Tough US Economy Survives 1980s Blows

THE United States financial system is tough. It may not duck every roundhouse punch. But it does bounce back pretty well from multibillion dollar blows - such as the developing-country debt crisis, the 1987 stock market crash, the savings and loan debacle, and, these days, the damage to the capital of some commercial banks from deflated real estate prices and other factors.

Notes Harvard University economist Martin Feldstein: ``Although cyclical fluctuations remain a problem throughout the industrial world, the Depression of the 1930s was the last time that we experienced the kind of financial crisis followed by economic collapse that had been a recurrent problem in both the United States and Europe for centuries.''

The postwar recessions in the US, including the present one, are nowhere near the magnitude of the Great Depression. An index put together 30 years ago by Geoffrey Moore, an expert on the business cycle, to compare the magnitude of downturns showed a 75 percent decline during the 1929-33 period.

Looking at earlier economic crashes, Dr. Moore's index declined 35 percent in 1920-21, 30 percent in 1907, 31 percent in 1893-94, 28 percent in 1882-85, and 27 percent in 1873-79.

During a serious postwar slump, such as that in 1958, the index dropped 23 percent - still a goodly number.

More recent research by Christina Romer, an economist at the University of California, Berkeley, finds that the severity of the pre-Depression recessions was not much worse than for the slumps after World War II. The economic statistics of those earlier days are poor, making her findings a topic of academic debate.

But she agrees that the economic misery in postwar slumps has been far less than in those earlier recessions. Recessions are generally shorter, with the Federal Reserve System (created in 1913 in response to the 1907 banking panic) easing credit to revive business activity. Bank depositors are protected by insurance. Unemployment insurance helps tide some workers over periods of joblessness. A larger proportion of businesses offer services, not goods, and service companies tend to be more stable than ma kers of products.

Moore offers an interesting comparison: The amount of assets involved in the S&L crisis as a proportion of total national output, slightly exceeds the amount of bank assets lost in the Great Depression as a percentage of gross national product. However, bank depositors in a failed bank were out of luck in the '30s; those with deposits of $100,000 or less (and some with more) are nowadays fully repaid by government insurance.

It shows the importance of measures taken by the government to limit the damage of a financial crisis, says Moore.

Looking at the shocks to the financial system in the 1980s, Harvard's Dr. Feldstein notes one ``primary culprit'' - a rising inflation rate resulting from monetary and fiscal policies of the late 1960s and the second half of the 1970s.

Inflation made real interest rates (after inflation) low or negative, leading to excessive borrowing by developing nations. It caused thrift institutions loaded with fixed rate mortgages to become insolvent in the early 1980s as interest rates soared into the double-digit range. High interest rates (to fight inflation) made bonds more attractive than stocks in 1987. Inflation, indirectly, raised the relative cost of funds to banks, and thus made it cheaper for corporate borrowers to raise funds through bonds and commercial paper or from insurance companies and leasing companies. Banks were driven to do more risky real estate lending.

So if the government can prevent inflation from getting out of hand again, it would help avoid a future financial crisis.

``The robustness of the American financial system depends on its ability to avoid widespread personal and institutional bankruptcies,'' writes Feldstein in a National Bureau of Economic Research paper.

The nation's financial ``safety net'' helps individuals avoid bankruptcy. Feldstein would like greater diversification of investments for institutions. Banks, for instance, could have have a more geographically diversified loan portfolios - something permissible under the Bush administration banking proposals.