Research Paper on the Great Depression

Research Paper on the Great Depression

Research Paper on the Great Depression

Assignment on Financial Crisis and the Role of a Business Analyst

FIN 1003 - FINANCIAL SYSTEMS IN CANADA

INFORMATION SYSTEMS BUSINESS ANALYSIS

GEORGE BROWN COLLEGE, TORONTO, ONTARIO

March 2014-03-16

Mohammad Hassan & Basant Ramachandran

The 1920 era in United States was usually referred to as the 'ROARING TWENTIES' due to the sustained economic prosperity. When the World War I war raging in Europe, US kept a neutral stand almost until the end and hence was least affected by any drain in their economy. The money supply was high, economy was booming, people could afford and splurge on expensive goods. This was the time when Radio was invented and was quickly adopted as a new means of faster and wider communication. The industry grew at a rapid pace, with the introduction of automobiles, television, refrigerator, washing machine, telephones, motion pictures, and electricity, buoyed by the accelerated adoption and increased consumer demand. The American industry expanded at the neglect of agriculture sector because people were migrating from rural areas to the cities in large numbers to participate in the industrial boom.

Financial innovations were also not far behind and the ideas like “Buy on credit and pay in instalment” were getting popular which allowed the average Americanhousehold to buy goods and services in small instalmentsthereby exposingthem to credit. Real estate market was also riding the credit boom. Consumers were building up high debts due to easy credits.

In the meanwhile, the stock markets were gaining popularity, with the average household flocking to buy stocks they little knew about by following the trends set by the few handful rich people who made millions by buying and selling stocks. The general public were unaware that these handful people traded in huge volumes and they managed to sway the stock prices single-handedly and made huge profits which would have been seen as a violation on the grounds of market manipulation today. People flocked the stock markets to make a quick buck and most of them were trading on margin which risked their exposure multi-fold. Looking back, there were glaring signs of an impending economical catastrophe.

By the end of 1929, the prices had doubled in the stock market and the Federal Reserve viewed the boom as an excessive speculation.As part of the measures taken to curb it, they tightened the monetary policy by raising the interest rates and limiting anyfurther rise in stock prices.On the 29th October, 1929 they got more than what they bargained for when more than sixteen million shares were traded in panic selling and the Dow Jones made losses amounting to more than 30 billion dollars in two days and 40% depreciation in valuation by the end of 1929. Along with the negative sentiments, the Wall Street crash of 1929 acted as a catalyst for triggering the decade long great depression. Considered as the mother of all crises, Great depression went on for a decade leading to World War 2.

Looking back at the root causes for the great slide, Stock markets weretrading heavily on margin and the crash worsened theseholdings.Consumers with credit exposures in the stock markets, housing and other goods and services went bankrupt due to default in their margin and debtpayments forcing the lender-savers, mostly banks following suit due to high number of defaults. More than 5000 banks went bankrupt in the first three years which forced the depositors to lose all their savings. The decline in stock prices led to bankruptcies leading to severe macroeconomic consequences like credit contraction, business failures, bank failures, mass layoffsall leading to a decline in the money supply.

Due to mechanised industrialization of 1920's, the industrial output was high leading to overproduction of goods and services, though the money supply was low which led to an under consumption forcing the industries to shut down and go bankrupt. As a result, the unemployment rate went up. By mid 1930, severe drought had hit the mid west leading to a sharp decline in agricultural production resulting in farmers defaulting on their loans. Large number of loan defaults hit the balance sheets of many banks operating in the agricultural regions prompting substantial withdrawals from banks building into a full-fledged panic reflecting across the board in the economy.

The economic contraction worsened due to the adverse selection and moral hazard which inturn was intensified due to the limited number of banks operating and uncertainty from the unsettled business conditions. The credit spread between corporate bonds and the treasury bonds were glaringly huge at 8% at the peak of 1932. The huge decline in prices acted as a catalyst paving way to debt deflation where the net worth fell drastically due to the increased indebtedness borne by the households and firms.

By the end of depression more than 9000 banks had defaulted which was primarily attributed to the loaned assets and fractional reserve lending policies which gradually became their liabilities.Under the Hoover administration, the government virtually did nothing to solve the mounting issues rather, on the contrary asked the countrymen to have faith and help each other expecting the situation to improve over a period of time. Riding the pressure, Hoover came out with few solutions like the proposal of Reconstruction finance corporation (RFC), where the government loans money back to the railroads, insurance companies and dams assuming the loans would stimulate the economy by creation of jobs and expected prosperity to trickle down through the economy. The above solutions came too little and too late. The proceeds never reached down to the people and enough jobs were not created. High unemployment, poverty and drought persisted and people were homeless due to high evictions following defaults. People started migrating from the drought hit areas to cities like California in huge numbers seeking jobs. In the meantime, World War 1 veterans staged and demanded an early payment of their bonus proceeds, due in 1945. Hoover administration rejected the plea which didn’t go well with the people’s morale and gradually lost the presidency.

