Role of Government and Citizen narratives in 1920s and 2008 crises

Shreya Gupta
WR 150: Narratives in Finance
December 2, 2016
Shreya Gupta 2
12/2/16
WR 150 J1

In “From Finance Capitalism to Financialisation: A Cultural and Narrative

Perspective on 150 years of Financial History,” Hansen argues that financial instability

happens when finance gets too dominant. Finance gains a dominant position because of

certain narratives in these periods that drive up the importance of finance. He defines

narratives as ones that “create order out of chaos by assigning meaning and causality to

seemingly incomprehensible and unconnected events; and in doing so, they shape our

perception, worldviews, decisions, and actions.”1 These narratives are the beliefs that people

and the government assign to different points in time to explain the economy, and they can

sometimes be enough to ignite people’s animal spirits. According to George A. Akerlof’s and

Robert J. Shiller’s, “Animal Spirits”, animal spirits are “the thought patterns that animate

people’s ideas and feelings,”2 like greed and fear. The narratives defined by the government,

termed as government narratives, can animate people’s animal spirits, which results in people

forming citizen narratives. These widespread citizen narratives are formed when people Commented [SG1]: Professor’s comments:
You still need to define this term
change their perceptions about the economy because of their ignited animal spirits. Are the Shreya:
I thought that the follow up sentence acted as a definition
for the citizen narratives. I am not sure what’s missing… it
government narratives only the ones causing the economic bubble or hindering the recovery will be helpful if you could expand more on this.

of the economy? Understanding how government narratives create a reference for citizen

narratives by animating their animal spirits can help us reach to the root cause of major crises

in US financial history. In both the 1920s and 2008, the combination of government

narratives and citizen narratives created a bubble that was hard to recover from.

In the 1920s, government created a narrative, which led to the securities market crisis

by provoking citizen narratives. The government believed that universalising the ownership

1
Per H. Hansen, “From Finance Capitalism to Financialisation: A Cultural and Narrative Perspectives on150
years of Financial History,” Cambridge University Press 15, no. 4 (2014): 605-642. Accessed October 6, 2016.
https://muse.jhu.edu/article/572609 .
2
George A. Akerlof and Robert J. Shiller, Animal Spirits (New Jersey: Princeton University Press, 2010), 1. Print.
Shreya Gupta 3
12/2/16
WR 150 J1
of financial securities would stabilise the economy by giving people a sense of citizenship,

under “industrial corporate capitalism.”3 During this decade, the US was experiencing high

levels of immigration, corporate mergers, financial instability, and the meaning of citizenship

wasn’t clearly defined. As a result, the government asserted that making every individual

hold a “stake in the future of the economy,”4 would give citizens a sense of responsibility

toward the country.

This started before WW1, when the government needed to raise funds for fighting the

war. In order to avoid taking the money from the public in the form of taxes and the resulting

decrease in spending, the government used state debt as a medium to raise funds. The

government thought that selling bonds would act as another medium of savings for American

individuals. Individuals would be willing to invest, as the money was collected for the cause

of helping the “noble sons who [went] out to die for [American individuals].”5 In order to

combat the immigration and citizenship issue and to raise funds for fighting the war, the

government hoped that people would invest in these “Liberty bonds”5. The Government used

advertisements to promote these bonds with slogans such as, “Billions of dollars are needed

and needed now,”6 “Lend - the way they fight--Buy Liberty bonds to your utmost.”7

According to Julia Ott, a historian, the government was successful in marketing and

promoting the loans and the stocks such that “at least 20 million Americans had purchased a

3
Julia Cathleen Ott, "When Wall Street Met Main Street: The Quest for an Investor’s Democracy and the
Emergence of the Retail Investor in the United States, 1890-1930,” Cambridge University Press 9, no. 4 (2009):
619-630. Accessed October 12, 2016. https://muse.jhu.edu/article/255463 .
4
Allen H. Jones, “Blueprint for an Ownership Society,” Mortgage Banking, 2004, no. 64(9): 68-72. Accessed
October 18. 64.9: 68-72. ProQuest. Web.
5
Richard Sutch, “Liberty Bonds,” Federal Reserve History, December 4, 2015,
http://www.federalreservehistory.org/Events/DetailView/100
6
Z. P. Nikolaki, “Hello! This is liberty speaking – billions of dollars are needed and needed now,” Library of
Congress Prints and Photographs Division Washington, D.C. 20540 USA, 1918,
http://www.loc.gov/pictures/collection/wwipos/item/93502270/
7
Lutz & Sheinkman Litho., “Lend - the way they fight--Buy Liberty bonds to your utmost / Lutz & Sheinkman
Litho., New York.,” Library of Congress Prints and Photographs Division Washington, D.C. 20540 USA, 1917,
http://www.loc.gov/pictures/collection/wwipos/item/00652845/
Shreya Gupta 4
12/2/16
WR 150 J1
war bond and roughly 10 million owned shares in publicly traded corporations”3 toward the

end of the 1920s. However, this narrative was enough to ignite the animal spirit of greed in

people, and create a widespread citizen narrative.

