U.S. Normality Changes with
#1 Rising Income
WW 2 generated savings, pent-up demand and few foreign few competitors generated 25 years of high profits higher wages and cooperative unions. Normality ended when
Carter appointee FED Chairman Volker found higher interest rates were not enough so he lowered commercial bank reserves. This quickly pushed the Federal Funds Rate to 20%. Banks
would not loan. Two recessions followed. The first cost Carter reelection and the second, though severe, was over so Reagan was reelected.
#2 Increased Foreign Competition Began 1970's Wage Stagnation
High Oil prices pushed Japan into more valued added exports like
automobiles, machinery and computers. This competition caused a
stagnate Rust Belt with lower wages and eventually lower employment.
Japan's manufacturers got lucky from increased demand for gas
efficient small green cars with catalytic converters. Detroit
protected profit by seeking tariff protection. Investment
needed to lower cost and increase product quality was ignored.
Auto union leaders protected their positions. Current worker
protected existing jobs and salaries by accepting a
two-tier wage system. It minimized the need for new
workers who would receive lower wages for a similar jobs. Feeling
political pressure Japan built many modern U.S. plants often in the
nonunion southern states offering the highest tax incentives.
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1980's Failing Manufacturing Brings
Events Causing Financial Instability Causes Great Recession
1980's U.S. and England Returned to Conservative Lax Business Regulation because increased regulation and increased welfare provisions had upset many voters. Think Great Society and lax derivative regulation which result in major increases hostile leveraged buyouts plus and over-investing in Real estate caused. They caused the Savings and Loan Crisis. Think Michael Milken Scandal, Keating Five results from poor Alan Greenspan advise.
1980's Major Investments Banks Went Public creating a need to balance client needs with equity needs. Think expansion of financial industry's share of GDP.
1980's Accounting Standards Declined as accountancy firms struggled to balance commitments to audit standards with the desire to grow their consultancy business. Think off-balance-sheet items and Arthur Anderson Scandal.
1980's Home Equity Loans Increased Current Consumption and Lowered Savings as they replaced equity building home improvement loans. Think many not prepared for retirement.
1983 Reverse Mortgages Approved for FHA loans. Think less retirement savings.
1986 Big Bang deregulates London's financial services industry, other will follow.
1999 Gramm–Leach–Bliley Act Increased Systemic Financial Risk once limited by the Glass-Steagall Great Depression Act. Initiated by Republicans it was signed by President Clinton.
Think financial industry expansion. See Five Bad Bush/Clinton Policies
2004 Uptick Short Rule of 1938 rescinded. Think stock market gambling.
2006 FASB requirement that housing assets be mark-to-market decreased financial system collateral. Action resulted from a 1991 Government Accountability Office investigation of the $160,000,000,000 savings and loan bailout. Think moral hazard.
From Financial Crisis to
Recession to Great Recession to Recovery
1. Great Moderation preceded the Great Recession 2. 2007-8 Financial Crisis was tamed by the Federal Reserve. 3. 2008-9 Recession was tamed by both monetary and fiscal policy.
4. European financial instability and world-wide austerity slowed economic recovery and income growth for all but the very, very, very wealthy. Think top 1/10th of one-percent.
5. Great Recession Recovery Has Varied Around the World
Understanding Balance Sheet Recessions
They are infrequent, severe, and long-lasting. Understanding them is necessary when judging society's efforts to manage The Great Recession. It is like understanding a doctor's attempt to relieve a headache requires knowing the level of difficulty. Was it a Migraine Headache? A balance sheet is caused by high levels of private sector debt. Assets must equal liabilities plus equity. If assets values like housing collateral fall below their associated debt, equity must make up the difference or insolvency results and debt must be repaid. Think 1837, 1873, 1890 & 1929 See Most Severe US Recessions.
Was Our Great Recession a Balance Sheet Recession? Economist Paul Krugman feels the financial crisis ..."was one manifestation of a broader problem... associated with a "balance sheet recession." Economist Richard Koo wrote Japan's 1990- ? "Great Recession "was a "balance sheet recession."
What Led To The Great Recession?
1. Free Market Capitalism Lowered Regulation.
2. Innovative Expanded Investment Banking.
3. Global Trade Imbalances
Great Recession Stages
2. Savings glut created as emerging countries lowered borrowing and increased trade surpluses after the 1997 Asian Debt Crisis made their foreign dollar dominate debt unsustainable. They expanded trade and kept personal consumption below economic growth. Less consumption and borrowing plus a trade surplus increased Dollar, Euro, and Yen reserves. Like the Petro Dollars in the 1980's this excess savings would be loaned for poor investments (housing).
Think savings from China and Russia and other re.
3. Aggregate demand stagnated as trade surplus countries didn't spend. Germany's 2005 economic renewal was saved and Japan's private sector saved much more after their 1990's credit bubble exploded. Adding to the demand shortage were companies who maintained profit by decreasing capital investment spending despite historically low interest rates. Globalization and technology also helped them maintain profit as wage increases were limited to most valuable employees. State and local governments, especially those with underfunded pension systems, also cut expenditures.
fi4. Increased current account deficits by wealthy nations balanced world trade. Higher demand for foreign goods was made possible by massive central bank supported low interest loans. The FED's historic monetary expansion was made possible by continued low inflation caused by expanded Flat World competition and low oil prices. Innovative financing and lax nancial regulation also fostered expanded financial asset demand. Think excess OPEC savings financed the 1970's Latin American Debt Crisis leading to Savings and Loan Crisis.
5. Real Estate and Stock bubbles came as expected from low long-term real interest rates. New home buyers borrowed surplus savings and investors devoured growing unique debt securities created by an expanding finance industry promising insured difficult to understand almost guaranteed financial instruments. Leverage rose dramatically. Fraud, near fraud and data manipulation exploded as mortgage servicers, banks, and the law firms broke the law to force people out of their homes. See Chain of Title and Brief History of Financial Bubbles.
6. Poor Crisis Management by politicians as their economic advisors believed market capitalism would prevent serious recessions. The Great Moderation solidified this view. Possibility of new financial instrument contagion were not understood. When panic started, political, intellectual and bureaucratic leaders resisted quick action in areas that required cooperation. A US depression was avoided by FED, Treasury and Congressional efforts that were slowed by austerity. Iceland, Ireland, Greece, Spain and Portugal experienced economic depression.
See The Great Recession. See Bubbles Credit and Their Consequences to see FED analysis of trying to slow down a bubble.