Stock Market Crash: What are the Politics Behind It?
Robert Brent Toplin has published a dozen books about history and politics. He is currently completing a book about differences between Democratic and Republican approaches to economic controversies from the time of the Great Depression to the present.
Americans are nervous. Their investments and homes have been losing value. Good jobs are hard to find. Each day the news brings more troubling reports about a mounting debt crisis in the USA, credit downgrades by a rating agency, and the vulnerabilities of Greece, Spain, and Italy. Americans wonder: How did we get in this mess?
Historian Alan Brinkley observed that “economists and historians still have not reached anything close to agreement” when trying to explain the Great Depression, and disputes about causes of the Great Recession are likely to remain as lively. Nevertheless, history provides some useful clues for tracing causes and effects.
Two perspectives are especially helpful. One draws attention to international factors. The other focuses on actions (and mistakes) made by leaders in Washington.
Americans are in the habit of focusing almost exclusively on domestic events when explaining their economic problems. Yet U.S. businesses are closely integrated with the global economy. One of the principal reasons that federal authorities rushed to save the mortgage giants, Fannie Mae and Freddie Mac back in 2008, was that foreign investors from Japan, Russia, China and other nations had more than $1 trillion in debt issued by those agencies.
Bond and stock markets move roughly in tandem these days. When Greece sneezes, the United States catches a cold. When stocks crash on Wall Street, often markets drop in Tokyo a few hours later.
This is not a new phenomenon. Back in the nineteenth century, financial experts did not speak about “globalization” as we do today, but finances were, in fact, closely connected.
When U.S. historians discuss the depression of 1873, for instance, they tend to focus on the events in America such as frenzied railroad building and the failure of a bank, Jay Cooke and Company. But the crisis of 1873, like many others, started abroad (in a decision to cease the minting of silver coins in Germany and bank failures in Vienna).
Currently, bankers and political leaders in Europe are trying to stop their region’s economic hemorrhaging by creating a large bailout program for the eurozone. They want to restore market confidence and prevent “contagion.”
To a degree, though, contagion is already affecting markets in America. Trading on the New York Stock Exchange has been volatile for months, in large part because of serious debt problems affecting Europe’s southern nations.
Politics in Washington are not, then, solely to blame for our economic woes. Global weaknesses have brought hard times to Wall Street and Main Street. But it is not appropriate, either, to attribute the bulk of our economic ills to foreign troubles, as President Herbert Hoover tried to do in the early 1930s. To a considerable extent, our difficulties are home-grown.
Investor and author George Soros astutely links American troubles to excessive confidence in “market fundamentalism”—a belief that private markets are highly efficient and can generally regulate themselves. Proponents of this viewpoint believe government bureaucrats are not in good positions to understand business affairs. Their fumbling interventions often block enterprise and innovation. Market fundamentalists subscribe to Ronald Reagan’s judgment: “Government is not the solution to our problem. It is the problem.”
Conservatives often tout the benefits of “free” markets, but in practice, market fundamentalism has produced a troubled history. Rapid deregulation of savings and loan institutions in the 1980s contributed to a smashup of the “thrifts” that cost more than $100 billion to repair. In 1998 risky trading in derivatives by managers at Long-Term Capital Management threatened the U.S. financial system (the Federal Reserve came to the rescue and limited the damage). Lax regulation of mortgage underwriting led to abuses involving sub-prime loans and various obscure real estate contracts.
Particularly troublesome was a little-noticed decision by the Securities and Exchange Commission in 2004, which allowed investment bankers to stretch their firms’ capital-to-debt leverage from 12-1 to 30-1 and in some cases 40-1. The exemption gave bankers opportunities to expand their trading in mortgage securities. That activity put the companies at risk when real estate collapsed in 2007-2008. Bear Stearns was about to go under when JPMorgan Chase grabbed it at a fire sale price. Lehman Brothers crashed in September, 2008, which led stock markets to drop precipitously around the world. Merrill Lynch averted bankruptcy by selling itself to Bank of America. Morgan Stanley and Goldman Sachs survived through reorganization and assistance from bailout funds.
In these and many other instances, largely unfettered markets produced both impressive booms and frightening busts.
From the 1980s to the Great Recession, American finance lost its stability, which had been fostered by the New Deal’s reforms of the 1930s. Regulations created at the time of Franklin D. Roosevelt’s presidency helped to keep banking and securities businesses from engaging in highly risky activities. During the Great Prosperity of the post-World War II decades, American bankers joked about a 3-6-3 arrangement in their industry. Bank managers borrowed money at 3%, loaned it out at 6%, and began play on the golf course by 3 PM. Economists identify this period as the era of “boring banking.”
