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Friday, December 15, 2017
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Is Economic Collapse in the US Inevitable? – Part 4

The impact of serious debt has threatened the United States several times, and we never seem to learn from our experiences because we are a nation that does not give serious consideration to our own financial history let alone the arcane information available from the experiences of foreign countries in that wasteland of the past. Consider these real and American lessons:

  • The Florida Real Estate Bubble was a speculative property bubble that occurred in Florida in the early and mid-1920s. Up until then, the state of Florida was relatively unpopulated and large parts of the state consisted of undeveloped swampland. The Roaring Twenties economic boom (and eventual bubble) made many people wealthy and created a new class of people who could afford to go on vacations. Developers and speculators noted the potential of the new leisure class and took avaricious advantage. Florida land prices skyrocketed and incredible amounts of money flowed in from Northern investors, especially from New York, Connecticut and Massachusetts. The Florida Real Estate Bubble created many millionaires until it finally crashed in 1925 and devastated the state’s economy.
  • The Roaring Twenties were a time of peace and prosperity; and the U.S. stock market soared as new technologies such as radio, the automobile and airplanes became commercialized. Many Americans speculated in the stock market, often with large amounts of borrowed money including their life’s savings. Some became extraordinarily wealthy. By the fall of 1929, the stock market peaked and then plunged from its own overheated weight. In October, 1929 the Roaring Twenties economic “bubble boom” finally popped. America’s Stock Market Crash of 1929 became a worldwide market failure that financially ruined a great many stock investors–some of whom jumped out of tall city buildings to their deaths. As the Crash unfolded, thousands of banks failed; unemployment skyrocketed; President Hoover was blamed and lost his bid for re-election; and the United States entered into the Great Depression along with the rest of the world, which lasted through the “dirty thirties”, and was only relieved by the huge financial impetus of the Second World War.
  • Perhaps the greatest speculative mania of all time was Kuwait’s Souk al-Manakh stock bubble in the early 1980s, which is as fascinating as it was devastating. The bull market began when investing in local “Gulf Companies” became in vogue with Kuwaitis who wished to ride the coattails of the Middle East’s oil-driven economic boom of that time. A peculiar Kuwaiti custom allowed traders to pay for stocks using post-dated checks under the assumption that default would be unthinkable for cultural reasons. Unsurprisingly, avarice prevailed as some traders speculated in stocks paid for by billions of dollars’ worth of unsecured checks, causing Kuwait’s stock market to inflate like a balloon and pop in a most analogous manner. That fall threatened the national economy of Kuwait and almost led to its bankruptcy and its failure to be able to persist as a nation.
  • The Stock Market Crash of 1987—which came to be known as Black Monday–was the largest one-day market crash in history. That great fall marked the end of a spectacular stock bull market that started in 1982 that was fueled by a supercharged business environment that included hostile takeovers, leveraged buyouts, and merger mania involving a worldwide collection of investors. The Dow stock index nearly doubled from 1986 until the fall of 1987. Early in the year, some informed investors realized that they were looking at a bubble, and they began quietly to sell off their shares. When the market began to drop, investment managers were encouraged to use a new tool called “portfolio insurance” to protect their investments from further losses as the market fell. On Monday October 19th, 1987, an avalanche of very aggressive “sell” orders hit the market as investors began to panic, which triggered additional “sell” orders and more use of portfolio insurance. By the end of that day, Black Monday, the Dow lost an incredible 22.6% of its value. Companies failed; people lost their jobs; and a short term recession hit hard.
  • Apparently, Japan failed to learn its lesson from its brush with disaster in October, 1987. During the late-1980s, Japan experienced a true “Bubble Economy”. Real estate and stock prices soared along with the country’s overheated economy. The “Bubble Economy” era came at the end of its thirty-year-old “Economic Miracle” that began after World War II and saw the country’s fortunes blossom as it became the world’s automobile and electronics manufacturing powerhouse. By the peak of Japan’s Bubble Economy in 1989, a house in Tokyo cost well over $2 million and the land underneath Tokyo’s Imperial Palace was said to be worth more than all of the land in California put together. Japan’s Bubble Economy peaked in late 1989 when people began to realize that the rapid and apparently foundationless financial market increases could not continue. The country’s highly-inflated stock and property markets began to crash. By 1992, Japan’s Nikkei stock index plunged to 15,000 from its peak of nearly 40,000, and the country’s real estate markets were decimated along with the rest of the economy. Since 1989, Japan’s Bubble Economy has deflated for over two decades, leading to this era being called the “Lost Decades”; and Japan is still working at its recovery.
  • The US Savings and Loans Crisis was the greatest bank collapse since the Great Depression of 1929. By 1989, more than 1,000 of the nation’s Savings and Loans (S&Ls) had failed. This effectively ended what had once been a secure source of home mortgages, especially for middle and lower socioeconomic class people. Half of the nation’s failed S&Ls were from Texas, pushing that state into recession. As bad land investments were auctioned off, real estate prices collapsed; office vacancies rose to thirty percent; and crude oil prices fell fifty percent. Some Texas banks, like Empire Savings and Loan, became embroiled in illegal land swaps and other frankly criminal enterprises. How could this have happened in a nation whose S&Ls were under the protective control of the Federal Savings and Loan Insurance Corporation (FSLIC)?

