Big birthday card
Our 250th national birthday celebration is tomorrow. So I’m concluding my four-part overview from the New To Las Vegas world headquarters of the entire financial history of the United States. In my opinion, this history can be captured in just three words: boom, bubble, bust. I recently described in Part 1, which you can read by clicking here, my perspective of the first century of American independence to 1876. Part 2, which you can read by clicking here, covered the next half-century to 1926. Part 3, which you can read by clicking here, got us up to our 200th birthday in 1976.
By the time of the bicentennial 50 yeas ago, the U.S. had experienced 33 boom-bubble-and-bust cycles consuming, with recoveries, about two-thirds of its then-200 years of existence, one cycle every three years. For better or for worse, financial volatility was firmly baked into our culture.You might ask, where are things heading right now? Keep reading.
But first, definitions again. A boom is a period of rapid economic expansion accompanied by rising asset prices (stocks, bonds, real estate, crops, metals, businesses or whatever) and higher profits. A bubble is a unsustainable rapidly accelerating increase in asset prices, often driven by speculators using borrowed money from expansive credit policies in what amounts to a euphoria. A bust is the sudden decline of asset prices and overall economic activity, often precipitated by a single event causing mass realization, panic selling (which pushes prices even lower), job losses, recession and a great sense of investor revulsion.
Unusually, the decade after our bicentennial was devoid of the usual BB&B pattern, but there were other problems with creeping repercussions. The twin Recession of 1980 and Recession of 1981 were downturns deliberately caused by the efforts of the Fed under Chairman Paul Volcker to end what was called the Great Inflation. This ran an amazing 18 years from 1965 to 1983. How great? The U.S. dollar lost 70% of its purchasing power. After adjusted for inflation, the S&P500 Index had an annualized real return of … 0%. Yes, 0%. The averaged 30-year fixed mortgage rate reached 18.6% in 1981.
Sort of like setting a back fire to stop a bigger fire, Volcker used sharp interest rate boosts–the prime borrowing rate eventually reached 21%–to choke off credit expansion and slow business expansion. Of course, this goosed up the unemployment rate to near 11%. But like wildlife killed in a planned backfire, what were a few million working-class jobs when the goal was to make American capitalism safe for capitalists?
Indeed, Volcker’s efforts set the stage for the start of a massive stock bull market in 1982–and a BB&B scenario of epic dimensions. “We’re gonna turn the bull loose,” Ronald Reagan said in 1985 as be became the first U.S. president ever to visit the New York Stock Exchange. A year later, famed corporate raider Ivan Boesky (who later went to prison for insider trading) told an audience, “Greed is all right by the way … I think greed is healthy.” Companies financing their expansions, mergers and acquisition–friendly or hostile–started borrowing huge amounts of money at increasing rates, offering little collateral. Wall Street was all too happy to oblige by underwriting “junk bonds”–high-yield, high-risk debt instruments that became the coin of the realm. Individual investors hankering for real returns after nearly two decades of bupkis borrowed to make their own investments. The boom.
In 1987, stocks were selling at historically high price-earnings ratios, fueled by higher borrowings. The bubble. Interest rates were rising along with federal spending deficits. Investors got spooked–along with computerized trading algorithms ironically called “portfolio insurance” programmed to sell at the first sign of danger. The bust. Enter the Stock Market Crash of 1987, October 19, to be precise, when stocks fell a staggering 22.6%, wiping out $500 billion of value off the New York Stock Exchange. Amazingly, this did not trigger a recession. Alan Greenspan, a jazz musician who came to economics later in life and had just taken over the Fed two months earlier, pumped liquidity into the financial system and cut interest rates. The stock market recovered that 22.6% drop in just two years, a lot quicker than the 25 years it took after the 1929 debacle. Greenspan’s actions drew wild plaudits in the media. He was the “Maestro,” the “Oracle,” the “Wizard.” His implied promise to Wall Street to lower interest rates in the event of future turbulence became known as the “Greenspan put.”