On the international front, the great depression had spread across globally and all the industrialized nations were going through similar phenomenon. After the World War 1, as per the Dawes Plan, US had loaned Germany to pay war reparations to Britain and France who will pay back US their war debt. Germany had difficulties paying this sum due to their economical issues and high discontent was building within. Hoover imposed high import taxes going against many economists suggestions, to protect the home agricultural sector and Europe responded back by hiking their taxes thereby preventing the sale of excess goods from US. International trade came to a grounding halt.Four years into the depression, America was in tatters, people had lost hope in their administration which reflected in the presidential election of 1932, where Franklin Delano Roosevelt(FDR) took a landslide win with his promise for revival of the economy with his hugely popular 'New Deal' solution.

One hundred days into his presidency, he had drafted and started executing his 'New Deal' promise with a slew of legislations and policy changes to channel government funds back to the economy and more importantly directed to reach the people by creating jobs through sponsoring projects. His policies centered around projects undertaken to fix the root causes of the depression and thereby creating fail safe measures to govern and regulate banks, insurance companies including government and federal watchdog agencies. All legislations executed through the new deal focused mainly on three basic goals – Relief for unemployed, Recovery from depression and further Reforms to prevent another depression.

In his New deal, he started by declaring a bank holiday forcing all banks to close and implemented an 'Emergency Banking Relief Act' which ensures only financially sound banks were able to open for business. The program required government federal examiners to survey all banks and issue licenses to sound ones by the treasury. His banking sector cleanup ensured adhering to strict regulations on operational front, credit exposures and in establishing strict lending guidelines.

Some of the proposals aimed at creation of jobs were Civilian conservation core (CCC) to create jobs targeted to the youth for construction of bridges and setting up flood control. Work programs administration (WPA) aimed at building hospitals, schools, parks etc. Tennessee Valley Authority (TVA) focused on providing electricity to the rural areas. Agriculture Adjustment Act (AAA) controlled and ensured certain crops were not cultivated. Social Security Act (SSA) was put in effect to setup a system of pension for the elderly and people with disability. On the Insurance front, Federal Deposit Insurance Corporation (FDIC) insured all savings accounts in banks, thereby protecting the customers from the risk exposed by the economy and the bank itself. On the financial markets, Securities and Exchange Commission (SEC) was instituted as an independent federal watchdog to regulate the stock markets. Stock markets around the world instituted measures like circuit breakers set at predetermined index levels to suspend trading in the event of rapid declines as was seen on the Black Tuesday, claiming that it would prevent such panic sales.

Looking back Roosevelt's new deal policies created jobs and initiated the recovery though with a limited success, but did not solve all the depression issues. America did not come out of the depression completely until World War 2, when the war production board (WPB) managed the conversion of industries to military production and the employment rose in wartime production.During the depression, the aggregate output fell steeply, with unemployment rising to 30%. John Maynard Keynes in his revolutionary book, “The General Theory of Employment, Interest and Money”, argued that short-run changes in aggregate output as experienced during depression were determined by changes in aggregate demand.

Exploring the Role of a Business Analyst in preventing such crises:

In trying to draw analogy with the council of advisors to US president, with the role of a business analyst to avoid the occurrence of such crisis, we believe that a BA must come up with proactive ideas and solutions to ensure preventionby setting up failsafe procedures for vital entities in play on the financial fabric of aneconomy.A BA should draw up plans and come up with a blueprint for guidelines, procedures and financial reporting for financial intermediaries and financial markets.Strict guidelines and introduction of a credit history system should be drawn up for regulating debt and lending policies and thereby prevent adverse selection and moral hazard problems.Regulatory watchdogs should be setup for every industry verticals like manufacturing, agriculture, logistics, infrastructure etc which helps flag off and alert any impending threats or deviation from fail safes requiring any policy shift and thereby provide early warning systems enabling an opportunity to take counter measures and prevent such crisis in future.

A business analyst should ideally posses skills defined in the underlying competencies defined in the BABOK chapter 8 which requires the ability to think broadly and deeply in a T manner keeping him updated on both the macro and micro level of aspects apart from Negotiation & Communication skills, Problem Solving, Logical & Analytical thinking, macro-economic business knowledge, Ethics & Respect, Leadership Influencing andPersonal Organisation. BA should use tools like six thinking hats, decision tables, document analysis, brainstorming, Root cause analysis, Cost benefit analysis among others when faced with problems.Look at the problems from different perspectives helps in understanding the solutions and its compliance addressing all aspects of a problem and hence preventing any further risks. BA should be able to read, analyse and interpret the macro-economic market dynamics and forecast any impending crisis correctly and collaborate with the relevant SME in different departments to clear, confirm and execute policies and procedures as counter measures.

Sources:

1. The Economics of Money, Banking and Financial Markets, 5th edition, Frederick S. Mishkin, ApostolosSerletis
2. Brittanica Database.

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