Hard Times
All last year and well into this one, Americans dismissed the bear market in stocks as little more than a playful and frisky cub pawing through the picnic litter. Only in the last 10 weeks have people begun to see him as an angry 800-pound grizzly, capable of lacerating national economic hopes and individual portfolios alike.
The trouble, to paraphrase Winston Churchill, is that this belated-realism stage is not the end. It is not necessarily even the beginning of the end. Finally taking the bear seriously--along with pondering the lessons of 1929, the Japanese doldrums and all the other financial crises that preceded it--may only be the end of the beginning, with a larger financial crisis still to unfold.
Washington leadership itself calls up unhappy precedents. The Bush administration, with its second-rate economic advisors and its cheerleader mentality, is caught in a maelstrom it can’t understand. Under the strain, it has begun to show unnerving resemblances to the ineffectual Hoover team of 70 years ago. Federal Reserve Chairman Alan Greenspan, whose place in economic history is also teetering, has few stimulative weapons left and seems to be worried about the United States having a decade of doldrums like the one that Japan experienced after its stock market crash in the early 1990s.
It’s also possible that the economic recovery that began in the fourth quarter of 2001 will wind down this autumn or winter as the fiscal and monetary stimulus that was pumped into the economy after Sept. 11 wears off. Beleaguered stock owners and overextended consumers could snap their wallets and checkbooks shut.
My guess is that we are halfway through a three-stage financial crisis. Over the course of the ‘80s and ‘90s, the finance, insurance and real estate sector of the economy grew so notably that it moved ahead of the manufacturing sector in the gross domestic product numbers. We are now being tossed by the wake of its over-ambition. Indeed, given the way finance and technology teamed to create the recent tech stock bubble, one can argue that boom-and-bust was a product of finance as much as of technology.
Much of our current crisis of confidence in corporations and the legitimacy of their stock prices also derives from the financialization of business--dishonest accounting, faked earnings, derivatives, off-the-books partnerships, run-amok stock options--rather than the old corporate bugaboos of price-fixing, polluting, bribery and restraint of trade. The big corporate crimes and transgressions now have little to do with a company’s product: They are financial, with chief financial officers the frequent masterminds. The United States has become a financial society.
If the first stage of the financial crisis, in 2000 and 2001, was bubble-related, the second stage, in 2002, is about the integrity of financial markets, institutions and valuations in the aftermath of two decades of mammoth expansions and hubris. The large investment firms of Wall Street earlier pressured corporations into looking at quarterly earnings as an end in themselves and, more recently, fleeced investors with corrupt stock research and ratings. Too many accounting firms, in turn, played along with corporate financial gimmickry for high consulting fees. Big banks like Citigroup and J.P. Morgan Chase, it now appears, helped the Enrons and other hungry raptors to set up financial flimflams. Enron shareholders are now suing nine of the big banking and investment conglomerates.
Out of this warped financialization have come competitions between huge industries like telecommunications and energy over who can stage the world’s biggest bankruptcies--first Enron, now WorldCom--and the destruction of hundreds of billions in stock and bond market capitalization as phony profits evaporate and Wall Street “buy” ratings implode.
Finance, too, is reeling as congressional hearings multiply and mutual-fund assets shrivel. Between 1980 and 2000, mutual-fund assets rose from $138 billion to $7.8 trillion as the stock market soared. Since 2000, however, the total value of U.S. stocks, as measured by the Wilshire 5000 Index, has fallen from a peak of more than $14 trillion to $7 trillion to $8 trillion.
There is absolutely no precedent for measuring what effect this crash--the largest assets collapse in history--will have on the U.S. economy and consumers. Straight dollar comparisons with the 1929 crash are meaningless because of inflation. However, as a percentage of U.S. gross domestic product, the loss of equity wealth between 2000 and 2002 is somewhat higher than during the same period after 1929. This time, however, more of the loss has hit the middle class. Thank you again, financialization.
Which brings us to a related point. The U.S. has been one of the world’s most speculative economies, and each great new industry coming of age--railroads and steel in the 19th century, autos, aviation, radio and electric utilities in the 1920s--has had bubbles that turned into brutal crashes. In the major crashes of those eras, finance was only an accomplice, a facilitator lacking the heft of a major share in the real economy of the GDP.
Not anymore. Which means that stage three of the financial crisis could well conjoin a negative wealth effect--worried investors and consumers cocooning for a cold winter--with a further downward lurch in the stock markets as mutual funds and the U.S. economy contract later this year or early next. If so, it could bring the financial industry’s own sectorial bloodbath, already beginning to be visible in bank stocks.
The experts dismissing this have argued that the economy is in a reasonably strong recovery from the brief recession of 2001. They discount both the drag on the economy of stock losses and the notion that the present recovery relied on post-9/11 stimuli that are lessening. They also reject any parallels to 1929-32 or to Japan after its 1990 stock market collapse.
Analogies, of course, must be taken with a grain of salt. History repeats only in outline, not detail. However, the probability is that the U.S. stock market collapse and economic disruption of 2000-2002 is at least a cousin of the U.S. downturn of 1929-32 and of the Japanese debacle now in its 12th year. A speedy “normal recovery” is unlikely.
Politics are likewise uncertain. The Bush administration, with its economic happy talk, excessive corporate influence and unwillingness to grapple with a serious new federal regulatory role, bears a resemblance to the GOP of the ‘20s. Like the unlucky Herbert Hoover, George W. prefers business self-regulation and volunteerism, which will prove inadequate if the crisis deepens.
However, in contrast to Hoover and his vice president, who were themselves free of any corporate scandal, Bush and Vice President Dick Cheney, both ex-CEOs of energy companies, have strong corporate biases and connections, leaving them wide open to charges of unethical behavior and cronyism. This adds to public disbelief and loss of confidence in the nation’s institutions.
If the stock market crash of 2000-2002 spreads into the real economy, triggering another downturn, the perception of Bush as corporate insider would intensify, and he could be crippled by loss of personal credibility as well as by Democratic control of Congress. A divided government in Washington during 2003-2004 could stand in the way of economic solutions, as it did in 1931-1932, when partisan parity in Congress produced deadlock with the Republican administration.
The fallibilities of Greenspan and the Federal Reserve also suggest that we are in the middle of an unusual crisis, not an everyday business cycle. History’s record is that while central banks have played roles in bringing about stock market bubbles and crashes, they have enjoyed less success in overcoming the major downturns once they happen. They have been part of the problem more often than part of the solution.
In the Mississippi bubble of 1720, the first of the modern line, the Bank of France was heavily involved. In the British railroad crash of the 1840s, belief in the omnipotence of the Bank of England helped swell the great bubble to bursting.
The U.S. boom-and-bust of the 1920s was partly linked to faith in the brand new Federal Reserve Board, which pumped up the bubble in 1925 and 1927 but then refused to help in the depths of 1931 and 1932. The Japanese stock market crash of 1990-92 came after the Bank of Japan had lubricated the stock bubble for several years and then popped it with rate hikes. No wonder the Greenspan Fed is reading up on the Japanese analogy.
Economic history, to be sure, does not have much to tell us about the next week or month. It’s easy to imagine more brief stock market upsurges in a badly oversold market. But over the next six months or year, the odds are that the downturn will spread to the consumer--and to the hubris-driven financial sector itself.
