Is the U.S. economy headed for depression?

OK, everybody. Let’s take a deep breath.

This week, like everyone reading the headlines, Answer Desk readers are a tad nervous about this whole housing market, subprime mortgage lending debacle. Yes, it’s complicated. And even economists and other experts can’t agree on just how bad it will get.

But readers like Michael in Colorado — who see a full-blown depression coming — are getting a little ahead of themselves. And while it may seem like a good idea to just ban all these risky loans — as David in Washington suggests — that may be going a little too far. Meanwhile, subprime borrower Latrice in Detroit is looking for some tips on refinancing her loan.

At this point in time, there's nothing but a big-fat-gigantic depression coming through the front door — and everyone but the most naive and "true believers" knows it. Its gonna be very, very bad. I think the jig is up. The facade is rotting away — quickly.
— Michael A., Denver, Colo.

There are certainly plenty of indications that things may get worse before they get better.

Economists and officials like Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson are correct in saying that — at this moment, today — the U.S. economy remains healthy. The question is what happens next, which no one, not even the sagest of economists, can predict. Economies are like mobs: they can get ugly, but you really can’t tell when or if the riot will start or how long it will last.

But a little perspective is in order. Some of us watching the current mortgage meltdown and stock market gyrations remember the real estate slide and stock market crash of the 1980s. (Others, including some of the younger mortgage brokers who made all these risky loans that are now going up in smoke, apparently weren’t around then.)

The lending problems in the 1980s — both in the savings and loan mortgage market and the junk bond mania on Wall Street — were much worse that anything we've seen so far today. When it was all over, more than 1,000 thrift institutions, holding $519 billion, had been closed down in the “greatest collapse of U.S. financial institutions since the 1930s,”  according to a summary report by the Federal Deposit Insurance Corporation.

At the worst of the 1980s crunch, we heard respected forecasters talk about 50 percent drops in housing prices and dire predictions of impending economic doom. Bookshelves sprouted titles like “How to Prepare for the Coming Economic Collapse” complete with advice on stocking up on canned goods.

But when the dust settled, the depression of the 1990s didn’t happen. Yes, we had a fairly nasty recession in 90-91, the housing market unraveled (home prices fell somewhat or were flat for many years in some markets), major commercial developers went bust, Congress had to write a check for over $100 billion to clean up the mess, and some S&L cowboys who wrote junk bonds that weren't worth the paper they were printed on went to jail. Within a few years, the economy was back on its feet again. Within a decade, the Fed chairman was worrying outloud about “irrational exuberance.”

It’s often said that economic cycles, and the markets that finance them, swing between fear and greed. Today, with the “fear factor” on the ascendancy, it’s useful to consider the scale of economic devastation brought by the Great Depression. Between 1929 and 1933, U.S. Gross Domestic Product fell from $103.6 billion to $56.4 billion — a 46 percent contraction that took 10 years to retrace. By contrast, the 1990-91 recession that followed the late 1980s housing collapse lasted 8 months, and GDP dropped by about 1 percent.

You can never say never again, but there are a number of reasons to believe that the odds of seeing another contraction on the scale of the Great Depression in your lifetime are pretty remote. The 1930s actually produced two back-to-back contractions; since then, historians have unearthed a number of government and businesses mistakes that actually made things worse and prolonged the agony.

Those lessons learned may help explain why modern recessions tend to be shorter and shallower than the panics and busts of earlier economic upheavals. From 1854 to 1919, for example, there were 16 downturns lasting an average of 22 months, according to the National Bureau of Economic Research. From 1919-1945, the average downturn lasted 18 months. From 1945-2001, the average recession lasted just 8 months.

While any recession is painful, recent downturns have been relatively mild by historical standards. One useful measure is the number of people who lose their jobs. In the recession of mid 1970s, the unemployment rate jumped from 4.6 percent to 9 percent. In the 1980-82 slump, the jobless rate shot up from 5.7 to 10.8 percent. In 1990-91 it went from 5.0 percent to 7.8 percent. In 2000, after falling to 3.8 percent, the jobless rate hit 6.3 percent in 2003 before dropping back to 4.5 percent today.

So before you buy a gun, fill your car with canned goods, and head for the woods – take a deep breath. The economy maybe headed for a rough patch. But it’s done so every ten years or so in our lifetime, worked out the problems that caused it to stumble, got up and dusted itself off, and went on its merry way. Your forecast is as good as mine. But, based on what’s going on today, we’re betting against a catastrophic, Hollywood-movie-style economic collapse.

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