The Current Stock Market Decline…
…should not freak you out, at least in and of itself. This is a ferocious bear market, but, so far, it is an almost exact repeat of what happened after the collapse of the .com bubble about 5 years ago. In fact, if we were to repeat that experience, we would see further declines from where we are today:
There were, in the grand scheme of things, pretty limited consequences of that equity bubble popping for most people in America. Partly, of course, this is because both the Fed and the Chinese government decided to make credit very easily available to U.S. consumers, and therefore many people who got a lot “poorer” in their 401K statements, suddenly got a lot “richer” in home equity. A ton of this increase and decrease in wealth was illusory. I agreed to say your house was $10 million if you agreed to say mine was worth $9 million, and suddenly we were both richer. It’s great until many people try to convert this wealth into other kinds of goods at once. In this way it was a lot like the .com bubble. My guess (and it’s only a guess) is that these two events will come to be seen as two sequential manifestations of the same underlying imbalances in the financial system.
What should concern you deeply, however, is the ever-growing TED Spread, as per a prior post. It is now well over 400 basis points, or about 50% above its historical peak at the time of the 1987 stock market crash, and about 10 times its “normal” level. It has continued to rise every week throughout the past month, indicating further worsening of the credit crisis, and rising perceived risk of contagion. We’ve injected so much debt into the system over the past decade that not only can’t we borrow our way out of the consequences of the real estate bubble popping, but we’re going to have to start paying off a lot of the existing debt in the face of a poor economy. What Paulson and Bernanke are doing is to make this adjustment only painful instead of catastrophic.
Jim are you in favor of the push for the government to acquire equity stakes in banks in exchange for providing cash to fix their insolvency?
— Freddie · Oct 10, 02:32 PM · #
I favor having this as one option to be used at the discretion of Treasury.
I think that the Paulson plan was (intelligently) designed to allow broad discretion by Treasury in how to prevent “bank runs” in the debt and debt derivative markets. One method envisioned under this law for doing so is direct purchase of bank equity. I see the simplest trade-off, as this is (i) a theoretically elegant approach, but on the other hand (ii)also raises the risks of long-term government entanglement with allocation of economic resources (which I view as a bad thing). I think it is impossible for me, with the information I have, to estimate how these effects balance out in specific cases. So I think it should be a method, though not the only method, available to Treasury.
I see dealing with this crisis as an extended campaign, and expect that the way these effects balance out will be different at different times.
— Jim Manzi · Oct 10, 03:23 PM · #
You might be right about the stock market’s impact on the overall economy. One difference between today and the dot-com bubble is that the crash isn’t just erasing recent gains. That is, someone who invested 10 years ago has seen no return. During the dot-com bubble someone who’d invested ten years prior to that point would have still had substantial gains. This matters for the state of folks’ 401ks and whatnot. Of course the impact of this point depends on exactly how low the market goes before bottoming out, and how fast it recovers.
— Justin · Oct 10, 03:23 PM · #
I think you are right that these two bubbles are really one bubble. The real estate bubble was the result of a emergency manuvers which temporarily arrested our fall at the cost of screwing up our economy to an even greater degree. That’s a pretty familier theme in human events: the fix that adds a whole new worse set of problems.
But if the tech bubble was the result of underlying imbalances, what do you think were? Globalization? A vast increase in productivity due to integrating computers into the economy? And is the current mess really just an added bonus mess, or could it be also related to underlying imbalances?
Alternativly, it could just be that speculation in the stock market created this huge tech bubble that then messed up the rest of the economy. There were no underlying imbalances. How much can the stock market drive the rest of the economy? The first tech bubble really was a stockmarket event, right? I don’t remember banks being invovled.
I want these questions answered and answered now. Then I will go fix this mess.
— cw · Oct 10, 04:27 PM · #
Is green technology our next bubble? If so, I want in on the ground floor.
— rortybomb · Oct 10, 05:55 PM · #
These charts would be more illuminating and meaningful if a log scale were used on the y-axis.
— y81 · Oct 10, 06:40 PM · #
Re log scale
You’re correct, of course. I fear that most economic types don’t have the sophistication to understand logarithms or exponentials. They’re completely in love with the linear scale because they can use the result to claim “hyperbolic growth” and then jump around and flap their wings and crow. I believe they do this to compensate for the fact that their calling has all the intellectual rigor of phrenology. I was going to say astrology but I think astrology actually has a bit more going for it. As a basis for some psychological descriptions it’s not bad.
The economists’ love affair with growth is all the more amusing given their inability to graph in such a manner as to make that growth comprehensible.
— LJR · Oct 10, 07:27 PM · #
It seems that every attempt to artificially manipulate the market, such as the bailout, the UK governments’s announcement that it will inject equity and various other governments’ guarantees of deposits, has not worked to restore confidence. Could this be because the market sees these moves as blatantly artificial? And everything is so telegraphed that the market sees it coming a mile off. It seems to me that you can’t fool the market with this kind of transparent tactic – the foundation is weak and not amount of temporary scaffolding will hold it. So the market is just seeing past these interventions and getting to the endgame. Politicians don’t seem to understand that their power does not extend to fooling markets. The market makes them look like amateurs.
— Paulo · Oct 10, 07:36 PM · #
LJR:
I’m pretty comfortable with my ability “to understand logarithms or exponentials.”
Paulo:
This is very possible. It is, however, also possible that the various flavors of the Paulson proposal, once implemented, could serve to create real value, rather than be attempts to “manipulate the market”. If, for example, making a market for various MBS allows revaluation of balance sheets and starts to allow interbank lending to resume.
The jury is certainly out on all this, however.