But trouble was already brewing again, somewhat centered in the Heart of Texas, home to hundreds of savings and loans. These were financial institutions largely geared to making mortgages to folks to buy homes, and somewhat loosely regulated. The fundamental flaw was an interest rate maturity mismatch. The thrifts, as they were known, funded these long-term, fixed-rate mortgage using short-term deposits from savings accounts. But when short-term interest rates soared in the early 1980s, the thrifts were caught, stuck with the long-term loans as depositors withdrew their funds for higher rates elsewhere. Most became insolvent. Still, federal regulators allowed these so-called “zombie thrifts” to remain open, relaxing capital requirements so they could take massive risks in a wild effort to wheel and deal their way out of debt. It didn’t work at all. The result was a shutting of more than 1,000 thrifts, and an estimated eventual clean-up cost to the Federal Government–mainly to make good on deposit insurance that had been raised from $40,000 to $100,000–of nearly $500 billion. At one point, collateral owned by the U.S. included part of the Dallas Cowboys.
These massive risks, which superficially made it seem like the economy was expanding, amounted to a massive, credit-fueled bubble. Guess what happened next? Greenspan’s Fed raised interest rates to prick the bubble. Not an unreasonable action, but that led directly to the bust known as the Recession of 1990. That ended after eight months in early 1991–pretty quickly, although President George H.W. Bush later complained bitterly it cost him a re-election loss in 1992 to Bill Clinton.
However, for the rest of the 1990’s, the U.S. hummed along. The period would prove to be the longest economic expansion ever. One reason was that the President Bill Clinton and his Treasury Secretary, Richard Rubin, pursued a policy of lowering the federal deficit, figuring that would naturally lower interest rates to the benefit of business expansion. But something intruded that would change everything.
The Internet.
Except that this happened a lot more quickly, this was just like the railroads in the 19th Century, which caused a frenzy of over-wrought BB&B investment and speculation with borrowed money in the name of technological advancement. The new notion that all computers could be connected with east-to-use interfaces called browsers to a system called the World Wide Web that would move information and, eventually, commerce at unimaginable speeds caused a sensation. The boom began after the public offering in 1995 of Netscape Communications Corp., a California company that the year before had produced the first commercially successful browser, Netscape Navigator. Investors started bidding up dot.com companies–firms with a web site and a concept, but often little else, especially profits or even cash flow. Still, despite efforts by Greenspan to cool the economy with interest rate hikes–and a now-famous warning about “irrational exuberance”–the tech-oriented Nasdaq Composite index rose 600% from 1995 to its peak on March 10, 2000.
Unlike some booms and bubbles, the date of this bust, as well as the cause, was clear. A mere 10 days later, on March 20, my former Forbes colleague Jack Willoughby authored a cover article for Barron’s with this headline: “Burning Up–Warning–Internet companies are running out of cash–fast.” The article said dozens of well-known internet companies were “likely to implode” without new funding to stop the “burn rate” of their cash when the dot.com bubble gets pricked: “For scores of ‘net upstarts, that unpleasant popping sound is likely to be heard before the end of the year.”
Jack utterly nailed this one. The Nasdaq Composite dropped 78% by 2002 and the Recession of 2001 was soon on. Extended by the September 11, 2001, Bin Laden attacks on American buildings, the recession ran for most of 2001 but was relatively mild in impact.
The Fed had responded to the 9/11 attacks by lowering interest rates and injecting liquidity into the American economy.In the short run, this worked. Not so much in the longer run.
This was because one of the few things both political parties agreed on was home ownership–the Democrats, for their lower-income base, and the Republicans, for the bottom lines of the home builders funding them. This became official government policy by the Fed and others–and of course became subject to immediate abuse. A new breed of financial institutions called subprime mortgage lenders arose to generate these loans, then package them into bundles called asset-backed securities that Wall Street could oversell to ordinary buyers and institutions as solid investments. The lenders got paid a cut of how much debt they generated and sold off, and didn’t have to make good on any bad loans. “Subprime,” which referred to the lower credit status of borrowers, was a wonderful term for the lenders because it hid the risk and made predatory lending and high-risk debt sound like as a normal financial thing..
