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The US housing boom collapsed and sub-prime mortgages, which had been an attractive investment both at home and abroad, now became a millstone round the necks of those financial institutions that had eagerly snapped them up. During 2008 the financial crisis developed with a sudden and terrifying force.
A comparison of the catastrophic banking crisis in 1931 with that of 2007–8 shows that the countries involved in 1931 accounted for 55.6 per cent of world GDP, while the figure for the latter period is 33.5 per cent (Reinhart, 2010; Maddison, 2010).
This is the most widespread banking crisis since 1931 and it is also the first time since that date that major European countries and the United States have both been involved.
Even in recovery, both the UK and the USA experienced persistent mass unemployment, which was the curse of the depression decade (Table 2).
Why did the eradication of unemployment prove to be so intractable?
In these circumstances, it has been natural to ask what the historical experience of the crisis of the 1930s has to teach us.
The big lesson that has been correctly identified is not to be passive in the face of large adverse financial shocks.The financial tidal wave was totally unexpected and was of such severity that immediate policy action was required to prevent total meltdown.For a while it seemed that the world stood at the edge of an abyss, a short step away from an even greater economic disaster than had occurred three-quarters of a century earlier.This paper provides a survey of the Great Depression comprising both a narrative account and a detailed review of the empirical evidence, focusing especially on the experience of the United States. there is a possibility that when this crisis is looked back upon by the economic historian of the future it will be seen to mark one of the major turning points’ (Keynes, 1931).We examine the reasons for and flawed resolution of the American banking crisis, as well as the conduct of fiscal and monetary policy. Keynes was right; Table 1 shows some of the dimensions.Indeed, aggressive monetary and fiscal policies were immediately implemented to halt the financial disintegration.Fortunately, countries were not constrained by the oppressive stranglehold of the gold standard.Meanwhile, the European Central Bank was forced to intervene to restore calm to distressed credit markets which were badly affected by losses from sub-prime hedge funds.On 14 September 2007, the British public became aware that Northern Rock, which had moved into sub-prime lending after concluding a deal with Lehman Brothers, had approached the Bank of England for an emergency loan.The run on Northern Rock was an extraordinary event for the UK.During the Great Depression no British financial institution failed, or looked like failing, but in 2007 there was immediate depositor panic.