— Jim Manzi · Oct 10, 07:58 PM · #
I can take the linear scale, but please change the awful Excel default gray background.
Showing it in a web page isn’t as bad as printing it, but let’s have some contrast.
— APP · Oct 10, 08:35 PM · #
I’d like to see this in a log scale, too. I’m having trouble eyeballing it this way.
— Matthew Yglesias · Oct 10, 09:21 PM · #
I don’t join in LJR’s rudeness, but I reiterate that a logarithmic vertical scale is more appropriate.
— y81 · Oct 10, 10:06 PM · #
Log scale graph, here, and with trendlines included, here.
Wish I had more to say, but I don’t.
— JA · Oct 10, 10:08 PM · #
I’m less worried about my retirement savings mutual funds going down for 5 or 10 years than my supposedly risk free FDIC-insured CDs and money market funds suddenly not being there at all. That’s a big difference compared to 2000. Stocks are supposed to be gravy, easy come easy go, while deposits are supposed to be the safe nest egg.
I suppose they’ll just inflate like crazy and steal 25% of the value of my savings…
— Steve Sailer · Oct 10, 10:54 PM · #
Basically, we were never as rich as we thought we were. The last decade’s growth was largely driven by huge flows of lending dollars to dubious mortgage borrowers who never had a chance in hell of paying the mortgages back when the music stopped and California’s houses stopped going to infinity in price.
Guess how much mortgage dollars lent to Hispanics increased from 1999 to 2006?
— Steve Sailer · Oct 10, 10:57 PM · #
No, take that back. I just thought of something.
Paulo writes: Could this be because the market sees these moves as blatantly artificial?
I’m pretty sure you’d be right if the bailout was indeed nothing but a smoke-and-mirrors effort — i.e., if it was merely a stab at psychological manipulation and market hypnosis.
The word that comes to mind is triage, as in the fact of the bailout is itself a type of S.T.A.R.T. (simple triage and rapid treatment), meant to keep the patient alive until the professional doctors — the Fed and Treasury, god help us — can use all their knowledge to get us out of the ICU and off to therapy. What you’re seeing in the market right now is the kind of nervous, doubt-ridden pacing you might see in a hospital waiting room.
— JA · Oct 10, 11:05 PM · #
Capital gains taxes rates were a factor. Low tax rate encouraged capital gains returns leading to excessive rises in asset prices, first in stocks mostly and then after the stock crash and the drop in interest rates, in house prices. History shows that when capital gains tax rates have been lowered to 20% or lower, strongly rising asset prices ensued that led to a bubble: cuts in the early 1920’s were followed by the New Era bull and the 1929 crash, cuts in the early 1980’s were followed by the Reagan bull that ended with the 1987 crash; the 1997 cut led to the net frenzy and subsequent tech wreck, and finally the 2003 cut (along with falling interest rates following the tech wreck) led to the housing bubble.
Mortgage securities and crazy loans were of course a factor in the current crisis, but these are consequences of the bubble psychology, they did not cause it.
High levels of investment deliberately encouraged by low tax policy produce the sort of sustained bull markets that induce energetic “animal spirits” in economic players. This is the intent of low tax policy.
Energetic animal spirits breed silliness like pets.com in the stock bubble and the irrational loans made in the housing bubble. This has been the observed patterns for centuries. If you look at the pre-1933 economy, which featured low taxes, you will see a series of asset bubbles each followed by a major financial panic: 1819, 1837, 1857, 1873, 1893, 1907, 1932/3. For fifty years after 1932 policy employed high taxes and the sort of sustained, strong bull markets simply did not occur in stocks or real estate and there was no opportunity for large scale asset bubbles to take hold. Since the 1981 tax cuts were have returned to the pre-1932 period, at least wrt to bubbles and panics.
— Mike Alexander · Oct 11, 12:30 AM · #
Forget the TED spread. That’s yesterday’s panic. Now we’ve got grain shipments piling up in ports because banks are refusing to accept other bank’s letters of credit. That needs to be solved, last week sometime, or it’s going to get very unpleasant in the developed world very fast.
— MouseJunior · Oct 11, 07:32 AM · #
Jim, I’ve been thinking over your response to my earlier question about whether the market is simply discounting ‘artificial’ government interventions. I accept that $700 billion is real money and it should be enough to create a decent market for bad assets. However, I can’t get away from the idea that we all know it’s not real – we all know the government will be rigging the market for these bad assets, because Ben Bernanke told us as much. Imagine instead if Warren Buffett had put up the $700 billion, saying that he saw fundamental value at these distressed prices. Don’t you think the market would have taken that more seriously, because it knows that Warren Buffett does not play games with the market. Or maybe the market is just reacting to the panic deliberately sowed by Paulson in his desperation to sell the bailout plan?
Either way, I think Paulson’s overly-clever, hard-ball negotiating approach has backfired badly. He got his way, but his scare-mongering hyperbole caused an even bigger problem. And I doubt whether governments will be able to buy or talk their way out of this. As much as this crisis represents a failure of the market, it might also expose the impotence of governments to make any real difference either. It’s all pretty unprecedented of course, but I think we’ll be rewriting a few textbooks during 2009.
— Paulo · Oct 11, 09:55 PM · #
Re: Since the 1981 tax cuts were have returned to the pre-1932 period
The total tax take of federal state and local governments combined is about where it has long been, historically. It is an illusion that there has been some huge cut in taxes. To be sure, there has been a decline in the amount of the take that goes through the Federal Income tax, but that has been compensated for by increases in other taxes. We are definitely not back to 1932!
— JonF · Oct 11, 11:27 PM · #