The narrative created by the government not only promoted the financial securities

market as another medium of savings, but also provided “a field for competitive men to

pursue economic opportunity.”3 This animal spirit of greed propelled people to form a citizen

narrative of shareholder democracy. This meant that shareholders “denounced welfare

capitalism, corporate governance and Hooverian economic policy”. This led to people

believing that “every man was entitled to participate in the stock market.”3 Using the

government narrative of citizenship as the basis for the new narrative, shareholder democrats Commented [SG2]: Professor’s Comments:
Sort of a strange term
Shreya:
made analogies between “market and nation, corporation and polity, shareholder and citizen”3
This is the term that I have taken from Julia Ott’s paper. So,
would it be ok to use the term if I put quotes “” around it?
and reinforced the narrative of shareholder democracy. This led to increasing confidence and

over-indulgence in stocks and bonds, and eventually people wanted freedom to use their

money and started restricting the state governance; “state oversight, [NYSE] alleged, would

only compromise access to its ‘free and open markets’”3. With the ignited animal spirits, the

focus shifted from the government’s ultimate goal of making people realize citizenship to

maximizing shareholder value and shareholder democracy with minimum government

intervention. The citizen narrative reached its highest level when people started buying stocks

with borrowed money. The freedom to buy stocks without governance led to speculation and

eventually the creation of a financial bubble, which burst in the crash of 1929. Both the

government and citizen narratives created the bubble and pushed the economy to become a

laissez-faire market with minimum government intervention, far from what the government

had anticipated.

In 1929, both the citizen and the government narratives made it harder for the

economy to recover. During the great depression, 11,000 banks failed due to the burst of the
Shreya Gupta 5
12/2/16
WR 150 J1
securities bubble. As a measure to recover the failing economy, the Secretary of the Treasury,

Andrew Mellon, asserted a narrative that the federal reserve bank should “liquidate labor,

liquidate stocks, liquidate the farmers, [and] liquidate real estate”. This liquidation doctrine Commented [SG3]: Professor’s Comments:
I don’t quite follow your chronology here
Shreya:
aimed to reduce the weak institutions in order to accelerate the healthier economic system.8
It will be helpful if you could tell me what you meant about
the problem with the chronology as everything is in 1929.
He believed that this doctrine would “purge the rottenness out of the system,” saying that

“people will work harder [and], live a more moral life ... Values will be adjusted, and

enterprising people will pick up the wrecks from less competent people.”9 He did recognize

the rising animal spirit, greed, during the bullish markets and thought that liquidation would

counteract the bullish market, subdue everyone’s greed and stabilize the economy. However,

the liquidation doctrine created a new citizen narratives of the fear of losing money, which

resulted in the failure of the whole financial system.

Mellon’s narrative along with people’s fear of losing money brought the economy

into an era of depression. This is evident from the failure of Caldwell and Co., which was a

“rapidly expanding conglomerate and the largest financial holding company in the South.”10

The problem started with the failure of the Bank of Tennessee, a principal subsidiary of

Caldwell, when “$3,840,000 in securities [was] not found among the assets of the closed

Bank of Tennessee.”11 Because of the government’s narrative, it wasn’t helping small

subsidiaries as it only wanted the fittest to survive. With no funds provided by the federal

reserve, weak banks were lacking cash and assets and thus, weren’t able to pay for

withdrawals by citizens. This caused panic around the country and slowly, other Caldwell

8
Gary Richardson, “THE GREAT DEPRESSION,” Federal Reserve History, April 2, 2014,
http://www.federalreservehistory.org/Period/Essay/10
9
Edward Gale Agran, Herbert Hoover and the Commodification of Middle-Class America: An American Promise
(London: Lexington Books, 2016), 161.
10
Gary Richardson. “Banking Panics of 1930 and 1931,” Federal Reserve History, November 22, 2013,
http://www.federalreservehistory.org/Events/DetailView/20
11
"ARKANSAS BANK HIT BY CALDWELL CRASH." New York Times (1923-Current File), Nov 17, 1930, 2.
http://search.proquest.com/docview/98836021?accountid=9676
Shreya Gupta 6
12/2/16
WR 150 J1
affiliates in nearby states, including Kentucky, also failed. The cascade of the failures created