This gave loan originators an incentive to qualify borrowers who really couldn’t afford their loans. No down payments. Adjustable rates that would start low, like 2.5% but would soon reset to 10%. The option to skip a payment or two. Not much checking about credentials. As they ran out of qualified (by traditional standards) borrowers, the subprime lenders paid for mortgage brokers–often fresh-out-of-college grads using high-pressure sales tactics–to find warm bodies to lend to. A California strawberry picker earning $15,000 a year “qualified” for a mortgage to buy a $720,000 home, which he lost within a year. Such mortgages became known as NINJA loans–no income, no job or assets. Some called them “liar loans.” Fraud became a big issue–by borrowers and by lenders. The boom.
There were more problems. First, as I noted, the loans were non recourse to the lenders, so they had no skin in the game. Second, the buyers of these asset-backed securities, which had solid reviews from the credit-rating agencies, were unaware that a small number of mortgage defaults in a bundle could crash the entire bundle. This was a trillion-dollar market–bigger than the stock market–and one that was largely unregulated. The bubble.
In a 2004 speech, Greenspan had encouraged homeowners to use adjustable-rate mortgages rather than fixed-rate. This proved to be spectacularly bad advice, especially since the Fed would raise interest rates 17 times over the next two years. In 2006, Greenspan retired after nearly 20 years in the harness. Just in time for himself, it turned out. The Great Recession, greatly aggravated by his policies, began in 2007. It officially ran until 2009 and saw spectacular events. These included the biggest-ever bankruptcy of investment banker Lehman Brothers, the forced sale of investment house Bear Stearns, the forced sale of Merrill Lynch, the collapse of almost all of the other subprime loan outfits, including Washington Mutual–whose CEO was paid $25 million that year–and even the U.S. takeover of giant mortgage houses Fannie Mae and Freddie Mac.
And more significantly, the loss by up to 10 million families of their homes due to foreclosures when they walked away from their mortgages they couldn’t afford. A lot of renters just should have stayed renters. The bust.
The Fed on Greenspun’s watch apparently had not tracked subprime lending. It was left to Greenspan’s Fed successor, Ben Bernacke, who himself originally had pooh-poohed the crisis, to pick up the pieces, partly by using magical digital credits called quantitative easing to buy back bonds and smooth things out. In retirement, Greenspan confessed error, including his assumption that artificial financial products called derivatives could smooth out the risk issues when it turned out they made things worse. He told a Congressional hearing, “I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity.” Concluded a federal commission, “The sentries were not at their posts.”
The Great Recession was so gigantic that nearly two decades later–past the recent death of Greenspan at age 100–the impact of the BB&B leading up to it lingers now. Millions of families never got back their financial mojo. The complete halt in home building then has led to the current housing squeeze, driving up home prices beyond the means of many average folks. Income disparities have grown, not only among average folk but among average folk and the well heeled. Bluntly put, the rich got a lot richer.
The Great Recession was our last great boom-bubble-and-bust, but the time-to-history ratios persist. By my count, we’ve now completed 37 boom-bubble-and-bust cycles, but that’s still about two-thirds of our quarter-millennium of existence.
And that’s not counting the boom and and now bubble we’ve been in since 2022–getting to be a longer period by historic standards. The stock market has gone up 140% in four years, and home prices 35%, accompanying the creation of America’s first trillionaire. There are still those out there who believe the good times will last forever, or This Time Is Different. They don’t seem to be troubled that like railroads and the Internet, there’s even a new hot thing: artificial intelligence companies.
By many standard measures, the economy is flashing bright signals of an impending bust. How long can it be before harried consumers with minimal income growth stop spending, the Fed raises interest rates to fight inflation, and businesses find their credit lines restricted?
That’s my three-word take on the financial history of the United States. Happy birthday, all!