Way back in 1933, Irving Fisher outlined what it took to make a depression or recession really nasty. In a nutshell: too much debt, followed by deflation that is brought on by everyone selling to reduce their debt. This creates a vicious cycle where you can sell everything you have but you still can’t cover your debt – and therefore you either go bankrupt or need a bailout. Sound familiar?
You can read it all in his paper “The Debt-Deflation Theory of Great Depressions” [pdf]. (Note that economics paper from that era are quite approachable, unlike now)
There’s a fascinating tidbit in this paper where he reflects on the preponderance of scandals to come to light during these scandals:
The public psychology of going into debt for gain passes through several more or less distinct phases:
(a) The lure of big prospective dividends or gains in income in the remote future;
(b) The hope of selling at a profit, and realizing a capital gain in the immediate future;
(c) The vogue of reckless promotions, taking advantage of the habituation of the public to great expectations;
(d) The development of downright fraud, imposing on a public which had grown credulous and gullible.
When it is too late the dupes discover scandals like the Hatry, Krueger, and Insull scandals. At least one book has been written to prove that crises are due to frauds of clever promoters. But probably these frauds could never have become so great without the original starters of real opportunities to invest lucratively. There is probably always a very real basis for the “new era” psychology before it runs away with its victim. This was certainly the case before 1929.
You could swap out “Madoff, Leland, and Dreier” for “Hatry, Krueger, and Insull” and this could pretty much be 2009, not 1929.
There is a bit of sunshine here: we can rest assured that we’re not the first to go through something like this (and I’m sure my great-grandkids will go through this too) and therefore we’ll get through it. The bigger question is: can this sort of thing even be avoided in the first place, or is it just human nature?