Tuesday, July 02, 2013

A Bank Run for the 21st Century

Could we have the equivalent of a 1930s style bank run in this day and age?  I think we already have, and that more and bigger are coming.

In this post, I will attempt to be non-judgmental -- to step back and look at the underlying forces at work which are based upon human nature in our earthly environment.  In the short term, we rant and rave about the evil and stupid people, but occasionally it is good to move beyond that, remove such negative emotion, and try to assess the science driving the action.

Twice in the last 13 years we in the U.S. have experienced declines in the broad stock market indexes of more than 50%.  What do we make of such massive declines in the wealth of the nation?  The conventional wisdom is that these blips are nothing to worry about.  The stock market is inherently volatile, but generally tracks the real economy.  Massive declines in the past have been quickly recouped.  So, while there may be more such scary episodes, one needs only to keep one's cool and in the long run we will continue to grow wealthier.

My take is that recent stock market crashes presage more of the same.  If the conventional wisdom is correct and we can expect more of these, then it's logical to conclude that there will be panic selling from time to time.  Is it reasonable to assume that all such panics will be temporary and quickly corrected as have been the last two (in 2001 and 2008)?

In 2001, the U.S. government reacted swiftly and decisively to the market crash.  Under the leadership of President George W. Bush, tax rates were slashed across the board on income including capital gains and estates.  In 2003, taxes on income, capital gains, and estates were cut yet again.  In the meantime, the Federal Reserve slashed interest rates from 6% to 1%.

In 2008, the U.S. central bank agreed to buy out trillions of dollars of failing mortgaged backed securities.  This was followed by additional bailouts (e.g. Troubled Asset Relief Program or TARP) and a nearly $1 trillion dollar stimulus program passed by Barack Obama and the Democratic legislature.

So the 2001 and 2008 market panics were reversed with the assistance of massive U.S. federal government bailouts and stimulus programs.  Is it safe to assume that such relief will always be available?  Do we have the equivalent of a Federal Deposit Insurance Program for the stock market?  Of course, the answer is no.  We have no systematic program to rescue the stock market.  Rather we have had a series of ad hoc government rescues.  There is no guarantee that the next time the U.S. government will react swiftly and decisively.  In fact, the political situation in the U.S. is such that precisely the opposite can be expected.

The current situation with regard to the stock market is analogous to the previous state of the banking system where periodic bank runs crippled the economy.  In recent decades, the middle class have come to rely upon the stock market for basic savings   Reaganomics in the 1980s was typified by the rise of 401k pension programs which encouraged middle class employees to fund their retirements by investing in the stock market.  This is just one of many "ownership society" programs which have tied the financial well-being of middle class Americans to the financial success of U.S. corporation.

Aligning the interests of the middle class with the interests of corporate America seemed to be a win-win proposition.  No longer would the benefits of profit-driven capitalism accrue only to the rich capitalists.  Now, the middle class would profit from the accumulation of real wealth, and the corporations responsible for generating this wealth would have a broader base of support.  But some side effects of the ownership society have come to pose serious impediments to the continuing success of this model.

With a greater stake in the stock market, the middle class increasingly favored policies designed to boost corporate profitability.  A whole slew of laws were passed to that end, including lowering of taxes on capital gains and dividends, decreased corporate regulation, and increased legal rights for corporations at the expense of workers.  But far and away the biggest boost to corporate profits has been the acceleration of globalization which has encouraged transfer of jobs to lower wage areas at the expense of places with high labor costs and aging infrastructure.  Corporate profits have claimed an increasing share of national income in the U.S., while the share going to labor has decreased markedly.

In recent years, real growth in the global economy, and in the U.S. in particular, has stagnated somewhat.  As the ownership society received successive bailouts (as noted above in 2001,2003, 2008, 2009), financial prosperity overtook the real economy.  This makes sense because it is stock market value that is now funding much of middle class retirement.  There is political pressure to keep equity prices high.  To this end, extensive sacrifices have been made in labor remuneration and security, environmental protection, and market regulation.  There is political pressure to keep stock prices high.

We've come to rely upon the federal government to keep stock prices high, but this has been accomplished in an ad hoc, contentious, and unfair manner.  The noble idea of distributing national wealth more broadly has resulted in an increasingly risky base for middle class prosperity, and an increasingly impoverished lower class.  There is no FDIC to guarantee one's savings in the stock market.

The ownership society is running out of ways to plausibly and politically maintain stock prices which have taken on a life of their own.  Inevitably, the conventional wisdom that corporate America should not be bailed out and that stock prices should not be government supported will play out in a stock market crash which will have results similar to the bank runs of the 1930s.  Loans that are backed by stock market wealth will totter, and consumption based upon plummeting paper wealth will fall.  Middle class security will evaporate before our eyes.  The Tea Party will blame Obama (assuming this happens before his 2nd term expires), and the Democrats will be left holding the bag.  The stage will be set for a change in the economic zeitgeist.

Of course it's possible that we'll have yet another round of ad hoc bailouts and continue on our present course.  But it seems implausible that we can do this for ever.  Eventually, we will succumb to political pressure to provide greater security for the politically powerful middle class.  We will implement some national wealth (stock market) counterpart to the FDIC guarantees which are taken for granted these days in our banking system.  We will look back upon the current era as a reckless and unstable gilded age.  For those of us currently in the middle class, the important point is that such security will be guaranteed only after another big collapse...