Then politicians, inspired by the ideals of market fundamentalism, and funded generously by the finance industry’s lobbyists, removed many of the rules. Finance became less transparent, less subject to public scrutiny. Principles of laissez-faire, which had been fashionable before the Great Depression, came back into vogue, but with new formulations.
When the Financial Crisis Inquiry Commission released its majority report on causes of the recent meltdown, its judgment resembled the conclusion of economists who studied causes of the Great Depression. “The crisis was the result of human action and inaction,” opined commissioners appointed by the Democrats. It was not caused by “Mother Nature.” The meltdown was “avoidable.” Millions of people suffered from investment declines, devalued homes, and lost jobs because Washington had created “a highway where there were neither speed limits nor neatly painted lines.” The commissioners essentially blamed market fundamentalism for the mess. They concluded that a “widely accepted faith in the self-correcting nature of markets” played a significant role in the meltdown.
Republican demands to restrain federal spending are now complicating efforts to mount a recovery. Economists who are aware of John Maynard Keynes’s insights recognize that deficit spending by the federal government is essential to jump-start a stalled economy. Keynes’s arguments about the value of a public stimulus seemed validated when a surge in federal expenditures during the Second World War helped to end the Great Depression quickly.
The Obama administration tried a Keynesian approach but in a timid way. Its “stimulus” package was small ($787 billion) in comparison to the size of the U.S. economy and in relation to the size of the economic downturn. Furthermore, nearly 40% of that stimulus package involved tax cuts (due to the administration’s efforts to win conservatives’ backing for its bill). Tax cuts are much less effective in revitalizing the economy than direct spending on infrastructure projects that employ many Americans who need a job.
The GOP’s oft-stated goal of reducing the national debt is important, but reviving the economy and creating jobs are the more immediate needs. If a Keynesian stimulus works, it can lead to greater prosperity and increased tax revenues (in short, a faster achievement of debt reduction).
Reform of the tax code can also reduce the debt by eliminating subsidies, ending special favors for corporations, and generally increasing revenues. But Republicans will have none of that. Many of them have signed pledges affirming their opposition to all tax increases.
Bill Clinton’s administration supported tax increases in 1993 to deal with budget deficits. The Democrats’ measure passed without a single Republican vote in the House and Senate. That legislation aided the achievement of balanced budgets and sustained prosperity in the late 1990s. Today’s Republicans refuse to learn from that historical experience. They govern through ironclad pledges rather than pragmatic decision-making about taxing, spending, and debt reduction.
The most recent GOP antics have amplified America’s financial crisis. Republicans refused to deal with President Obama’s offer of a “grand bargain” that included $4 trillion in debt reduction. The GOP turned away principally because Obama’s proposal included some tax increases. Rather than compromise, Republicans took the nation to the brink, threatening to create the first major default in the country’s history.
Now we see the consequences of my-way-or-the-highway politics. Investors are no longer confident that the U.S. will honor its financial obligations after reading about the near-default. Stock markets around the world are reacting nervously to reports about the S & P’s downgrade of America’s rating. Worries are growing that the rating agency’s decision will force businesses and local governments in the U.S. to borrow at higher interest rates.
Republicans argued often that leaders in Washington needed to take strong measures to reduce the national debt. Ironically, their risky gamble of playing politics with the debt ceiling has added emotion to the global panic. In the long run, the GOP’s game of chicken regarding the debt ceiling seems likely to expand the U.S. debt.
Republicans’ efforts to lecture the nation on the dangers of profligate spending constitute an extraordinary case of political chutzpah. The GOP gave us two huge tax cuts in 2001 and 2003 that benefited the rich especially and destroyed the budget surplus. Republicans in the White House and Congress rushed America into an unnecessary war in Iraq but kept the costs of that military engagement off the books. They delivered a costly drug benefit for senior citizens but did not provide ways to pay for it. Republicans vigorously advocated deregulation over many years, fostering the recklessness that produced a financial breakdown and Great Recession.
Yet, as the GOP’s House Speaker, John Boehner, warned recently, we must “stop the spending binge that’s hurting growth.” Evidently, Boehner is not troubled by contradictions.
We could not do much in recent years about the looming economic crisis in Europe. But we did have had considerable control over our own economic destiny in that period, and we frequently squandered opportunities to manage it effectively.
George Soros must not be surprised by recent developments. When he wrote about market fundamentalism in the 1990s, Soros predicted that excessive allegiance to unregulated markets could someday produce a global meltdown. The crash he anticipated occurred in 2007-2009. We may now be watching a second act in that tragic drama.
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