The US Economy Then and Now. Problems of the 80s Revisited.

It is a common occurrence for the majority of markets to bottom out around October and November. A slowdown occurs annually just prior to the Christmas rush as consumers, savers and financial institutions as a whole wrap up the third quarter and begin preparations for the next year. On October 29th, 1929 the market bottomed out and the fall lasted roughly 22 months. This week there was some slight recovery where the DOW jumped about 900 points. This is less than impressive when you consider that the US economy is expected to grow by only about 0.2%.  Does this mean that there is the possibility of a recovery? Grover Norquist was quoted saying he didn’t want to abolish government, but reduce it to the size where I can drown it in a bathtub. Norquist is the head of the lobby group “Americans for Tax Reform” and was a strong proponent of the deregulations that led us into the current mess. The deregulation, coupled with the automated computer systems that helped flame the fire with automatic selling, leaves the U.S. economy with a considerable amount of work to do. However it is important that we distinguish this current recession from those of the past.

History Lesson

In the 1983 recession (Reagan Recession) the president was finally convinced to raise corporate taxes. A three year plan was instituted that raised one hundred billion dollars through taxes after the congress agreed to reduce government spending by $3 for every dollar raised. The tax increase that was implemented was the largest peace time increase in American history. During the height of the early 80s recession Reagan’s approval rating dropped to 35%.

The major difference between then and now?

Scale. A number of restrictions were removed by the government which increased the lending power of banks. What did the banks do? They immediately began speculative lending and real estate lending. They did this just as the economy soured because of the various oil crises from the 1970s. Next thing you know, 49 banks have failed and another 540 banks were considered on the verge of failure. The Republican Party was going into the 1984 election with a candidate who at that time was destined for failure.

What happened?

The federal government stepped in and bought up large quantities of private debt. Then the most important part of the whole mess, the federal government used $4.5 billion tax payer dollars to bail out the Continental Illinois National Bank because it was too big to fail. The economy recovered and the ground work for our current problems was laid when the federal government didn’t implement any regulations to prevent this from repeating. The banks reassured the government that they would self-police.

The modern context and similarities to now.

Sen. John McCain is falling behind rapidly Barack Obama, while George Bush Jr. has the lowest presidential approval rating since Truman. The Republican Party is going into an election with a track record of screwing the pooch when it comes to the economy. Deregulation, over the course of a few decades, created a situation where banks lent out far too much money and when the loans defaulted near the same time that the market as a whole cooled, the whole thing went shit-storm on us. The overall interconnection of the modern system compared to that of the 1980s has helped make this current banking crisis much worse.

Stocks vs Bonds

It is common knowledge that when interest rates are high you invest in bonds and when interest rates are low you buy stock. In a high interest rate time you receive a better return on your investment while in low interest rate times the dividends from stock are much more profitable. In the 80s, with the massive foul up of the ‘82 to ‘84 recession, inflation and interest rates sky rocketed. In 1979, the interest rate was about 11%. By 1982, the interest rate climbed to 21.5%, as high as they were when junk bonds became a profitable venture. Compare that with the 1990s, when interest rates were about 5%. The low interest rates of the 90s is why we had the boom in the tech sector. The jump in interest at the dawn of the millennium shut that boom down.

Junk Bonds

The appeal of junk bonds is that they were rated below investment grade (medium safe investment: likelihood of return in case of default). With junk bonds, if the company that the bond was purchased from collapsed, there would be no return. With high interest rates, though, return from the bonds was considerably higher. Essentially, what happened with these high risk bonds is that they became brokered deposits for various banks. Banks would purchase up the bonds and use the returns to finance other risky ventures. If the bonds defaulted, then banks would receive no return capital. This led to the Savings and Loans crisis of 1986 until 1990. the total cost of this failure was $124 billion to the tax payer.

Hedge funds fun

Hedge funds are essentially unregulated and secretive close-knit investment firms that have selective clientele to raise capital for specific sectors in the economy. It was estimated that, by 2006, roughly 196 hedge funds were operating in the United States, many of which had assets valued at over $1 billion. The total amount of $743 billion in assets and the total industry was believed to account for an additional $700 billion. Total total value $1.4 trillion.

Thanks for nothing federal government

How did they get this? They purchased the debts of various banks. They received large returns from an investment that would offer no security if any of the banks defaulted. What happened? The market began to cool because of high oil prices, seasonal norms, and people stopped paying their debts because they lacked the funds, the banks couldn’t pay the hedge funds and the whole system defaulted. The final price tag on the tax payers has yet to be determined. Financial aid only ever seems to go to those who pay the most to political parties not in taxes.The middle class of America takes another beating.