deeper panic. Panic ignited the animal spirits of fear among the account holders. As the fear

spread from one town to another, hundreds of banks ceased their operations. “Bank runs,”

during which account holders attempted to pre-emptively withdraw their money, drove down

many banks. A large number of small banks, even those that were perceived to be doing

well, were being liquidated. The failure of many of its subsidiaries, because of their high

investments in stocks, created a pressure on Caldwell and ultimately led to its failure. This

example shows that the government initiative to not help failing banks ignited fear which

created further citizen narrative of fear of losing money and caused the crash of financial

system. Commented [SG4]: Professor’s Comments:

You don't really have too many specific examples of these
"citizen narratives."
Looking at another example, the housing bubble in 2008 also reflects the relation Shreya:
How can I make these more specific? I know these
narratives are more indirect but I would like to know your
between the government narratives and citizen narratives. In 2008, the government had a suggestion on how can I make these narratives more
specific.
narrative to promote ownership of homes. Recognizing that homeownership has been the

dream of every American individual, the Clinton and Bush administrations took initiatives to

promote homeownership. The Clinton administration implemented “National

Homeownership Strategy, an unprecedented public-private partnership to increase

homeownership to a record-high level over the next 6 years.”12 It was an effort made to

promote housing among Americans. Similarly, with homeownership a top priority, the Bush

administration introduced the “ownership society.”4 Ownership society was based on the

belief that “government serves people best by helping to* become self-sufficient – and that

homeownership is the surest path to self-sufficiency.”4 Despite the fact that the bubble blew

up in 2008, this belief in homeownership had driven the policies from a long time ago. The

government, in an effort to increase the homeownership, set up government sponsored

12
“Urban Policy Brief”, Office of Policy Development and Research (PD&R) U.S. Department of Housing and
Urban Development, number 2. August 1995. https://www.huduser.gov/publications/txt/hdbrf2.txt
Shreya Gupta 7
12/2/16
WR 150 J1
enterprises (GSEs). These enterprises focused on curbing the problem of high down payment Commented [SG5]: Professor’s Comments:
We need a better sense of time here.
Shreya:
on mortgages which was faced by many low income and middleclass families. The Bush
I am not sure how specific should I be as the GSEs were set
up and were promoting homeownership all this time. I just
administration made an effort to loosen the requirement of the down payment and the Loan to wrote the sentence to make the reader realise that I
acknowledge that there were GSEs for a long time.
However, their major effect was shown in 2008.
value (LTV) ratio. In 2008, the Bush administration introduced loans which required “Zero

Down Payment Mortgage,” an effort undertaken to generate approximately 150,000 home

owners in a year. The government believed that “credit history [was] a more important

indicator of loan preference than the level of down payment.”4 The emphasis put on

homeownership by the government ignited people’s animal spirits which further created more

dominant citizen narratives.

In 2008, the government promoted riskier loans to low median income groups and

private institutions. At the same time, the strong performance of the housing market over the

last 25 years and the rise in the Dow Jones Industrial average by almost 20 times encouraged

people to buy homes. People eventually learned that “it was good to take financial risks.”13

With higher willingness to take loans, people started taking housing loans of more than they

could afford and these mortgage loans became a source of easy money. Easy money ignited

the people’s animal spirit of greed, and people started believing that housing prices would

never fall. The citizen narrative of ever rising housing prices was driven by over confidence

in the housing prices and the stock prices. Thus, private banks undertook complex

investments, driven by greed. With unprecedented belief in rising housing prices, citizens got

involved in reckless financial behavior. This is evident from the high leverage ratio of “40 to

1.”1414 This citizen narrative, coupled with the government narrative of providing full

13
Douglas J. Elliott and Martin Neil Baily, “Telling the Narrative of the Financial Crisis: Not Just a Housing
Bubble” The Brookings Institution, (2009), https://www.brookings.edu/wp-
content/uploads/2016/06/1123_narrative_elliott_baily.pdf
Shreya Gupta 8
12/2/16
WR 150 J1
homeownership, led to the creation of the housing bubble, as people now started buying

homes above and beyond their means.

