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The Great Depression Q&A

Recently, St. Louis Fed Economist Dave Wheelock sat down to answer some questions about some parallels between the current economic recession and the Great Depression.

Why do we have these periods of booms and busts?

Well, you do have shocks that are uncontrollable—when you have wars and severe weather events, for instance. You have technology shocks. Then, you do have these episodes of financial mania that seem to just arise. It’s hard to put your finger on it. Some people will describe it as myopia on the part of investors. They’ll think that prices will go one way forever. Other people will suggest monetary policy flooded the market with a lot of liquidity. That money and credit had to go someplace. Economists are generally reluctant to talk about irrational behavior, but there is a growing field of behavioral finance, which emphasizes this myopic behavior. It’s a tough question to answer, but it’s certainly intriguing.

Stablity of Life Insurance under Great Depression Strain

While there were several notable failures of insurance companies during the Depression, the only relatively large life company in difficulty was the $150,000,000 Illinois Life of Chicago, whose failure was followed by indictment of several of its officers on charges of conspiracy and embezzlement of funds of the company to support hotel properties in which they were interested. Most life insurance companies were so strong financially that they were not obliged to seek loans from the Reconstruction Finance Corporation. At the same time, they were indirectly aided by RFC loans to the railroads. Although the insurance companies held railroad bonds in large amounts, they were mostly high-grade, first-lien obligations. An estimate of the amount of defaulted bonds held by life insurance companies placed the proportion at less than 2 per cent of the bond portfolio, or less than 1 per cent of total assets.

Historical Evolution of Life Insurance // The Great Depression Pressures Life Insurers

State regulation (put in place after the Armstrong Investigations) still prohibited insurers from investing in the stock market. As such, the stock market crash did not have the same devastating impact on life insurers as it did other institutions. Only 20 out of 350 insurers (5.7 percent) went into receivership during the Great Depression. Of those that failed, virtually all of the policyholder claims were still honored from solvent reinsurers. This compares to more than 4,000 bank failures out of approximately 25,733 state and national banks (15.5 percent) at the height of the Great Depression in 1933. In stark contrast to insurers, bank failures resulted in losses to depositors of about $1.3 billion from 1929 to 1933. However, the life insurance industry did not escape unscathed. Life insurers were primarily invested in conservative long-term bonds, real estate, and mortgage loans. As the Great Depression wore on, mortgage defaults and low interest rates hurt both asset valuations and investment earnings. Low interest rates also hurt insurers’ ability to support crediting rates on annuity policies priced before the economic fallout. Compounding this problem was insurers’ use of overly optimistic mortality tables. At the same time, policyholders could no longer afford their policies or they cashed them in for needed liquidity. The result was lapsed policies and high surrenders that drained cash flows. Higher mortality losses and rising disability claims further increased cash outflows. Accounting for the changes in the economic environment, insurers shifted their investments toward government securities, commercial real estate mortgages and public utility bonds. Despite the challenges of the time, it is important to note life insurers provided a substantial amount of liquidity at a time when such sources were very limited.
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