000 banks to fail.

By contrast, the Fed's response under Mr. Bernanke is entirely proactive. The Fed has cut interest rates, worked closely with the US Treasury to bail out key private firms like Bear Stearns and AIG, and flooded markets with liquidity.

Still, differences between the 1930s and today are profound, and not easily comparable say economic historians such as Ballard Campbell, author of the recent book "Disaster, Accidents and Crises in American History."

Unlike the stereotyped image of the period, only a tiny number of Americans were invested in Wall Street when it crashed in 1929. In the '30s, there was no mass participation in pension investments such as 401ks or 403bs – such investments didn't exist. The instant market information flows of today were not available, for better or worse.

That's one reason why the pace of government response may be faster today than in the lead up to the Great Depression.

French economist Jean-Paul Fitoussi, director of a research center at Sciences Po in Paris, adds that the size of the US state sector is key, as is individual access to credit. The US government financed 10 percent of the economy in the 30s; today it represents more than 30 percent. But access to credit by individuals today creates greater ties between finance and the "real economy," he notes.

"There are so many new imponderables that it is unclear if a prolonged systemic depression can repeat itself," says Mr. Campbell, at Northeastern University in Boston. On balance, he doesn't think it will happen. "The cherishing of lifestyles ... the mentality of the West today ... is something that won't allow government to do what it did before – sit back and fold its hands."

But the current crisis, like the one in the 1930s, does appear to be ushering in a major shift toward more government regulation and intervention.

Some historians compare the Ronald Reagan era of deregulation to a similar period of "rugged individualism" touted by Herbert Hoover's White House from 1929-33. That view was based on a small town ethos of personal responsibility of the 19th century. But when banks failed in the 1930s, many thrifty people lost their savings. The crisis was so great that in an increasingly urban America, people often did not come to the aid of each other, in the way that Hoover had assumed.

"If there is anything cathartic in this crisis," writes Mandelson in The Guardian, "it will be a healthy new skepticism for financial products we don't understand, a heightened intolerance for excessive risk-taking…."

Today's calls for a new Bretton Woods, and global decisive action to create confidence and liquidity are common sense moves to stave off a depression, says Philippe Waechter, director of economic research at Natixis Asset Management in Paris. "If you look in the last two centuries in the US and Europe, when you have a war or a huge shock, you finance it, and you pay for it later. You take on a very large public debt, on a huge scale, and pay for it down the road. In World War II, World War 1, the '30s – every government increased debt and paid later. We need to save the system to avoid a depression."

But Charles Wyplosz, of the Graduate Institute in Geneva, says there cannot be a literal return to the original Bretton Woods in the sense that "the Bretton Woods [monetary] system was based on fixed interest rates." He says that fixed rates, independent monetary policy, and free capital markets cannot exist together.

A French source at the office of the EU presidency in Brussels says that in this week's meeting "we are talking about Bretton Woods because it is a way of speaking to people about new rules at a global level."

As current EU president, France's President Sarkozy says he will seek the backing of the other 26 EU states to hold an international conference as early as next month on reforming the world financial order put in place by Bretton Woods.