Similar to 1920s, in 2008, when the financial bubble burst, the government took

actions to avoid economic failure and recover the economy. However, the government’s steps

were again misguided. In 2008, because of the citizen narrative of ever rising housing prices,

many financial institutions lent millions of dollars to each other and were highly

interconnected. Thousands of mortgage backed securities moved to and from institutions on

an hourly basis. Worrying about the interconnectedness, the government believed that failure

of one institution would not just hurt its owners and bond holders but also those of other

connected firms like banks, insurance companies, hedge funds, pension funds and other

financial institutions.14 In July 2007, one of the important financial institutions, Bear Sterns,

was rescued by the government due to the fear that failure of this institution might cause a

domino effect and eventually lead to a failure of the whole financial system. In order to meet

all the regulations, Federal Reserve Bank made sure that there were enough assets with the

failing institutions to back it up for the loan.

However, the problem occurred when other bigger banks like Lehman Brothers

(which was declared bankrupt) started facing trouble. After a lot of discussions, the

government turned around on its actions to save the failing banks and decided to let Lehman

Brothers fail. This action was supported by the government narrative that saving all the

institutions would bring all “investment banks under the same assumed umbrella of

protection”13 and encourage reckless risk-taking. The government feared that saving Lehman

Brothers might make citizens assume that “the government would protect those banks from

failure.”13 The government’s decision to rescue Bear Sterns and not rescue Lehman Brothers

14
Peter Walison, "From Bad to Worse," in Hidden in plain sight: what really caused the world's worst financial
crisis and why it could happen again, 2015, (New York: Encounter Books, 2015), 313.
Shreya Gupta 9
12/2/16
WR 150 J1
created the ultimate problem as it caused an imbalance between the narratives assumed by the

people and the government actions. The inconsistent narratives pursued by the government to

save and not save investment institutions created a massive confusion among people about

the markets. The government inconsistent narratives then became the basis for the people to

then form their own citizen narratives which made it harder for the economy to recover.

Government actions promoted citizens to form their new narrative of risk aversion,

rising from the animal spirit of fear. According to Eliot and Bailey, “‘risk aversion’ is the

term economists use to describe the preference of individuals and institutions to avoid risk

when they make economic decisions, if they can do so without cost.”13 The confusion created

by the inconsistent narratives promoted by the government disturbed the citizen narratives

which caused a panic in the economy, encouraging people to be fearful about losing their

money. Citizens’ fear of losing money created a deeper crisis because their “behaviors

towards risky assets changed dramatically.” The extent of the crisis is evident from the drop

in the Dow Jones industrial average by “more than 50% on March 5, 2009” 15 in less than 18

months and an approximately 20% decrease in the housing pricing index in 36 months (2007-

2009)16. Furthermore, lower liquidity came from low confidence and fear led to reduction in

the provision of loans by the banks and higher level of loan rates, which then resulted in

lesser investment and consumption in the economy and pushed the economy into a period of

great recession. Thus, the dramatic change in citizen narratives caused by government’s

inconsistent narratives resulted in the great recession in 2008.

Some readers might think that the government was the root cause of the crises in the

1920s and 2008 as it initiated the push toward increased ownership of stocks or houses and

15
“Dow Jones Industrial Average,” Yahoo finance, http://finance.yahoo.com/quote/%5EDJI?ltr=1
16
“The U.S. Housing Market in 9 Charts”, Wall Street Journal,
http://blogs.wsj.com/economics/2016/06/23/the-u-s-housing-market-in-9-charts/
Shreya Gupta 10
12/2/16
WR 150 J1
not the citizens. While it is true that the initial steps were taken by the government, it is

important to realize that citizen narratives have also played a dominant role in creating a

bubble or hindering the recovery of the economy in the US history. If the government was the

only culprit, then in the 1920s, the ownership of stocks would have only acted as another

means of savings and not promoted shareholder democracy. Similarly, in 2008, if the

government was the only one promoting narratives, then the ownership of homes would have

only met the needs of a large number of Americans and not created this narrative that housing

prices will never fall. It’s important to notice that “Wall Street financial institutions failed to

put in place … the sound risk management processes” and the “flaws … were accepted

because they allowed behavior that was very profitable in the short term”. Willingness to take

risks and “easy money conditions of the mid‐2000’s”13 created the housing bubble. Similarly,

in the 1920s, the increased freedom to buy stocks was encouraged by the citizen narrative of

shareholder democracy, which caused the bubble in the financial stocks market. This shows

that if the people’s animal spirits were in control and if they had not created any further

citizen narratives, then these two eras in history might not have experienced such financial

crises on a large scale. The aggravated animal spirits acted upon the government narratives

and created a bubble or hindered the recovery. Hence it was not only the government

narratives but also the citizen narratives which ended up playing a key role in the economic

breakdown.