Savings and Loans were specialized banks that used low-interest, but federally-insured, deposits in savings accounts to fund mortgages which made them popular for less affluent Americans seeking the American dream of owning their own homes. The S&L debacle began innocently enough in the 1980s. Money markets became more popular in that era by offering higher interest rates on savings. Consequently, investors became pulling money out of savings accounts, depleting the banks’ source of funds and threatening the very existence of that segment of the American financial industry.

S&L banks rushed to ask Congress to remove the low-interest rate restrictions, and in 1982, that wish was granted, which allowed S&Ls to raise interest rates on savings deposits. In addition, those banks were no longer restricted to mortgages, but were allowed to make commercial and consumer loans. Most importantly–and in the future, most dangerously–the law removed restrictions on loan-to-value ratios. A second federal decision sealed the combination that would eventually lead to a nationwide recession. The Federal Home Loan Bank Board regulatory staff was reduced because of budget cuts by the Reagan Administration. This impaired the board’s ability to investigate possible risky loans—thus creating a bonanza for crooks.
To raise capital, S&Ls invested in progressively more speculative real estate and commercial loans. Between 1982 and 1985, these assets increased 56%. In Texas, forty S&Ls tripled in size, some growing 100% each year. This created huge interest on the part of investors. As a result of the banks’ poor judgment in selection of loan recipients, by 1983, thirty-five percent of the country’s S&Ls became unprofitable, and nine percent went bankrupt. As banks went under, the state and Federal insurance set aside to protect and control them began to run out of the money needed to refund depositors. However, many S&Ls remained open, continued making bad loans, and the losses kept mounting—the certain components of a fraudulent bubble.

By 1989, the situation was becoming dire. Finally Congress and the then President George H.W. Bush knew the industry had to be bailed out; it was too-big-to-fail—a mantra that would be repeated in the next and even greater recession. They enacted a taxpayer-financed measure known as the Financial Institutions Reform, Recovery, and Enforcement Act which provided $50 billion to close failed banks and stop further losses. It set up a new government agency called the Resolution Trust Corporation (RTC) to resell Savings and Loan assets, and use the proceeds to pay back depositors. FIRREA also changed Savings and Loan regulations to help prevent further poor investments and fraud.

S&L bank failures cost the FSLIC $20 billion, which bankrupted that federal corporation. In addition, more than five hundred banks were insured by state-run funds. They also failed and those failures cost another $185 million, thus destroying forever the idea of state-run bank insurance funds. Heads rolled: Five U.S. Senators, known as the Keating Five, were investigated by the Senate Ethics Committee for improper conduct because they had accepted $1.5 million in campaign contributions from Charles Keating, head of the Lincoln Savings and Loan Association—one of the institutions with the most egregious criminal records. The Senate also pressured the Federal Home Loan Banking Board, the agency responsible for investigating possible criminal activities at Lincoln, to overlook possibly suspicious activities.

The final tally may never be known for sure, but what is known is staggering; and it threatened the financial security of the greatest economy in the world. Between 1986 and 1995, more than half of the nation’s Savings and Loans, with total assets of more than $500 billion failed. By 1999, the crisis cost $160 billion, with taxpayers footing the bill for $132 billion, and the S&L industry paying the rest. The lion’s share of those costs went to attorneys with investors and taxpayers losing almost everything.

Kimberly Amadeo, Savings and Loans Crisis: Causes, Cost: How Congress Created the Greatest Bank Collapse Since the Depression, about.com, February, 2016 and Paul Krugman, What A Real External Bank Bailout Looks Like, The New York Times, February, 2016, and The Savings and Loan Crisis and Its Relationship to Banking, FDIC.gov.

