Household Debt and the Great Depression

March 15, 2014

In November 1930, before anyone knew how Great the Depression would be, Charles Persons published an article in the Quarterly Journal of Economics called “Credit Expansion, 1920 to 1929, and Its Lessons.” His thesis was stated forcefully in the first paragraph:

“The thesis of this paper is that the existing depression was due essentially to the great wave of credit expansion in the past decade.”

He then meticulously documented data on the stunning growth in borrowing by households during the 1920s. As is common in the run-up to severe economic downturns, there was a tremendous growth in mortgage debt. “The great field of credit expansion in the last decade lies in the realm of urban real estate mortgages”, Persons wrote. In nominal terms, outstanding mortgage debt grew by more than eight times from 1920 to 1929, according to Persons.

Persons also highlighted the rise in installment debt, or consumer debt used to purchase new furniture, clothing, sewing machines, and cars. Martha Olney at Berkeley examined the rise in purchases of cars and other durables during the 1920s, and concluded that “societal attitudes toward borrowers changed radically between 1900 and 1920; by the mid-1920s, buying on credit was considered normal, not sinful.”

Persons concluded his 1930 article with a statement that is eerily similar to many we here today: “The past decade has witnessed a great volume of credit inflation. Our period of prosperity was based on nothing more substantial than debt expansion.”

Both the Great Depression and our recent Great Recession were preceded by large increases in household debt driven by new lending technologies. The 1920s had the installment loan; the mid-2000s had the subprime mortgage loan. Is it a coincidence that the two most severe recessions in the last 150 years were preceded by a dramatic expansion in household debt driven by new lending technologies? This is a central question of our book.

Many readers may want to read the Olney and Persons studies. Unfortunately, both are behind pay walls, and we could not find free versions posted. The pay locations are linked to in the above text.


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7 Responses to Household Debt and the Great Depression

  1. bill white on March 15, 2014 at 7:45 pmi

    Because so many focus on federal fiscal policy as a driver of macroeconomic activity and the federal government paid down debt, many have failed to not the growth in private and state and local debt during the 1920s. This did not cause the global downturn caused by economic troubles in Europe, but the cyclical downturn was sharply accelerated by the impact of impact on debtors. Sharp deflation and the rolling bank runs–and accompanying high employment and low national income–eventually led into a liquidity trap.

  2. SteveB on March 16, 2014 at 12:22 pmi

    What should matter is not the total amount of debt, but the debt payments. If interest rates are very low, the amount of debt can be very high without causing a burden. Now that many people since 1998 have refinanced their homes at much lower rates, their payment burden is much less, and the lower monthly payments also provided a boost in extra income that could be spent at shopping centers. You need to explain why you think the debt level is more important than the debt payment level.

    • Nate on March 17, 2014 at 9:01 ami

      > What should matter is not the total amount of debt, but
      > the debt payments. … If interest rates are very low,
      > the amount of debt can be very high without causing a
      > burden. ….

      For debt load to be steady, there has to be some balance between new borrowing (which increases available money) and debt servicing (which decreases it). From my benighted perspective, it seems like the new borrowing is the aspect of things that is more prone to significant shocks.

  3. The Bogan on March 16, 2014 at 6:53 pmi

    In a previous blog post you wrote that “[t]he financial system intermediates this process, but ultimately creditors are lending to debtors.”

    You probably saw commentary around the BoE confirming the endogenous money theory/reality. This means that it is not creditors lending to debtors with banks simply acting as intermediaries (the Paul Krugman view), but confirms that banks create debt money ‘out of thin’ air. This, of course, has significant impact on the role of debt in the economy.

    Moving forward, will this be incorporated into your analysis?

  4. Benjamin Cole on March 17, 2014 at 10:18 pmi

    Interesting, but….

    Yes, leveraging up before the Fed pulls the rug out from underneath the economy is dangerous….in the individual and aggregate cases, no less….

    but does the Fed have to pull the rug out?

    That said, perhaps less leverage in an economy is a good thing…that suggests no homeowner mortgage interest tax deduction, and perhaps no taxes on dividend income…perhaps eliminate corporate tax deductibility of income expenses….

    or we could beat up on Fannie and Freddie and let it go at that….

    • Richard on March 19, 2014 at 12:21 pmi

      “but does the Fed have to pull the rug out?”

      Do you like inflation?

  5. Martha Olney on March 18, 2014 at 11:05 ami

    Thanks for the shout-out. The book in which my work was published is Buy Now Pay Later: Advertising, Credit, and Consumer Durables in the 1920s (Univ of North Carolina Press, 1991). It should be available in university libraries or through inter-library loan. The article to read is “Avoiding Default: The Role of Credit in the Consumption Collapse of 1930,” Quarterly Journal of Economics Vol. 114, No. 1 (Feb., 1999) , pp. 319-335. I wouldn’t be surprised if someone had posted a pdf illegally somewhere. Legally, it’s accessible through jstor.