The 1920s and 2008 financial crises were caused by the coupled effect of government

and citizen narratives. In the 1920s, the promotion of war bonds followed by Shareholder

democracy inflated the economic bubble, while the liquidation doctrine followed by the fear

of losing money made it harder for the economy to recover. Similarly, promotion of home

ownership followed by the narrative of ever rising housing prices created the 2008 housing

bubble while the inconsistent narratives followed by risk aversion hindered the recovery of
Shreya Gupta 11
12/2/16
WR 150 J1
the economy. These narratives in the two major periods of U.S history help us identify the

root cause of the problems. While 1920s and 2008 show a clear relation between the

government and citizen narrative and different business cycles in the economy, the same

relation can be used to identify the roots of other crises in the US history. For example, the

reckless behavior of venture capitalists during dotcom bubble and the online trading in 1987.

From a broader view, it can be said that it is always the combination of both government and

citizen narratives, which together define the economic crises.

Shreya Gupta 12
12/2/16
WR 150 J1
References:

"ARKANSAS BANK HIT BY CALDWELL CRASH." New York Times (1923-Current

File), Nov 17, 1930, 2.
http://search.proquest.com/docview/98836021?accountid=9676.
“Dow Jones Industrial Average,” Yahoo finance,
http://finance.yahoo.com/quote/%5EDJI?ltr=1
“The U.S. Housing Market in 9 Charts”, Wall Street Journal,
http://blogs.wsj.com/economics/2016/06/23/the-u-s-housing-market-in-9-charts/
“Urban Policy Brief”, Office of Policy Development and Research (PD&R) U.S. Department
of Housing and Urban Development, number 2. August 1995.
https://www.huduser.gov/publications/txt/hdbrf2.txt
Agran, Edward Gale. Herbert Hoover and the Commodification of Middle-Class America:
An American Promise (London: Lexington Books, 2016), 161.
Akerlof, George A. and Shiller, Robert J. Animal Spirits. New Jersey: Princeton University
Press, 2010, 1. Print.
Elliott, Douglas J. and Baily, Martin Neil. “Telling the Narrative of the Financial Crisis: Not
Just a Housing Bubble” The Brookings Institution, (2009).
https://www.brookings.edu/wp-
content/uploads/2016/06/1123_narrative_elliott_baily.pdf
Hansen, Per H. “From Finance Capitalism to Financialisation: A Cultural and Narrative
Perspectives on150 years of Financial History.” Cambridge University Press 15, no. 4
(2014): 605-642. Accessed October 6, 2016. https://muse.jhu.edu/article/572609.
Jones, Allen H.. “Blueprint for an Ownership Society,” Mortgage Banking, no. 64 (9) (2004):
68-72. Accessed October 18. ProQuest. Web.
Lutz & Litho. Sheinkman. “Lend - the way they fight--Buy Liberty bonds to your utmost /
Lutz & Sheinkman Litho., New York.,” Library of Congress Prints and Photographs
Division Washington, D.C. 20540 USA, 1917.
http://www.loc.gov/pictures/collection/wwipos/item/00652845/
Nikolaki Z. P.. “Hello! This is liberty speaking – billions of dollars are needed and needed
now,” Library of Congress Prints and Photographs Division Washington, D.C. 20540
USA. 1918. http://www.loc.gov/pictures/collection/wwipos/item/93502270/
Ott, Julia Cathleen. "When Wall Street Met Main Street: The Quest for an Investor’s
Democracy and the Emergence of the Retail Investor in the United States, 1890-
1930.” Cambridge University Press 9, no. 4 (2009): 619-630. Accessed October 12,
2016. https://muse.jhu.edu/article/255463.
Pam Martens, “Hoenig: Wall Street Banks “Excessively Leveraged” at 22 to 1 Ratios,” Wall
Street on Parade, May 9, 2014. http://wallstreetonparade.com/2014/05/hoenig-wall-
street-banks-%E2%80%9Cexcessively-leveraged%E2%80%9D-at-22-to-1-ratios/
Shreya Gupta 13
12/2/16
WR 150 J1
Peter Walison, "From Bad to Worse," in Hidden in plain sight: what really caused the world's
worst financial crisis and why it could happen again, 2015, (New York: Encounter
Books, 2015), 313.
Richardson, Gary. “Banking Panics of 1930 and 1931,” Federal Reserve History. November
22, 2013, http://www.federalreservehistory.org/Events/DetailView/20.
Richardson, Gary. “THE GREAT DEPRESSION,” Federal Reserve History. April 2, 2014.
http://www.federalreservehistory.org/Period/Essay/10.
Sutch, Richard. “Liberty Bonds,” Federal Reserve History, December 4, 2015,
http://www.federalreservehistory.org/Events/DetailView/100