Paul Krugman: Partying Like It’s 1929

Paul Krugman is an economist. He also knows his history and what happens when you ignore it. I know my history. But America has forgotten. Just as we forgot about Vietnam, and are repeating the same mistake in Iraq, so are we repeating the mistakes of the 1920s:

But what we should be asking is: How did we get here?

Why does the financial system need salvation?

Why do mild-mannered economists have to become superheroes?

The answer, at a fundamental level, is that we’re paying the price for willful amnesia. We chose to forget what happened in the 1930s — and having refused to learn from history, we’re repeating it.

Contrary to popular belief, the stock market crash of 1929 wasn’t the defining moment of the Great Depression. What turned an ordinary recession into a civilization-threatening slump was the wave of bank runs that swept across America in 1930 and 1931.

This banking crisis of the 1930s showed that unregulated, unsupervised financial markets can all too easily suffer catastrophic failure.

As the decades passed, however, that lesson was forgotten — and now we’re relearning it, the hard way.

But the root of the problem is debt. We are drowning in debt. For a long time that debt was profitable for the lenders. But the free ride is over. An economic system that runs on debt is one headed for disaster. We have a disaster on our hands:

If the subprime mortgage mess has taught us anything, it is that we are leverage addicts. Nearly all of us are -- from Northern Virginia, where we bought big houses with no money down, to Wall Street, where traders borrowed cash to make bigger bets on the housing market.

Seeing Zero Percent Interest Until Next Year! on envelopes causes us to tear them open, find the Web address, enter some information and send new credit cards hurtling toward our mailboxes. Financing cars for three years is so passe; we finance them for six or seven. And now we buy -- or used to buy -- houses with pick-your-payment mortgages. We are leveraged from here to China. U.S. consumers spend more than 14 percent of their after-tax income just to stay current on household debt.

The question worth asking now is: Why do we love leverage so much that it hurts?

The simple answer, according to personal finance experts, is that we want more -- more money, more house, more car, just more, more, more. We often think we deserve more. Leverage gets us more. With historically low interest rates, leverage is the easiest and quickest tool to get more stuff.

The problem is that too much leverage has a downside that is easy to overlook. When everyone else is using leverage so successfully to get more, do we wonder what will happen if interest rates go up? Not so much.