  • The dramatic increase in the NASDAQ stock index, primarily technology stocks, in 1999-2000 and its subsequent collapse in 2000-2004 is a fairly recent example of a bubble. The so-called Dot-com Bubble was a speculative bubble in the shares of early internet companies called “Dot-coms.” From the mid to late-1990s, technology company stocks in the Nasdaq stock index soared to incredible heights, making scores of investors and technology company founders extremely wealthy. At this time, many people began to believe that technology had led to the creation of a “New Economy” where the traditional business cycle and recessions were a thing of the past. These “New Economy” beliefs led to excessive risk-taking in business and investments as Dot-com companies went public (such as the infamous Pets.com and Webvan) even though they had negative earnings or astronomically high business valuations. In early 2000, the technology stock bubble crashed spectacularly as the Nasdaq plunged from over 5,000 to barely 1,000 by 2002 and the U.S. economy was hurled into a recession which took a decade to get over. Investors became significantly more wary, but the nation continued its profligate spending, borrowing, and raising Congressional debt limits.
  • Americans have a very short memory span and tend not to learn from history. The United States housing bubble was an economic bubble affecting many parts of the United States housing market in over half of American states. It followed upon the dot.com bubble disaster by only a few years. With a combination of greed, false promises, industry/government collusion, and outright criminal enterprise, US housing prices peaked in early 2006, started to decline in 2006 and 2007, and reached new lows in 2012. Increased foreclosure rates in 2006–2007 among U.S. homeowners led to a crisis in August 2008 for the subprime, Alt-A, collateralized debt obligation (CDO), mortgage, credit, hedge fund, and foreign bank markets. In October 2007, the U.S. Secretary of the Treasury called the bursting housing bubble “the most significant risk to our economy.” He may have been right for the time, but the nearly twenty trillion dollar national debt may well exceed even that statement.

The collapse of the U.S. housing bubble had a direct impact on home valuations, mortgage markets, home builders, real estate, home supply retail outlets, Wall Street hedge funds held by large institutional investors, and foreign banks to the level that a worldwide recession if not a depression was inevitable. December 30, 2008, the Case-Shiller home price index reported its largest price drop in its history.

Concerns about the impact of the collapsing housing and credit markets on the larger U.S. economy caused President George W. Bush and the Chairman of the Federal Reserve Ben Bernanke to announce a limited bailout of the U.S. housing market for homeowners who were unable to pay their mortgage debts. In 2008 alone, the United States government allocated over $900 billion to special loans and rescues related to the U.S. housing bubble, with over half going to Fannie Mae and Freddie Mac (both of which are government-sponsored enterprises) as well as the Federal Housing Administration. On December 24, 2009, the Treasury Department made an unprecedented announcement that it would be providing Fannie Mae and Freddie Mac unlimited financial support for the next three years despite acknowledging losses in excess of $400 billion so far, much of which was due to criminal malfeasance. Wikipedia, United States Housing Bubble.

The causes and machinations that led to the bubble and its inevitable implosion are many and varied. There is blame aplenty to go around. The reader is referred to the following fascinating books to gain an insight into what occurred. A take home message is that capitalism is still powerful and only partly regulated; the same schemers in and out of government are still in office except for a very few who actually got the prison terms they deserve; and the government has certainly not learned a lesson in frugality. They bailed out the “too-big-to-fail” corporations, and their greed and avarice continues largely unfettered. The temptation for Congress to spend other peoples’ money is too great, and the pebble can be kicked on down the road. The government’s reaction to this bubble and to its inability to rein in its addiction to spending is “not on my watch.”

-Michael W. Hudson, The Monster: How a Gang of Predatory Lenders and Wall Street Bankers Fleeced America—and Spawned a Global Crisis, St. Martins/Griffin, New York, 2010.

-Gretchen Morgenson and Joshua Rosner, Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon, Times Books, New York, 2011.

The lesson for the United States should be to substitute the nation of China for Britain and France as Americans ponder the Egyptian experience. The situations are chillingly similar except that the stakes are logarithmically more serious now; China—the holder of a huge amount of American debt–might well set America’s finances to right over a hundred years of occupation, but during that time there likely would be a worldwide depression, loss of American sovereignty and influence, and the potential for such a chaotic new order that no one can predict the final outcome. Yes, it could happen to us.

The world and the United States has had numerous other economic scares, but the above described financial debacles should suffice to drive home the risks we face as a result of our burgeoning national debt. Contrary to the advocates of Keynesian economics and those who refuse to consider the possibility of American financial failure, the potential is there. We were saved from the Great Depression which could have resulted in the final destruction of the American economy only by the advent of the Second World War. We do not have the dubious advantage of such a fortuitous situation arising and coming to our aid in this era. No, we will have to get control of our debt, or others will do it for us. Like France and Egypt, and a host of other countries before us, we will not like the results of such salvation. And, that egregious eventuality is preventable. Elect representatives with courage; accept universal austerity measures; come to grips with the notion that it will take a generation, maybe two, to set our house in order. The failure to do so would be most lamentable and entirely unacceptable.

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