By AMITY SHLAES
Police short sales and block them, says Securities and Exchange Commission Chairman Christopher Cox. Fire the SEC chairman, says John McCain. Investigate those short sellers, say state attorneys general. Hold hearings to grill Wall Streeters says Nancy Pelosi. "Fire the whole Trickle-Down, On-Your-Own, Look-the-Other-Way crowd" says Barack Obama, and "get rid of this whole do-nothing approach to our economic problems." The Democratic presidential candidate wants public affirmation of his argument that the whole free-market philosophy of economics has been wrong.
Some of this talk carries an implicit suggestion: Do what I say or we will have another Great Depression. And no wonder: This September feels a lot like autumn 1929.
But there's an important fallacy here. The stock market crash of October 1929 and the Great Depression were not the same thing. What made the depression great was not magnitude but duration -- the fact that unemployment was still 20% 10 years later. In the 1930s, policies like the ones described above did not speed recovery; they impeded it.
Not long after the market crashed to 199 from its 381 high at the end of the summer of 1929, President Herbert Hoover turned on short sellers. Like our SEC, he demanded a curb on short sales. "Bear raids" or "bear parties" were to be stopped; the blame for the crash all belonged to "certain gentlemen."
Then, as now, there was a lengthy discourse on the difference between "normal" short sales and "naked" ones. New York Stock Exchange President Richard Whitney argued that curtailing such sales postponed unavoidable pain -- or even made it greater.
It was wrong, he said, to vilify shorts. "Such a contract to deliver something in the future which a person does not own is common to many types of business," Whitney carefully spelled out in layman's language. "When a builder contracts to build a skyscraper he is literally short of every bit of material." Yet the anti-short and anti-Street mood grew. In a spirit every bit as zealous as Sen. McCain, lawmakers assigned attorney Ferdinand Pecora to lead a commission hunting for wrongdoing on Wall Street.
Most observers have concentrated on the corruption that was indeed uncovered by investigators. Whitney, for example, discredited his own argument when he emerged later as a trickster and embezzler.
But the most important fact about this early period is the Dow's movement. Clean-up pronouncements cheered voters, and momentarily, the Dow Jones Index rose a bit later in 1929. But the hostility whipped up by politicians scared a market already well spooked by monetary, banking and international challenges. By summer 1932 the Dow plummeted to the 50s range. This was the year Hoover created the Reconstruction Finance Corp., after which Washington's rescue entity of today is supposedly modeled.
In 1933 there was a moment when the U.S. really did seem poised for recovery -- the moment of Franklin Roosevelt's inauguration. Confronting the banking crisis, President Roosevelt did what President Bush, Congress and the Treasury are likely to do in coming days: create a mechanism to sort out banks and their holdings, to separate good assets from bad.
Such an office can shorten a crisis -- the Resolution Trust Corporation, created to deal with the 1980s Savings and Loan debacle did. There was nothing necessarily partisan about the process. Hoover's Treasury secretary, Ogden Mills, and Roosevelt's new Treasury secretary, William Woodin, sat together at the task, just as Republicans and Democrats presumably will now. The establishment of the SEC in 1934 likewise set the country up for recovery.
But like today's politicians, Roosevelt also used the downturn as a weapon to trash markets generally. The New Dealers even used the same mocking phrases Mr. Obama does today. The rich might think that wealth trickled down, Roosevelt's speechwriter Sam Rosenman would later note, but "Roosevelt believed that prosperity did not 'trickle' that way."
In 1933 and 1934, Roosevelt went on the attack. The Sergey Brin of the 1920s was Samuel Insull, the Chicago utilities magnate who created the format for the modern electrical grid, taught housewives about refrigerators, employed thousands and proved it was possible for the private sector to raise the prodigious amounts of cash necessary for utilities, the most capital-hungry of industries. But the credit crunch killed off Insull's leveraged companies, rendering shareholder portfolios worthless.
Insull was extradited from Greece and hauled back to Chicago. A jury refused to convict him of fraud. But federal or state prosecutors continued to harry him until he died of a heart attack or stroke in 1938.
The deity of the markets, the Alan Greenspan of the 1929s, was Andrew Mellon. He served as Treasury secretary to Presidents Harding, Coolidge and Hoover. In 1932, while Mellon was still in office, a young Democratic Congressman from Texas -- Wright Patman -- launched a campaign to impeach him.
The Roosevelt administration was more systematic. Treasury Secretary Henry Morgenthau instructed a staff lawyer, Robert Jackson, to prosecute Mellon for tax evasion. Jackson hesitated. Morgenthau, anticipating New York's Eliot Spitzer, insisted, saying, "You can't be too tough in this trial to suit me." Jackson then jumped up, exclaiming, "Thank God I have that kind of boss," as Morgenthau recounted in his memoirs.
A grand jury declined to indict Mellon. The government then began multiple actions against him. Exoneration came, but only after Mellon's death. Roosevelt put Jackson on the Supreme Court.
In these years, the market was trying to recover, but prosecutors and tax collectors kept getting in the way. Mrs. Pelosi might note that even after the Pecora Commission finally completed its hearings, unemployment was still 20% rather than 10%.
Roosevelt's first effort at raising wages to revive the economy, the National Recovery Administration, was declared unconstitutional. Next came the Wagner Act, which led to massive unionization. Wages increased and unemployment even dipped a bit, but productivity did not rise in commensurate fashion. This contributed to companies' struggles, as Lee Ohanian of UCLA has shown. Industrial production plunged. In 1938, John L. Lewis of the CIO attained the apogee of his power, but unemployment was again at that appalling two in 10.
The signal Washington emitted in these years was clear: Not Open for Business. A poignant moment came in August, 1937, when Mellon died in Southampton, N.Y. When this star of their old firmament winked out, investors felt themselves in uncharted waters. Other negatives -- rising labor costs, regulatory tightening, a doubling of reserve requirements for banks -- suddenly seemed insurmountable. The market dropped from 189 in August to 120 by the next February, well below the lowest ebb in 1929.
A desperate Treasury Secretary Morgenthau traveled to New York to placate a crowd of 1,000 economists and businessmen at the Hotel Astor in November, 1937. The audience laughed at him for daring to try. By the next year the New Dealers were quietly telling themselves their anti-wealth experiment was over -- and turning to the impending war in Europe.
The point for us in our own fragile moment is clear. To be sure, clean up is necessary. It can even help the market -- some. But in the long run what works politically is different from what works economically. Revenge, however sweet, cannot bring recovery.
Ms. Shlaes, a senior fellow at the Council on Foreign Relations, is author of "The Forgotten Man: A New History of the Great Depression" (HarperCollins, 2007).
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