A summary of my last read, Bubble Man, by journalist Peter Hartcher. Some is quoted directly, some paraphrased.
The 1996-2000 stock market boom was the biggest speculative mania the world has ever seen. American stock ownership went from 5% of population in the 1950s to 50% in 2000, and had put $6 trillion into mutual funds. This exceeded the value of their homes.
If the market had been in line with long run averages, it was valued at $5.3 trillion in 2000, instead of the peak valuation of $17.7 trillion. Three years later, $7.8 trillion of that value had evaporated. What happened, and who is to blame?
What is amazing is the lack of insight during the mania. The fact that the entire US private sector was suffering a decline in profitability is a little known secret. During the last 3 years of the boom, as stock prices rose 67%, corporate profits fell 6%. Of the 10,000 publicly traded companies, only eleven had earnings of at least 20% growth during the bubble years! This was the largest loss of corporate profits of any time, even more than during a recession!
In 2000, only 1% of Wall Street investment banks and brokerages issued a Sell recommendation.
After the bust, the US authorities did two things. First, they lowered interest rates to below inflation to stimulate the economy. People went on a spending spree, and borrowed net $2 billion per day on housing, or $800 billion per year.
The problem with a real estate bubble is that when the bubble bursts and housing prices fall, the debt remains. Second, the government cut taxes and overspent, increasing the budget deficit which had been in balance in 2001, to $478 billion by 2004. By that election, we were still shy 300,000 jobs from prior to the downturn, making Bush the first president to lose jobs during his tenure. The savings rate went negative: the more people made in stock market gains, the less they saved.
9/11 had nothing to do with the bubble or the recession. On 9/11/02, the stockmarket had been falling for 1.5 years, and the economy had been in recession for 6 months.
Greenspan was a strict budget man at one time. He coaxed Clinton to balance the budget, and succeeded after meeting with him privately in Little Rock. By 2000, we had a surplus of $236 billion. Greenspan convinced Clinton by making a a deal: shrink the deficit, and he would let interest rates fall. This is why the Democrats felt so deceived when Greenspan suddenly reversed course and embraced the Bush tax cuts. Why did he do it? Greenspan did this, to avoid political interference from Bush, who from day one in the White House was criticizing the Fed chairman. It was a political arrangement.
Now, this is where it gets interesting. When did Alan Greenspan first talk about the a bubble. 1996. No typo here. At the dinner of the American Enterprise Institute on 12/5/1996, Greenspan mentioned “irrational exuberance” was present in the stock market, and it shook the world. In September 2006, Greenspan said in FOMC meeting, “I recognize that there is a stockmarket bubble problem at this point”. So he made the decision to announce it that December evening to the public.
Although the stock market wave to Greenspan’s speech was powerful, the political response was poisonous. Some of the most powerful men in Washington were furious. The angriest was the senior Republican in Congress, majority Senate leader Trent Lott. He started bashing Greenspan in public. Greenspan spent many hours each day grooming his political connections and popularity, and he did not like being unpopular and resented. So he did NOTHING.
Twelve days after the celebrated speech, the FOMC met again, and this was Greenspan’s chance to do something about the bubble. He did not propose raising interest rates, raising lending margin requirements, or anything at all! Instead, the Fed kept feeding cheap money into the bubble, changing official interest rates by a net -1.25% during the bubble years. Greenspan let himself be intimidated by the political difficulty of popping the bubble.
From 1996 onward, the Fed started to prepare for the stock market crash. They incorporated expectations of a 20% crash, but the market continued to boom. The Fed’s stockmarket disaster emergency squad, made up of Rubin, Greenspan and other officials and dubbbed the plunge protection team by the Washington Post, met regularly to review crash contingency plans.
Meanwhile, Greenspan fed the bubble with cheap money, endorsements in the media, and reassurance to investors. His former deputy, Alice Rivlin:”Greenspan doesn’t like to lose and if he thinks he’ll lose he switches sides”. Six months after his irrational exuberance speech, Greenspan said we had entered a new era of productivity, and the markets jumped for joy.
Investors were piling in their retirement savings and life hopes. A 2001 SEC survey found that 5/6 investors thought the government provided insurance for stock market losses.
Interesting stuff, Poway. I remember when Greenspan did a 180 on the wisdom of deep tax cuts, from criticism to praise. Shortly after, he was approved for another term.
The intersection of economics and politics makes for some interesting stories.
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